contributions will be only one. The personnel assigned to these particular examinations include revenue agents; excise, employment and pension tax specialists; engineers; economists, and experts in computer audit techniques, each of whom will work on these cases at some point during the audit process. They will not all be involved in the political contributions issue, nor will all of them necessarily be working on these cases at one time.

In addition to the commitment of these resources, we have taken a number of other steps to improve the effectiveness of our efforts in the political contributions area. In August of last year, we established a Political Campaign Contribution Compliance Project in our National Office, under the direction of the Assistant Commissioner (Compliance), to receive and disseminate to our field offices validated information regarding possible tax violations in this area. To augment this process, I met with the Chairman of the Securities and Exchange Commission earlier this year, and we agreed to improve the liaison between our organizations, thereby assuring that we timely identify and utilize all of the tax-related information uncovered by SEC investigations. Two IRS professionals, representing our Audit and Intelligence Divisions, now review all SEC reports for issues having tax significance.

Another IRS effort which is being better mobilized to deal with the matter of illegal slush funds and political contributions is our use of industry-wide examinations. The Service initiated the practice of simultaneously examining major firms within a particular industry in 1971, and found that this approach was useful in identifying common issues and applying the tax laws uniformly. A feature of this approach has been internal meetings of agents and examiners to exchange data and discuss problems which may arise in the examination of a given industry. Techniques for creating "slush funds" and hiding illicit political contributions, along with methods for detecting such activities, are being discussed at these internal meetings, and we are scheduling more of them.

In December of last year, the Service issued new and expanded guidelines regarding the examination of political organizations and committees, candidates, and contributors. We are currently developing a new set of examination guidelines covering the treatment of "slush funds." Further, in an area more directly related to the concerns of this Subcommittee, 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 made through foreign affiliates.

The International Enforcement Program also incorporates joint undertakings with the tax administration authorities of other nations with which we have tax treaties. These cooperative efforts have proven increasingly effective as a source of evidence of diverted funds, and we believe that this sort of coordination with tax treaty partners should be continued and strengthened. In addition, we are currently evaluating the desirability of examining more foreign subsidiaries of domestic corporations as an improved means for detecting the extent and character of the use of slush funds.

All of the efforts which I have just discussed, Mr. Chairman, are in response to a wide variety of evidence, both formal and informal, which suggests the existance of previously undetected abuses of the tax system. A number of cases recently developed by the IRS are illustrative of the international schemes involved in establishing slush funds and making the type of payments in question. These corporate arrangements are both sophisticated and quite diverse.

For example, our investigation of one large corporation revealed that a slush fund was both initiated and largely devised by the corporate president who was concerned because the corporation did not have funds available for which no public accounting was required. This scheme, which was in operation over a number of years, included the contracting of foreign consulting services at an inflated rate with the understanding that the excess over normal fees would be returned to the corporate officer in the United States, who had complete control over these funds. No accounting for records were maintained for the amounts received or the purpose of the expenditures.

Another corporation removed assets from normal inventory control and distributed them to its various local offices. The decontrolled assets were subsequently sold by the local offices and proceeds remitted to the home office in cash. The purpose of the diversion of these assets was to generate funds to be used at the discretion of certain corporate officers.

Another corporate slush fund was created with the aid of a wholly-owned foreign subsidiary's corporate officer who withdrew and placed into the fund a large

sum of money each month over a period of time. Large, unsubstantiated expense vouchers, excessive insurance commission checks and fictitious sales commissions were used to substantiate the initial withdrawals.

A recent examination revealed that a corporation based in the United States reimbursed a foreign subsidiary, through a major bank, for the subsidiary's advance to another subsidiary in another foreign country. The latter susidiary made a contribution to a local political party for campaign use. The parent company had also expensed, as professional services for the foreign subsidiary, another large amount paid on behalf of the subsidiary to the opposing political party. A total of over $100,000 was paid to the two opposing parties and reflected as business expenses on the corporate return.

One multinational corporation devised a complex scheme of kickbacks from the construction of a foreign facility and from contracts to supply raw materials. False invoices were used in the diversion of funds. The contracts written in this kickback scheme specifically provided the payments to be made outside the United States and would not be made from any person or corporation subject to United States law. All payments were directed through foreign conduits and at least two foreign bank accounts before being placed into various Swiss accounts. On occasional European trips, the corporate officers would pick up cash from these accounts to be used at their discretion.

Mr. Chairman, the common denominator in these schemes has been the use of foreign subsidiaries, foreign bank accounts, foreign affiliates and other entities to disguise the sources for these slush funds. The diversity of techniques used in these schemes is practically unlimited. Illegal payments have been reflected as legal services, loans, advances to subsidiaries, insurance expense, unclassified expenses, commissions, and corporate officer's bonuses. Erroneous invoices and supporting data have been created for these expenditures. Collusion by corporate officers has aided in the disguise of these payments.

