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A number of state False Claims Acts allow individuals to pursue “qui tam” whistleblower suits against delinquent taxpayers. In this article, McDermott Will & Emery's Peter Faber, Alysse McLoughlin and Mark Yopp discuss these actions and argue that False Claims Act proceedings are expensive, burdensome and wholly unnecessary as an added enforcement mechanism.
By Peter L. Faber, Alysse McLoughlin and Mark W. Yopp
Peter L. Faber, Alysse McLoughlin, and Mark W, Yopp are partners in McDermott Will & Emery's state and local tax practice.
An article in the April 19 Daily Tax Report: State about New York's settlement of a large tax whistleblower case quotes a number of attorneys who recommend that other states should follow New York's lead in applying False Claims Act statutes to tax cases. This is a bad idea.
While it is true that New York State has raised significant amounts of money in pursuing whistleblower suits against taxpayers, the issue is whether using False Claims Acts to pursue delinquent taxpayers is an appropriate means of enforcing the tax laws. The same dollars might have been raised by audits of the taxpayers by the Department of Taxation and Finance following normal audit procedures. All of the states have competent departments of revenue and laws that provide for collecting taxes from delinquent taxpayers, including civil fraud and criminal penalties where appropriate. Are False Claims Acts needed as additional enforcement mechanisms? We submit that they are not.
As state and local tax specialists, we handle tax audits, appeals, and litigation around the Country. We can testify from personal experience that state revenue departments vigorously enforce the tax laws. Their auditors and other professionals are competent and hard-working. They conduct tax proceedings professionally and efficiently. Moreover, state tax statutes typically provide not only for enforcement procedures but for significant penalties for negligence and fraud and taxpayers that engage in criminal tax conduct can and do go to jail.
The extension of New York State's False Claims Act to tax cases in 2010 has produced a separate enforcement structure that exists alongside the normal tax audit structure. This structure is cumbersome and expensive and is wholly unnecessary. Let's look at how the structure works.
Under the New York State False Claims Act, a whistleblower, or the Attorney General on his own initiative, can commence a legal action against an individual or a company that they believe has not complied with the tax law. Whistleblower cases typically begin with a complaint filed under seal by an individual whistleblower. The Attorney General is notified about the complaint and may intervene and take over the case if he feels that this would be appropriate. If he does not, the individual whistleblower is free to continue the action separately. This is what has happened in a case involving Citicorp, in which a whistleblower alleging a violation of federal tax law that became a New York State tax issue because New York State generally conforms to the federal definition of taxable income has sued Citicorp for hundreds of millions of dollars under the False Claims Act despite the fact that both the Internal Revenue Service and the New York State Department of Taxation and Finance felt that his claim was wholly without merit. Even if the Attorney General decides to take over a case, the Attorney General's Office (AGO) lacks substantial tax expertise. While the AGO has been willing to consult with the New York State Department of Taxation and Finance and the New York City Department of Finance in particular cases, it has maintained control over the handling of those cases. We have had cases in which the AGO has conducted extensive and costly investigations of issues that the State and City tax authorities would have immediately recognized were routine matters to be handled in audits without any suggestion of penalties.
The stakes are high in False Claims Act proceedings. A taxpayer can be liable for treble damages in these cases, even if its conduct was not fraudulent. The standard for liability under New York's False Claims Act is whether there was a “reckless disregard” of the tax laws, and the AGO in several cases has taken the position that a mere failure to seek outside tax advice indicated such a “reckless disregard” even though the taxpayer's in-house tax people were confident, based on past practice and prior audits, that the tax returns that they were filing were correct. The New York State Court of Appeals, the State's highest court, has held in People ex rel Schneiderman v. Sprint Nextel Corp., 42 N.E.3d 655 (N.Y. CT. App. 2015) that the fact that a taxpayer's position is objectively reasonable is no defense against False Claims Act liability if it turns out that the Tax Department and the courts disagree with that position, even though the position was adopted in a good faith belief that it was correct.
The New York False Claims Act has a ten-year statute of limitations. Since a corporation must show that it made a good faith effort to determine that its tax treatment of an item was correct to avoid being charged with a “reckless disregard” of the tax law, this may place an impossible burden on corporations when the people who made the decisions years before have died or are no longer employed by the taxpayer.
