Court Rejects Duty of Clarity Argument Where IRS Had Provided Clarity (3/26/15)

In Bombardier Aero. Corp. v. United States, 2015 U.S. Dist. LEXIS 34801 (D. Tex. 2015), here, Bombardier Aerospace Corporation ("BAC") was a  provider of "management services to aircraft owners and leaseholders of fractional interests in aircraft (collectively, "Aircraft Owners") through its Flexjet program."  BAC was compensated by various fee arrangements, including monthly management fees ("MMF") for certain fixed costs -- "costs associated with ownership of the aircraft, such as insurance, inspection, crew salaries, crew training, aircraft hangaring, and scheduling costs."  The other fees BAC charged were variable operational costs dependent upon use.

Section 4261, here, imposes an excise tax on "taxable transportation."  In this discussion this is sometimes referred to as the "FET."  BAC paid the tax on the required the users to pay it the tax on the variable services and remitted those payments to the IRS.  BAC did not collect the tax from users to pay on the MMF and thus did not initially remit those taxes to the IRS.  In two prior audits, the IRS did not require MMF to pay the FET.  During the audit in question, however, the IRS determined that BAC was liable for the FET.  BAC paid a portion of the tax and sued for refund.  The Government counterclaimed for the balance.

The tax in question was not BAC's tax - it was the user's.  In cases where a collection agent is required to collect and pay over another person's tax, Section 6415(a), here, permits the collection agent to maintain a refund suit provided that the collection agent has either refunded the collected tax to the taxpayer upon whom it was imposed or obtained the consent of that taxpayer to obtain the refund.  Of course, the taxpayer -- the user -- had never paid the portion of the tax BAC paid, so BAC could not meet the first requirement.  And BAC had not obtained the consent of the taxpayers, so BAC failed procedurally to meet that requirement for a refund.  (There is some discussion of the issue of when the consent procedural requirement must be met, but I don't want to discuss that issue in this blog.)

I focus here on certain arguments that BAC made as to IRS past practice and IRS's failure to assert the tax in prior audits of BAC.

BAC's first argument was that the IRS was precluded "by the Duty of Clarity from recovering FET on MMF."  I don't recall that I had encountered the alleged "Duty of Clarity" before.  Apparently subsumed in this rubric was the following specifics:

BAC contends on the following six grounds that it is entitled to a refund and abatement of FET on MMF: first, the IRS expressly approved BAC's tax treatment of MMF in the two prior audits that involved the 11 preceding years; second, the IRS's concessions were substantial, involving more than $40 million in FET; third, after conceding this issue in the prior audits during the Tax Periods, and a few weeks before the first tax return for the Tax Periods was due, the IRS failed to advise BAC that it was changing its position that FET were due on MMF; fourth, the IRS stipulated in Executive Jet that FET did not apply to MMF which the Executive Jet court noted in its opinion), and at no time has the government issued a statement deviating from this position; fifth, more than 50 years ago, in Revenue Ruling 58-215, the IRS opined that FET do not apply to any fees—including MMF—paid by fractional aircraft owners to management companies; and, sixth, the IRS admits in its IRS Audit Technique Guide (2008), concerning fractional management companies such as BAC, that neither title 26 of the United States Code nor any IRS published guidance addresses the issues discussed in this chapter, and these issues include the application of FET to the MMF at issue. BAC posits that, at most, the results of the two prior audits spanning the 11-year period (1995 through 2005) and the IRS's concession of the MMF issue in Executive Jet stand for the proposition that BAC must collect and remit FET on [a variable fee] only, which BAC has done, and, absent clear guidance, the IRS cannot retroactively impose secondary FET liability on BAC for MMF collected from the Aircraft Owners. BAC maintains that clear guidance would have allowed it to determine that it was liable to collect and remit FET on these fees; that, since the time it filed this suit, the IRS has conceded the exact issue in a lawsuit involving one of BAC's direct competitors; and that the Duty of Clarity prevents the IRS from assessing FET from BAC on payments of MMF.

In response, the Government factually asserted that, before the resolution of the first of the prior audits, a TAM was issued which held that BAC was liable for the tax on the MMF, so that, for the period currently in issue, BAC clearly was aware of the Government's position that FET was due on the MMF.  The Government explained that the IRS's did not assert the tax previously, not becuase it was not due, but "solely on the concept of unfair competitive disadvantage, which was made clear in the March 1, 2007 letter from IRS Appeals and confirmed in the testimony of the IRS Appeals officer involved with both previous examinations, who testified that this rationale was based on the treatment given MMF in Executive Jet [a large competitor]" in prior years.  The Government asserted that the IRS was asserting and trying to collect from  the competitors in the years currently involved for BAC.

