Understanding the timing of a US Federal tax controversy is helpful in creating a sound and efficient strategy. This timeline shows the typical timing of a US Federal tax controversy, from the IRS’s examination of the return, through administrative appeals, litigation in Tax Court, Circuit Court appeal, and to ultimate assessment of tax.
Most tax cases are decided by the US Tax Court (Tax Court). The Tax Court issues two categories of opinions: (1) formally published dispositions; and (2) unpublished dispositions. The first category consists of opinions that are published in the Tax Court Reports and technically are called “division opinions” but are more commonly referred to as “T.C. opinions.” The second category consists of three sets of unpublished dispositions: (1) memorandum opinions (commonly referred to as “memo opinions” or “T.C. memos”); (2) summary opinions; and (3) orders. A common question asked by taxpayers relates to the difference between these forms of dispositions in terms of precedential effect. (more…)
Knowing your options for a US Federal tax controversy is helpful in creating a sound and efficient strategy. The attached chart depicts the typical options involved in a US Federal tax controversy, from the IRS’s examination of the return, through administrative appeals, litigation in Tax Court, Circuit Court appeal, and to ultimate assessment of tax.
At the ABA Section of Taxation meeting in Boston last week, Chief Judge Marvel of the US Tax Court announced that the court anticipates issuing revisions to its rules in the near future. These rule revisions will address two areas: (1) e-filing matters, including the ability to electronically file a petition; and (2) revisions necessitated by changes made by Congress at the end of 2015 (for our earlier report on this subject, see here). Chief Judge Marvel also noted that the court is continuing to review its rules and prior comments received from the public, and may issue further revisions in the future.
In Altera Corp. v. Commissioner, 145 T.C. No. 3 (July 27, 2015), the Tax Court, in a unanimous reviewed opinion, held that regulations under Section 482 requiring parties to a qualified cost-sharing agreement (“QCSA”) to include stock-based compensation costs in the cost pool to comply with the arm’s-length standard were procedurally invalid because Treasury and the IRS did not engage in the “reasoned decisionmaking” required by the Administrative Procedures Act and the cases interpreting it. The Commissioner of Internal Revenue (“Commissioner”) appealed this holding to the Ninth Circuit Court of Appeals, Dkt. Nos. 16-70496, 16-70497. The Commissioner filed his opening brief on June 27, 2016. Two groups of law school professors filed amicus briefs in support of the Commissioner’s position. On September 9, 2016, Altera Corporation (“Altera”) filed its answering brief with the Ninth Circuit.
Altera begins with the observation that the Commissioner “has remarkably little to say” about the Tax Court’s rationale in holding the QCSA regulation invalid. According to Altera, the Commissioner either did not respond to the salient points in the Tax Court’s analysis or, more often, actually admitted that those points were correct. Instead, the Commissioner advanced a “new, litigation-driven position” that Section 482’s “commensurate with income” requirement is an independent “internal standard” that “does not require consideration of transactions between unrelated parties.” Indeed, Altera notes, the Commissioner now argues “that the arm’s-length standard may be applied without considering any facts at all.” Thus, rather than engage with the Tax Court’s reasoning, the Commissioner “mistakenly accuses the Tax Court of overlooking an argument that is missing from the administrative record.”
One often overlooked debt-equity issue is presented by continuing transfers to a subsidiary that is reasonably creditworthy at the inception but subsequently encounters difficulties, in spite of which (or maybe because of which) and continues to receive advances from the common parent or one of its finance subsidiaries. The issue is whether the subsequent difficulties should cause the advances made after some point in time to be equity rather than debt.
Scott Singer Installations, Inc. v. Commissioner, T.C. Memo. 2016-161, [read here] involves a corporation that began business in 1981 and operated with some success. In order to fund its growth, its sole shareholder began to borrow from other persons and relend the proceeds to the corporation in 2006. (No notes were executed; no interest was charged; and no maturity dates were imposed.) The corporation was initially profitable, but experienced a decline in business in 2008. The court held that the shareholder loans from 2006 through 2008 constituted debt because the corporation’s success provided a basis for the shareholder’s having a reasonable expectation that those loans would be repaid, but that the funds transferred after 2008 were not debt because as a result of the decline in business, the shareholder “should have known that future advances would not result in consistent repayments.”
