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Tax Court Issues Five Discovery Orders Addressing Admissibility of Expert Reports

by and | Jul 20, 2016 | , , , ,

On July 13, 14, and 15, 2016, Judge Laro of the US Tax Court (Tax Court) ruled on five taxpayer-filed motions in limine to exclude expert reports in Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al. v. Commissioner. At issue in the case are a number of IRS transfer pricing adjustments to the taxpayer-corporation’s income under Section 482.

In support of its adjustments, the IRS offered numerous expert reports to the Tax Court, and the taxpayer sought to exclude these reports. The taxpayer raised the following major arguments:

Argument: The IRS expert reports failed to contain opinions.

The taxpayer argued that three of the reports should be excluded because they did not comply with Tax Court Rule 143(g)(1), which requires that expert witnesses generally prepare written reports, and requires that expert reports include “a complete statement of all opinions the witness expresses and the basis and reasons for them.” In federal district court practice (under somewhat different rules), this requirement generally means that an expert must separately state, and clearly delineate, his or her expert opinions in a written report—usually in a “conclusions” or “opinions” section. In Tax Court, the requirement for a clear and concise written expert report is even more significant than in federal district court practice because, under Rule 143(g)(1), expert reports are treated as direct testimony of the expert (although, in many cases, additional expert testimony and cross-examination may be helpful or necessary).

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Tax Court Judge Howard A. Dawson, Jr. Passes Away

by | Jul 18, 2016 | ,

US Tax Court Judge Howard A. Dawson, Jr. passed away on July 15, 2016. The longest-serving judge in Tax Court history, Judge Dawson was appointed to the bench in 1962 by President John F. Kennedy and remained in service as a Senior Judge at the time of his death. This morning, Chief Judge L. Paige Marvel released a statement acknowledging his passing and discussing his many accomplishments.



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Tax Court Order Indicates That E-Discovery and Predictive Coding Are Here to Stay

by , , and | Jul 18, 2016 | , , , , ,

On July 13, 2016, Judge Buch of the US Tax Court denied an Internal Revenue Service (IRS) motion to compel the production of electronically stored information (ESI) by Dynamo Holdings Limited Partnership and Beekman Vista, Inc., which was not delivered as part of a discovery response based on the mutually agreed-upon use of “predictive coding.” Predictive coding is an electronic discovery method that permits an efficient and effective approach when reviewing for relevance a large amount of data and documents. It is a relatively new discovery method that is gaining acceptance by courts around the country as an alternative to the costly and laborious physical review of data and documents. Judge Buch previously authorized the use of predictive coding in Dynamo Holdings, Ltd. vs. Commissioner, 143 T.C. No. 9 (2014).

The IRS and the taxpayers had agreed that the taxpayers would run a search for terms determined by the IRS on the potentially relevant documents. The taxpayers provided the IRS with samples of randomly selected documents from the universe of potentially relevant documents, from which the IRS identified the relevant documents. These selections were used to create a predictive coding model, which a computer can use to identify conceptually similar documents.  The IRS also selected a “recall rate” of 95 percent. A search method’s recall rate is the percentage of all relevant documents in the search universe that are retrieved by that search method. The higher the recall rate, the fewer relevant but retrieved documents there will be. The taxpayers then delivered to the IRS all of the documents retrieved using the predictive coding model that were not privileged. More documents were identified in the initial search for terms than were identified using the predictive coding model. The IRS filed a motion to compel production of the documents identified in the initial terms search that were not produced.

The Tax Court denied the IRS’s motion, explaining that document review results are never perfect. The court stated that the IRS was seeking a perfect response, but that the Tax Court Rules and the Federal Rules of Civil Procedure require only that the responding party make a “reasonable inquiry” when making a discovery response. The court explained that “when the responding party is signing the response to a discovery demand, he is not certifying that he turned over everything, he is certifying that he made a reasonable inquiry and to the best of his knowledge, his response is complete.”  The use of predictive coding does not change this standard, and the court held that the taxpayers satisfied the reasonable inquiry standard when they responded using predictive coding.

Practice Note: Due to the amount of data and documents generated by taxpayers in the normal course of business, discovery of ESI can be extremely burdensome and expensive for taxpayers.  Nonetheless, it has become commonplace to see discovery requests for ESI.  Although there is a substantial amount of guidance on this subject in other courts, the Tax Court has issued [...]

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Expert “Hot Tubbing” in the Tax Court

by and | Jul 15, 2016 | , ,

The use of expert witnesses in litigation can be tricky.  Taxpayers want to avoid the perception that their expert is a “hired gun” who is merely their biased advocate.  The US Tax Court has repeatedly stated that such expert testimony is not useful or credible.