The court then addresses the argument as follows:

At the outset, the court notes that, although BAC uses the phrase "Duty of Clarity," see P. 4/29/14 Br. 36 ("This obligation is called the government's 'Duty of Clarity.'"), the phrase is not found in either Central Illinois, 435 U.S. 21, 98 S. Ct. 917, 55 L. Ed. 2d 82, or General Elevator v. United States, 20 Cl. Ct. 345, 353 (1990), the cases that BAC cites to support such a duty. The court's own research indicates that, although federal courts have sporadically used the phrase "Duty of Clarity," they have never done so in this context or for the purpose for which BAC employs it. Even so, the government does not argue that there is no Duty of Clarity, or that, regardless of the doctrine's name, it had no duty to give clear guidance to a tax collector in the circumstances of this case; indeed, it maintains that it did give such guidance. The court will therefore use the phrase "Duty of Clarity."

The court then discussed the two cases cited -- Central Illinois and General Elevator -- which did relieve a collector of other taxes from liability, which did suggest, in other circumstances, that the IRS owes a duty to inform collectors of their obligation to withhold.

The court then holds (some footnotes omitted):

The court holds that a reasonable trier of fact could only find from the summary judgment evidence that BAC was given notice of a precise and clear duty to collect FET on MMF, that is, that the notice was sufficient to apprise BAC about what the IRS thought the law was and therefore what actions BAC was required to take. 

BAC relies on a host of factors that the court details above (including the Federal Circuit's decision in Executive Jet) to contend that it lacked sufficiently clear and precise notice of its obligation to collect FET on MMF. But it is undisputed that, on February 14, 2004, before any Tax Period at issue in this case, the IRS notified BAC via the 2004 TAM that all of the fees received by the manager in the Flexjet program were subject to FET. In other words, unlike in General Elevator, where the IRS apparently expected the employer to divine its tax collection obligations from such sources as a revenue ruling that had been suspended indefinitely and did not specifically cover the employer's practices, and two other rulings that related to "somewhat similar circumstances," in the present case the IRS stated its position unequivocally in a TAM involving the very conduct at issue in this litigation, which was addressed to BAC's predecessor. n17
   n17 In its reply brief, BAC asserts that it "never received prior notice that the IRS believed that the [MMF] were subject to FET." 6/3/14 Br. 13. BAC's counsel made a similar assertion at oral argument. See Tr. Oral Arg. 20 ("After they told us that you don't have to do anything else, they issued nothing telling us or the world that they were changing their position and now taxing management fees."). It is difficult to understand how BAC can take this position given the undisputed summary judgment evidence to the contrary. 

BAC argues that the 2004 TAM was nullified because, after it was issued for the first audit cycle, the IRS conceded during the same administrative audit that BAC did not owe FET on MMF, and it conceded the same issue in the next audit cycle as well. BAC maintains that these two concessions constitute a final decision in favor of the taxpayer that is subsequent and contrary to the 2004 TAM. Based on the same two IRS concessions, BAC maintains that the 2004 TAM could not have provided "clear, non-speculative notice" for purposes of satisfying the Duty of Clarity. P. 2/10/15 Br. 5. It essentially contends that the IRS confused it when, after issuing the 2004 TAM, it conceded in the two audits that no FET were owed for two tax years (conceding millions of dollars in proposed FET assessments) and refunded more than $1.2 million of FET on MMF. 

