to its attention, or when we or our staff detect circumstances, indicating a possible pattern of activity which, in our judgment warrants enforcement action. As I mentioned at the outset, our basic mandate in this matter is one of full disclosure rather than of passing judgment on corporate morality or of imposing our own views as to what is "proper" or "improper."

As in a number of other situations where we perceive a serious problem and take action to deal with it, persons subject to the statutes we administer understandably may wish us to provide them with clear guidelines as to how they should proceed, and what will be permissible and what will not. I wish we were in a position to oblige beyond the principles that may be gleaned from the cases we already have brought, but that is not yet possible, although we expect to provide guidance to the extent that we can. In the meantime, good judgment, sensitivity to ethical questions and adequate controls over the use of corporate funds will certainly be helpful.

We did not get into this area either in pursuit of headlines or as part of some some sort of crusade; rather, we were simply seeking to do the job which Congress gave us, even in a difficult, and often distasteful, area. We are aware that our actions have been painful to some persons, not all of whom, by any means, have been guilty of improper activities, and that the measures we have taken have given rise to considerable concern on the part of the business community. Nevertheless, I believe that, on balance, the work we have done thus far in this field has been beneficial. It has, at least, brought the problem of foreign payments to the light of day and out of the realm of obscurity and concealment. It has alerted corporations to the risks and difficulties created by tolerating questionable practices, and it may well contribute to a general raising of the standards under which American corporations conduct themselves in the vital field of international trade.

Mr. Nix. Now, we have here today two witnesses. We have Hon. Donald C. Alexander, Commissioner, Internal Revenue Service, and Hon. Phillip A. Loomis, Jr., Commissioner, Securities and Exchange Commission.

I, on behalf of this committee, welcome both of you gentlemen. We recognize the seriousness of the problem that we are to discuss today. We recognize the fact that there must be found adequate solutions to the problem, and we are firm in the belief that your cooperation will be given fully and freely in order to attain these objectives.

sir.

Let us start with Hon. Donald C. Alexander. You may proceed,

STATEMENT OF HON. DONALD C. ALEXANDER, COMMISSIONER, INTERNAL REVENUE SERVICE

Mr. ALEXANDER. Thank you, Mr. Chairman. I would like to introduce those with me from the Internal Revenue Service. On my immediate right is Mr. Singleton Wolfe, our Assistant CommissionerCompliance.

On Mr. Wolfe's right is Mr. Robert Tobin, analyst from our Audit Division.

On Mr. Tobin's right is Mr. David Reizes of our Office of Chief Counsel.

Finally, Mr. Burke Willsey, my assistant.

Mr. Chairman, we are glad to be here with you. We had filed a statement earlier in June when we were scheduled to appear at that time. We have submitted a further statement today modifying and amplifying to some extent the statement that we had submitted in

June.

With your permission, Mr. Chairman, I would like to summarize and discuss the statement, rather than read it to you. Mr. Nix. You may proceed, sir.

Mr. ALEXANDER. Mr. Chairman, we also are proud of the Securities and Exchange Commission and its work in this area, and are grateful to the Commission for its cooperation with us in our effort to give the country and the Congress exactly what you described, a fair and firm enforcement of the tax laws, and in particular, the section of the Internal Revenue Code-(section 162 (c))—which denies an income tax deduction for illegal payments to government officials and employees, whether foreign or domestic.

There has been much in the press with respect to illegal or improper, or both, payments by U.S. corporations or their foreign subsidiaries to foreign officials.

We are deeply concerned with this problem, Mr. Chairman, and we can assure you that we are alert to it and we are doing our best within the statutory limitations imposed upon us and within the geographic limitations imposed upon us, to meet our obligations to the public and to the Congress.

The corporations involved in these recent SEC disclosures, as well as disclosures in the press, are normally included in our large case audit program, because of their size. Now, your large case audit program includes all corporations in the United States except banks, savings and loans, and utilities, with gross assets in exces of $250 million. Banks, savings and loans, and utilities are included if their gross assets exceed $1 billion. And our audit coverage of the corporations included in our large case program, almost 1,200 of them-Mr. Wolfe? STATEMENT OF SINGLETON WOLFE, ASSISTANT COMMISSIONER OF COMPLIANCE, INTERNAL REVENUE SERVICE

Mr. WOLFE. That is right.

