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Are You Required to Disclose Supporting Legal Authorities During Discovery?

by Kevin Spencer and McDermott Will & Schulte | Jun 30, 2017 | IRS Audits, Transfer Pricing Resource, Trial Courts, Uncategorized

Discovery in tax litigation can take many different forms, including informal discovery requests (in the US Tax Court), request for admissions, interrogatories and depositions. In addition to obtaining facts, litigants frequently want to know the legal authorities on which the other side intends to rely. Over the years, we have seen numerous requests, both during examinations and in litigation, where the Internal Revenue Service (IRS) requests a listing of the legal authorities supporting a taxpayer’s position.

Sometimes it is beneficial for a taxpayer to disclose those authorities. For example, in some IRS audits it may be worthwhile to point out to the IRS agent the applicable authority and cases that directly support the taxpayer’s position. However, once a case progresses to litigation, it is clear that the parties disagree and that simply pointing out relevant authorities will not help the IRS to concede the case. This raises the question of how to respond to such a request while in litigation.

The Tax Court recently addressed this issue in a pending case involving issues under Internal Revenue Code Section 482 (see here). The IRS issued interrogatories that requested information seeking to obtain the taxpayer’s legal arguments. The taxpayer objected on the grounds that this was inappropriate. The Tax Court, in an unpublished order, agreed:

Tax Court Rule 70(b) does not require a party to disclose the legal authorities on which he relies for his positions. See Zaentz v. Commissioner, 73 T.C. 469, 477 (1970). Other courts have held that interrogatories requiring a party to disclose legal analyses and conclusions of law are impermissible. See, e.g., Perez v. KDE Equine, LLC, 2017 WL 56616 at *6 (W.D. Kentucky Jan. 4, 2017); In re Rail Freight Fuel Surcharge Antitrust Litigation, 281 F.R.D. 1, 11 (D.D.C. Nov. 17, 2011).

Practice Point: Although this unpublished order technically reflects only the view of the issuing Judge, it is an important point that litigants should remember. There are numerous ways to determine an adversary’s legal position. Generally, however, discovery requests directly asking for an opponent’s supporting legal authorities are not an appropriate technique. Techniques to make that determination include: issuing requests for admissions relating to the elements of potential legal theories, filing a dispositive motion like summary judgment which will invoke a response from the other side, and discussing with your opponent whether the case should be submitted (in Tax Court) fully stipulated. And sometimes the most efficient way to get the information is to pick up the phone and just ask. Typically, litigants are wary of putting their legal theories down in writing and pinning themselves down early in a case. But most lawyers love to hear themselves talk!

The Bruins Score! Court Rules Away from Home Meals Are 100 Percent Deductible

by Kevin Spencer and Ruth Wimer | Jun 28, 2017 | Court Procedure Matters, Trial Courts, Uncategorized

In a surprising decision, the US Tax Court (Tax Court) concluded that the pregame away-city meals provided to the Boston Bruins hockey team was not subject to the 50 percent deduction disallowance on the basis that the meals were both for the “convenience of the employer” and were provided at an “employer operated eating facility.” In Jacobs v. Commissioner, 148 TC No 24 (June 26, 2017), the court found that meals—consisting of dinner, breakfast, lunch and snacks—were served in a room provided without charge by the hotel and to all employees of the Bruins traveling to the games.

Most businesses are well aware of the 50 percent deduction disallowance provided in Internal Revenue Code (IRC) Section 274(n)(1), which applies to meals provided to executives or other employees traveling for the business purpose of the employer. “De-minimis” meals (those which are provided infrequently and low in value), however, are excepted from the 50 percent disallowance. Also exempt are those meals provided at employer-operated eating facilities, (e.g., the company cafeteria) and meeting the following requirements:

the facility is located on or near the business premises of the employer;
the revenue derived from the facility normally equals or exceeds the direct operating costs of the facility; and
the facility is available on substantially the same terms to each member of a group of employees that is defined under a reasonable classification which does not discriminate in favor of highly compensated employees.

