My Suggestions to Tax Court on Procedure Related Matters (11/23/20)

On September 1, 2020, I sent the Tax Court Clerk a letter with suggestions regarding matters related somewhat to tax procedure.  A copy of the letter is here.  I have not had any response to the letter.  I thought I would excerpt and post the contents of the letter here in the event others might be interested in the subjects:

September 1, 2020

Stephanie A. Servoss
Clerk of the Court
United States Tax Court
400 Second Street, NW
Washington, D.C. 20217

Re: Suggestions for Tax Court Rules or Other Practices

Dear Ms. Servoss:

I write to make suggestions that might be incorporated in Tax Court Rules or otherwise adopted:

1. Make Public Tax Court Style Manual.  If there is a Tax Court style manual or other similar guide for judges (such as there is, for example, in the U.S. Supreme Court), I think the taxpayers and the bar would benefit from that style manual being public information.  I have been informed that there is such a Tax Court style manual or guide but that it is not public information.  The public need for access to the manual plays beyond checking to see whether judges conform to the manual (the Court may not require conformance, which I infer from deviations in practices, such as the location of periods and endquotes, that are normally covered by style manuals).   For example, commenters on such style manuals state that it is better practice to conform court submissions to the court=s style manual unless there is a good reason to deviate.  Whether that concern is fair or not is not the issue.  Whether the public should know the contents of the style manual is the issue, for such use as the public may choose to put those contents. 

2. Make Public Changes to Opinions After the Original Publication.  The Supreme Court advises the public of changes to Slip Opinions.  An example of such public notice of change is at: www.supremecourt.gov/opinions/19pdf/19 7diff_o7kq.pdf.  I recommend that a similar public disclosure be made for Tax Court opinions. 

3. Establish a Process for NonParties to Advise the Court of Possible Material Nonsubstantive Errors.  By nonsubstantive, I mean to exclude comments on application of the law to the facts found and legal analysis.  Nonsubstantive thus would include material comments on the syntax or such matters that can lead to confusion for readers.  Many of the errors of this sort are apparent and any reader may just mentally supply the corrections.  For example, I noticed a verb missing in a sentence recently, but it was easy to supply mentally and likely would not be confusing to most readers (although it may slow them down a bit to do the mental gymnastics).  But some errors may require the reader to work harder to understand the opinion and thus might be appropriate for correction, much as the Supreme Court does.  Parties would be expected to call outcome-determinative nonsubstantive errors to the Court's attention but may not call them to the Court's attention if they are not outcome-determinative.  Many nonparties study Tax Court opinions and spot such errors in the few cases in which they appear and could offer a valuable service to the Court, taxpayers and practitioners where the Court determined that correction is appropriate.  I understand from my sources that, from time to time, nonparties (generally practitioners) may write informally to the judge (by email or letter) advising of the nonsubstantive errors but, quite appropriately, do not hear back and do not know whether any action was taken (short of periodically checking the slip opinions or final T.C. opinion).  The point is that, I think, it would be helpful to all involved (including readers) to have a regularized process to get the information to the Court for such use as it may deem appropriate.  I do not think that any response would be required to the person making the comment or suggestion, other than perhaps a routine form thank you letter or email.  I also do not think it would be necessary to make those letters (or emails if included in the process) from nonparties public on the website or otherwise.  I suspect that most of the comments or suggestions will not require any action, but some may warrant action (e.g., correction of the slip opinions).

Thank you for considering these suggestions.

Sincerely yours,

John A. Townsend

cc: Alexandra Minkovich (by email: Alexandra.minkovich@bakermckenzie.com)
Chair, ABA Tax Section Court Procedure
and Practice Committee

Keith Fogg (by email: kfogg@law.harvard.edu)

JAT Comment:

More Coca-Cola - On Transfer Pricing and Blocked Income Regulation (11/23/20)

I recently wrote on burden of proof issues in The Coca-Cola Company v. Commissioner, 155 T.C. ___, No. 10 (2020), here.  Tax Court (Judge Lauber) Issues Significant Transfer Pricing Decision in Coca-Cola; Burden of Proof Issues (11/19/20; 11/21/20), here.  Coca-Cola is a transfer pricing case, meaning that it is a valuation case.  Valuation cases are generally humdrum on the issue of valuation, an issue raised in many contexts including in abusive tax shelters since the 1970s when I first began observing them.  Transfer pricing can be abusive as well because valuation can be abused.  I don’t propose to delve into the factual issues bearing on valuation Coca-Cola and whether the underlying valuations Coca-Cola used were abusive.  

