July 27, 2015
For those who have been wondering why they have seen no reports on the evidentiary hearing in the Microsoft summons enforcement case (see our previous report here), the hearing was postponed at the request of both parties. It has been rescheduled for August 25.
July 16, 2015
[Note: Miller & Chevalier filed an amicus brief in this case on behalf of the National Association of Publicly Traded Partnerships]
As discussed in our previous report here, Comptroller of Maryland v. Wynne presented the Supreme Court with a tricky constitutional issue because it implicated some fundamental principles found in the Court’s precedents, but those principles did not all point in the same direction. In particular, Maryland relied on a state’s unquestioned power to tax the income of its domiciliaries wherever earned, while the taxpayers relied on the Commerce Clause’s limitations on double taxation.
The Court’s 5-4 May 18 decision in favor of the taxpayers produced a superficially unusual lineup. The dissenters included the two Justices generally regarded as the most liberal, Justices Ginsburg and Kagan, and the two most conservative Justices, Thomas and Scalia. In the state tax area, however, this lineup is not so surprising. Although tax cases do not necessarily split along ideological lines, the more liberal Justices often are more likely to side with the tax authorities against wealthy taxpayers. Justices Ginsburg and Kagan showed sympathy for the State’s position at oral argument, and they eventually voted in accordance with that position. Justices Thomas and Scalia, by contrast, have a strong ideological view on Commerce Clause challenges to state taxes, and it was virtually a foregone conclusion from the start that they would vote to uphold Maryland’s taxation scheme. In case anyone had forgotten his views, Justice Scalia (joined by Justice Thomas) wrote a 14-page separate dissent to “point out how wrong our negative Commerce Clause jurisprudence is in the first place.”
The majority opinion, written by Justice Alito, was largely unfazed by Justice Scalia’s attack on negative Commerce Clause jurisprudence. The opinion acknowledged in one sentence that Justices Thomas and Scalia had disputed the validity of interpreting the Commerce Clause to have a negative component, but then observed that the doctrine has “deep roots” and moved on, except for a short discussion at the end of the opinion. (Justice Scalia retorted that “many weeds” also have deep roots.)
The majority focused on trying to provide a relatively simple approach to the case under the Court’s existing precedents and on responding to Justice Ginsburg’s different reading of those precedents expressed in her dissent. The Court majority thus rejected the State’s attempts to distinguish certain precedents on the basis of differences in the type of tax. Specifically, the Court “squarely rejected the argument that the Commerce Clause distinguishes between taxes on net and gross income.” And the Court similarly ruled that there was no basis for treating individuals less favorably than corporations under the Commerce Clause.
Having discarded these possible distinctions, the Court ruled that the validity of Maryland’s taxation scheme should be determined based on the “internal consistency test” previously applied in some corporate tax cases. That approach figured more prominently in the Court’s jurisprudence in the 1980s and early 1990s, but had not been invoked much in recent years. Several Justices, however, posed questions at oral argument concerning the test, and Maryland’s inability to show that its scheme satisfied the test proved fatal. The Wynne decision now highlights the test as a key component of future challenges to state tax schemes that arguably create impermissible double taxation. And by the same token, states devising new approaches to raising funds must focus on whether their taxing schemes are “internally consistent.”
The internal consistency test asks whether interstate commerce would be placed at a disadvantage if every state had the same taxing scheme as the one at issue. The Court describes the test as allowing “courts to isolate the effect of a defendant State’s tax scheme.” The Court explained that, if the tax fails the test, this means that it “inherently discriminate[s] against interstate commerce without regard to the tax policies of other States” and that the discrimination is not caused merely by “the interaction of two different but nondiscriminatory and internally consistent schemes.”
This approach led to an arguably paradoxical result in Wynne that was pointed out by the dissent. Maryland’s taxing scheme failed the internal consistency test because of the combination of two features—failure to credit income taxes paid to other states and Maryland’s own taxation of in-state income earned by non-residents. If every state had that taxing scheme, non-resident income would be taxed by multiple states, which would discriminate against interstate commerce. If Maryland did not tax non-resident income, however, its scheme would no longer fail the internal consistency test. Changing Maryland law in that way would save the constitutionality of the tax, even though it would not have helped the Wynnes in the slightest. As Maryland residents, they would still have been subjected to full taxation by two different states on the same income without a credit. The majority held, however, that this objection was irrelevant to the constitutional analysis. The focus is on the inherent structure of a state’s tax, and the impact on a particular taxpayer is not determinative.
