Fifth Circuit Reverses Tax Court in BMC Software

The Fifth Circuit reversed the Tax Court’s decision in BMC Software yesterday. As we speculated that it might at the outset of the case here, the Fifth Circuit’s decision hinged on how far to take the legal fiction that the taxpayer’s accounts receivable created under Rev. Proc. 99-32 were deemed to have been established during the taxpayer’s testing period under section 965(b)(3). While the Tax Court treated that legal fiction as a reality that reduced the taxpayer’s section 965 deduction accordingly, the Fifth Circuit treated that legal fiction as just that—a fiction that had no effect for purposes of section 965: “The fact that the accounts receivable are backdated does nothing to alter the reality that they did not exist during the testing period.” The Fifth Circuit based its decision on a straightforward reading of the plain language of the related-party-indebtedness rule under section 965, holding that for that rule “to reduce the allowable deduction, there must have been indebtedness ‘as of the close of’ the applicable year.” And since the deemed accounts receivable were not created until after the testing period, the Fifth Circuit held that the taxpayer’s deduction “cannot be reduced under § 965(b)(3).”

The Fifth Circuit also rejected the Commissioner’s argument that his closing agreement with the taxpayer mandated treating the deemed accounts receivable as related-party indebtedness. Here, the Fifth Circuit found that the interpretive canon that “things not enumerated are excluded” governed in this case. Because the closing agreement “lists the transaction’s tax implications in considerable detail,” the absence of “a term requiring that the accounts receivable be treated as indebtedness for purposes of § 965” meant that the closing agreement did not mandate such treatment.

BMC Software Fifth Circuit Opinion

Taxpayer’s Opening Brief Filed in BMC Software

The taxpayer filed its opening brief in the Fifth Circuit appeal of BMC Software v. Commissioner.  As we described in our earlier coverage, the Tax Court relied on the legal fiction that accounts receivable created pursuant to Rev. Proc. 99-32 in a 2007 closing agreement were indebtedness for earlier years (2004-06) in order to deny some of the taxpayer’s section 965 deductions.  There are three main avenues of attack in the taxpayer’s brief.

First, the taxpayer argues that the Tax Court incorrectly treated those accounts receivable as “indebtedness” as that term is used in the exception to section 965 for related-party indebtedness created during the testing period.  The taxpayer contends that the Tax Court looked to the Black’s Law definition of “indebtedness” when it should have looked to the tax law definition.  And the taxpayer argues that the tax law definition—that “indebtedness” requires “an existing unconditional and legally enforceable obligation to pay”—does not include the fictional accounts receivable created under Rev. Proc. 99-32.  The taxpayer argues that those accounts did not exist and were not legally enforceable until 2007 (after the section 965 testing period) and therefore did not constitute related-party indebtedness during the testing period for purposes of section 965.

Second, the taxpayer argues that the Tax Court was wrong to interpret the 2007 closing agreement to constitute an implicit agreement that the accounts receivable were retroactive debt for purposes of section 965.  The taxpayer observes that closing agreements are strictly construed to bind the parties to only the expressly agreed terms.  And the taxpayer argues that the parties did not expressly agree to treat the accounts receivable as retroactive debt for section 965 purposes.  Moreover, the taxpayer argues that the Tax Court misinterpreted the express language in the agreement providing that the taxpayer’s payment of the accounts receivable “will be free of the Federal income tax consequences of the secondary adjustments that would otherwise result from the primary adjustments.”  The taxpayer then makes several other arguments based on the closing agreement.

Finally, the taxpayer makes some policy-based arguments.  In one of these arguments, the taxpayer contends that the Tax Court’s decision is contrary to the purpose of section 965 and the related-party-indebtedness exception because the closing agreement postdated the testing period and therefore cannot be the sort of abuse that the related-party-indebtedness exception was meant to address.

BMC Software – Taxpayer’s Opening Brief

Fifth Circuit to Address Section 965 Deduction in BMC Software Appeal

In BMC Software v. Commissioner, 141 T.C. No. 5, the Tax Court was faced with considering the effect that some legal fictions (created under a Revenue Procedure regarding transfer pricing adjustments) have on the temporary dividends-received deduction under section 965.  And while both the section 965 deduction and the legal fictions under the Revenue Procedure appear to have been designed to benefit taxpayers by facilitating tax-efficient repatriations, the Tax Court eliminated that benefit for some repatriated amounts.  The taxpayer has already appealed the decision (filed on September 18) to the Fifth Circuit (Case No. 13-60684), and success of that appeal may hinge in part on whether the Tax Court took the legal fictions in the Revenue Procedure too far.

First, some background on the section 965 deduction:  In 2004, Congress enacted the one-time deduction to encourage the repatriation of cash from controlled foreign corporations on the belief that the repatriation would benefit of the U.S. economy.  To ensure that taxpayers could not fund the repatriations from the United States (by lending funds from the U.S. to the CFC, immediately repatriating the funds as dividends, and then later treating would-be dividends as repayments of principal), Congress provided that the amount of the section 965 deduction would be reduced by any increase in related-party indebtedness during the “testing period.”  The testing period begins on the earliest date a taxpayer might have been aware of the availability of the one-time deduction—October 3, 2004—and ends at the close of the tax year for which the taxpayer elects to take the section 965 deduction.  Congress thus established a bright-line test that treated all increases in related-party debt during the testing period as presumptively abusive, regardless of whether the taxpayer had any intent to fund the repatriation from the United States.

BMC repatriated $721 million from a controlled foreign corporation (BSEH) and claimed the section 965 deduction for $709 million of that amount on its 2006 return.  On that return, BMC claimed that there was no increase in BSEH’s related party indebtedness between October 2004 and the close of BMC’s 2006 tax year in March 2006.  In the government’s view, however, this claim became untrue after the IRS reached a closing agreement with the IRS in 2007 with respect to BMC’s 2003-06 tax years.

That agreement made transfer pricing adjustments that increased BMC’s taxable income for the 2003-06 tax years.  The primary adjustments were premised on the IRS’s theory that the royalties BMC paid to its CFC were too high.  By making those primary adjustments and including additional amounts in income, BMC was deemed to have paid less to its CFC for tax purposes than it had actually paid.

The typical way of conforming BMC’s accounts in this circumstance is to treat the putative royalty payments (to the extent they exceeded the royalty agreed in the closing agreement) as deemed capital contributions to BSEH.  If BMC were to repatriate those amounts in future, they would be treated as taxable distributions (to the extent of earnings and profits).  But Rev. Proc. 99-32 permits taxpayers in this circumstance to elect to repatriate the funds tax-free by establishing accounts receivable and making intercompany payments to satisfy those accounts.  The accounts receivable created under Rev. Proc. 99-32 are, of course, legal fictions—the taxpayer did not actually loan the funds to its CFC.  BMC elected to use Rev. Proc. 99-32 and BSEH made the associated payments.

