Tax Case Illustrating the First Rule of Persuasion--Avoid Irritating the Person You Seek to Persuade (12/3/23)

In Fitzgerald Truck Parts, Inc. v. United States, 2023 WL 8100540, 2023 U.S. Dist. LEXIS 208420 (M.D. Tenn. 11/21/23), CL here and GS here, “After a trial held in Cookeville, Tennessee between July 10 and July 14, 2023, a jury found that Fitzgerald Truck Parts and Sales, LLC (“Fitzgerald”) was not liable for excise tax on some  12,830 glider semi trucks sold between 2012 and 2017.” The Government moved for Judgment as a Matter of Law or New Trial. The Court denied the motion.

I am not sure there is any federal tax procedure issue involved in the opinion, except that tax procedure necessarily involves trial procedures. For that reason, this decision is a doozy, primarily because the judge appears (my inference) to be irritated with the Government claims on the motion.

The essential facts are recounted in the opinion (pp. 1-3 bold face supplied by JAT):

          For more than 30 years, and up until Environmental Protection Agency (“EPA”) regulations essentially abolished the market, Fitzgerald manufactured glider semi-trucks. It did so by placing rebuilt engines and transmissions from wrecked highway tractors into glider kits produced by original equipment manufacturers. The kits from those manufacturers generally included such things as the cab, frame, sheet metal, mounting brackets and steering gear, to which the rebuilt powertrains were then added. Through this method, the goal was to offer for sale essentially a new truck – albeit with a rebuilt engine and transmission – at a lower price than a comparable truck from the factory.

          Not only did the customer receive a reduction in price, the customer was also not on the hook for  excise taxes, at least if the governing regulations were followed. Herein lies the core of the parties’ dispute.

          Under the Internal Revenue Code, a 12% federal excise tax is imposed “on the first retail sale” of “tractors of the kind chiefly used for highway transportation in combination with a trailer or semitrailer.” 26 U.S.C. § 4051(a)(1). The code also contains a safe harbor provision that states:

(f) Certain repairs and modifications not treated as manufacture (1) In general An article described in section 4051(a)(1) shall not be treated as manufactured or produced solely by reason of repairs or modifications to the article (including any modification which changes the transportation function of the article or restores a wrecked article to a functional condition) if the cost of such repairs and modifications does not exceed 75 percent of the retail price of a comparable new article.

26 U.S.C. § 4052(f)(1).

          It has been Fitzgerald’s position throughout that the trucks it produced met the safe harbor [*3] provision. The Internal Revenue Service (“IRS”) disagrees. In accordance with IRS regulations, Fitzgerald paid the excise tax on one truck for each quarter of the tax years at issue, meaning excise taxes were not paid on some 12,800-plus gliders. The stakes are enormous, especially for a company that is no longer producing trucks, and never collected the excise tax from the purchaser in the first place. Those taxes are more than ten million dollars. Penalties and interest place that figure in the neighborhood of $300 million.

The opinion recounts some Government claims regarding evidence that are standard fare in tax cases to a jury, such as prior audits approving or not questioning the taxpayer’s reporting. That’s not particularly interesting to me, although taxpayers with former audits and counsel representing them may find that discussion interesting.

I was particularly interested in the expert witness's claims first at pp. 3-4 in connection with the Government's motion to redact from the trial transcript the court's concerns about the Government's expert witness and then at pp. 18-22 the Government's complaint about the court's rejection of that expert testimony.

II. Motion to Redact.

In a first for the Court, the Government accuses the Court of acting libelously in its Daubert [Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993)] ruling in relation to the Government’s proposed expert Dr. Yingzhen Li. It seeks to redact two pages of the transcript of the Daubert hearing wherein the Court discusses Dr. Li’s insipid testimony and [*4] suggests that he reached a foregone conclusion based upon what the Government told him. In other words, Dr. Li was a hired gun. The bulk of the Government’s brief, however, both in support and in reply on its Motion to Redact, focuses on whether the Court reached the correct conclusion in not permitting Dr. Li to testify. Perhaps this is because the Government has no legal basis to request the transcript be redacted.

 It did not go well from there. 

The court later (pp. 18-22) addresses the Government claim that the court improperly rejected Dr. Li as an expert based on the court’s Daubert consideration. This too did not go well. Here is part of what the court said:

          At the conclusion of a Daubert hearing, the Court ruled that Dr. Li would not be allowed to testify as an expert witness. Among other things, the Court observed:

          Throughout his testimony today and many mentions in his written report, his goal is to say that plaintiff's claims and representations aren’t truthful. And that, to a large extent, explains why he can identify no standards in the economic field to support his opinions.

          Daubert requires much more than a witness come in with a PhD, with an impressive work history, and simply give opinions because he says so. Indeed, that kind of analysis has been rejected by many courts. What he requires and what I was looking for from Dr. Li is some type of economic principles, accepted within the field, that [*19] he brought to bear in coming to his opinions and then let cross-examination and the wisdom of the jury, based upon the law that the Court will provide the jury, to determine what weight to give to it.