A reasonable trier of fact could not find in BAC's favor on these grounds. The evidence shows that, when the IRS Appeals officer wrote to BAC on March 6, 2007 conceding that FET were not owed, he stated, in relevant part:As I indicated in our discussion, I am recommending the excise tax on aircraft management fees issue be conceded in full by the Government for the tax periods indicated due to the unfair competitive disadvantage principle established by International Business Machines Corp., 343 F.2d 914, 170 Ct. Cl. 357 (Ct. Cl. 1965), and followed by Sirbo, 476 F.2d 981 (CA-2, 1973). No Form 906 closing agreement will be entered into because as I explained the underlying issue is very strong for the Government, but will be conceded for the periods indicated only for the reason stated above.D. 5/20/14 App. 19. The evidence therefore establishes that the IRS Appeals officer was addressing excise taxes on aircraft management fees for the tax quarters ending June 30, 1998 through December 31, 2005, i.e., periods prior to the ones at issue in this lawsuit, and that the concession was not based on any agreement with BAC's position regarding whether FET were owed on MMF. To the contrary, the letter asserted that the government's position was "very strong." BAC could not therefore have reasonably interpreted the letter to take any position other than this: with respect to tax years prior to the ones in question in this litigation, the IRS was conceding that FET were not owed, and it was entering into this concession based solely on the "unfair competitive disadvantage principle."n20 The 2004 TAM was therefore not compromised in the least.
   n20 BAC at once challenges whether the IRS actually did so for this reason and  asserts that "the reasoning behind [the IRS's] concessions in the two prior audits is unimportant." P. 6/3/14 Br. 14-15. Although there is ample record evidence that the IRS made this concession based on the taxation of MMF paid as part of Executive Jet's fractional interest program (most recently the subject of the NetJets case), the court agrees with BAC's assertion that the IRS's precise reasoning (or motivation) is "unimportant." This is because what matters for purposes of applying the Duty of Clarity is that BAC was on notice that the IRS, when conceding the issue for the tax periods in question, was not questioning the merits of whether FET were owed on MMF but was conceding the point for reasons unrelated to the merits. Indeed, the IRS opined in the letter that the government's position was "very strong." 

   BAC also relies on a June 7, 2006 memorandum of IRS Manager John S. Munholland, in which he stated that the concessions by the IRS were based upon a legal conclusion that MMF were not payments for taxable transportation and therefore not subject to FET. This reliance is misplaced for purposes of applying the Duty of Clarity because it is based on a position taken in a document that was first produced after the fact—during discovery in this litigation. It therefore could not have confused or misled BAC concerning its obligation to collect FET on MMF. 

* * * * 

In sum, regardless of what was happening in the industry, and regardless of the IRS's concession concerning prior tax periods, the 2004 TAM provided clear and non-speculative advice to BAC that it was obligated to collect FET on MMF. The court therefore holds that the government is entitled to summary judgment concerning BAC's Duty of Clarity argument.

Then the court addressed BAC's argument for estoppel.  The Court rejects the argument, finding that the IRS did not in fact, for the period involved, treat other providers similarly situated differently.  That a court held for a provider in another case does not mean that the IRS treated that provider differently.

The Court then held for the Government on its summary judgment motion for its counterclaim for basically the same reasons.

JAT Comments:

1.  Note that the IRS gave relief based on the IBM case, International Business Machines Corp. v. United States, 343 F2d 914 (Ct. Cl. 1965).  Here is what I say about IBM in the current version of my text:

Finally, in a rare case where a PLR improperly gave a taxpayer a competitive advantage, one case preceding § 6110 when the administrative rules and generally case law had a similar prohibition on one taxpayer’s attempt to rely on another taxpayer’s PLR, the Court of Claims appellate division (the predecessor to the Court of Appeals for the Federal Circuit) permitted reliance in a backhanded way.  See International Business Machines Corp. v. United States, 343 F2d 914 (Ct. Cl. 1965), cert. denied, 382 US 1028 (1966), discussed below at p. 91.  I say IBM is a rare case because taxpayers frequently seek to bootstrap reliance on a PLR via the IBM case, but rarely succeed.

Although courts rarely apply IBM, this case illustrates that the IRS is not unreceptive to competitive disadvantage arguments where the facts permit.  In this case, the facts really did not support the argument.

2.  I too had never encountered the Duty of Clarity.  I guess it is like a duty of fairness to someone who has an obligation to collect from others and may not have the ability after the fact to collect.  As clarified above, I think it entails a number of equitable concepts -- such as duty of consistency, duty of fairness, and such fuzzy notions that usually don't but sometimes  may apply in tax cases.  At any rate, the judge did not apply the concept nor even concede that it could apply.

3.  One thing I have learned over the years is that it is not good to lose your credibility with a judge.  Notice in footnote 17 that the lawyer seems to have been called off base.  I have no idea whether that hurt his case, but the fact that the judge felt it necessary or, at least, appropriate to mention it suggests that it played some part, if not a controlling part.  BAC's case on the merits was pretty weak anyway, and in that environment anything that can be done to help the client is best.  Taking aggressive positions with the facts is not good.