Friday, May 2, 2014

Discovery from IRS Files and Employees About Fair Notice of Liability and Treatment of Other Taxpayers (5/2/14)

In NetJets Large Aircraft, Inc. v. United States, 2014 U.S. Dist. LEXIS 58677 (SD OH 2014), here, Magistrate Judge Terence P. Kemp, here, resolved discovery disputes in this tax refund and abatement action relating to transportation tax under Section 4261, here.  Magistrate Judge Kemp does a very good job addressing discovery issues related to the IRS's alleged inconsistent application of the Section 4261 tax.  I am not sure the opinion will survive unscathed on appeal to the district judge, but it is a good opinion.  So I offer it to readers of this blog.

The taxpayers "provide aircraft management and aviation support services to aircraft owners and leaseholders (with whole and/or fractional interests in the aircrafts)."  I think the question in terms of the substantive application of the law is whether the taxpayers' role in providing ownership or leasing and all related services to fractional owners/leaseholders is serving in an analogous role to airline companies who must collect the tax from their customers (who, after all, can viewed as leasing the space on the plane for the time of the trip).

In a prior case, Executive Jet Aviation, Inc. v. United States, 125 F.3d 1463 (Fed. Cir. 1998), here, the Court held "the occupied hourly fees that fractional management companies received from fractional owners were subject to the tax imposed by section 4261(a)."  The taxpayers in NetJets apparently try to differentiate that case on the basis that the Executive Jet decision was premised on the arrangement not being "a bona fide economic arrangement."

Subsequently, the IRS promulgated regulations that, according to the taxpayers, make such arrangements bona fide when agreements of the type that the taxpayers used with their customers.

Notwithstanding the alleged distinction of the Executive Jet Aviation decision, the IRS asserted the tax against the taxpayers.

The litigation and the discovery disputes ensued.

The basic rule of discovery is that it be relevant to a legitimate dispute in the case.  To determine that, the Court reviewed the relief the taxpayers sought as follows:
(1) Plaintiffs do not provide "taxable transportation" under 26 U.S.C. §4261, and thus the payments Plaintiffs receive from aircraft owners are not subject to the section 4261 excise tax;
(2) The IRS failed to provide clear guidance to Plaintiffs that they were required to collect and remit the section 4261 excise tax on the monthly management and fuel variable surcharge fees they received from aircraft owners;
(3) The IRS violated its duty to treat similar taxpayers in a consistent manner because it has assessed the section 4261 excise tax against certain of the fees that Plaintiffs charge fractional aircraft owners while not assessing the tax against those same fees with respect to certain of Plaintiffs' competitors; and
(4) The IRS is legally bound by a Technical Advice Memorandum ("TAM") it issued to Plaintiffs' predecessor, Executive Jet Aviation, in 1992, which provides that only the occupied hourly fees paid by fractional aircraft owners, and not monthly management or fuel variable surcharge fees, constitute payments for "taxable transportation" under 26 U.S.C. §4261. Under applicable Treasury regulations, as well as the IRS's own internal guidelines, the IRS is bound by the 1992 TAM until such time as the IRS issues Plaintiffs another TAM modifying or replacing the one from 1992. The IRS has never issued such a subsequent TAM, and thus its assessment of the section 4261 tax against Plaintiffs' monthly management and fuel variable surcharge fees, in violation of Treasury regulations and IRS guidelines, was unlawful.
As the Court noted, the first is a legal dispute -- how to interpret the law and apply it to the taxpayers' facts.  Discovery from the Government is not required for that.

But, the other three claims, the Court held, have enough claim to possible merit that discovery is required.  I thought it might be helpful to summarize the Court's analysis.  For each heading, I will provide my own statement of the issue involved.

1.  Does the IRS's alleged failure to provide proper guidance foreclose the IRS from collecting a tax otherwise due?

I think most practitioners would probably answer that question no.  In this case, the Government's position was that the statutes and the Executive Jet decisions should have put the taxpayers on notice, in any event.  But as noted by the Court, the taxpayers' argument was more subtle.  I am not sure I can faithfully summarize the Court's reasoning (seemingly to me very tight and good), I will say generally that the Court read two precedents as requiring fair notice to a taxpayer obligated to collect and pay over tax.  Central Illinois Public Service Co. v. United States, 435 U.S. 21 (1978), here; and General Elevator Corp. v. United States, 20 Cl. Ct. 345 (1990).  The Court then concluded:
While the parties may dispute exactly what amount of notice the IRS must provide to employers with secondary liability for collecting taxes, since notice is an issue in this case, Plaintiffs are entitled to discovery about it.
The discovery the taxpayers wanted on this issue was the internal deliberations which might be proof that the taxpayers' uncertainty was reasonable in view of the lack of notice from the IRS.  The Court concluded that "because internal IRS deliberations would inform the question of whether Plaintiffs' actions were reasonable in light of the published guidance and absent evidence that permitting such discovery would be unduly duplicative, burdensome, or privileged the Court determines that those deliberations are within the proper scope of discovery."

2.  Does the IRS's possible alleged inconsistent treatment of the taxpayers by not applying the tax to others foreclose the IRS from collecting the tax otherwise due?

From the unstartling proposition that, as a general matter, similarly situated taxpayers should be treated the same by the IRS, the Court opens up discovery on that issue.  Yet, most of the times this genre of argument is made either for relief on the merits or for discovery that might lead to relief on the merits, it fails.  The Court noted some different treatments among the courts, but extended its interpretation of Sixth Circuit authority to making this a discoverable issue.

Unless all cases are open to this type of discovery in every tax case (which will bog litigants and courts down interminably), I am not sure the Court articulated a basis for permitting the discovery in this case.  I encourage readers of this blog to read the opinion.

I do note that the Court did later in the opinion address the Section 6103 issue regarding the confidentiality of the other taxpayers' tax return information.  Basically, the Court said that the Government must assert that issue, like a privilege, in the context of the documents and information sought.  For example, the documents related to Executive Jet Management, Inc. must be produced subject to assertion of appropriate privilege, including Section 6103.

3.  Is the IRS bound by a TAM it issued to taxpayers' predecessor?

The Court punted on this one, finding that it "does not have enough evidence at this time to determine what testimony, if any, would be relevant to this theory."

The Court then resolved a dispute as to whether the taxpayer had complied with regulations requiring notice to and approval from the Commissioner before IRS officials could disclose information.  26 C.F.R. §301.9000-1 through 7; see United States ex rel Touhy v. Ragen, 340 U.S. 462, 467-69 (1951), here.  The Court applied the case authority that discovery in a case in which the U.S. is a party trumps this requirement.

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