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.