IRC Section 119(a) allows an employee to exclude the value of any meals furnished by or on behalf of his employer if the meals are furnished on the employer’s business premise for the convenience of the employer. Generally, the expenses of IRC Section 119 meals can be used to satisfy the requirement that the revenue from the eating facility equal direct operating costs.

In Jacobs, the Tax Court concluded that the group meals served in the away-city hotel rooms provided at the hotels where the Bruins hockey team stayed for the games was an “employer operated eating facility,” which deems the rooms as the “eating facility” and “on the business premises of the employer” for purposes of the requirements. The rooms were also considered the business premises of the employer for purposes of the IRC Section 119 requirement. In light of its holding, the Tax Court did not need to address the taxpayer’s alternative argument that the meals were expenses for entertainment sold to customers under IRC Section 274(n)(2)(A).

Practice Point: The decision in Jacobs is seemingly expansive in permitting employers to deduct meals provided away from what has traditionally been considered an employer facility. The decision may provide an opportunity to employers to seek additional expense deductions.

Tax Court Considering Requiring Notice of Non-Party Subpoenas

by McDermott Will & Schulte | Jun 26, 2017 | Court Procedure Matters, Trial Courts, Uncategorized

We previously wrote about the lack of a US Tax Court (Tax Court) rule requiring notice to other parties before service of non-party subpoenas for the production of documents, information, or tangible things and inconsistent practices for Judges at the Tax Court. See here and here. To recap, Tax Court Rule 147 allows a party to issue a subpoena to a non-party but does not require that prior notice be given to the other side of the issuance. Prior notice is required under the Federal Rules of Civil Procedure, which govern federal cases before the US district courts. As previously discussed, this absence of a Tax Court rule has led to inconsistent orders from the Tax Court on the subject.

Change may be coming soon, according to comments from Tax Court Chief Judge Marvel on June 16, 2017 at the New York University School of Professional Studies Tax Controversy Forum. Judge Marvel indicated that the Tax Court is considering amendments to Tax Court Rule 147 to conform to the Federal Rules of Civil Procedure. This would be a welcome development for taxpayers, as the Internal Revenue Service (IRS) would no longer be able to issue subpoenas and gather information from non-parties without a taxpayer’s knowledge and access to the same materials.

Practice Point: The Tax Court has not indicated when the next amendments to its Rules will be released. Until that time, taxpayers in litigation should not expect that the IRS will provide notice of subpoenas issued to non-parties. As we have pointed out before, taxpayers should routinely and regularly issue discovery requests on the IRS seeking: (1) a list of all third-party contacts, including the documents sent and received; (2) copies of all subpoenas, including a copy of all documents sent and received; and (3) a list of the dates on which the third-party contacts occurred, including phone calls and meetings. These requests should be made at the beginning of every case, and it should be stated that the requests are continuing in nature.

Former Tax Court Judge Diane L. Kroupa Sentenced in Connection with Tax Evasion Matter

by McDermott Will & Schulte | Jun 22, 2017 | Trial Courts, Uncategorized

We have previously blogged on the criminal tax proceedings related to former US Tax Court Judge Kroupa (see here and here). In October 2016, Judge Kroupa pleaded guilty to multiple tax criminal charges related to her tax returns and interactions with the Internal Revenue Service. Based on sentencing guidelines, the recommended sentence was between 30‒37 months. Judge Kroupa and the government submitted filings on the appropriate sentence, in which Judge Kroupa provided detailed reasons why she believed the court should impose a sentence of 20 months imprisonment. These filings can be found here and here. According to a report in today’s BNA Daily Tax Report, the court sentenced Judge Kroupa to 34 months in prison and ordered her to pay $457,000 in restitution, which is owed jointly with her former husband. She was also sentenced to three years of supervised release. Judge Kroupa’s former husband was sentenced to 24 months in prison and one year of supervised release.