Let me emphasize at this point, by the way, that in cases of the sort I have just been discussing, significant U.S. revenue consequences cannot be assumed. In the first place, 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 thus may not have claimed illegitimate deductions. Moreover, in cases where the financial structure of a foreign affiliate of a U.S.based firm does not allow for cash flow between the two organizations, it is not unlikely that the foreign affiliate's annual income tax would fall wholly within the jurisdiction of the host nation, leaving the parent company and U.S. taxes unaffected.

Further, some payments made to non-governmental officials or employees for the purpose of obtaining business can be viewed as "ordinary and necessary" business expenses. Such payments represent accepted practice in some economic sectors, when they are made with the knowledge of the employer of the person to whom the payment is made, and when there is no intent to corrupt. Similarly, the U.S. Supreme Court held that, in some cases, payments which could be described as "kickbacks" might be accepted as legitimate business expenses. For example, the Thomas B. Lilly case (343 U.S. 90, 72 S. Ct. 497), involved an optician who made payments, equal to one-third of the sales price of eyeglasses, to those doctors who prescribed glasses for their patients. Finding that such payments were an industry-wide practice and did not violate state or federal law, the court conIcluded that they were a deductible business expense.

Even greater disparities of circumstance arise when we examine variations in accepted business practice between nations. In some nations, for example, the payment of fees to political personalities to represent a corporation's interests is an accepted practice, taking the place of the role played by lobbyists in this country. However, as regards payments to government officials, foreign or domestic, the Internal Revenue Code is quite clear. Section 162 (c) (1) states: "No deduction shall be allowed. . . for any payment made, directly or indirectly, to an official or employee of any government, or 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, Mr. Chairman, the Internal Revenue Code and its related Regulations prohibit the allowance of any deduction for monies paid to a foreign official if a similar payment would have been unlawful under the Federal Statutes of the United States. As a result, a deduction for tax purposes would be denied

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for kickbacks or bribes, even when a corporation migat consider such a payment a necessary concomitant of doing business in a given foreign country, since payment of similar kickbacks or bribes to a U.S. official would be unlawful.

I would like to observe, in conclusion, that the matters of concern to 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-these are all matters dealt with rather clearly by existing statutes and regulations. The problem is principally one of enforcement, and more particularly, one of detection. In this respect, our task is certainly made more difficult by the complexity inherent in the recent rapid growth in transnational corporate activity.

For this reason, I find myself in concurrence with SEC Commissioner Loomis, when he observed in testimony before this Subcommittee last month, that he saw a reasonable correlation between full disclosure and corporate morality. Although we keep no data on our audit case closures by issue, the predominance of foreign subsidiaries and overseas transactions in these particular problem areas leads me to believe that, 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 offered by multinational business operations.

In closing, Mr. Chairman, let me assure you that we in IRS are acutely aware of the important task we face in making certain that we uncover the existence of these funds and the payments made from them. We welcome your assistance, and we will be happy to furnish you whatever information we may have which you may find necessary for your work.

Mr. Nix. Commissioner Alexander, it is my view that this practice is certainly not a new one. It has a history of long-standing operation, where financial organizations in one country, operating in another country, sought the services of agents, citizens of that foreign country, who were conversant with conditions in that foreign country, and who acted for foreign corporations. That we know.

I, therefore, would like to confine myself for the moment to the disclosures that were made in the last 3 years.

First, I would ask you whether or not you have any record of the number of American companies whose practices amount to a violation of law within the time now, I am not confining myself to those against whom legal action has been initiated, but I am confining myself to those in which facts have been adduced to warrant investigations by your Department.

Mr. ALEXANDER. Mr. Chairman, that is a difficult question for me to answer. Let me say that until cases become a matter of public record by reason of their transfer from the administrative or investigative process into court, we, of course, are bound not to discuss them.

I do not believe that we can give you an exact number of cases involving the issue which you described, which have been within this 3-year period or are currently under examination or in process. Mr. Wolfe, can you amplify?

Mr. WOLFE. I think I can help you somewhat, Mr. Chairman. We have identified at least 50 large, as we said in our letter to you, corporations that-in which there may be a possible violation. We have not yet fully determined whether they did deduct as an illegal deduction this amount. That is where the problem lies.

Mr. ALEXANDER. Those are cases currently in process as contrasted with cases in which the issue has been identified.

Mr. Nix. Suppose I put it this way. Suppose for the moment we eliminate those companies under investigation where legal proceedings have not yet been finalized for presentation to the agency re

sponsible for deciding, which leaves those corporations in which the investigation has disclosed violations where your Agency has initiated legal proceedings.

