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APA Challenge to Notice of Deficiency: QinetiQ Requests Supreme Court Review

by Jeffrey M. Glassman and Roger J. Jones | Apr 13, 2017 | Appellate Courts, Court Procedure Matters, IRS Guidance, Trial Courts, Uncategorized

On April 4, 2017, QinetiQ U.S. Holdings, Inc. petitioned the US Supreme Court to review the US Court of Appeals for the Fourth Circuit’s decision that the Administrative Procedure Act of 1946 (APA) does not apply to the Internal Revenue Service (IRS) Notices of Deficiency. We previously wrote about the case (QinetiQ U.S. Holdings, Inc. v. Commissioner, No. 15-2192) here, here, here and here. To refresh, the taxpayer had argued in the US Tax Court that the Notice of Deficiency issued by the IRS, which contained a one-sentence reason for the deficiency determination, violated the APA because it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The APA provides a general rule that a reviewing court that is subject to the APA must hold unlawful and set aside an agency action unwarranted by the facts to the extent the facts are subject to trial de novo by the reviewing court. The Tax Court disagreed, emphasizing that it was well settled that the court is not subject to the APA and holding that the Notice of Deficiency adequately notified the taxpayer that a deficiency had been determined under relevant case law. The taxpayer appealed to the 4th Circuit, which ultimately affirmed the Tax Court’s decision. (more…)

Santander Holdings USA Asks the Supreme Court to Address Economic Substance Doctrine

by Roger J. Jones | Apr 7, 2017 | Appellate Courts, Court Procedure Matters, Trial Courts, Uncategorized

From 2003 to 2007, Sovereign Bancorp, Inc. (Sovereign) – now known as Santander Holdings USA, Inc. (Santander) – engaged in a so-called STARS transaction with Barclays Bank. According to Santander, “[b]y engaging in the STARS transaction, Sovereign transferred some of its income tax liability from the United States to the United Kingdom,” it “secured a loan of $1.15 billion,” and it received a payment “which effectively reduced its lending costs.” On its Federal corporate income tax returns for those years, Sovereign claimed foreign tax credits (FTCs) for UK taxes it paid in connection with the STARS transaction. It also claimed deductions for the interest paid on the $1.15 billion loan.

In 2009, the Internal Revenue Service (IRS) issued a Notice of Deficiency disallowing Sovereign’s FTCs and its deductions for interest paid on the $1.15 billion loan. The IRS did not challenge Sovereign’s compliance with the statutory and regulatory rules governing FTCs, instead arguing that Sovereign’s STARS transaction lacked “economic substance.” Sovereign paid the deficiency and sued for a refund in the US District Court for the District of Massachusetts. When the district court held for Sovereign on both issues, the IRS appealed to the US Court of Appeals for the First Circuit, but only with respect to the FTC issue. The crux of the issue was how to treat the UK taxes and the related FTCs for purposes of the “economic substance” analysis. Relying on Salem Financial, Inc. v. U.S., 786 F.3d 932 (Fed. Cir. 2015), and Bank of New York Mellon Corp. v. Comm’r, 801 F.3d 104 (2d Cir. 2015), the IRS argued that the UK taxes should be treated as an expense but that the related FTCs should be ignored in determining pre-tax profit. Citing IES Indus., Inc. v. U.S., 253 F.3d 350 (8th Cir. 2001), and Compaq Computer Corp. v. Comm’r, 277 F.3d 778 (5th Cir. 2001), Sovereign argued that either both should be included in the profit analysis or both should be ignored. The First Circuit held that Sovereign’s STARS transaction lacked “economic substance,” and upheld the disallowance of the FTCs at issue. In doing so, it treated the UK taxes as expenses that reduced pre-tax profit and ignored the related FTCs, following the Federal and Second Circuit’s approach. Santander Holdings USA, Inc. v. U.S., 844 F.3d 15 (1st Cir. 2016).

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Tax Court Holds Section 883 Regulations Valid under Chevron Test

by Roger J. Jones | Apr 3, 2017 | Appellate Courts, Court Procedure Matters, IRS Guidance, Trial Courts, Uncategorized

On March 28, 2017, the US Tax Court issued its opinion in Good Fortune Shipping SA v. Commissioner, 148 T.C. No. 10, upholding the validity of regulations issued under Internal Revenue Code (Code) Section 883.