The “Issue of First Impression” Defense to Penalties

by McDermott Will & Schulte | Jun 14, 2017 | Trial Courts, Uncategorized

The Internal Revenue Code (Code) contains various provisions regarding the imposition of penalties and additions to tax. The accuracy-related penalty under section 6662(a), which imposes a penalty equal to 20 percent of the amount of any understatement of tax, is commonly asserted on the grounds that the taxpayer was negligent, disregarded rules or regulations, or had a substantial understatement of tax. Over the years, the Internal Revenue Service (IRS) has become increasingly aggressive in asserting penalties and generally requires that taxpayers affirmatively demonstrate why penalties should not apply, as opposed to the IRS first developing the necessary facts to support the imposition of penalties.

There are many different defenses available to taxpayers depending on the type and grounds upon which the penalty is asserted. These defenses include the reasonable basis and adequate disclosure defense, the substantial authority defense, and the reasonable cause defense.

Another defense available to taxpayers is what we will refer to as the “issue of first impression” defense. The Tax Court’s recent opinion in Peterson v. Commissioner, 148 T.C. No. 22, reconfirms the availability of this defense. In that case, the substantive issue was the application of section 267(a) to employers and employee stock ownership plan (ESOP) participants. The court, in a published T.C. opinion (see here for our prior discussion of the types of Tax Court opinions) held in the IRS’s favor on the substantive issue but rejected the IRS’s assertion of an accuracy-related penalty for a substantial understatement of tax on the ground that it had previously declined to impose a penalty in situations where the issue was one not previously considered by the Tax Court and the statutory language was not entirely clear.

The Tax Court’s opinion in Peterson is consistent with prior opinions by the court in situations involving the assertion of penalties in cases of first impression. In Williams v. Commissioner, 123 T.C. 144 (2004), for instance, the substantive issue was whether filing bankruptcy alters the normal Subchapter S rules for allocating and deducting certain losses. The Tax Court agreed with the IRS’s position, but it declined to impose the accuracy-related penalty because the case was an issue of first impression with no clear authority to guide the taxpayer. The court found that the taxpayer made a reasonable attempt to comply with the code and that the position was reasonably debatable.

Similarly, in Hitchens v. Commissioner, 103 T.C. 711 (1994), the court addressed, for the first time, an issue related to the computation of a taxpayer’s basis in an entity. Despite holding for the IRS, the court rejected the accuracy-related penalty. It stated “[w]e have specifically refused to impose additions to tax for negligence, etc., where it appeared that the issue was one not previously considered by the Court and the statutory language was not entirely clear.” Other cases are in accord. See Braddock v. Commissioner, 95 T.C. 639, 645 (1990) (“as we have previously noted, this issue has never before, as far as [...]

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Dealing with Allocations of Tax Liabilities in Non-IRS Agreements

by Jane Zhao and McDermott Will & Schulte | May 23, 2017 | Trial Courts, Uncategorized

Taxpayers often enter into tax sharing agreements to agree on how the parties may allocate current or future tax liabilities or potential refund. Sometimes these agreements are heavily negotiated (e.g., a corporation acquiring a subsidiary of an unrelated party); sometime they are not (e.g., marital settlement agreements among individuals with little assets). A recent US Tax Court (Tax Court) opinion is a reminder that such agreements between private parties are not binding on the Internal Revenue Service (IRS) in a tax proceeding.

In Asad v. Commissioner, the IRS disallowed certain deductions for rental-property losses claimed by the taxpayers on their joint returns for two years. The taxpayers, who had since divorced, both sought relief from joint and several liability under Internal Revenue Code (Code) Section 6015. In their divorce agreement, the taxpayers agreed that each would be liable for 50 percent of the tax liabilities for the two years. The IRS conceded that each taxpayer should be relieved of joint and several liability for a fraction of the liabilities (28 percent and 41 percent for the ex-wife and 72 percent and 59 percent for the ex-husband). At trial, the taxpayers argued that they should each be liable for 50 percent of the tax liabilities in accordance with the divorce agreement.