Finally, one other interesting aspect of the Court’s opinion was the prominence it gave to an amicus brief authored by a group of “tax economists” who argued that the Maryland taxation scheme operated economically like a tariff on out-of-state income. That discussion illustrated how the Court focused on the economics of the taxation scheme and how the tax operated in the abstract.
In sum, Wynne will become a key precedent in future Commerce Clause challenges to state taxes, inviting an economic focus and demanding an analysis under the internal consistency test.
July 9, 2015
While the Eleventh Circuit begins the process of reconsidering the Clarke summons enforcement case following the Supreme Court’s remand (see our prior reports here), a federal district court is poised to address similar issues much sooner in a case that has garnered extensive publicity. (Incidentally, briefing is now underway in Clarke, with the respondents’ opening brief on appeal due on August 14.).
As most readers probably know, the government is engaged in a major transfer pricing audit of Microsoft in connection with its cost-sharing arrangements with affiliates in Puerto Rico and Asia. The IRS has hired the law firm of Quinn Emanuel as a consultant to assist in the audit, including participating in interviews. That unusual course of action by the IRS has attracted much attention, including from the Senate Finance Committee, which sent a letter to the IRS demanding an explanation and requesting that the IRS halt the use of such private contractors “for both the examination of records and the taking of sworn testimony.”
Microsoft has vigorously challenged the legality of the IRS’s engagement of Quinn Emanuel. The IRS contends that its action is authorized by a temporary regulation promulgated without notice-and-comment on June 9, 2014, which provides that third-party contractors “may receive books, papers, records, or other data summoned by the IRS and take testimony of a person who the IRS has summoned.” 26 C.F.R. § 301.7602-IT(b)(3). The IRS contends that Quinn Emanuel did not commence work under the contract until approximately a month after the regulation was issued, although technically it was retained earlier.
Microsoft has pursued its challenge on multiple fronts. It submitted several FOIA requests to the IRS, and its FOIA requests for documents relating to promulgation of the temporary regulation and its contacts with the private law firms are the subject of pending lawsuits in federal district court in Seattle (Western District of Washington). (An earlier FOIA suit was dismissed after the IRS capitulated and turned over its contract with Quinn Emanuel.) The immediate action, however, lies in a summons enforcement suit pending before the same judge as the FOIA cases (Judge Ricardo Martinez).
After issuing more than 200 IDRs, the IRS issued several designated summonses seeking additional information. Microsoft forced the IRS to go to court to seek enforcement of the summonses and then argued that it was entitled to an evidentiary hearing (and discovery of the documents being sought in the FOIA litigation) before being required to comply. Microsoft’s objections centered on the Quinn Emanuel engagement, with Microsoft contending that the IRS had improperly delegated key aspects of the tax audit and that it was entitled to a hearing to explore exactly what was the firm’s role.
On June 17, the district court granted Microsoft’s motion to conduct an evidentiary hearing. Citing repeatedly to Clarke, the court remarked that Microsoft needed to carry only a “fairly slight burden to trigger an evidentiary hearing.” The court found the hearing appropriate because Microsoft had made a “plausible” showing that the regulation is invalid. The court first observed that the statutory provisions establishing the summons authority do not appear to leave room for delegation to non-government officials. In particular, the term “delegate” of the Secretary of the Treasury is defined as “any officer, employee, or agency of the Treasury Department duly authorized by the Secretary” to perform the delegated task. I.R.C. § 7701(a)(12)(A)(i). Although the court acknowledged that this argument based on the plain language of the statute raised a question of law, the court added that there were “factual questions” raised as well. In support, it pointed to Microsoft’s contention that the IRS had not satisfied the requirements for an exception from notice-and-comment procedures and that the regulation is fatally flawed for being “issued without reasoned analysis.” The court also stated that the timing of the regulation in close proximity to the Quinn Emanuel contract “plausibly raises an inference of improper motive.”
With respect to Microsoft’s specific objection to Quinn Emanuel’s participation, the court made a more convincing case for a hearing to explore factual issues. The court found that the language of the contract suggested that the firm “may be participating in components of the audit examination for which delegation is statutorily proscribed, such as inspecting books and taking testimony.” The court also found that, given the timing of the firm’s retention, Microsoft had plausibly raised an inference that the firm had “played an unauthorized role in the issuance of several IDRs” and might have been provided taxpayer information in violation of section 6103.