Code Section 887(a) imposes a four percent tax on a foreign corporation’s US-source gross transportation income for each year. Code Section 883(c)(1) exempts from US tax a foreign corporation’s gross income from the international operation of ships if the foreign country in which the corporation is organized grants an equivalent exemption to corporations organized in the United States. Code Section 883(c)(1) provides that this exemption does not apply if 50 percent or more of the value of a foreign corporation’s stock is owned, directly or indirectly, by individuals who are not residents of a foreign country that grants an equivalent exemption to US corporations. Regulations issued under Section 883 provide that ownership through shares of a foreign corporation issued in bearer form is disregarded in determining whether the corporation passes the 50 percent or more test (Ownership Regulations).

The taxpayer in Good Fortune Shipping challenged the validity of the Ownership Regulations. It based its challenge on its claim that the Ownership Regulations do not satisfy the two prongs of the test under Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). This argument, in turn, was based primarily—if not exclusively—on the taxpayer’s assertion that US Congress had left no “gap” in Code Section 883 for US Department of the Treasury and the Internal Revenue Service (IRS) to fill; this is because the operative term “own” that appears in the statute has a common, ordinary meaning such that further interpretation by the IRS is not necessary. Thus, the taxpayer argued, the Ownership Regulations fail step one of the Chevron analysis. (more…)

Giving Back – Providing Pro Bono Tax Assistance

by Kevin Spencer, McDermott Will & Emery and McDermott Will & Emery | Feb 23, 2017 | Trial Courts, Uncategorized

Here at McDermott, we value giving back to the community through pro bono efforts. In particular, we provide substantial assistance in pro bono tax cases to low-income individuals through our relationships with low-income taxpayer clinics throughout the country. Over the years, we have settled dozens of cases for low-income taxpayers in docketed tax cases and routinely reduced or eliminated deficiencies asserted by the Internal Revenue Service (IRS). When settlement has not been possible, we have litigated cases in the Tax Court and obtained favorable results not just for our clients but for the low-income taxpayer community as a whole. For example, we represented a husband and wife on a penalty issue involving an issue of first impression and convinced the Tax Court that the IRS had for years been improperly asserting and collecting penalties on improperly claimed refundable tax credits. In a recent article, we detail some of the pro bono efforts by low-income taxpayer clinics and private practitioners.

Practice Point: In addition to assisting low-income individuals who cannot afford legal representation, providing pro bono tax services benefits tax practitioners in many ways. It provides the opportunity for younger attorneys to take responsibility for a case and to get valuable experience in dealing with clients, negotiating with the IRS, and potentially gaining courtroom experience. Assisting taxpayers on a pro bono basis is also rewarding and can make a significant difference in the lives of low-income individuals.

Retaliation Claims By Corporate Whistleblowers – What Is Too Far?

by McDermott Will & Emery | Feb 22, 2017 | Court Procedure Matters, Privilege and Non-Disclosure, Trial Courts, Uncategorized

This week, a French court announced an indictment against UBS related to its alleged treatment of Nicholas Forissier, a former audit manager who provided information to French authorities a decade ago in a tax evasion investigation of UBS. According to at least one press account, the indictment alleges that Forissier was “forced to work under difficult conditions, including internal criticism and eventual dismissal for gross misconduct in 2009” in retaliation for his cooperation with French authorities. Forissier’s case is apparently one of several whistleblower retaliation claims percolating in the French courts against UBS regarding non-disclosure of offshore accounts for tax purposes.

US law provides significant protections of potential whistleblowers for alleged tax violations. Revisions to IRC section 7623, effective from December 20, 2006, make whistleblower awards mandatory in some cases. The revised law has resulted in several large, public awards (the $104 million award given to Bradley Birkenfeld, for example, also related to UBS disclosures).

Protection for IRS whistleblower claimants is found under a number of statutes and rules. IRC section 6103(i)(6) provides stringent confidentiality rules (including personal liability for government violators) regarding the government’s disclosure of information tending to reveal the existence of a whistleblower or confidential informant. Also, the grand jury secrecy rule, Fed. R. Crim. P. 6(e), may provide an additional protection in an ongoing grand jury investigation. Further, OSHA, the False Claims Act and the Fair Labor Standards Act may provide protections against termination of whistleblowers and against adverse employment decisions related to a current employee’s status as a whistleblower, in an appropriate case.

Practice point: It is also worth noting that these protections are not absolute. In fact, because an IRS whistleblower claimant may be in a privileged relationship with the target of an investigation, the IRS has more recently been called upon to clarify that the agency cannot and should not gather or use privileged information to develop a case, or else undermine the entire case as a violation of that privilege, i.e., the “fruit of the poisonous tree”. See our prior coverage on this issue here.