The Tax Court disagreed. It reasoned that although the divorce agreement established the taxpayers’ rights against each other under state law, it did not control their liabilities to the IRS. The court noted that case law, legislative committee reports, and reports issued by the Department of Treasury and the General Accounting Office have all observed that though divorce decrees may provide for an allocation of liabilities, such an allocation is not binding on creditors who do not participate in the divorce proceeding, and binding the IRS to such a divorce decree was impractical. Accordingly, in this case, though the taxpayers would have agreed to a 50/50 split on the tax liability, their divorce agreement did not alter their liabilities to the IRS.

Practice point: When negotiating agreement containing a sharing of tax liabilities, taxpayers should remember that such agreement is not binding on the IRS, which is not a party to that agreement. In the event one party is ultimately found liable for more than the amount or percentage dictated in an agreement, that party must seek contribution from the other party and cannot force the IRS to collect from the other party.

Chief Special Trial Judge Panuthos to Step Down, Effective September 1, 2017

by McDermott Will & Schulte | May 16, 2017 | Trial Courts, Uncategorized

Last week, the US Tax Court (Tax Court) announced that Chief Special Trial Judge (STJ) Peter J. Panuthos has decided to step down as Chief STJ, effective September 1, 2017. STJ Lewis R. Carluzzo will take over as Chief STJ beginning September 1, 2017. STJ Panuthos has been Chief STJ for the past 25 years, and has a long list of accomplishments, including assisting in the expansion of pro bono services to unrepresented taxpayers. The Tax Court’s press release provides more background on STJs Panuthos and Carluzzo.

STJs are an important part of the Tax Court, and perform many different functions for the Court. The statutory authority for STJs is found in Internal Revenue Code (Code) Section 7443A(a), which authorizes the Chief Judge of the Tax Court to appoint STJs. Code Section 7442A(b) provides that the Chief Judge may assign a variety of proceedings to be heard by STJs, any declaratory judgment proceeding, any proceeding under Code Section 7463 (relating to small tax case procedures), any proceeding where the amount in dispute does not exceed $50,000, lien/levy proceedings, certain employment status proceedings, whistleblower proceedings and any other proceedings which the Chief Judge may designate. Although STJs may potentially hear a wide variety of matters, most cases conducted by STJs related to small tax proceedings where the amount in dispute is less than $50,000. These cases are conducted as informally as possible and the rules of evidence are relaxed; however, the trade-off is that these types of cases are not appealable by either party and may not be treated as precedent for any other case (although there is no prohibition against citing such cases for their persuasive value). For more information on the statutory and Tax Court rules on STJs, see here.

Canadian Tax Court Holds that Agreements Reached Under the Mutual Agreement Procedure are Binding on the Canada Revenue Agency

by K. Christy Vouri-Misso and Steven Hannes | May 9, 2017 | Court Procedure Matters, Transfer Pricing Resource, Trial Courts, Uncategorized

On March 10, 2017, the Tax Court of Canada held that agreements reached under the Mutual Agreement Procedure (MAP) precluded the Canada Revenue Agency (CRA) from redetermining the transfer prices of rock salt sold by Sifto Canada Corp. (Sifto Canada) to a related party in the United States.

In 2006, Sifto Canada reevaluated the transfer pricing of its rock salt sales to its US affiliate for 2002 through 2006. Siftco Canada discovered that the sales prices had been for less than an arm’s length price and in 2007 made an application to the CRA’s voluntary disclosure program reporting additional income from the sale of rock salt for 2002-2006 of over C$13 million. In 2008, the CRA accepted the application and assessed additional tax on that income.