The fact of a prior State Tax Department audit that addressed the issues and approved the taxpayer's positions does not bar a False Claims Act proceeding. We have had cases in which the fact that the taxpayer was currently being audited by the State Tax Department did not stop the AGO from conducting its own independent investigation.
False Claims Act proceedings are more formal and adversarial than are Tax Department audits. Information is often requested through formal subpoenas that may be sweeping in scope because the AGO may be unfamiliar with the kinds of records that taxpayers typically keep. Tax Department audits of large corporations are usually conducted by teams of auditors who know the industry and who may have audited the particular taxpayer in previous audit cycles. The tax auditors are experienced and know the law, the regulations, and the other authorities. They are familiar with the issues that are likely to be presented by a corporation's tax returns. The AGO, in contrast, typically will not be familiar with those issues and, as a result, its investigation is likely to be inefficient and time-consuming.
Most states have a voluntary disclosure agreement procedure under which a company that believes that it may have understated its tax liabilities for prior years can come forward voluntarily and reach agreement with the state tax department that it will begin filing returns, or file them correctly, going forward with liabilities for prior periods being limited to the last few years and with a waiver of penalties. State revenue departments have encouraged these procedures because they get delinquent taxpayers back on the rolls. Under the New York False Claims Act, getting a voluntary disclosure agreement does not shield a taxpayer from False Claims Act liability for treble damages with a 10-year statute of limitations. This could deal a fatal blow to the State's voluntary disclosure agreement process. Would a company that had not filed tax returns in New York because of a good faith belief that it lacked taxable nexus with the State but that was concerned about whether that position was correct come forward and request a voluntary disclosure agreement if it knew that, even though the State Tax Department would only assess liabilities for the past three years, the Attorney General could assess liabilities, including treble damages, for the past ten years?
New York State Tax Department audits are conducted with due regard for taxpayer privacy concerns. In fact, the Department itself has insisted on having tight non-disclosure provisions in closing agreements that conclude audits. This enables the parties to have frank and candid discussions of issues, with taxpayers feeling free to disclose to Tax Department auditors documents and other materials that are highly confidential. The AGO is under no such constraints. In fact, when the AGO has been asked to agree to the same privacy standards that apply to the Department, it has explicitly refused to do so. A False Claims Act investigation typically ends with a press release and perhaps a press conference by the AGO. We can testify from personal experience that this can affect the conduct of a proceeding.
We do not mean to be critical of the attorneys in the New York AGO's Taxpayer Protection Bureau. They are smart, conscientious professionals, and they are carrying out their responsibilities effectively. But we are critical of the law that has created a separate administrative structure for enforcing the tax law that is expensive and burdensome and that is wholly unnecessary.
We are not suggesting that whistleblowers be discouraged or that they do not play a significant role in enforcing the tax laws. The issue is: how should whistleblower matters be handled administratively and how should the whistleblowers be compensated? The right answer is that they should report their suspicions to the state department of revenue and the department should determine whether the taxpayer in question should be audited and should pay additional taxes, using its normal audit procedures and applying, if appropriate, the civil and criminal penalties set forth in the tax laws. If the revenue department chooses to compensate a whistleblower, that would be fine, but the revenue department, not the AGO or some private party, should make the determination as to whether to proceed against the taxpayer. This is how the federal system works. If someone feels that a company has not been paying its correct federal taxes, he or she notifies the Internal Revenue Service and the Service, if it feels it appropriate, takes enforcement action under the regular tax law procedures. The whistleblower may be entitled to compensation. In other words, there is no need to set up a parallel enforcement structure with draconian penalties and cumbersome and expensive procedures to accommodate a scheme in which people are encouraged to blow the whistle on delinquent taxpayers.
If people feel that state revenue departments are not doing an adequate job of enforcing the tax laws, the remedy is to give them more resources to do so. Giving state revenue departments the funds to expand their audit staffs and modernize their auditing and collection procedures is the right way to do this. Setting up a parallel enforcement structure in another government agency makes no sense.
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