District Court Orders Microsoft Summonses Enforced, Finding No Legal Obstacle to Involvement of Outside Law Firm
December 3, 2015
The district court has ordered enforcement of the IRS’s summonses in its high-profile audit of Microsoft. As we have previously discussed, Microsoft’s objections to the summonses centered on the IRS’s novel decision to bring in an outside law firm (Quinn Emanuel) as a consultant to whom certain tasks would be delegated. The objections also touched on the issue being litigated in the Clarke case concerning the appropriateness of enforcing a summons that is arguably designed to assist the IRS in Tax Court litigation. (See prior posts on Clarke here.) The district court’s decision in Microsoft turns on its analysis of the factual record and does not break any new legal ground.
With respect to the law firm’s involvement, the essence of the court’s holding was its conclusion that nothing in Code section 7602 prohibits the degree of involvement by an outside contractor that had been shown by the evidence. (Microsoft had argued that, by its terms, section 7602 authorizes only the Secretary of the Treasury (or his specified delegates within Treasury) to “take testimony” or otherwise exercise the summons power.) The court did not affirmatively endorse the IRS’s involvement of the law firm. To the contrary, the court remarked that it was “troubled by Quinn Emanuel’s level of involvement in this audit. The idea that the IRS can ‘farm out’ legal assistance to a private law firm is by no means established by prior practice, and this case may lead to further scrutiny by Congress.” But the court held that it would take further action by Congress to prohibit such involvement; current law does not impose any bar. Because it found no statutory problem, the court saw no need to consider Microsoft’s arguments challenging the validity of the recent temporary regulation that explicitly addresses the IRS’s use of outside contractors.
In reaching its conclusion, the court pressed counsel for Microsoft to specify where the law draws the line between permissible and impermissible involvement of an outside contractor, and the court ultimately found Microsoft’s answers unpersuasive. As summarized by the court, Microsoft admitted at the hearing that the contractor “is permitted under law to examine Microsoft’s books and records, formulate questions to ask witnesses under oath, attend those interviews, and even ask questions via a notepad so long as it is the IRS lawyer who speaks the words.” In the court’s view, nothing in Code section 7602 “prevents the IRS from taking this a step further and having the contractor ask a question while an IRS lawyer continues to run the interview.” The court’s statements imply that it could well be prohibited for an outside contractor to “run the interview” and certainly for it to control the audit. But the court found that the record in this case provided “no factual basis” for Microsoft’s assertion that Quinn Emanuel would be “conducting the audit.” (This finding is hardly surprising given that the only witness at the evidentiary hearing was an IRS official.) Rather, the court concluded, the evidence indicated that Quinn Emanuel “will be gathering limited information for the IRS under the direct supervision of the IRS.”
Distinct from the issues directly raised by Quinn Emanuel’s involvement, Microsoft argued that the summons was issued for the illegitimate purpose of preparing for Tax Court litigation, not for conducting an audit. As we have discussed elsewhere, the legal issue raised by efforts to enforce a summons to aid in Tax Court litigation is more squarely presented in the Clarke case currently pending in the Eleventh Circuit on remand from the Supreme Court. Here, the district court found that there was no factual predicate for Microsoft’s argument, noting that “the record does not contain any direct evidence that these summonses were issued to circumvent the discovery procedures of tax court.” The court pointed to the testimony at the evidentiary hearing, where the IRS witness stated that the investigation was still in the audit phase and the summonses were issued to help the IRS “get to the right number.” Microsoft’s counter to this testimony was to ask the court to draw an inference from the involvement of Quinn Emanuel—namely, that a firm known for trial litigation likely was providing advice on trial preparation and the subsequently issued summonses therefore were an aspect of that trial preparation. The court characterized this evidence as “entirely speculative” and concluded that “Microsoft has entirely failed to meet its burden of proof necessary to prevent the enforcement of these summonses.”
The district court’s decision appears to end this aspect of the Microsoft litigation, as Microsoft is likely to comply with the summons enforcement order rather than seek to have it stayed so that it could appeal. The action on the question of the IRS’s ability to use the summons power to aid in Tax Court litigation now shifts to the Eleventh Circuit, where briefing is nearly complete in the Clarke case and the court has indicated that oral argument will likely be scheduled for the last week of February 2016.
August 31, 2015
The government has filed its opening brief in the Eleventh Circuit in the Clarke case. The case is now back in that court for the second time after a remand from the Supreme Court that did not persuade the district court to retreat from its prior denial of an evidentiary hearing. See our previous report here.
On the merits, the appellants’ primary argument is that they are entitled to a hearing to explore their allegation that the government is misusing the summons enforcement process to obtain discovery for pending Tax Court proceedings. To that end, the appellants ask the court not to restrict its consideration of the validity of the summons to the situation existing on the date it was issued, but instead to look at the later decision to enforce the summons – well after the statute of limitations had expired. Secondarily, the appellants argue that the district court erred in refusing to allow them to make supplemental submissions in the wake of the Supreme Court’s remand, which arguably changed the legal standard to be applied to appellants’ contentions.
The government’s response brief is due in late September.
In the Microsoft case, the district court held an evidentiary hearing on August 25 and has ordered the parties to submit supplemental briefs on September 2.
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 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.