After the assessment, Sifto Canada applied to the Canadian Competent Authority (CCA) and its US affiliate applied to the United States Competent Authority (USCA) for relief from double taxation under Articles IX and XXVI of the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital, as amended (the Treaty). The CRA did not audit Sifto Canada during this time and based its position paper on Sifto Canada’s voluntary disclosure application. Under the MAP process, the USCA and CCA then agreed to the transfer prices.

During the negotiation process for the MAP, the CRA began auditing the transfer prices of the rock salt for those years and then, subsequent to the signing of the MAP agreements, the CRA determined that the transfer prices should have been even higher than the amounts reported by Sifto Canada in the voluntary disclosure and issued further reassessments of its tax.

The CRA argued that: (1) the MAP agreements only provided relief from double taxation and did not set transfer prices; (2) the CCA only entered into agreements with the USCA and did not enter into a binding agreement with Sifto Canada regarding the transfer prices; and (3) that the government had a duty to reassess the tax once it determined that the transfer prices were not at arm’s length.

The Tax Court of Canada did not agree with the CRA and held the government to its MAP agreements. The Court found that by reaching an agreement under the MAP process, the CCA necessarily had to find that the transfer prices were at arm’s length under the Treaty. Further, the Court found that under the factual matrix of this case, the CCA’s letters exchanged with Siftco Canada clearly described the terms of the MAP agreements, asked Siftco Canada to accept those terms, and Sifto Canada then accepted the terms establishing a binding agreement. Finally, the Court found the agreements were not “indefensible on the facts and the law” and thus were binding on the Canadian government.

Practice Point: This case is helpful to taxpayers with cross-border transactions between the US and Canada and demonstrates that MAP agreements are binding on the CRA.

The IRS’s Assault on Section 199 (Computer Software) Doesn’t Compute

by Jean A. Pawlow, Kevin Spencer and Robin L. Greenhouse | Apr 24, 2017 | Court Procedure Matters, IRS Appeals, IRS Audits, IRS Guidance, Trial Courts, Uncategorized

Internal Revenue Code Section 199 permits taxpayers to claim a 9 percent deduction related to the costs to develop software within the U.S. The relevant regulations and their interpretation, however, place substantial restrictions on claiming the benefit.

Moreover, the regulations and the government’s position haven’t kept up with the technological advances in computer software.

Before claiming the deduction on your return, consider that the Internal Revenue Service has this issue within its sights, and perhaps it will be the subject of one of their new “campaigns.”

In 2004, Congress enacted I.R.C. Section 199 to tip the scales of global competitiveness more in favor of American business. The main motivation of the statute was to create jobs by encouraging businesses to manufacture and produce their products in the U.S. The tax benefit, however, isn’t available for services, a theme that pervades many of the provisions in the statute and regulations.

Originally published in Bloomberg BNA Daily Tax Report – April 24, 2017 – Number 77

Overview of Tax Litigation Forums

by Elizabeth Chao and McDermott Will & Schulte | Apr 21, 2017 | Appellate Courts, Court Procedure Matters, IRS Guidance, Tax Refunds, Trial Courts, Uncategorized

Taxpayers can choose whether to litigate tax disputes with the Internal Revenue Service (IRS) in the US Tax Court (Tax Court), federal district court or the Court of Federal Claims. Claims brought in federal district court and the Court of Federal Claims are tax refund litigation: the taxpayer must first pay the tax, file a claim for refund, and file a complaint against the United States if the claim is not allowed. Claims brought in the Tax Court are deficiency cases: the taxpayer can file a petition against the IRS Commissioner after receiving a notice of deficiency and does not need to pay the tax beforehand.

As demonstrated in the chart below, approximately 97 percent of tax claims are instituted in the Tax Court. It should be noted that, after a taxpayer files a petition in Tax Court, the taxpayer no longer has the option of bringing the claim in any other court for the year(s) at issue.

Tax Court Versus Tax Refund Litigation