A technique that is common in Australia, and has been gaining traction in the Tax Court, is the use of concurrent expert testimony.  This technique—referred to as “hot tubbing”—involves expert witnesses engaged by the taxpayer and the Internal Revenue Service (IRS) conferring directly with the judge and engaging in conversation about the evidence in the case and their opinion.   (more…)



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Tax Court Clarifies the Rules and Grants IRS’s Motion to Compel Nonconsensual Depositions

by and | Jul 12, 2016 | , ,

On July 8, 2016, Judge Buch of the US Tax Court (Tax Court) granted the Internal Revenue Services (IRS) motion to compel depositions of six individuals in Dynamo Holdings Ltd. P’ship v. Commissioner.  That case involves the question of whether certain transfers between related entities are disguised gifts or loans.  The IRS has been attempting to take sworn testimony of individuals relating to its examination of Dynamo for several years, which was part of the Supreme Court’s opinion in United States v. Clarke, 135 S.Ct. 2361 (2014).  That summons’s enforcement action is still proceeding. (See United States v. Clarke, lead case: 15-11663).  As a subject of the ongoing discovery disputes, the IRS filed a motion to compel the depositions of six witnesses from Dynamo in the Tax Court. We have previously discussed the Tax Court’s prior opinion in this case regarding the use of predictive coding in responding to the IRS’s discovery requests for electronically stored information.

The Tax Court recognized its longstanding position that nonconsensual depositions are an extraordinary method of discovery.  In ruling on the motion to compel depositions, the court explained the two requirements necessary under the Tax Court Rules of Practice and Procedure (Tax Court Rules) to consider such a motion and three factors to consider in deciding whether to grant such a motion.  To request nonconsensual depositions, the movant must show:  (1) the testimony that the movant seeks to obtain through the depositions is discoverable under Rule 70(b) of the Tax Court Rules; and (2) the testimony sought practicably cannot be obtained through informal consultation or communication, interrogatories, requests for production of documents, or consensual depositions.

If the movant can establish the two requirements, the court will weigh the movant’s:  (1) basis for the deposition; (2) purposes of the depositions other than having a substitute for cross-examination; and (3) prior opportunities to obtain the information sought through the depositions.

Judge Buch found that the two requirements were met because the testimony sought was central to this case, and the IRS could only obtain the information through the examinations, which four of the six witnesses refused to attend.  Additionally, he found that all three factors weighed in favor of compelling the depositions because the information was directly related to the witnesses’ knowledge, which was hard to access through other means, and the IRS has not had a chance to obtain the information because of the witnesses’ refusals to appear when summoned.

Practice Note:  Historically, depositions in the Tax Court were rare.  Since the Tax Court Rules were amended in recent years, this discovery practice has increased dramatically.  In the last five years we have seen the IRS increasingly and routinely request depositions.  This discovery tool, although not at the level that is experienced in district court, is one of the IRS’s new techniques to solidify the taxpayer’s position prior to trial.  We expect this practice to continue for the foreseeable future.  What does this mean to taxpayers?  The costs of litigating in Tax [...]

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Tax Court (Again) Rejects IRS Use of Secret Subpoenas

by | Jul 11, 2016 | , , ,

On July 8, 2016, Judge Mark V. Holmes of the US Tax Court issued an order in Ernest S. Ryder & Associates, Inc., APLC, et al., v. Commissioner, ordering the Internal Revenue Service (IRS) to serve on the taxpayer all non-party subpoenas that he had issued in the case, together with all responses and documents that nonparties produced after receiving those subpoenas. The order mirrored a prior order issued by Judge Holmes almost a year ago in Kissling v. Commissioner, Dkt. No. 19857 (July 16, 2015).

In both cases, the IRS served subpoenas on third parties (77 subpoenas in the most recent case) and argued to the court that there is no Tax Court rule that requires him to notify taxpayers about whom he is subpoenaing in a Tax Court case, and he would prefer to keep his pretrial preparation secret. Although Judge Holmes agreed that the Tax Court’s rules do not specifically require notice of non-party subpoenas, he disagreed with the IRS that this absence creates an implication that secret subpoenas are favored. Reviewing the history of its rules on subpoenas and the close connection with Fed. R. Civ. Proc. 45, which requires notice to other parties before service of non-party subpoenas for the production of documents, information, or tangible things, Judge Holmes adopted the notification requirement of Fed. R. Civ. Proc. 45 as a modification to the pretrial order that governed the case.