To give full effect to the legal fiction, Rev. Proc. 99-32 provides that each account receivable is “deemed to have been created as of the last day of the taxpayer’s taxable year for which the primary adjustment is made.”  So although BMC’s accounts receivable from BSEH were not actually established until the 2007 closing agreement, those accounts receivable were deemed to have been established at the close of each of the 2003-06 tax years.  Two of those years (those ending March 2005 and March 2006) fell into the testing period for BMC’s section 965 deduction.  The IRS treated the accounts receivable as related-party debt and reduced BMC’s section 965 deduction by the amounts of the accounts receivable for those two years, which was about $43 million.

BMC filed a petition in Tax Court, arguing (among other things) that the statutory rules apply only to abusive arrangements and that the accounts receivable were not related-party debt under section 965(b)(3).  The government conceded that BMC did not establish the accounts receivable to exploit the section 965 deduction, but argued that there is no carve-out for non-abusive transactions and the accounts receivable were indebtedness under the statute.

The court held that the statutory exclusion of related-party indebtedness from the section 965 deduction is a straightforward arithmetic formula devoid of any intent requirement or express reference to abusive transactions.  The court also held that the accounts receivable fall under the plain meaning of the term “indebtedness” and therefore reduce BMC’s section 965 deduction under section 965(b)(3).  So even though both the section 965 deduction and Rev. Proc. 99-32 were meant to permit taxpayers to repatriate funds with little or no U.S. tax impact, the mechanical application of section 965(b)(3) and Rev. Proc. 99-32 eliminated that benefit for $43 million that BMC repatriated as a dividend.

This does not seem like the right result.  And here it seems the culprit may be the legal fiction that the accounts receivable were established during the testing period.  The statute may not expressly address abusive intent, but that is because Congress chose to use the testing period in the related-party-debt rule as a blunt instrument to stamp out all potential abuses of the section 965 deduction.  This anti-abuse intent is baked into the formula for determining excluded related-party debt because the opening date of the testing period coincides with the earliest that a taxpayer might have tried to create an intercompany debt to exploit the section 965 deduction.  BMC did not create an intercompany debt during the testing period; the accounts receivable were not actually established until after the close of the testing period.  Perhaps the court took the legal fiction that the accounts receivable were established in 2005 and 2006 one step too far.  And perhaps the Fifth Circuit will address this legal fiction on appeal.

BMC Software – Tax Court Opinion

Reply Brief Filed on Stay Motion in Loving

Yesterday, in Loving v. IRS (the subject of a recent post), the Government filed its reply brief in support of its motion to stay the district court’s injunction of the new registration regime for paid tax-return preparers.  With respect to its likelihood of success on the merits, the Government argued the ambiguity of the statute authorizing Treasury to “regulate the practice of representatives of persons before” it.   With respect to the threat of irreparable harm, the Government argued that the injunction risked delaying the implementation of the regulatory regime until the 2015 return-preparation season and that the problem of unregulated return preparers represents a “major public concern.”

Loving – USG Reply Brief re Motion for Stay

Government Seeks Appellate Stay of Order Enjoining Enforcement of New Registration Regime for Paid Tax Return Preparers

The Government has appealed to the D.C. Circuit from the district court decision enjoining the IRS from enforcing its new registration regime for paid tax return preparers.  Loving v. IRS, D.C. Cir. No. 13-5061.  The Government has also asked the court of appeals to stay the decision pending appeal, after the district court declined to grant a stay.  The Government’s stay motion recites that, the appeal has not yet been authorized by the Solicitor General’s office, but that, if the appeal is authorized, the Government intends to file its opening brief in March and to move for an expedited oral argument.

To recap the district court’s decision:  In 2011, the Treasury Department promulgated regulations that extended Circular 230 (the regulations that govern practice before the IRS) to non-attorney, non-CPA tax-return preparers who prepare and file tax returns for compensation.  Under the new regulations, tax-return preparers must register before they can practice before the IRS, and they are deemed to practice before the IRS even if their only function is to prepare and submit tax returns.  In order to register initially, tax return preparers must pass a qualification exam and pay a fee.  To maintain their registration each year, they must pay a fee and take at least fifteen hours of continuing education courses.  The IRS estimated that the new regulation sweeps in 600,000 to 700,000 new tax return preparers who were previously unregulated at the federal level.

Three tax return preparers who were not previously regulated by Circular 230 brought suit challenging the 2011 regulations and seeking declaratory and injunctive relief.  In January 2013, the U.S. District Court for the District of Columbia (Boasberg, J.) granted the plaintiffs’ motion for summary judgment.  The court recognized that, under Mayo Foundation, the two-step analysis of Chevron should be applied to determine the validity of the regulations.  The court explained, however, that “the battle here will be fought and won on Chevron step one” because “Plaintiffs offer no independent argument for why, if the statute is ambiguous, the IRS’s interpretation would be ‘arbitrary or capricious . . .’ under Chevron step two.” Focusing in this way on the unambiguous statutory text, the court held that the Treasury Department lacked statutory authority to issue the regulations.

The court rejected the Government’s argument that the agency had inherent authority to regulate those who practice before it, because a statute (31 U.S.C. § 330) specifically defined the scope of the Treasury Department’s authority.  Under that statute, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.”  The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns.  Turning to provisions in the Internal Revenue Code that regulate tax return preparers, the court reasoned that Congress could not have intended § 330 to be the authority for regulating tax return preparers because “statutes scattered across Title 26 of the U.S. Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers.”  The court rejected the Government’s resort to policy arguments.  “In the land of statutory interpretation, statutory text is king.”  Holding that the new regulations were ultra vires, the court enjoined the IRS from enforcing the registration regime.

In the motion for a stay pending appeal filed with the district court, the Government argued that the injunction substantially disrupted the IRS’s tax administration and that shutting down the program would be costly and complex. The district court was not persuaded, concluding that “[t]hese harms, to the extent they exist are hardly irreparable, and some cannot even be traced to the injunction.”

The Government’s stay motion in the court of appeals, filed February 25, argues that “[f]ailure to grant the stay will work a substantial and irreparable harm to the Government and the taxpaying public, crippling the Government’s efforts to ensure that individuals who prepare tax returns for others are both competent and ethical.”  According to the Government’s brief, the “IRS estimates that fraud, abuse, and errors cost the taxpaying public billions of dollars annually.”  In their March 8 response, the Plaintiffs/Appellees argue that the Government failed to establish any imminent irreparable harm traceable to the injunction, noting that even the Government acknowledged that most of the alleged harms would not occur until 2014.  The tax return preparers also emphasize that the injunction merely preserves the historical status quo.

