KPMG, the accountancy firm, told the US Justice Department that it would unleash a “nuclear bomb” that would leave more than 1,000 companies without an auditor, if it indicted the firm for selling fraudulent tax shelters, according to newly released internal documents.

The Justice Department began to investigate KPMG in 2004 for allegedly helping wealthy clients to save money by setting up illegal tax shelters. The investigation came after Arthur Andersen’s indictment in 2002 for obstructing the US Government’s inquiry into Enron.

Roger Bennett, KPMG’s lawyer, argued that his client’s indictment could wipe out one of the four remaining large accounting groups, as the Enron inquiry had eradicated Andersen.

Mr Bennett told prosecutors at a meeting on March 22, 2005, that “a death spiral is going to start, and KPMG will be out of business”.

KPMG employed 20,000 people “whose lives will be destroyed”, he said, according to the memos, first reported by Bloomberg News.

“We’re asking you to use a smart bomb, not a nuclear bomb.” Mr Bennett said that KPMG had “gotten rid of all the wrongdoers” and promised to cooperate to help David Kelley, the US attorney bringing the case, to indict the staff involved in the scheme.

Mr Kelley referred to Mr Bennett’s argument as “ridiculous”, according to the documents, although it seemed to work. Two senior US Justice Department officials intervened and KPMG avoided an indictment.

In return, the accountant settled with the Government in April 2005 by agreeing to pay a $456 million fine.

The documents, although several years old, have only just come to light as part of a criminal investigation into 18 former KPMG partners accused of orchestrating the tax shelters. They are awaiting trial in September on charges of cheating the US Treasury out of at least $2 billion, in what the US Government has labelled America’s biggest ever criminal tax case.

The KPMG cases have prompted a full-scale investigation into the use of tax shelters in the United States.

Last month, American federal prosecutors charged four partners at Ernst & Young, the accountancy group, with a scam that allegedly used the September 11 terrorist attacks of 2001 to deprive the US Government of hundreds of millions of tax dollars. If convicted, the four could face years in jail.

The E&Y partners allegedly helped wealthy clients to cut their tax bills by creating phony losses on fictional investments that they could offset against their taxable income. It is alleged that they used “false and fraudulent factual scenarios” such as the World Trade Centre attacks, which sent the value of investments plunging across the globe, as a way to sidestep taxes, Michale Garcia, the US attorney bringing the case, said last month.

E&Y, which has not been indicted in relation to the tax shelters, allegedly made $121.7 million in fees from bogus tax shelter profits in the form of a cut of the savings that it generated for its clients. Many had made their fortunes from the technology boom.

KPMG declined to comment on the documents relating to the tax shelters.

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