Mr. ALEXANDER. Mr. Chairman, I would like to supply you for the record what we can give you for the time period that you described. We are talking now about cases that have proceeded to the courts or cases in which this issue has been identified, raised, and disposed -of.1

I would like to furnish to you and to this subcommittee what we can within the bounds imposed upon us with respect to these disclosures, and surely we can give you an aggregate if we can identify the aggregate.

Frequently the issue before you is one of many issues in an audit of very large and complex corporate taxpayer. Issues are raised by the examining agents in these team audits. Many of them are disposed of, as the facts are developed, by concessions by the taxpayer, sometimes by concession by the Internal Revenue Service, sometimes by mutual resolution, rather than concession, in the administrative process, before they go to court.

Very few cases and very few issues

Mr. Nix. You see, Commissioner Alexander, however the cases were disposed of, the fact remains that they were disposed of, and, if the final decision was adverse to the persons charged or the company charged, then a wrong has been admittedly committed and that case has been closed, and I see no reason why there should not be a disclosure to this committee or to the public, for that matter, of the facts attendant upon the conclusion of each. That is what I am speaking of.

Now, as to other cases under investigation and under consideration, I can understand the reluctance on the part of your organization not to disclose.

As to those cases-this is a third category-where charges have already been made, I see no reason for secrecy in that regard. I don't think that the law under which you operate would require secrecy after a formal charge has been made.

Mr. ALEXANDER. After a formal charge has been made, Mr. Chairman, through the institution of court proceeding or otherwise, then the restrictions imposed upon us by section 61.3 of the Code are lifted, at least to the extent of the charge.

Mr. Nix. Yes. Now, I would like to elicit from you some estimate of the amount of tax dollars that the Government of the United States would have lost had these proceedings not been intiated through your organization, your Agency.

Mr. ALEXANDER. Mr. Wolfe, are you or your cohorts in a position to supply this information?

Mr. WOLFE. Mr. Chairman, are you referring to the amount of revenue lost as a result of the illegal deductibility of these payments, be they political contributions or kickbacks or bribes?

Mr. Nix. Yes. I am referring to the amount that would have been lost had the tax not been recovered.

Mr. WOLFE. I think we can probably furnish that along with these others. We would have to break it out because it is one maybe among

1 See apendix 7, p. 221.

many other adjustments that we have made to a corporate taxpayer's taxable income. It would have to be broken out and the tax figured on that separately, so I think we could probably, when we provide you with the other information-we will give you as best we can an estimate of the revenue that would have been lost had we not made this examination. Yes, sir.

Mr. Nix. I would like that to include those instances of disguised contributions, slush funds-also slush funds. Now, this subcommittee has no wish to take any action that would impede the progress of your investigation. Nor do we wish to indulge in any sensational exposé. We seek simply to elicit the facts in the situation in which you find yourself for the purpose of taking some constructive action for the future.

We cannot recover and reform the past, but certainly we are vested with the authority and we should have the inclination to preserve whatever we have for the future.

Mr. Whalen.

Mr. WHALEN. Thank you, Mr. Chairman. Commissioner Alexander, we ought to set the record straight. Regarding section 162(c) (1)— the violation, as I understand it, is not in the making of a bribe, but rather attempting to deduct that sum which went into the bribe. Is that correct?

Mr. ALEXANDER. That is correct, Mr. Whalen.

Mr. WHALEN. And this is how you become involved in this process? Mr. ALEXANDER. Yes. We become involved in the process only if two things occur in a bribe situation. One, the bribe is made, and, two, the bribe is improperly treated for tax purposes, deducted by the briber or the bribee, if also subject to U.S. tax, fails to report it.

Mr. WHALEN. The point I am trying to make is that you have no means by which you can detect bribery or illegal contributions to political funds in another country other than through the domestic tax returns which are submitted to your office.

Mr. ALEXANDER. Other than through tax papers or the failure to file tax papers, submitted or which should have been submitted to us. I am sure that many bribes to foreign officials have no tax consequences because the organization refrained from claiming a deduction with respect to the bribe or the briber had no tax consequences in the United States, because it was solely a foreign transaction which at best might have a deferred consequence for U.S. tax purposes. Mr. WHALEN. Now, what are the penalties for violation of section 162(c) (1)?

Mr. ALEXANDER. Disallowance of the claimed deduction and, if appropriate, negligence penalty of 5 percent or a fraud penalty of 50 percent interest at a present rate of 9 percent per year on the amount of the underpayment, and, if there has been a flagrant violation of U.S. tax laws, a possible criminal charge.

Mr. WHALEN. Against whom?

Mr. ALEXANDER. Again the corporation, the U.S. corporation, or against U.S. citizens.

Mr. WHALEN. Citizen or employee of that corporation.

Mr. ALEXANDER. That is correct.

Mr. WHALEN. Have any such cases in recent years been filed in Federal court?