In our experience, the IRS does not view Kissling as the law in the Tax Court and questions its value. It remains to be seen whether the Tax Court will formally adopt the notification requirement in Fed. R. Civ. Proc. 45 or will continue to permit each judge to determine how to deal with secret subpoenas. Unless and until the court amends its rules, issues an opinion on the issue, or the IRS voluntarily follows the approach set forth by Judge Holmes, taxpayers and their counsel should consider as part of their pretrial preparation in Tax Court cases requesting from the IRS notice of all subpoenas issued to non-parties along with copies of all subpoenas, responses and documents produced by the non-parties. This request should be noted as being continuing in nature. If the IRS asserts that no subpoenas have been issued, taxpayers can use this representation against the IRS if they later discover that non-party subpoenas were issued. If the IRS refuses to respond or produce the requested information, taxpayers can point to these two orders as persuasive authority (albeit non-precedential and non-binding) that notice should be provided and the information should be produced.



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Commissioner Files Opening Brief in Ninth Circuit Appeal of Altera

by | Jul 5, 2016 | , , , ,

In Altera Corp. v. Commissioner, 145 T.C. No. 3 (July 27, 2015), the Tax Court, in a unanimous reviewed opinion, held that regulations under Section 482 requiring parties to a qualified cost-sharing agreement (QCSA) to include stock-based compensation costs in the cost pool to comply with the arm’s-length standard were procedurally invalid because the US Deparment of Treasury and the Internal Revenue Service (IRS) did not engage in the “reasoned decisionmaking” required by the Administrative Procedures Act and the cases interpreting it. For a discussion of the Tax Court’s Altera opinion, see our prior On the Subject. The Commissioner of Internal Revenue (Commissioner) appealed this holding to the Ninth Circuit Court of Appeals; he filed his opening brief on June 27, 2016.

According to the Commissioner, the Tax Court’s holding was based on several related errors: (1) the Tax Court mistakenly concluded that promulgation of the QCSA regs required the IRS to engage in an “essentially empirical” analysis; (2) this led the court to apply the wrong standard; (3) in its analysis, the court relied heavily on its holding in Xilinx, Inc. v. Commissioner, 125 T.C. 37 (2005), that analysis of QCSAs must comport with the arm’s-length standard, meaning that a taxpayer can defend a QCSA by reference to comparable behavior between unrelated parties; and (4) the Tax Court failed to take into account that the finalization of the new QCSA regulations worked a “change in the legal landscape,” which should have altered the court’s analysis of the new regulations’ validity. Moreover, “the coordinating amendments [to the existing QCSA regulations] supersede [the Ninth Circuit’s] understanding of the arm’s-length standard as reflected in its own Xilinx opinion.” (more…)



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Tax Court Adopts Rules for Judicial Conduct and Judicial Disability Complaints

by and | Jun 15, 2016 | , ,

In a June 14, 2016 press release (available here), Chief Judge L. Paige Marvel of the United States Tax Court announced the adoption of rules for judicial conduct and judicial disability complaints.  The rules conform with the Rules for Judicial Conduct and Judicial Disability Proceedings promulgated by the Judicial Conference of the United States.  Links to the rules can be found here.

On a somewhat related point, at least one taxpayer has filed a motion for reconsideration related to an unfavorable ruling made by former Judge Diane L. Kroupa.  It remains to be seen how the Tax Court will deal with that motion and the fall-out from Judge Kroupa’s criminal indictment for tax evasion while she was a Tax Court judge.  Prior coverage of Judge Kroupa’s indictment for tax evasion can be found here.



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Tax Court Rules in Favor of Medtronic in Transfer Pricing Case Against IRS

by and | Jun 10, 2016 | , , ,

At least a partial taxpayer victory in the Medtronic case, T.C. Memo. 2016-112. The Tax Court held that Medtronic met its burden of showing the Internal Revenue Service (IRS) abused its discretion by  making arbitrary and capricious Internal Revenue Code (IRC) Section 482 reallocations with respect to taxable income of Medtronic’s Puerto Rico subsidiary. It further concluded that the IRS’s use of the comparable profits method is not required under the IRC Section 482 commensurate with income standard. Although the Tax Court found the taxpayer’s royalty rates established using the comparable uncontrolled transaction method to be unreasonable, the court undertook to determine the proper allocations itself, and made two significant adjustments to the taxpayer’s royalty rates. Finally, the court rejected the IRS’s alternative allocation that intangibles were transferred under IRC Section 367(d).



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“Snow Day” Case Highlights Importance of Timely Filing Requirements

by and | Jun 3, 2016 | , ,

On June 2, 2016, the  US Tax Court issued a unanimous court-reviewed opinion in Guralnik v. Commissioner, 146 T.C. No. 15 (available here), addressing several points related to the timely filing of court documents.  The opinion provides important reminders to taxpayers to ensure that they meeting filing deadlines. (more…)



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