Mr. ALEXANDER [continuing]. Is 100 percent. Now, that doesn't mean we audit all of them each year. Some of them have net operating losses, and we audit those when the losses are relevant to their tax obligation. And it is more economical for us and for them to audit two income tax returns at a time.

We seek 100 percent audit coverage of these major corporations, and these major corporations are basically the ones involved in this problem.

At the present time, approximately 300 revenue agents and specialists in our compliance activity headed by Mr. Wolfe are assigned to large case audits now in progress, in which contributions for political purposes have been identified as a specific issue.

Now, these political contributions include both domestic contributions and foreign contributions, so not all these 300 revenue agents are working on the problem which you have described, because the issue is one of many in a large case audit and the issue involves domestic nondeductible political contributions as well as the type of payments that you described.

In addition to these resources, we have taken a number of steps to improve the effectiveness of our efforts in this area. In August of last year, we established a political campaign contribution compliance project under the direction of the Assistant Commissioner of Compliance to receive and disseminate to field offices information regarding possible tax violations in this area.

Earlier this year I met with the Chairman of the Securities and Exchange Commission and we agreed to improve the liaison between our respective agencies, thereby trying to assure that we identify and utilize all the tax related information uncovered by SEC investigations.

We have two IRS professionals now reviewing all SEC reports for issues having tax significance, and, as I mentioned earlier, the SEC cooperation has been excellent. I trust that our cooperation has been satisfactory to the SEC.

Another way that we are seeking to fulfill our obligation is through industrywide examinations. We began this practice in 1971, in which we examine simultaneously all the major firms within a particular industry. We find that this approach is very useful and helpful to us, given our limited resources and given the wide scope of our responsibility.

Meetings between agents working on cases involving companies within the same industry help identify and develop issues, and we intend to intensify our work in this area.

In December of last year, Mr. Chairman, we issued new expanded guidelines regarding examination of political organizations and committees, candidates, and contributors, including particularly, disguised contributions and disguised payments of the type discussed in the press and unearthed by the SEC.

We are currently developing a new set of examination guidelines covering specifically the treatment of slush funds.

Our international enforcement program specializes in the examination of international transactions of multinational corporations.

Since 1972, this program has stressed the detection of illegal payments through foreign affiliates. In this international enforcement program, we seek to work effectively with tax administration authorities of other nations with whom we have tax treaties.

We have 34 tax treaties at this time, and we are seeking to negotiate and implement tax treaties with other countries. These cooperative efforts are helpful to us and are helpful to our treaty partners.

We need to strengthen and continue this effort, and we are evaluating the desirability of examining more foreign subsidiaries of domestic corporations as an improved means, and sometimes the only means, for detecting the extent and the character of the slush funds.

Now, these efforts are in response to a wide variety of evidence, formal and informal, suggesting previously undetected abuses of the tax system.

A number of cases recently developed by the IRS illustrate certain international schemes involved in establishing slush funds and making the type of payments in question.

In one large corporation, a slush fund was initiated and largely devised by the corporate president, and it involved the contracting of foreign consulting services at an inflated rate with kickbacks into the slush fund. No accounting was maintained.

Another corporation removed assets from normal inventory control and distributed the assets to its various local offices. The decontrolled assets were sold by the local offices and the proceeds remitted in cash.

Another slush fund was created by the use of large unsubstantiated expense vouchers and excessive insurance commission checks and fictitious sales commissions.

Others involved techniques in which transfers of funds are made from the U.S. parent to a U.S. subsidiary to a foreign subsidiary, then perhaps to another foreign subsidiary, and then finally to the slush fund, with or without tax consequences.

Professional services, of course, are a convenient way of channeling money into slush funds, and kickbacks, as I mentioned earlier, are frequently used.

Now, I don't want to imply by this discussion that by any means do all multinational corporations or major corporations having foreign subsidiaries engage in these schemes. This is not so.

The Internal Revenue Service is not about to indict all multinational corporations for the sins of the few, but some have sinned, and where the sins affect tax liability by reducing a tax obligation otherwise due to the United States, it is our responsibility to do something about it.

The common denominator in these schemes has been the use of foreign subsidiaries, foreign bank accounts, foreign affiliates, and other entities, to disguise the source of the slush funds. The diversity of techniques is practically unlimited.