I rather today point to this discussion of the “blocked income” issue.  The issue is described in high overview (pp. 184-185, beginning here):

2. Brazilian "Blocked Income"

Petitioner alternatively contends that, if TCCC owned the Brazilian trademarks, Brazilian law would have prevented the Brazilian supply point from paying, for use of those trademarks, royalties anywhere close to the amounts determined in the notice of deficiency. During 2007-2009 Brazilian law restricted the amount of trademark royalty and technology transfer payments that a Brazilian entity could pay to a foreign parent. The parties have stipulated that those maximum amounts were approximately $16 million for 2007, $19 million for 2008, and $21 million for 2009.

Relying on what is commonly called the "blocked income" regulation, respondent contends that these Brazilian legal restrictions should be given no effect in determining the arm's-length transfer price. See sec. 1.482-1(h)(2), Income Tax Regs. The regulation generally provides that foreign legal restrictions will be taken into account only if four conditions are met. See id. subdiv. (ii). Petitioner contends that this regulation does not apply here or that the necessary conditions were met. Alternatively, it contends that the blocked income regulation is invalid under the Administrative Procedure Act and/or Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).

As the parties have observed, the validity of section 1.482-1(h)(2), Income Tax Regs., has been challenged by the taxpayer in 3M Co. & Subs. v. Commissioner, T.C. Dkt. No. 5816-13 (filed Mar. 11, 2013). The Court has granted a motion to submit the 3M case for decision without trial under Rule 122, and the case is still pending. We will accordingly reserve ruling on the parties' arguments concerning the blocked income regulation until an opinion in the 3M case has been issued.

The Blocked Income Issue as I recall it from my transfer pricing forays over the years hearkens back to Commissioner v. First Sec. Bank of Utah, 405 U.S. 394 (1972), here.  In that case, in high level summary, the Court held that § 482 did not authorize the IRS to allocate income from one related company to another if state law prohibited the income from being paid.  The Blocked Income Issue is whether the foreign law prohibition upon paying royalties prohibits the IRS from allocating the income to the U.S. party.  The underlying “Blocked Income” regulations, 26 CFR 1.482-1(h)(2), here, imposes the following conditions on the First Sec. Bank results (no allocation).

(ii) Applicable legal restrictions. Foreign legal restrictions (whether temporary or permanent) will be taken into account for purposes of this paragraph (h)(2) only if, and so long as, the conditions set forth in paragraphs (h)(2)(ii) (A) through (D) of this section are met.

(A) The restrictions are publicly promulgated, generally applicable to all similarly situated persons (both controlled and uncontrolled), and not imposed as part of a commercial transaction between the taxpayer and the foreign sovereign;

(B) The taxpayer (or other member of the controlled group with respect to which the restrictions apply) has exhausted all remedies prescribed by foreign law or practice for obtaining a waiver of such restrictions (other than remedies that would have a negligible prospect of success if pursued);

(C) The restrictions expressly prevented the payment or receipt, in any form, of part or all of the arm's length amount that would otherwise be required under section 482 (for example, a restriction that applies only to the deductibility of an expense for tax purposes is not a restriction on payment or receipt for this purpose); and

(D) The related parties subject to the restriction did not engage in any arrangement with controlled or uncontrolled parties that had the effect of circumventing the restriction, and have not otherwise violated the restriction in any material respect.

I don’t propose to develop the Blocked Income Issue further here, since I am sure it has been adequately developed in the 3M case to which the Coca-Cola both referred and deferred.  Readers should just be aware that further enlightenment is coming in 3M.

