Statement of Stephen T. Winn, President and Chief Executive Officer,
Computer Language Research, Inc., Carrollton, Texas,
on behalf of Software Publishers Association

Testimony Before Subcommittee on Oversight
of the House Committee on Ways and Means

Hearing on the Recommendations of the National Committee on Restructuring
the IRS on Taxpayer Protections and Rights

September 26, 1997

Madam Chairwoman and members of the subcommittee:

My name is Stephen T. Winn and I am President and Chief Executive Officer of Computer Language Research, Incorporated, a tax return preparation software company headquartered in Carrollton, Texas. I am testifying today on behalf of the Software Publishers Association, the leading software trade association composed of 1200 companies, ranging from the largest and best known to many other, smaller firms. Thank you for giving the SPA and me the opportunity to give you our views on three important elements of the IRS restructuring debate.

First, we are strong supporters of electronic filing. Tax software publishers have been helping the Fortune 1000 corporations process and file their returns in electronic formats for many years. Further, millions of individuals are now using computers and our software to fill out their tax returns. The next logical step, of having those returns filed electronically, is only a relatively small step away. Providing incentives, including a longer time period for filing --- which is logical given that it takes the IRS less time to process an electronic return --- and financial incentives for transmitters, are both good ideas which would accelerate the movement away from paper-filing. The IRS study commission was correct in their view that electronic filing will be far more efficient, less prone to error, and cheaper over the long run than paper-based returns. Eliminating paper returns for millions of individual filers, and for thousands of small and medium sized businesses, will dramatically lower IRS error rates and enhance taxpayer --- customer --- faith in our tax collection process. Concrete steps beyond mere platitudes are called for and the Commission's recommendations are a good start.

Second, the proposal to eliminate the differential between interest owed the government and that owed the taxpayer --- with the taxpayer getting the lower rate --- is long overdue. Whatever revenue was raised from this artifice was too much. At the same time, I understand the problems of "revenue neutrality" and will leave suggestions for solving the controversial aspects of this proposal to others.

My third topic is one of extreme concern to my firm and other business software publishers. To our dismay and over our objections, the IRS, during audits of licensees of business software, is attempting to seize the software industry's single most important asset, its intellectual property, through prolonged and potentially ruinous litigation, without compensation, without offering even the most basic protections to the publisher. In my view, the IRS is on a wrong-headed crusade based on a fundamental misunderstanding of what software is and what it does.

First, let me give you a quick primer on software. It is created by a programmer, who writes out instructions for a computer in human-readable form called "source code." A corporate tax program, such as those published by my firm, may have 300,000 pages of source code, as well as notes the programmer makes as he proceeds, and comments from users who call in during the tax season with ideas and problems with the software.

The source code is then taken to a "compiler", which turns it into machine-readable, "executable" or "object code." When you buy software at your local computer store, it usually comes in the form of CD-ROM disks; this is executable code.

Source code is the crown jewel of any software company. It contains all the trade secrets, know-how, and tricks of the trade that set one firm's product apart from another firm's. We do not share our source code with anyone and we guard it by aggressively prosecuting any infringement of copyright, trademark, and trade secret laws.

This then brings us to the present problem. The IRS wants our software and is using the audits of our corporate customers to try and get it. In two cases now being litigated, as well as in at least another 5 cases about to begin the litigation process, the IRS has issued Information Document Requests (IDR's) and summonses for the software. In some instances, the IRS has issued "designated summonses" demanding that the taxpayer turn over the tax software. A designated summons is a powerful tool, in that it stops the running of the statute of limitations until lifted. Unfortunately for our customers, a standard software licensing agreement prohibits the licensee from giving it to anyone, including the IRS. In response, the IRS has issued summonses to the software publishers demanding the software. The most recent summons that CLR has received demands both the executable code --- the CD-ROM disks --- as well as the voluminous and highly sensitive source code versions of the software.

At CLR, which has been creating tax return software in one form or another for 30 years, our first thought was to find out what problems the IRS was having understanding our customers' tax returns so that we could help them find a solution. That is the way we have worked with the IRS since our inception and the IRS and the taxpayer had always come away satisfied. The IRS responded that they did not have a particular problem with the software but that the IRS National Office wants it anyway. Further, the IRS said that they have such broad powers under Section 7602 that they can take whatever they want on audit from either the taxpayer or from a third party software publisher. They then refused to negotiate with us further concerning a national accord which would allow the IRS to do its job while protecting our key asset.