          But his inability to identify persuasively or credibly any type of economic principles he applied regretfully leads the Court to conclude that he’s simply not satisfying the standard and I will say the low bar in Daubert for the Court to recognize him as an expert under 702. At the pretrial conference . . . , I identified the first part of this trial as the safe harbor analysis. Reading Dr. Li’s written report, listening to his testimony here today and then analyzing the safe harbor analysis statute, the Court simply cannot find anything in his report that's going to be relevant or based upon reliable standards that will go – that will be helpful to the jury on the issue of the cost of repair or to modify an article that is less than 75 percent of the retail price of a comparable new article. Nothing he says is going to help the jury make a determination on whether or not the repaired or modified article, if new, is taxable under Section 4051. And nothing in his report and his testimony will help the jury determine was the original article not taxable for the purpose of Section 4051 or another provision. Without that kind of analysis supported by economic principles that have been accepted, even if Dr. Li meets this standard of qualifications based on his doctorate and work experience, the Court finds him lacking on the test of relevancy and reliability.

(Doc. No. 182 at 120-22).

The court rejected the Government's claim that the taxpayer had not disagreed about the witness' being an expert, saying that the Daubert standards, although relatively low, still required the court to reach an independent judgment as to whether the witness' testimony invoked his expertise in a way that could assist the jury. Here the court elaborated:

To this day, Dr. Li’s reasoning and/or methodology has yet to be cogently explained. He began his Daubert hearing testimony by stating that he was an expert in the “transactional analysis field,” (Doc. No 182 at 73), even though that phraseology was not used in his expert report. (Doc. No. 182 at 73). Next, during a colloquy with the Court, Government’s counsel suggested that “there is a concept that is recognized within the courts of testing economic substance,” and Dr. Li then [*21] claimed that is what he did in relation to the samples he “tested.” (Id. at 81). Later, during cross-examination, Dr. Li stated that he conducted a “forensic accounting analysis,” even though he admitted he was not a forensic accountant. (Id. at 82). Finally, in its brief seeking a new trial, the Government contends that Dr. Li “was offered as an expert in economics and data analysis.” (Doc. No. 19801 at 13).

As a part of his “method,” Dr. Li performed text searches utilizing software. His “theory” – based on the premise provided to him by the Government – was that the highway tractors in the universe he was considering had to have been taxed. Upon review, Dr. Li could not make that determination because the records supplied by Fitzgerald did not contain the titles for the tractors. (Id. at 85). Later, Dr. Li attempted to retreat from that position, claiming that his instruction from the Government was that “ownership was required,” whether that be “reflected in the title or maybe purchase receipt[s].” (Id. at 89).

Whatever his methodology, it was not the “testing of economic substance” as argued by the Government. “The economic substance doctrine allows courts to enforce the legislative purpose of the [Tax] Code by preventing taxpayers from reaping tax benefits from transactions lacking in economic reality.” Klamath Strategic Inv. Fund ex rel. St. Croix Ventures v. United States, 568 F.3d 537, 543 (5th Cir. 2009) (citing Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1353–54 (Fed. Cir. 2006)). “The doctrine permits the IRS to ‘ignore for tax purposes any sham transaction, i.e., a transaction designed to create tax benefits rather than to serve a legitimate business purpose.’” Est. of Kechijian v. Comm’r of Internal Revenue, 962 F.3d 800, 808 (4th Cir. 2020) (quoting Hines v. United States, 912 F.2d 736, 739 (4th Cir. 1990)). In essence, “[t]he economic substance doctrine seeks to distinguish between structuring a real transaction in a particular way to obtain a tax benefit, [*22] which is legitimate, and creating a transaction to generate a tax benefit, which is illegitimate.” Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1375 (Fed. Cir. 2010) (citing Coltec, 454 F.3d at 1357). “Such transactions include those that have no business purpose beyond reducing or avoiding taxes, regardless of whether the taxpayer’s subjective motivation was tax avoidance.” Id.

Fitzgerald’s placing repaired engines into glider kits and then reselling the combined unit as a glider tractor was not a “sham transaction” serving “no legitimate purpose.” Whether, in doing so, Fitzgerald met the safe harbor provision is a question that Dr. Li did not and could not address utilizing his expertise as an economist. The Government does not, and cannot, argue otherwise. 

Regardless, the exclusion of Dr. Li was harmless evidence (sic) given the evidence presented at trial. Dr. Li’s opinion was essentially that Fitzgerald (1) bought engines that it repaired and placed into glider kits and (2) did not have titles to the tractors from which the engines came. Beyond simply looking at documents, the Government has not shown how Dr. Li’s education, training and/or experience led him to these less-than-startling conclusions that were admitted to by Fitzgerald’s own witnesses.

Finally, the Court’s (sic) did not make gratuitous comments or render such opinions in relation to Dr. Li. Those comments were based upon Dr. Li’s report and his vacillating and wabbling* answers to this Court’s questions. A new trial based upon the exclusion of Dr. Li will not be granted. 

* I did not recognize this as a word, but a quick google search educated me that wabbling is a synonym for wobbling.

I suppose that the broader lesson is that an any person trying to persuade another (whether a judge, a jury, an IRS agent, an IRS Appeals Officer, etc.) should not irritate the person he seeks to persuade. One way to irritate a judge is to stretch arguments too thin. Prudence might suggest leaving off arguments of that nature,