The court, however, stated that it was not prepared to accede to Microsoft’s request for document discovery regarding the issuance of the summons. Asserting that a “more stringent” showing of wrongdoing is required to warrant discovery, the court ruled that it would consider the discovery request after the evidentiary hearing, which it scheduled for July 21.
The parties have been skirmishing in advance about how the hearing should be conducted, and those disputes give concrete expression to the concerns the government expressed in Clarke about burdensomeness if evidentiary hearings are too readily allowed in summons enforcement proceedings. The IRS has put forth an official to testify at the hearing who it asserts has the most knowledge of the circumstances surrounding the issuance of the summons. Microsoft, however, wants to examine a more senior official about the bigger picture and has urged the court to require the IRS to make available at the hearing or for deposition Heather Maloy, the soon-to-be ex-Commissioner of LB&I. (Ms. Maloy’s last scheduled day at the IRS is tomorrow, July 10.) Microsoft has also asked the court to order the IRS to provide, 10 days in advance, summaries of the substance of the testimony it intends to introduce at the hearing. The government, for its part, has asked the court to clarify several evidentiary and procedural matters surrounding the hearing. The court heard argument on these various pre-hearing requests at a telephone conference on July 7.
Thus, in addition to the remand decision in Clarke itself, the high-profile Microsoft case promises to shed further light on how the lower courts will approach evidentiary hearings in summons enforcement actions in the wake of Clarke.
Eleventh Circuit Set to Consider Whether IRS Impermissibly Used Summons Power to Obtain “Discovery” in the Tax Court
July 1, 2015
As we previously reported, the Supreme Court’s decision in the Clarke summons enforcement case was not a complete victory for the government. The Court set forth a standard that appeared to leave a little more room than before for summoned parties to obtain an evidentiary hearing in resisting summons enforcement actions. The Court left open the possibility that the lower courts on remand could require a hearing in Clarke itself at which IRS officials would have to testify.
The Eleventh Circuit elected not to address this question in the first instance after the Supreme Court remand. Instead, it sent the case straight back to the district court with instructions to reconsider its original enforcement order in light of the Eleventh Circuit and Supreme Court opinions. But the district court saw no reason to change its tune on remand. First, it refused the private respondents’ request to introduce additional evidence in opposition to the summons enforcement request. The district court then issued a six-page opinion rejecting point-by-point—in some instances for lack of evidence—the arguments made by the respondents for why the summons might be thought to be improperly motivated. The respondents have now appealed that latest decision back up to the Eleventh Circuit.
As noted in our previous report, an important aspect of the Supreme Court’s decision was how it dealt with the respondents’ objection that the government sought summons enforcement in order to obtain “discovery” in a Tax Court case that was filed soon after issuance of the summons. The government had argued that this objection carried no weight because the validity of a summons must be judged as of the time of its issuance, and therefore a later action to seek enforcement to aid litigation in the Tax Court could not be invoked as a ground for challenging the summons. The district court had endorsed this argument, but the Supreme Court declined to do so. Instead, the Supreme Court remarked that it was expressing “no view on the issue” and left this question open for the court of appeals to decide on remand. The Court emphasized that, in deciding this issue, the court of appeals would not be confined by the deference ordinarily owed to the district court’s decision on whether or not to order the questioning of IRS agents in a summons enforcement action. Rather, the Supreme Court ruled that this argument implicated a “legal issue about what counts as an illicit motive” on which the court of appeals would have “no cause to defer to the district court.”
That legal issue is now teed up for the court of appeals. The district court’s new opinion on remand essentially repeated the brief analysis of this point from its first opinion, stating that “events occurring after the date of issuance but prior to enforcement should not affect enforceability.” The court of appeals will review that ruling de novo. Having reversed the district court and ordered an evidentiary hearing when it last considered the case, it would not be surprising to see the court of appeals reach the same outcome as before and hold that the government’s conduct in the Tax Court proceedings provides enough justification for the court to hold an evidentiary hearing to explore the IRS’s motivation for issuing the summons.
The Eleventh Circuit has not yet issued a briefing schedule.