Loving – District Court Opinion Granting Injunction

Loving – District Court order denying stay and modifying injunction

Loving – Government Motion for Stay

Loving – Appellees’ Response to Motion for Stay

Home Concrete Decision Leaves Administrative Law Questions Unsettled While Excluding Overstatements of Basis from Six-Year Statute of Limitations

[A shorter version of this blog post appears on SCOTUSblog.]

The Supreme Court last week ruled 5-4 in favor of the taxpayer in Home Concrete, thus putting an end to the long-running saga of the Intermountain litigation on which we have been reporting for the past 18 months.  The opinion was authored by Justice Breyer and joined in full by three other Justices, but Justice Scalia joined only in part.  The result is a definitive resolution of the specific tax issue – the six-year statute of limitations does not apply to an overstatement of basis.  But the Court’s decision provides a much less definitive resolution of the broader administrative law issues implicated in the case.

As foreshadowed by the oral argument (see our previous report here), the tax issue turned on the continuing vitality of the Court’s decision in The Colony, Inc. v. Commissioner, 357 U.S. 28 (1958).  To recap, the Court held in Colony that the “omits from gross income” language in the 1939 Code did not encompass situations where the return understates gross income because of an overstatement of basis, and hence the extended six-year statute of limitations did not apply in those situations.  The government argued that Colony did not control the interpretation of the same language in current section 6501(e) of the 1954 Code, because changes elsewhere in that section suggested that Congress might have intended a different result in the 1954 Code.

The administrative law issues came into play because, after two courts of appeals had ruled that Colony controlled the interpretation of the 1954 Code, the government tried an end run around that precedent.  Treasury issued regulations interpreting the “omits from gross income” language in the 1954 Code as including overstatements of basis, thus bringing those situations within the six-year statute of limitations.  Under National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967 (2005), the government argued, an agency is empowered to issue regulations that define a statute differently than an existing court decision, so long as the court decision did not declare the statutory language unambiguous.  Because the Colony opinion had indicated that the 1939 Code language standing alone was “not unambiguous,” the government argued that Treasury’s new regulations were entitled to Chevron deference, which would supplant any precedential effect that Colony would otherwise have on the interpretation of the 1954 Code provision.

The Court’s Opinion

Justice Breyer wrote the opinion for the Court, joined in full by Chief Justice Roberts and Justices Alito and Thomas.  Justice Scalia joined Justice Breyer’s analysis of the statute, but departed from his analysis of the administrative law issues.

The opinion dealt straightforwardly with the basic tax issue.  First, the Court emphasized that the critical “omits from gross income” language in the current statute is identical to the 1939 Code language construed in Colony, and it recounted the Colony Court’s reasoning that led it to conclude that the language does not encompass overstatements of basis.  Colony is determinative, the Court held, because it “would be difficult, perhaps impossible, to give the same language here a different interpretation without effectively overruling Colony, a course of action that basic principles of stare decisis wisely counsel us not to take.”  With respect to the statutory changes made elsewhere in section 6501(e), the Court concluded that “these points are too fragile to bear the significant argumentative weight the Government seeks to place upon them.”  The Court addressed each of these changes and concluded that none called for a different interpretation of the key language (and that one of the government’s arguments was “like hoping that a new batboy will change the outcome of the World Series”).

The Court then turned to the administrative law issues, reciting the government’s position that, under Brand X, the new regulations were owed deference despite the Court’s prior construction of the language in Colony.  The opinion first responded to that position with a two-sentence subsection:  “We do not accept this argument.  In our view, Colony has already interpreted the statute, and there is no longer any different construction that is consistent with Colony and available for adoption by the agency.”

Standing alone, that was not much of a response to the government’s Brand X argument, because Brand X said that the agency can adopt a construction different from that provided in a prior court decision so long as the statute was ambiguous.  These two sentences were enough for Justice Scalia, however, and he ended his agreement with Justice Breyer’s opinion at this point.  In a separate concurring opinion, Justice Scalia explained that he is adhering to the view expressed in his dissent in Brand X that an agency cannot issue regulations reinterpreting statutory language that has been definitively construed by a court.

With the other Justices in the majority not feeling free to ignore Brand X, Justice Breyer’s opinion (now a plurality opinion) then proceeded to explain why Brand X did not require a ruling for the government.  According to the plurality, Brand X should be given a more nuanced reading than that urged by the government, one that looks to whether a prior judicial decision found a statute to be “unambiguous” in the sense that the court concluded that Congress intended to leave “‘no gap for the agency to fill’ and thus ‘no room for agency discretion.’”  Under Chevron jurisprudence, the opinion continued, unambiguous statutory language provides a “clear sign” that Congress did not delegate gap-filling authority to an agency, while ambiguous language provides “a presumptive indication that Congress did delegate that gap-filling authority.”  That presumption is not conclusive, however, and thus this reading of Brand X leaves room for a court to conclude that a judicial interpretation of ambiguous statutory language can foreclose an agency from issuing a contrary regulatory interpretation.  In support of that proposition, the plurality quoted footnote 9 of Chevron, which states that “[i]f a court, employing traditional tools of statutory construction, ascertains that Congress had an intention on the precise question at issue, that intention is the law and must be given effect.”

The plurality then ruled that the Court in Colony had concluded that Congress had definitively resolved the legal issue and left no gap to be filled by a regulatory interpretation.  Given its analysis of the scope of Brand X, the plurality explained that the Colony Court’s statement (26 years before Chevron) that the statutory language was not “unambiguous” did not necessarily leave room for the agency to act.  Rather, the Colony Court’s opinion as a whole – notably, its view that the taxpayer had the better interpretation of the statutory language and had additional support from the legislative history – showed that the Court believed that Congress had not “left a gap to fill.”  Therefore, “the Government’s gap-filling regulation cannot change Colony’s interpretation of the statute,” and the Court today is obliged by stare decisis to follow it.

The Concurring and Dissenting Opinions

Justice Kennedy’s dissent, joined by Justices Ginsburg, Sotomayor, and Kagan, reached a different conclusion on the basic tax dispute.  The dissent looked at the statutory changes made in the 1954 Code and concluded that they are “meaningful” and “strongly favor” the conclusion that the “omits from gross income” language in the 1954 Code should not be read the way the Colony Court read that same language in the 1939 Code.  Given that view, the administrative law issue – and the resolution of the case – became easy.  The dissent stated that the Treasury regulations are operating on a blank slate, construing a statute different from the one construed in Colony, and therefore they are owed Chevron deference without the need to rely on Brand X at all.