The court cited no case in which this approach was applied. Whether shareholder could have a reasonable expectation of repayment is a factual issue for which authority is not needed. However, this approach is somewhat unusual. A particularly difficult question in many cases is the point after which advances should be treated as equity. The general downturn in the economy may have simplified it here. It is important to note that the advances made before 2009 were not recharacterized as equity; it appears that if it were appropriate to treat them as debt when they were made, they remain debt.
The Tax Court in Scott Singer focused heavily on the lender’s reasonable expectation of repayment in characterizing the later advances as equity. However, it is important to note that the debt-equity determination is often extremely complex and fact-specific. The question of lending to a troubled company arises frequently in the third-party lending context. In these situations, a lender often seeks a higher interest rate and/or additional collateral to account for the problems that the company is experiencing. When a third-party lender extends credit to a troubled company, they often look to assets and their priority relative to other creditors in considering whether to loan additional funds.
Business people at a company need to be cautioned that pumping money into a subsidiary that is sustaining losses (and probably needs the money to prevent sinking) may lead to adverse tax consequences unless the entity’s stock becomes worthless. One approach may be to have the subsidiary issue a combination of notes and preferred stock.
Facebook is in a protracted battle with the IRS related to its off-shoring of IP to an Irish affiliate. Read more here. The IRS issued an administrative summons for the documents, and Facebook has refused to comply with the summons. The IRS is asking the court to enforce the summons and force Facebook to turn over the requested documents. The court agreed that on its face, the summons was issued for a legitimate purpose. Facebook will now have to tell the court why it refuses to turn over the documents. Review the court order here. Assumedly, Facebook is asserting that it is not required to disclose the requested materials based upon a claim of privilege. The case demonstrates that the IRS is aggressively seeking documents and information from taxpayers and their representatives in cases involving international tax issues.
The US Tax Court is physically located in Washington, DC, but its judges travel nationwide to conduct trials in 70 designated cities. At the time the petition is filed with the Tax Court, the taxpayer will request a specific location for trial. The Tax Court will issue a notice setting the case for trial approximately five months before the trial date.
However, before the notice for trial is sent out, the Tax Court will have announced the dates and locations of the trial sessions. The most recent sessions for Fall 2016 and Winter 2017, which were just released by the Tax Court, can be found here and here. Taxpayers who have not yet received a notice setting the case for trial may review the trial session schedules in advance and want to find out which judge will be presiding over those sessions. Although the name of the judge presiding over a trial session is not listed on the Tax Court’s website, a taxpayer can call the Clerk’s Office and ask whether a particular judge has been assigned to the calendar.
A company never litigates in a vacuum: statements in pleadings or court papers and testimony by company officials can be used against the company in parallel or subsequent proceedings, even unrelated cases. Eaton Corporation PLC was sued recently for alleged violations of federal securities laws because one of its officers made an admission on an earnings call that provisions of federal tax law barred Eaton from making tax-free spinoffs for a limited period of time, and the company’s prior statements allegedly suggested such spin-offs could occur. Eaton Corp. Sued Over Statements About Post-Inversion Spinoff. Companies make similar statements in litigation on a regular basis. Often, such statements form a necessary component of a company’s litigation position. Nevertheless, companies should carefully consider the risk that a statement will expose it to a shareholder-derivative lawsuit and incorporate that risk into its litigation strategy.
Taxpayers value confidentiality, particularly if there is a dispute with the IRS that involves highly-sensitive trade secrets or other confidential information. Not surprisingly, complex tax litigation often raises the question of what confidential information has to be “made public”—through discovery responses or the introduction of exhibits or testimony in a deposition or at trial—so that a taxpayer can dispute IRS adjustments in court if administrative efforts to resolve the case are not successful. Fortunately, the Tax Court tends to protect highly-sensitive trade secrets or other confidential information from public disclosure even when the judge must review the information to decide the case.
In the Tax Court, the general rule is that all evidence received by the Tax Court, including transcripts of hearings, are public records and available for public inspection. See Internal Revenue Code (Code) Section 7461(a). Code Section 7458 also provides that “[h]earings before the Tax Court . . . shall be open to the public.” Code Section 7461(b), however, provides several important exceptions. First, the court is afforded the flexibility to take any action “which is necessary to prevent the disclosure of trade secrets or other confidential information, including [placing items] under seal to be opened only as directed by the court.” Second, after a decision of the court becomes final, the court may, upon a party’s motion, allow a party to withdraw the original records and other materials introduced into evidence. In our experience, the trend appears to be erring on the side of protecting information from disclosure.
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