Should Taxpayers File Amicus Briefs in Tax Court Cases?

by Kevin Spencer and McDermott Will & Schulte | Feb 15, 2017 | Appellate Courts, Court Procedure Matters, Trial Courts, Uncategorized

Amicus–or “friend of the court”–briefs are not uncommon in Supreme Court and appellate court cases. The purpose of an amicus brief is generally to provide assistance to the court by presenting additional arguments either in support or opposition of one of the litigant’s positions. Amicus briefs should not rehash the same arguments presented by one of the parties, but rather should provide insights and a different perspective that is not presented by the parties, and to inform the court of the impact of the issues in the case on other affected parties. The Federal Rules of Appellate Procedure provide detailed rules on how and when to file an amicus brief. See here for Federal Rule of Appellate Procedure 29, which governs amicus filings.

Sometimes, amicus parties want to get involved at the trial court level before the trial record is fixed. Thus, increasingly, amicus briefs are being filed in trial courts, and in particular in the United States Tax Court (Tax Court). When, why and how to file an amicus brief in a trial court is not clear. Indeed, most trial courts do not have procedural rules that directly address those filings. This post provides an overview of some of the considerations and procedures for filing such briefs in a Tax Court case.

Whether to allow an amicus to participate in a case is within the sound discretion of the court. Because the filing of an amicus brief is discretionary, the typical practice is to file a motion seeking permission or“leave” of the court to file an amicus brief accompanied with a statement stating that the litigants do, or do not, object to the filing of the amicus brief.

In deciding whether to grant permission to file anamicus brief, the Tax Court generally examines whether “the proffered information is timely, useful or otherwise helpful.” The court also considers whether amici are advocates for one of the parties, have an interest in the outcome of the case and possess unique information or perspective. This is consistent with the standards applied by other courts in making the determination.

Practice Point: Several factors should be considered by taxpayers in deciding whether to file an amicus brief in Tax Court. In addition to the cost, taxpayers may want to consider whether their position is being adequately represented by another taxpayer’s case and whether they believe that they can provide arguments that might persuade the court to adopt their position. Participation as an amicus can also be helpful to taxpayers in coordinating legal positions and ensuring that the best possible arguments are presented on issues of first impression. An effective amicus brief has the potential to persuade the court, and can be an effective tool to resolve an issue favorably. This is especially true when, because of the specific facts of the taxpayer, the perspectives of other taxpayers are not adequately addressed.

Tax Court Affirms That Reportable Transaction Penalty Is Constitutional

by Joshua M. Ellenberg and McDermott Will & Emery | Feb 10, 2017 | Court Procedure Matters, IRS Guidance, Trial Courts, Uncategorized

In Thompson v. Commissioner, 148 T.C. No. 3 148 (2017), the US Tax Court confirmed that the Internal Revenue Code (IRC) Section 6662A penalty for reportable transactions is constitutional and does not violate the Excessive Fines Clause of the Eighth Amendment.

IRC Section 6662A(a) imposes a penalty on any “reportable transaction understatement.” A “reportable transaction understatement” generally refers to the difference between the increase in the amount of federal income tax that is calculated from the proper treatment of an item that results from a reportable or listed transaction and the taxpayers actually treatment of that item. IRC Section 6662A(b). If a taxpayer fails to adequately disclose a reportable transaction giving rise to an understatement under IRC section 6662A, the penalty is imposed at a rate of 30 percent, and there are no available defenses. IRC Section 6662A(c). However, if a taxpayer sufficiently discloses the details of the transaction, the penalty rate is 20 percent of the amount of the reportable transaction understatement. IRC Section 6662A(a). In this latter instance, a taxpayer may avoid the penalty if he shows reasonable cause and good faith, as well as that there is substantial authority for a position he claimed on the tax return, and the taxpayer reasonably believed that such treatment was more likely than not the proper treatment of the transaction in question. IRC Section 6664(d)(1) and (3).