Justice Scalia’s concurring opinion declared a pox on both houses.  He was extremely critical of the plurality’s approach, accusing it of “revising yet again the meaning of Chevron . . . in a direction that will create confusion and uncertainty.”  He also criticized the dissent for praising the idea of a “continuing dialogue among the three branches of Government on questions of statutory interpretation,” when the right approach should be to say that “Congress prescribes and we obey.”  Justice Scalia concluded:  “Rather than making our judicial-review jurisprudence curiouser and curiouser, the Court should abandon the opinion that produces these contortions, Brand X.  I join the judgment announced by the Court because it is indisputable that Colony resolved the construction of the statutory language at issue here, and that construction must therefore control.”

What Does It Mean?

The Home Concrete decision provides a clear resolution of the specific tax issue.  The six-year statute of limitations does not apply to overstatements of basis.  The multitude of cases pending administratively and in the courts that involve this issue will now be dismissed as untimely, leaving the IRS unable to recover what it estimated as close to $1 billion in unpaid taxes.

Indeed, in a series of orders issued on April 30, the Court has already cleared its docket of the other Intermountain-type cases that had been decided in the courts of appeals and kept alive by filing petitions for certiorari.  In Burks and the other Fifth Circuit cases in which the taxpayers had prevailed, the Court simply denied certiorari, making the taxpayers’ victory final.  For the certiorari petitions filed from courts of appeals that had sided with the government, such as Grapevine (Federal Circuit), Beard (Seventh Circuit), Salman Ranch (Tenth Circuit), and Intermountain and UTAM (D.C. Circuit), the Court granted the petitions and immediately vacated the court of appeals decisions and remanded the cases to the courts of appeals for reconsideration.  Now constrained by Home Concrete, those courts will enter judgments in favor of the taxpayers in due course.

Notably, although the retroactive nature of the Treasury regulations was a significant point of contention in the litigation, retroactivity did not play a role in the final resolution.  The Court held that Colony is controlling and leaves no room for the agency to construe the “omits from gross income” language differently.  Thus, Treasury does not have the ability to use its regulatory authority to extend the six-year statute to overstatements of basis even prospectively.  Any such extension will have to come from Congress.

The effect of the decision on administrative law generally is considerably more muddled.  First, a couple of observations on what the Court did not do.  It did not signal any retreat from Mayo.  Treasury regulations addressed to tax issues will continue to be judged under the same Chevron deference principles that apply to regulations issued by other agencies.  Furthermore, as noted above, the Court did not rely on the retroactive aspect of the regulations.  Thus, the decision does not provide guidance one way or another on the extent to which Treasury is constrained in its ability to apply regulations to earlier tax years.

What the Court did do, however, is to weaken the authority of Brand X.  Under the reasoning of Justice Breyer’s plurality opinion, courts are now free to decline to defer to a regulatory interpretation that construes ambiguous statutory language – if the court concludes that a prior court decision, using “traditional tools of statutory construction” that go beyond the text, determined that Congress intended to resolve the issue rather than leave a gap for the agency to fill.  Although there were only four votes for that proposition, Justice Scalia’s approach would lead him to agree with such a result just as he did in Home Concrete, so lower courts may treat the plurality opinion as controlling.  There is, however, room for debate about the impact of the Home Concrete approach.  Justice Breyer’s opinion emphasizes the fact that Colony was decided long before Chevron, and lower courts may disagree regarding its impact when the court decision at issue is post-Chevron and, in particular, post-Brand X.  At a minimum, the Home Concrete decision should make agencies less confident in their ability to use regulations to overturn judicial interpretations of statutes and should give taxpayers more ammunition to challenge such regulations if necessary.

Interestingly, Justice Breyer’s approach, and in particular his invocation of Chevron’s footnote 9 reference to “traditional tools of statutory construction,” was previewed in the argument in the Federal Circuit in the Grapevine case.  As we reported at the time, that argument involved considerable discussion of whether the determination of “ambiguous” at Chevron step 1 must be based entirely on the statutory text, as Brand X suggests, or can be based on other “traditional tools of statutory construction,” as Chevron footnote 9 declares.  In its decision, the Federal Circuit stuck to the statutory text and ruled for the government.

Justice Breyer’s opinion, however, supports the proposition that Chevron step 1 analysis can look beyond the statutory text.  If that portion of Justice Breyer’s opinion had commanded a majority, it would be extremely significant because it would justify looking beyond the statutory text not only in assessing the impact of Brand X when there is a court decision on the books, but also in considering a Chevron deference argument in the first instance.  A court could decide, under the approach suggested by Justice Breyer, that a statute whose text standing alone is ambiguous nonetheless leaves no room for agency interpretation – if other tools of statutory construction show that Congress intended to resolve the issue rather than leaving a gap for the agency.  On this point, however, the plurality opinion cannot be treated as controlling because Justice Scalia would surely look askance at a decision that used legislative history to find a lack of ambiguity at Chevron Step 1.  By the same token, the dissenters had no occasion to address this point, so we do not know if any of them would have agreed with Justice Breyer’s approach.  For now, it is fair to say that Justice Breyer has heightened the visibility and potential importance of Chevron footnote 9, but that Home Concrete alone probably will not yield a significant change in how courts approach Chevron step 1.

In sum, Home Concrete may be a bit of a disappointment to those observers who thought that the decision would bring great clarity to the administrative law issues presented.  In that respect, it joins a long list of administrative law cases that reach the Supreme Court and seem to yield as many questions as answers.  But for the taxpayers with millions of dollars riding on the difference between a three-year and six-year statute of limitations, the decision is not disappointing at all.  It is a huge victory.

Supreme Court opinion in Home Concrete

Supreme Court Rules in Kawashima, Finding That Section 7206 Offenses Can Justify Deportation

The Supreme Court (opinion attached below) has affirmed the Ninth Circuit’s decision in Kawashima, ruling that resident aliens who pled guilty to making (or assisting in making) a false tax return in violation of Code section 7206 had committed “aggravated felonies” that made them deportable.  The vote was 6-3, with Justice Thomas writing the opinion and Justices Ginsburg, Breyer, and Kagan dissenting.