As I have mentioned, illegal payments have been reflected as legal services, loans, advances to subsidiaries, insurance expanses, unclassified expenses, commissions, and corporate officers' bonuses.

Erroneous invoices and supporting data have been created for these expenditures. And collusion by certain corporate officers has aided in the disguise of these payments.

As I have mentioned before, our responsibility is not to try to eliminate all sin wherever we find it but instead to administer and enforce the tax law.

In some cases involving slush funds, there are no U.S. tax consequences. Although a business may have engaged in a number of dubious financial machinations to create a slush fund, it may have chosen not to adopt the same course on its tax returns and it may not have claimed illegitimate deductions.

In some cases such as a transfer of funds from one corporation to another, there may be no tax consequence at all or no immediate tax consequence by reason of the transfer, even though the transfer of funds is a step in the creation of a slush fund. If the transfer is without tax consequence, the Internal Revenue Service is not the agency to cope with the problem.

Section 162(c), which I mentioned previously, provides that no deduction shall be allowed for any payment made directly or indirectly to an official or employee of any government, of any agency or instrumentality of any government, if the payment constitutes an illegal bribe or kickback, or, if the payment is to an official or employee of a foreign government, the payment would be unlawful under the laws of the United States if such laws were applicable to such payment and to such official or employee.

In plain language, the Internal Revenue Code prohibits the allowance of any deduction for moneys paid to a foreign official if a similar payment would have been unlawful under the Federal statutes of the

United States, whether or not the payment is lawful under the laws of the particular country employing the foreign official who receives the payment or the benefit of the payment.

Now, these matters have become a concern of all of us here: Illicit political contributions, bribery, the creation of secret slush funds through kickbacks and falsified financial records, and the conscious misrepresentation of taxable corporate income. All this is dealt with rather clearly by existing statutes and regulations.

Our problem is principally one of enforcement and primarily one of detection. Our task is made more difficult by the complexity inherent in the transnational corporate entities and their activities, and is made more difficult by the limitations on our capabilities to demand and examine books and records of foreign entities.

Now, I concur with Commissioner Loomis of the SEC and his statement before the subcommittee last month that he saw a reasonable correlation between full disclosure and corporate morality. Corporate morality includes meeting one's tax obligations.

Where our authority to regulate and track corporate financial activities is diminished by the boundaries of our national sovereignty, a full and open disclosure of these activities would be our best assurance against further abuse of the options afforded by multinational business operations.

As I stated at the beginning, Mr. Chairman, you have every reason. to expect firm and fair enforcement from the IRS, and you have every reason to demand that.

We have every reason to deliver that to you, and we are doing our best to do so.

We would be glad to answer any questions that the subcommittee may have.

[Mr. Alexander's prepared statement follows:]

PREPARED STATEMENT OF HON. DONALD C. ALEXANDER, COMMISSIONER OF INTERNAL REVENUE

Mr. Chairman and members of this subcommittee, I welcome the opportunity to appear before your Subcommittee to discuss with you the Service's response to reports of charges by the SEC and others that some corporations have made bribes to "political figures" and have made other substantial illegal payments, both in the U.S. and abroad, which may have been treated as deductible business expenses for tax purposes. According to the reports, illicit payments have been made from "slush funds" created under the direction of corporate officials by the diversion and omission of income, overstatement of expenses, and the falsified treatment of transactions with foreign subsidiaries of businesses or others associated with such businesses.

The corporations involved in the recent SEC disclosures, as well as most of those cited in other published reports, are normally included in our large case audit programs, because of their size and the complexity of their financial structure. Thus, these organizations were either already under examination, or scheduled for audits, at the time of the recent publicity regarding political contributions and foreign bribery. We include in our large case audit program all corporations (except banks, savings and loans, and utilities) with gross assets in excess of $250 million. Banks, S&L's, and utilities are included if their gross assets exceed one billion dollars. Audit coverage in our large case program is 100 percent.

At the present time, approximately 300 revenue agents and specialists are assigned to large case audits now in progress, in which contributions for political purposes have been identified as a specific issue for examination. This represents approximately 20 to 25% of the personnel normally committed to the coordinated examination of large cases.

Of course, because we are dealing with very large organizations in these instances, the audits will cover a multiplicity of complex issues, of which political