The tax production software we publish is not customized or produced specifically for one company. It is merely a set of algorithms for calculating a return. The taxpayer must enter its financial data onto the return, usually relying on a general ledger software package for the financial numbers. No one disputes that a company's books and records are necessary both to prepare and audit the return. In order to audit that return, the IRS must be able to establish an audit trail that shows them how a number flows from the final tax return to the general ledger. Ordinarily, this audit trail is provided in the form of work papers. All tax preparation software packages produce work papers to facilitate this mapping of source data to the finished return. If a tax software program did not produce these reconciling work papers, no one would use our software because no one --- not the taxpayer, who has the highest interest in making sure his return is correct, or his auditors --- could ascertain how a number on the return tied back to company's financial books.

The IRS is arguing that the software has somehow replaced the reconciling work papers so that the only way that they can track a number from general ledger to the final return is to access the software itself. This is simply not true, however. The fact is, in every instance of which we are aware, the taxpayer has been able to provide the IRS with an audit trail from final return to financial books without access to the software.

So if the taxpayer can demonstrate a clear audit trail from source data to the finished return, why does the IRS persist in demanding access to tax return production software?

We believe the IRS wants access to 3rd party software so that they can process alternative scenarios through the software. In other words, they want to use the software rather than examine it. They want to be able to improve the efficiency and effectiveness of their auditing process by confiscating software rather than using their own. (I should note here that CLR won a competitive bid two years ago to license an international tax program to the IRS at a cost of $2 million. We also trained 100 IRS examiners in the program just so they would have their own audit software). As much as we all appreciate the need for an efficient IRS, the SPA strongly believes that stealing software is not a proper reason to issue an IRS summons --- especially a designated summons, which stops the running of the statute of limitations and makes our customers very unhappy.

We also think that the IRS is suspicious that a computer might be used to substitute for audit work papers that reconcile financial books to the tax return. Although I can understand that the IRS has to deal with some tough cases, this is really a little paranoid. If the computer software does not produce a reconciling work paper for a particular number, then it isn't going to do the Service any good to review the software because the support is simply not there. If the computer software does produce a reconciling work paper for a particular number, then all the taxpayer has to do is print it. The IRS doesn't need access to the software to obtain audit work papers.

We think that another more sinister motive is emerging. Rather than deal with specific audit issues pertaining to specific taxpayers, the IRS seems to be positioning itself to go on a fishing expedition to study all taxpayers that have used particular features in the software. If the IRS wins access to source code and programmer notes, can we expect a John Doe summons to follow requesting that we turn over information about who is using what feature in the software?

The SPA is also concerned that the next summons offensive will target the publishers of general ledger and accounting programs. It is those programs, after all, that generate the numbers that are used in the tax return. If, as the IRS claims, it cannot be expected to rely on numbers on a return produced by a computer, then the source of those numbers must also be suspect. And what about the company's network for collecting those numbers? The list of potential summons targets could easily go on and on and on.

What would the IRS get if they did win access to a publisher's source code?

They would get nothing usable by a field agent. Indeed, there are very few programmers with a tax background. The IRS would have to hire one of our competitors or someone capable of becoming a competitor to understand the source code. Only a part of the code deals with tax matters; the other part is instructions to the computer regarding the operating system, printing, what color the screens should be, etc. It is those hard-won tricks-of-the-trade that a competitor would find very interesting.

It is my understanding that no IRS audit of any taxpayer has to this day ever included the seizure and unrestricted use of third party tax compliance software by the IRS. Yet now the IRS would have us believe that it is impossible for it to perform an audit without such seizure and unrestricted use. The SPA believes such an assertion is without merit.

We are very pleased that Congressman Sam Johnson has introduced legislation to address this problem. The bill is quite modest and is not IRS-bashing by any means. It merely prevents the IRS from seizing third party, computer source code from a tax preparation or accounting program in examination. It also permits the IRS to gain access to the executable version of software under conditions designed to minimize the risk of disclosure to a third party. The bill would also clarify that courts have the power to protect a publisher's intellectual property rights in any IRS summons enforcement action. Finally, it gives the IRS unfettered access to the software in any criminal proceeding. I strongly urge this committee to give Congressman Johnson's bill every consideration and to include it in any taxpayer rights legislation that you pass.

This concludes my statement, Madam Chairwoman. I would be happy to answer any questions that you or the committee may have.