As we have previously reported, the Kawashima case involves the interplay between two subsections of the deportation statute’s definition of aggravated felonies, 8 U.S.C. § 1101(a)(43).  Subsection (M)(i) broadly includes offenses “involv[ing] fraud or deceit”; subsection (M)(ii) adds violations of Code section 7201 (tax evasion).  The Kawashimas argued that subsection (ii) is addressed to tax offenses and therefore the statute does not include the less serious tax offenses covered by section 7206.  The government argued that section 7206 offenses involve “fraud or deceit,” and therefore they are covered by subsection (ii).  (See here for a more detailed analysis of the Supreme Court briefing).

The majority agreed with the government, applying a literal and technical approach to the statutory language that did not afford much weight to the historical understanding of the criminal tax provisions.  The Court first found that the conduct of willfully submitting a false tax return inherently involves ‘deceit” and therefore is encompassed within subsection (i).  The Court then rejected the Kawashimas’ primary argument that this conclusion was untenable because it would make subsection (ii) entirely superfluous (since tax evasion also involves deceit).  To support that conclusion, the Court accepted the government’s technical argument that subsection (ii) was not superfluous because there was theoretically a situation where tax evasion does not involve “deceit” – namely, when a taxpayer files a truthful tax return but evades payment by moving his assets beyond the reach of the IRS.  Thus, the Court ruled that, “[a]lthough the Government concedes that evasion-of-payment cases will almost invariably involve some affirmative acts of fraud or deceit, it is still true that the elements of tax evasion pursuant to §7201 do not necessarily involve fraud or deceit.”

The dissenters characterized the majority’s construction of the statute as “dubious,” criticizing in particular its contortions to avoid the conclusion that its construction “effectively renders Clause (ii) superfluous.”  According to the dissent, the government’s proposed instances of tax evasion not involving “deceit” are not just “rare,” they are “imaginary.”  Given that the Court has previously “declined to interpret legislation in a way that ‘would in practical effect render [a provision] entirely superfluous in all but the most unusual circumstances,” the dissent argued that the majority’s reading is unsustainable.  Pointing to an amicus brief filed by former IRS Commissioner Johnnie Walters, the dissent also stated that the Court’s decision would have adverse consequences for the efficient handling of tax prosecutions.  In particular, it will discourage aliens from pleading guilty to the lesser section 7206 offense instead of going to trial on a tax evasion charge, because of the risk of deportation.

Kawashima Supreme Court opinion

Lively Oral Argument in Home Concrete Leaves Outcome in Doubt

The Supreme Court heard oral argument in the Home Concrete case on January 17, with the Justices vigourously questioning both sides on both the statutory and administrative deference issues.  The Court will issue its decision by the end of June.  The following is a recap of the argument that is also published at SCOTUSblog.  A full transcript of the oral argument can be found here.

Home Concrete involves the scope of the extended six-year statute of limitations applicable when a taxpayer “omits from gross income an amount properly includible therein.”  The case presents two main issues:  (1) whether that statutory language covers overstatements of tax basis, even though the Supreme Court construed the same phrase in a predecessor statute not to do so; and, (2) if the Court does not accept the government’s statutory argument, whether it must defer to a recent Treasury regulation that adopts the government’s proffered interpretation.  The argument was lively, with all Justices save Justice Thomas asking questions at some point.  It was also somewhat disjointed, as the discussion jumped from topic to topic without any obvious agreement among the Justices concerning which issue would be the ground for resolving the case.

Arguing on behalf of the United States, Deputy Solicitor General Malcolm Stewart began by making a determined effort to persuade the Court that it should prevail on a standard statutory analysis without the need to resort to Chevron deference.  In response to questions from the Chief Justice and Justice Scalia suggesting that the Court’s decision in The Colony, Inc. v. Commissioner derails that argument from the start, Stewart argued that Colony did not purport to give a definitive definition of the “omits from gross income” language wherever it appears in the Code.  Rather, it just interpreted the language for the 1939 Code, and the 1954 Code should be read differently because of the additional subsections that were added.

Several Justices (the Chief Justice, Justice Scalia, and Justice Sotomayor) expressed skepticism that Congress would have used such an obscure mechanism to change the interpretation of the “omits from gross income” phrase.  Stewart responded that he would agree if Colony had been on the books when the 1954 Code was enacted.  But in fact Colony was not decided until 1958, and Congress was acting against the backdrop of the existing circuit conflict on the meaning of the 1939 Code.  Justices Kennedy and Scalia immediately questioned that response, stating that it is “very strange” to say that the same language would have a different meaning depending upon when Colony was decided.  Justice Scalia then elaborated on his skepticism over the government’s attempts to prevail on the statute alone, stating that “we’re not writing on a blank slate here.”  “I think Colony may well have been wrong, but there it is.  It’s the law.  And it said that that language meant a certain thing.”

At that point, Justice Kagan sought to rescue Stewart by interjecting that the government has two arguments and the second one – that Treasury had the power to reinterpret the statute in regulations – was independent of Colony’s interpretation of the statutory language.  Although Stewart first tried to steer the Court back to the statute, Justice Kagan persisted, and the Chief Justice then entered the fray to question the linchpin of the government’s deference argument – namely, that Colony had found the statute to be “ambiguous.”  The Chief Justice pointed out that Justice Harlan, in using that word in 1958, “was writing very much in a pre-Chevron world” and likely was using the word not as “a term of art,” but rather in an attempt to be gracious to the lawyers and courts that had taken the opposite position.  Justice Ginsburg, however, pointed out that the Court had characterized the new subsection in the 1954 Code as “unambiguous” and therefore should be taken at its word that the 1939 Code was ambiguous.

Another line of questioning explored the extent to which there was ever a well-entrenched view that Colony controlled the meaning of the 1954 Code.  Stewart rejected the taxpayer’s position that everyone understood Colony as controlling prior to the Son-of-BOSS litigation, stating that there was a “surprising dearth of law” on the point, but the only arguably relevant case was a 1968 Fifth Circuit decision that suggested that Colony was not controlling.  The taxpayer and the Fifth Circuit dispute that reading of the case.  (No one observed that the likely reason there was no case law on this issue was because the IRS accepted Colony as controlling and therefore never attempted to invoke the six-year statute for overstatements of basis.)  Justice Breyer asked about a 2000 IRS guidance document that appeared to adopt the taxpayer’s view of Colony, but government counsel dismissed it as merely the view of a single District Counsel.  That prompted the Chief Justice to ask acerbically “at what level of the IRS bureaucracy can you feel comfortable that the advice you are getting is correct?”

When Gregory Garre took the podium on behalf of the taxpayer, Justice Kagan asked why Congress had added the new subsection addressing a trade or business.  Garre argued that it was designed to resolve the Colony issue favorably to the taxpayer, noting that there was nothing problematic about the fact that the new subsection addressed the specific problem of cost of goods sold instead of explicitly sweeping more broadly.  That answer triggered a more extensive discussion of why Congress acted as it did and whether it was drawing a distinction between sales of goods and services (addressed in the new subsection) and sales of real estate (at issue in Colony).