JAT Comments.

Tax Court (Judge Lauber) Issues Significant Transfer Pricing Decision in Coca-Cola; Burden of Proof Issues (11/19/20; 11/25/20)

Yesterday, the Tax Court decided The Coca-Cola Company v. Commissioner, 155 T.C. ___, No. 10 (2020), GS here, a transfer pricing company case in which the IRS seems to have substantially prevailed.  Transfer pricing cases are fact intensive cases.  However, in this discussion, I won’t wander through the morass of facts but rather deal with burden of proof issues that, although presented in a fact setting, can be considered at a conceptual level independent of the facts of the case.  However, I do ask that readers keep in mind that transfer pricing cases are, at bottom, simply valuation cases.

I recently wrote an article on burden of proof in tax cases.  John A. Townsend, Burden of Proof in Tax Cases: Valuation and Ranges—An Update, 73 Tax Lawyer 389 (2020), here.  In that article, I discussed the seminal case of Helvering v. Taylor, 293 U.S. 507 (1935), see discussion beginning on p. 411, here.  In that case in summary and without nuance, the Court held that in a deficiency case in the Tax Court, once the taxpayer shows the deficiency is “arbitrary and excessive,” the IRS bears the burden of persuasion (risk of nonpersuasion) to show that the taxpayer has a deficiency.  Three nuance points:  (i) I address in the article (p. 397 n. 28, here) that “arbitrary and excessive,” although stated in the conjunctive is really disjunctive; (ii) if the issue involves a deduction turning upon valuation, the taxpayer will bear the burden of persuasion with respect to value to support the deduction; and (iii) the burden of persuasion is often called the risk of nonpersuasion which is more descriptive of how the burden of persuasion performs, but I used the term burden of persuasion here.

I illustrate the key concept of the article in a simple example. Assume that the taxpayer receives property in a service income transaction.  Taxpayer reports $40 income on his tax return based on valuing the property at that amount.  The IRS determines a deficiency of tax by valuing the property at $100.  The parties litigate in the Tax Court.  The Tax Court cannot find a finite value by a preponderance of the evidence but can find a range where the low end of the range is the lowest value proved by a preponderance of the evidence and the high end of the range is the highest value proved by a preponderance of the evidence.  Let’s say that range is from $70 to $80.  (This range may also be called the range of equipoise where the Court (or other trier of fact) is in equipoise as to the valuation based on the preponderance of the evidence standard.)

In the example, Helvering v. Taylor, 293 U.S. 507 (1935) requires that the value be determined at $70 because the taxpayer has shown the deficiency determination excessive because of the excessive valuation.  The IRS thus bears the burden of persuasion as to an amount that would produce some deficiency amount.  In the example, the evidence proves by a preponderance a value of at least $70 and the Tax Court should determine the deficiency accordingly.

The IRS Says Audit Rates Increase as Income Rises and Offers Data and Explanations (11/8/20)

The IRS offers a web page titled “Audit Rates Increase as Income Rises” (Page Last Reviewed or Updated: 03-Nov-2020), here.  The web page provides tables with data drawn for the years 2013-2015 from the 2019 Databook, Table 17a, showing that the audit rates are significant for the no total positive income returns because of the high rate of refundable EITC errors.  For positive income returns, the audit rates range from less than 1% for $1-$25,000 of positive income and up to 12% in one year and 8% in the other two years for income up to and exceeding $10 million of positive income.  

The web page explains (excerpts):

Despite common misperceptions about IRS examination rates, the reality is that the likelihood of an audit significantly increases as income grows.

Taxpayers with incomes of $10 million and above had substantially higher audit rates than taxpayers in every other income category for each calendar year from 2010 through 2015. Those with incomes above $1 million also had higher exam rates than all other groups earning less.

* * * * 

The typical audits for higher-income taxpayers involve at least three different tax years, often include related entities, and routinely take years to resolve. The highest income taxpayers face the most significant chance of an examination, and they face the most highly trained and experienced IRS agents and teams utilizing our most sophisticated tools and techniques.