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Battat v. Commissioner: A Primer on the History of the US Tax Court

by McDermott Will & Emery and Jeffrey M. Glassman | Feb 9, 2017 | Court Procedure Matters, Trial Courts, Uncategorized

In Battat v. Commissioner, the US Tax Court recently affirmed its own constitutionality, in releasing an opinion relating to the President’s authority to remove Tax Court Judges. The taxpayer filed a motion asking the court to disqualify all Tax Court Judges and to declare unconstitutional IRC Section 7443(f), which provides circumstances by which the President can remove Tax Court Judges. The court denied this motion, holding that the President’s limited removal authority does not violate separation of powers principles. The opinion describes the court’s operations, including procedures for the removal of judges, statutory provisions relating to the establishment and government of the court, and caselaw relating to the jurisprudence of the court. Most interestingly, it provides a detailed history of the Tax Court—from its creation by Congress in 1924 as the Board of Tax Appeals and its reestablishment as the US Tax Court in 1969 through present day.

Change in Leadership at DOJ Tax Division

by Kevin Spencer and McDermott Will & Schulte | Feb 3, 2017 | Appellate Courts, Court Procedure Matters, Trial Courts, Uncategorized

The Department of Justice (DOJ) Tax Division is responsible for litigating tax refund claims brought in Federal district courts and the Court of Federal Claims and handling appeals from decisions of the United States Tax Court (the Chief Counsel’s office is responsible for Tax Court litigation). Effective January 23, 2017, David A. Hubbert became the Acting Assistant Attorney General for the DOJ Tax Division. He replaces Carolyn Ciraolo, who resigned on January 20, 2017. A copy of the DOJ press release, which includes biographical information on Mr. Hubbert, can be found here. In accordance with the change, the Internal Revenue Service on January 31, 2017, announced corresponding changes in the address for correspondence to the DOJ Tax Division and the signature block for any Notice of Appeal from a Tax Court case.

Practice Note: The changing of the guard is routine when there is a change in the administration, as demonstrated by the prior resignation of William J. Wilkins as Chief Counsel. However, this year may be a little different as the new administration seems determined to “shake things up.” In the coming weeks and months, we expect a lot of personnel changes. Stay tuned!

IRS Issues IPU on Summons of Foreign Owned US Businesses

by Bradford E. LaBonte and Kevin Spencer | Feb 2, 2017 | Court Procedure Matters, IRS Appeals, IRS Audits, Transfer Pricing Resource, Trial Courts, Uncategorized

On January 30, 2017, the Internal Revenue Service (IRS) released an International Practice Unit (IPU) on the use of a summons under IRC Section 6038A (IRC Section 6038A Summons) when a US corporation is 25-percent owned by a foreign shareholder. See IPU here. The IPU describes the steps that the IRS should take when issuing an IRC Section 6038A Summons, and what to do when the US corporation does not substantially comply with the summons.

In general, IRC Section 6038A imposes reporting and recordkeeping requirements (together with certain procedural compliance requirements) on domestic corporations that are 25-percent foreign-owned, which the regulations refer to as a domestic reporting corporation (DRC). Among other requirements, a DRC is required to keep permanent books of account or records per IRC Section 6001 that are sufficient to establish the correctness of the federal income tax return of the DRC, including information, documents, or records to the extent they may be relevant to determine the correct US tax treatment of transactions with related parties. See Treas. Reg. Section 1.6038A-3.

The IRS may issue an IRC 6038A Summons when: (i) the taxpayer under exam is a DRC; (ii) there was a transaction between the DRC and the 25 percent foreign shareholder or any foreign person related to the DRC or to such 25 percent foreign shareholder; and (iii) the DRC is appointed to act as a limited agent with respect to any request by the IRS to examine its records or produce testimony that may be relevant to the tax treatment of any transaction between the DRC and a foreign related party. If the DRC does not substantially comply in a timely manner with the IRC 6038A Summons, the IRS has sole discretion to determine the amount of the DRC’s deductions related to transactions with, and the cost of property purchased from (or transferred to), the foreign related party.

The IPU is particularly relevant in light of final regulations published in the Federal Register on December 13, 2016 (TD 9796) which treat a domestic disregarded entity wholly owned by a foreign person as a domestic corporation for purposes of the reporting, record maintenance and associated compliance requirements under IRC Section 6038A. The regulations are effective for tax years beginning after December 31, 2016, and ending on or after December 13, 2017. The IPU refers to these regulations in describing the criteria which must be met before the IRS issues an IRC Section 6038A Summons.

Practice Point: For US entities that are owned by foreign entities and file US tax returns, it is crucial to have all of the relevant information for the entity in the US. US taxpayers are required to support all of the positions claimed on a return. For example, if there are expenditures of the US entity that are paid for by the foreign affiliate, there should be adequate documentation in the US to support those payments.

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