The key administrative law precedent at issue on the deference argument is National Cable & Telecommunications. Ass’n v. Brand X Internet Services, in which the Court accorded deference to a regulation that overturned existing court of appeals precedent.  The Court did not show any interest in backing away from Brand X, but it did suggest that it might read the case somewhat more narrowly than the government would like.  In Brand X, Justice Stevens wrote a short concurring opinion stating that the holding would not apply to a Supreme Court opinion because at that point no ambiguity would be left.  At the beginning of the argument, Justice Scalia echoed that view when he objected to Stewart’s reliance on the statement in Colony that the statute was “not unambiguous” by observing:  “Yes, but once we resolve an ambiguity in the statute, that’s the law and the agency cannot issue a regulation that changes the law just because going in the language was ambiguous.”  The Chief Justice returned to this point at the argument’s close.  He asked the only questions during the government’s rebuttal argument, seeking to confirm that the Court has never applied Brand X to one of its own decisions – that is, that “we’ve never said an agency can change what we’ve said the law means.”

The more open-ended issue concerning the scope of Brand X is what exactly was meant in that case by the statement that the judicial construction can trump a later regulation “only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.”  The Court’s exploration of this point began with a lighthearted comment by Justice Scalia that the question in the case boils down to whether indeed Colony meant “ambiguous” when it used that term.  Justice Alito followed up, however, pointing out that every statutory interpretation question in the Supreme Court “involve[s] some degree of ambiguity . . ., [s]o what degree of ambiguity is Brand X referring to?”

Garre’s response to this question was to go back to the original Chevron decision, which “looks to whether Congress has addressed the specific question presented.”  Under that approach, Colony should be regarded as having found the degree of clarity necessary to insulate it from being overturned by regulation, because the Court concluded that Congress had addressed this specific question.  Justice Kagan, later seconded by Justice Ginsburg, questioned that approach, commenting that the relevant question is “how clearly did Congress speak to that specific situation?”  Because the Colony Court stated that the text was ambiguous and had to do a lot of “tap dancing” through the legislative history to resolve the case, she stated that Colony must be read as indicating “a lot of ambiguity.”  Justice Breyer then jumped in to express agreement with the taxpayer’s argument that the Colony Court’s resort to legislative history was just a standard mode of statutory construction that did not require treating that case as finding an ambiguity under Brand X.  Instead, Justice Breyer stated, “[t]here are many different kinds of ambiguity and the question is, is this of the kind where the agency later would come and use its expertise”?

The argument devoted relatively little attention to the retroactivity question.  The Chief Justice observed that, in light of Brand X, a taxpayer could never feel confident about a tax precedent because the IRS can change the rule and apply it retroactively.  This observation, however, did not obviously elicit much concern from the other Justices, with the notable exception of Justice Breyer who had stated early on that it was “unfair” for the IRS to promulgate “a regulation which tries to reach back and capture people who filed their return nine years before.”  Later, Justice Breyer acknowledged that merely tagging the retroactivity as unfair “is not enough” and asked Garre an incredibly long question designed to explore possible justifications for avoiding the retroactive application of the regulations even if the Court were to defer to them on a prospective basis.  These ideas, however, did not appear to gain any traction with the other Justices.

Predicting the outcome on the basis of this oral argument is dicey.  Justice Kagan appeared sympathetic to the government’s position, while Justice Breyer was very troubled by the unfairness of it.  Justices Ginsburg and Sotomayor seemed to tilt towards the government.  But most of the Justices expressed enough difficulty with both sides that their votes cannot reasonably be forecast.  Overall, however, it did appear that the Court is more likely heading towards a relatively narrow decision than towards one that would break new ground in administrative law.  The Court’s approach to Colony will likely be critical.  If the Court treats Colony as precedential with respect to the 1954 Code, as it was generally regarded for fifty years, then it would not be difficult to rule for the taxpayer.  Brand X might be distinguished because Colony is a Supreme Court decision, or perhaps on the ground that the case should not be treated as finding an “ambiguity” in Chevron terms.  Conversely, if the Court views Colony as inapplicable to the 1954 Code, then, notwithstanding Justice Scalia’s observation to the contrary, the Court will essentially be writing on a blank slate.  If so, Brand X would likely lead to a ruling for the government.

Home Concrete Argument Preview

The long journey of the Intermountain cases toward a definitive resolution enters its final phase on Tuesday morning when the Supreme Court hears oral argument in the Home Concrete case.  (The final brief, the government’s reply brief, was filed last week.)  Each side will have 30 minutes for its argument, with the government going first and having the opportunity for rebuttal (using whatever portion of the 30 minutes that remains after its opening argument).  Deputy Solicitor General Malcolm Stewart (the Deputy SG in charge of tax cases) will argue for the government.  Gregory Garre, who served as Solicitor General during the last few months of the Bush administration in 2008-09, will argue for the taxpayer.  Both counsel have many Supreme Court arguments under their belts.

Regular readers of the blog know that we have covered these issues extensively since the Tax Court issued its decision in Intermountain.  The following is a preview of the argument that summarizes the issues for those who have not been following it so closely (or perhaps have gotten tired reading about it and want a refresher course).  A shorter version of this argument preview appears at SCOTUSblog.

We will return later in the week with a report on the argument.

Introduction

Depending on how the Court resolves a threshold statutory construction issue, Home Concrete could yield a decision of broad importance or one of interest only to tax lawyers.  The ultimate issue concerns the scope of an extended statute of limitations applicable only to tax cases.  The first possible ground for decision is purely a matter of interpreting the language of the tax statutes.  But the government faces significant hurdles on that ground, notably the Court’s 1958 decision in The Colony, Inc. v. Commissioner, which interpreted the same words in a predecessor statute in the 1939 Code in accordance with the taxpayer’s position.  If the Court rejects the government’s position that the statutory language alone is dispositive, the case will move to the second issue presented – whether the Court must adopt the government’s statutory construction because Chevron requires it to defer to recently promulgated Treasury regulations.  A decision on that issue could be a significant administrative-deference precedent that would have broad ramifications outside the tax context as well.

Background

Generally, the IRS has three years from the date a tax return is filed to assess additional tax on the ground that a taxpayer underreported its tax liability.  Under 26 U.S.C. § 6501(e)(1)(A), however, there is an extended six-year statute of limitations if the taxpayer “omits from gross income” a significant amount that it should have included.  A similar provision governing partnership tax returns is found at 26 U.S.C. § 6229(c)(2).  The question presented in Home Concrete is whether that “omits from gross income” language includes a situation where a taxpayer overstates its basis. 