One may ask, whether regardless of the audit rates, should the IRS simply audit fewer lower-income taxpayers receiving EITC? Here’s the challenge with doing that: Error rates on tax returns claiming EITC are around 50%, and the improper payment rate involving EITC claims is more than $17 billion each year. There are several factors behind why the improper payment rate is at that level – some of this is that, despite significant guidance provided by the IRS and others, people (including tax preparers) simply misunderstand the complex EITC rules, and others involve misreporting income. Each year, at the start of the tax filing season, IRS participates in EITC Awareness Day events throughout the country in an effort to increase participation by eligible people and enhance the rate of compliance.

The IRS fully appreciates the importance of the refundable EITC and the significant difference it makes for people. More than 25 million people claim EITC per year, generating more than $63 billion each year to people in need. This program lifts millions of Americans out of poverty, and the IRS is proud to work hard each year to raise awareness about the program since many, many people simply overlook claiming this important refundable credit that they are entitled to.

At the end of the day, the IRS strives to properly serve compliant taxpayers and uphold the nation’s tax laws, ranging from civil side audits and notices to criminal investigations in the most egregious cases. We face tough choices each year as far as where to deploy resources given the breadth of our responsibilities, but our choices are guided by fair and impartial audit plans throughout the process.

FTPB 2020 Update 06 – Presumptions in Litigation (11/6/20)

In the discussion of Presumptions in the 2020 editions of the Federal Tax Procedure book (Practitioner Ed. pp. 576-577; Student Ed. pp. 399-400), I quote Rule 301. Presumptions in General Civil Actions and Proceedings.  I had not updated that discussion to include the revision of Rule 301 in 2011.  (Apologies to readers.)  As revised the Rule (here) reads:

Rule 301. Presumptions in Civil Cases Generally

In a civil case, unless a federal statute or these rules provide otherwise, the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption. But this rule does not shift the burden of persuasion, which remains on the party who had it originally.

As stated in the Committee Notes on Rules-2011 Amendment, the Rule was amended in 2011 solely for readability and stylistic reasons but without change in substance from Federal Rule of Evidence 301 as enacted in 1976.  That means that the discussion in the 2020 editions is appropriate for present purposes.

I have also in the working draft for the 2021 editions of the Federal Tax Procedure book made other changes in the section dealing with Presumptions.  Those changes are not materially different from the discussion in the 2020 editions, so I do not offer them now.  However, those wanting most of that nuance can find it in John A. Townsend, Burden of Proof in Tax Cases: Valuation and Ranges—An Update, 73 Tax Lawyer 389, 403-407 (2020).  (The article can be viewed and downloaded at SSRN here.)

Robert Frank Editorial on Decline in Enforcement Resources and Tax Evasion (11/3/20)

 Noted economist Robert H. Frank (Wikipedia here) has written an excellent NYT op-ed: Without More Enforcement, Tax Evasion Will Spread Like a Virus (NYT 10/30/20), here.  Excerpts

Few people enjoy paying taxes, but as Oliver Wendell Holmes Jr. reminded us, “Taxes are what we pay for civilized society.” On reflection, most of us therefore offer at least implicit support for penalties against tax evasion — penalties that have little meaning unless backed by significant enforcement resources.

Yet prodded mainly by anti-tax Republicans, Congress has cut the Internal Revenue Service budget steadily since 2011. By 2019, the agency was auditing only one in every 222 individual returns, down from one in 90 in 2011. Similar reductions have occurred for corporate returns, and were proportionately larger for the wealthiest individuals and largest corporations.

These cuts have not saved the government money. The former I.R.S. commissioner John A. Koskinen estimated, for example, that every $1 trimmed from the agency’s budget has resulted in $4 in lost revenue. But this estimate refers only to direct, or first-round, losses. Because the extent to which people comply with tax laws depends strongly on the behavior of others around them, the ultimate revenue losses are certain to be much larger.

* * * *

What the reductions in I.R.S. funding will continue to unleash, then, is a characteristic feature of all behavioral contagion processes: an explosive chain of feedback loops that greatly amplify any initial change in behavior.