United States v. Clarke
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US Supreme Court Denies Petitions for Certiorari Filed In Two Federal Tax Cases

On January 9, 2017, the US Supreme Court denied the petitions for certiorari filed in two federal tax cases.

In Chemtech Royalty Assoc. LP v. United States, Sup. Ct. Dkt. No. 16-810 (2016), 823 F.3d 282 (5th Cir. 2016),

Dow Chemical Co. challenged the decisions by the US Court of Appeals for the Fifth Circuit finding that the partnerships were a “sham” that should be disregarded for tax purposes and imposing the 40 percent substantial understatement penalty. In its petition, Dow complained of the “especially stringent” scrutiny applied by the Fifth Circuit to review a taxpayer’s decision to use the partnership form. “Applying that improper presumption against partnerships, the court became the first court in the nearly seventy years since Culbertson [337 US 733 (1949)] to hold that an investor that contributes its own capital in exchange for an equity interest in the partnership can be disregarded for tax purposes if its equity stake, like preferred stock, is relatively protected against fluctuations in profits and losses.”

The US Supreme Court also denied the petition filed by Dynamo Holdings Ltd. Partnership, Dynamo Holdings Limited Partnership v. United States, Sup. Ct. Dkt. No. 16-358 (2016) 816 F.3d 1310 (11th Cir. 2016),seeking review of an Eleventh Circuit decision that upheld the enforcement of IRS summonses.   Dynamo asked the Supreme Court to consider whether it was unfairly denied a request to amend the case submission to support an evidentiary hearing under then new standard established by this Court in an earlier appearance of this case. Dynamo complained that “this Court held for the first time, United States v. Clarke, 573 US ___, 134 S. Ct. 2361 (2014), that an individual or entity that receives an IRS summons is entitled to a limited evidentiary hearing to obtain discovery to support the claim that the summons should be quashed where that party points to specific facts or circumstances plausibly raising an inference of bad faith.” In contrast,  “[W]hen this case began in 2011, the standard in the Eleventh Circuit was that an individual or entity was entitled to an evidentiary hearing based upon the mere allegation of improper purpose . . . [and Dynamo was found by] the Eleventh Circuit to have satisfied that standard.  On remand from Clarke, the district court denied Petitioners request to make amended submissions to meet the new standard, and the district court and Eleventh Circuit ruled that Petitioners’ former submissions did not meet the new standard.”

Practice Tip:

In deciding whether to file a petition for certiorari, the party should consider the likelihood of the petition being granted and whether the Court’s denial of the petition will result in an adverse negative inference for a continuing issue that is being litigated in other jurisdictions. These cases illustrate how difficult it is to have the Supreme Court grant review.  The Supreme Court accepts few petitions each year and in the absence of a split in the circuits, a petition is unlikely to succeed [...]

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Tax Court Clarifies the Rules and Grants IRS’s Motion to Compel Nonconsensual Depositions

On July 8, 2016, Judge Buch of the US Tax Court (Tax Court) granted the Internal Revenue Services (IRS) motion to compel depositions of six individuals in Dynamo Holdings Ltd. P’ship v. Commissioner.  That case involves the question of whether certain transfers between related entities are disguised gifts or loans.  The IRS has been attempting to take sworn testimony of individuals relating to its examination of Dynamo for several years, which was part of the Supreme Court’s opinion in United States v. Clarke, 135 S.Ct. 2361 (2014).  That summons’s enforcement action is still proceeding. (See United States v. Clarke, lead case: 15-11663).  As a subject of the ongoing discovery disputes, the IRS filed a motion to compel the depositions of six witnesses from Dynamo in the Tax Court. We have previously discussed the Tax Court’s prior opinion in this case regarding the use of predictive coding in responding to the IRS’s discovery requests for electronically stored information.

The Tax Court recognized its longstanding position that nonconsensual depositions are an extraordinary method of discovery.  In ruling on the motion to compel depositions, the court explained the two requirements necessary under the Tax Court Rules of Practice and Procedure (Tax Court Rules) to consider such a motion and three factors to consider in deciding whether to grant such a motion.  To request nonconsensual depositions, the movant must show:  (1) the testimony that the movant seeks to obtain through the depositions is discoverable under Rule 70(b) of the Tax Court Rules; and (2) the testimony sought practicably cannot be obtained through informal consultation or communication, interrogatories, requests for production of documents, or consensual depositions.

If the movant can establish the two requirements, the court will weigh the movant’s:  (1) basis for the deposition; (2) purposes of the depositions other than having a substitute for cross-examination; and (3) prior opportunities to obtain the information sought through the depositions.

Judge Buch found that the two requirements were met because the testimony sought was central to this case, and the IRS could only obtain the information through the examinations, which four of the six witnesses refused to attend.  Additionally, he found that all three factors weighed in favor of compelling the depositions because the information was directly related to the witnesses’ knowledge, which was hard to access through other means, and the IRS has not had a chance to obtain the information because of the witnesses’ refusals to appear when summoned.

Practice Note:  Historically, depositions in the Tax Court were rare.  Since the Tax Court Rules were amended in recent years, this discovery practice has increased dramatically.  In the last five years we have seen the IRS increasingly and routinely request depositions.  This discovery tool, although not at the level that is experienced in district court, is one of the IRS’s new techniques to solidify the taxpayer’s position prior to trial.  We expect this practice to continue for the foreseeable future.  What does this mean to taxpayers?  The costs of litigating in Tax [...]

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