The textual question at the heart of this case goes back almost 70 years.  The 1939 Internal Revenue Code, which was later superseded by the 1954 Code, contained a provision with language identical to that of current section 6501(e)(1)(A).  Taxpayers argued that the extended statute of limitations applied only when there was a literal omission of gross income – that is, a failure to list an item of gross income on the return.  The government argued that the extended statute also applied when there was an overstatement of basis, because that leads to an understatement of gross income.  The issue generated a circuit conflict and eventually made it to the Supreme Court in the Colony case. 

In the meantime, Congress enacted the 1954 Code, which largely carried forward the previous statute.  Congress did not change the “omits from gross income” language and did not directly address the then-existing dispute about its scope.  Congress did add a new subsection that specifically defined “gross income” in the case of a trade or business, and it defined that term so that an overstatement of basis could not possibly be an omission of “gross income.”

Thereafter, the Colony case arrived in the Supreme Court.  Construing the 1939 Code, the Court ruled for the taxpayer, holding that “the statute is limited to situations in which specific receipts or accruals of income are left out of the computation of gross income” and therefore it did not apply to overstatements of basis.  Little did the Court know that 50 years later litigants would be parsing its reasoning to see how the case fits into the framework of Chevron – specifically, whether the Colony Court should be understood to have found the statutory language before it unambiguous.  Two statements by the Colony Court are particularly relevant.  First, the Court stated that, although the statutory text “lends itself more plausibly to the taxpayer’s interpretation, it cannot be said that the language is unambiguous.”  The Court then looked to the legislative history, where it found persuasive support for the taxpayer, and also concluded that the government’s interpretation would apply the statute more broadly than necessary to achieve Congress’s purpose.  Second, having been urged by the parties to consider whether the new legislation shed any light on the meaning of the 1939 Code, the Court stated that its conclusion was “in harmony with the unambiguous language” of the 1954 Code.

Fast forward 50 years.  The issue has lain dormant, as everyone assumed that Colony controlled the interpretation of the identical language in the 1954 Code.  The IRS learned that many taxpayers had engaged in a series of securities transactions that came to be known as a Son-of-BOSS transaction.  The IRS views this transaction as a tax avoidance scheme that manipulates certain tax rules to produce an artificially inflated basis for an asset that is then sold, producing either a noneconomic paper loss or a smaller gain than it should.  The IRS has successfully challenged these transactions, with the courts generally concluding that they lack “economic substance” and therefore the taxpayers cannot take advantage of the apparent tax benefits.  But in many cases, the IRS discovered that more than three years had elapsed before it could challenge the tax treatment, and therefore the standard statute of limitations had expired.

Seeking to recover what it estimated as almost $1 billion in unpaid taxes, the IRS began to argue that the extended six-year statute of limitations applied to these transactions because they involved an overstatement of basis.  It contended that Colony was not controlling because the Court’s decision should be limited to the 1939 Code and that a different result should obtain in the Son-of-BOSS cases (which arise outside the “trade or business” context and hence are not encompassed within the new subsection added in 1954).  This argument initially fell flat in the courts, as the Tax Court and the Ninth and Federal Circuits held that Colony controls the interpretation of the “omits from gross income” language of the 1954 Code.

The government then moved on to Plan B.  The Treasury Department issued temporary regulations interpreting the “omits from gross income” language to include overstatements of basis.  (These regulations have since been issued without material change as final regulations after a notice-and-comment period.)  The government then filed a motion for reconsideration in the Intermountain case, arguing that the Tax Court should reverse its decision because of an “intervening change in the law” requiring it to accord Chevron deference to the new regulatory interpretation.  The Tax Court was unimpressed, voting 13-0 (in three different opinions giving three different grounds) against the government.

Unfazed, the government filed appeals in several cases heading to different circuits, and the tide began to turn.  First, the Seventh Circuit became the only court thus far to agree with the government’s statutory argument.  The Fourth and Fifth Circuits quickly rejected that view and also rejected the government’s Chevron argument, holding that after Colony there was no ambiguity for the Treasury Department to interpret.  Three other court of appeals decisions followed in short order, however, and all three circuits ruled for the government on Chevron deference grounds.  Of particular note on that point is the Federal Circuit’s decision, since the Federal Circuit had already rejected the government’s pre-regulation statutory interpretation.  The Federal Circuit explained that it still believed that the taxpayer had the best reading of the statute, but that it was required to defer to the regulation because it could not say that the regulation’s interpretation was unreasonable.  The Court granted certiorari in Home Concrete, the Fourth Circuit case, to resolve the conflict.

Arguments

With respect to the meaning of the statute, the taxpayer rests primarily on Colony, characterizing the IRS as having “overruled” that decision.  The taxpayer argues that its reliance on stare decisis is buttressed by the fact that Congress reenacted the same statutory language in later years against the background of Colony, thereby putting a legislative stamp on the Court’s determination that the words “omits from gross income” should be interpreted not to include overstatements of basis. 

The government in turn argues that Colony is irrelevant because it involved a different statute, which was materially changed in 1954 when Congress added a subsection making clear that there is no extended statute of limitations for overstatements of basis by a trade or business.  Implicit in Congress’s decision to make that addition was its understanding that overstatements of basis would be covered outside of the trade or business context; otherwise, the new provision would be superfluous.  The taxpayer responds that the new subsection is not superfluous and that it is absurd to conclude that the 1954 Code cut back on taxpayers’ statute of limitations protections when the only changes made to the statute favored taxpayers. 

In addition to the Colony-related arguments, both sides argue that their position reflects the best reading of the statutory text and purpose.  The taxpayer argues that “omits” means leaving something out, while the government emphasizes that overstatements of basis inevitably cause an understatement (that is, an “omission” of a portion) of gross income.

The taxpayer makes a couple of other narrow arguments that could theoretically divert the Court from reaching the deference issue:  (1) that the regulations were procedurally defective; and (2) that by their terms, the regulations do not apply to cases like this one, where the three-year statute had already expired before the regulations were promulgated.  These arguments did not prevail in any court of appeals, and the Court is unlikely to adopt them.  That will lead the Court to a deference issue of potentially broad doctrinal significance.

Back in 1971, the Second Circuit thought it obvious that the Treasury Department did not have the power to affect pending litigation that the government claims here, stating that “the Commissioner may not take advantage of his power to promulgate retroactive regulations during the course of litigation for the purpose of providing himself with a defense based on the presumption of validity accorded to such regulations.”  But the D.C. Circuit, in reversing the Tax Court’s reviewed Intermountain decision, said that the Second Circuit’s statement has been “superseded” by Supreme Court precedent.  The Home Concrete case is well positioned to determine who is right.

Basically, the government argues that the Court’s Chevron jurisprudence has already crossed all the lines that are necessary to get to its desired end result here.  In Smiley v. Citibank, N.A., the Court afforded deference to a regulation in a case that was already pending when the regulation was issued, stating that it was irrelevant whether the regulation was prompted by litigation.  In National Cable & Telecomms. Ass’n v. Brand X Internet Servs., the Court afforded deference to a regulation that overturned existing court of appeals precedent, holding that a “court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.”  Put those two together, the government argues, and there is no justification for failing to defer to Treasury’s interpretation because Colony had described the 1939 statute as not “unambiguous.” 

Not so fast, says the taxpayer, arguing that, after Colony, the law was settled and there was no ambiguity that could permissibly be “clarified” by regulation.  Smiley is different, because the regulation there did not overturn a previously settled interpretation.  Brand X is not applicable because Colony is properly read as having held that Congress did unambiguously express its intent not to include overstatements of basis.  More generally, the taxpayer contends that the retroactive effect of the government’s position is a bridge too far that is not authorized by these precedents.  Among the several amicus briefs filed in support of the taxpayer, one filed by the American College of Tax Counsel focuses exclusively on the retroactivity question, asserting that “retroactive fighting regulations” designed to change the outcome of pending litigation “are inconsistent with the highest traditions of the rule of law” and should not be afforded Chevron deference.

Analysis

At the end of the day, the deference issue may turn on the Court’s comfort level with the amount of authority the government is asking courts to concede to agencies – particularly an agency frequently in a position to advance its fiscal interest through regulations that will affect its own litigation.  That general topic has been flagged in the court of appeals opinions.  In the Federal Circuit decision holding that the new regulation trumped that court’s precedent, the court observed that the case “highlights the extent of the Treasury Department’s authority over the Tax Code” because “Congress has the power to give regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.”  Conversely, Judge Wilkinson cautioned in his concurring opinion in Home Concrete that “agencies are not a law unto themselves,” but must “operate in a system in which the last words in law belong to Congress and the Supreme Court.”  In his view, the government’s invocation of Chevron deference in this case wrongly “pass[es] the point where the beneficial application of agency expertise gives way to a lack of accountability and risk of arbitrariness.”

In recent years, the Court has not evinced much concern over the amount of power that its Chevron jurisprudence has given to agencies.  But this case could induce it to look more closely at the big picture.  Justice Scalia’s position will be of particular interest.  Justice Scalia was an early force in the development of Chevron deference, dating back to his time on the D.C. Circuit shortly after Chevron was decided.  But recently, he has expressed some uneasiness that the way in which the doctrine has developed had given agencies too much power.  He dissented in Brand X, commenting that the decision was creating a “breathtaking novelty:  judicial decisions subject to reversal by executive officers.”  And just last June, he noted in a concurring opinion in Talk America, Inc. v. Michigan Bell Telephone Co., that he would be open to reconsidering Auer v. Robbins (a decision that he authored in 1997) because its rule of extreme deference to an agency’s interpretations of its own regulations “encourages the agency to enact vague rules which give it the power, in future adjudications, to do what it pleases.”  Justice Scalia’s questions at oral argument, and the reaction of other Justices to them, will be worth watching. 

 

Supreme Court Struggles With Confusing Criminal Tax and Deportation Interplay in Kawashima Oral Argument

We are finally getting around to updating Kawashima, the Supreme Court case involving the question of whether a conviction under section 7206 is a deportable offense under the immigration laws.  The Court heard argument on the case back in November.  A decision likely will be issued this spring.  It’s hard to read which way the Court is leaning based on the arguments.  Several Justices seemed to balk at petitioners’ technical argument that a false statement on a return (under section 7206) can be something less than intending to deceive the IRS (a crime involving “fraud or deceit” is deportable under the immigration laws — see our prior post).

The argument first focused on the Code’s “willfulness” concept and whether the requirement in section 7206 that the false statement be submitted willfully in fact turned an act that — without willfulness — might not be intended to deceive into something that showed intent to deceive.  Petitioners’ counsel tried to focus the Court on the concept that intent to deceive required intent to induce an action or reliance and not merely intent to make a false statement.  This position seemed to concern several Justices given that the false statement was on a document submitted to the government for a specific purpose (reporting taxes).  The argument also briefly turned to the question of the case law — largely Tax Court case law — which historically held that a conviction under section 7206 did not automatically trigger the extended limitations period for fraud unless the IRS independently proved fraud.  The Justices did not substantively comment on this point during petitioners’ time but came back to it during the government’s argument and it seemed to get some traction with the Chief Justice.

Petitioners’ counsel and Justice Scalia spent a substantial amount of time discussing whether the inclusion of both section 7201 and the “fraud or deceit” provision in the deportation law rendered the former superfluous if the government’s reading was adopted.  This involved a discussion of the text of section 7201, which has long been textually framed as an attempt “to evade or defeat any tax” and does not specifically use the words fraud or deceit.  While the Justices did not seem to be happy with the responses by petitioners’ counsel, an amicus brief submitted by Johnnie Walters — a former IRS Commissioner — deals with the history and meaning of section 7201 quite compellingly.  And when questioning the government’s counsel, Justices Ginsburg and Kagan both seemed concerned that the government’s position could read one part of the deportation statute out of the law based on this historic reading of section 7201.  This led Justice Breyer to introduce the idea that section 7206 does not seem to meet the common law definitions of fraud or deceit — a point not raised by counsel as best as we can tell — but something that could be relevant in determining Congressional intent.

Piercing through the government’s argument, Justice Kagan was able to get its counsel to admit that even the evasion-of-payment cases under section 7201 have to involve some sort of fraud in order to be prosecuted under that statute.  Counsel also basically admitted that the IRS/DOJ has never prosecuted a section 7201 case that didn’t involve fraud.  This triggered a question by Justice Breyer as to whether the government’s position would make every single perjury statute a deportable offense — something that would profoundly impact both defendants and the system.  Justice Kagan then returned to the circularity of the government’s arguments regarding superfluity (a point we have made a few times previously).

As we said at the outset, it is difficult to see where all of this is going.  Petitioners do seem to us to have the stronger case when you consider the historic meaning of section 7201 (which is fundamental to criminal tax practice) but the statutory text could be confusing when read outside of that context.  We will update you as soon as we see a decision.

Next Page »