Ninth Circuit Archives - TAX CONTROVERSY 360

Ninth Circuit

Supreme Court Punts on Attorney-Client Privilege Question

by Kevin Spencer, Sarah M. Raben and McDermott Will & Emery | Feb 2, 2023 | Appellate Courts, Court Procedure Matters, IRS Audits, Privilege and Non-Disclosure, Trial Courts

In a surprising move, the Supreme Court of the United States (SCOTUS) dismissed a dispute involving the proper test to apply when determining whether an unnamed law firm’s mixed bag of communications involving both legal advice and discussions of tax preparation was privilege. The dismissal came less than two weeks after oral arguments, with SCOTUS stating that “[t]he writ of certiorari is dismissed as improvidently granted” (commonly known as a “DIG,” which infrequently happens when SCOTUS determines there is no conflict warranting review, one or both parties have changed their position, or no consensus can be reached by the Justices and dismissal is preferable to fractured opinions with no controlling rationale).

BACKGROUND

The law firm and an unnamed company were each served with subpoenas for documents and communication related to a criminal investigation. Both produced some documents but withheld others on the grounds of attorney-client privilege and the work-product doctrine. The government moved to compel production, which the district court granted in part, explaining that the documents were not protected by any privilege, and they were discoverable under the crime-fraud exception. The company and law firm continued to withhold the documents, and the government filed motions to hold them in contempt. The district court ruled that certain dual-purpose communications were not privileged because the “primary purpose” of the documents was to obtain tax advice, not legal advice. On appeal to the US Court of Appeals for the Ninth Circuit, the law firm and the company argued that the court should have relied on a broader, “because of” test, not the “primary purpose” test. The Ninth Circuit disagreed and concluded that the “primary purpose” test governs, and the primary purpose of the communications was tax advice. SCOTUS granted certiorari in October 2022.

SUPREME COURT

In its brief, the law firm asked SCOTUS to adopt a more expansive “significant purpose” test, which was applied by the US Court of Appeals for the District of Columbia Circuit in In re Kellogg Brown & Root, Inc. The law firm argued that the test applied in Kellogg “appropriately protects attorney-client dual purpose communications” and that the test “asks a single question that arises directly from the long-established test for attorney-client privilege: whether a client is seeking or obtaining confidential legal advice from his or her lawyer.”

The government argued that courts consistently emphasize the need to construe the attorney-client privilege narrowly and that the primary or predominant purpose test “thus molds the scope of the privilege to its purpose of encouraging effective legal advice, while avoiding sweeping in communications predominantly about a nonlegal matter.”

During oral argument, the Justices seemed skeptical of a need to change the test and expressed some confusion as to how any privilege analysis would change from a practice perspective. Justice Kagan invoked the saying “if it ain’t broke, don’t fix it.” Shortly thereafter, SCOTUS issued the DIG.

Practice Point: More [...]

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The IRS Can Share Your Tax Information with Foreign Governments

by Kevin Spencer and McDermott Will & Emery | Oct 28, 2022 | Appellate Courts, Court Procedure Matters, IRS Audits, IRS Guidance

The recent Zhang v. United States case, Docket No. 21-17093 (9th Cir. Oct. 18, 2022), serves as a reminder that the Internal Revenue Service (IRS) can force you to disclose and share your tax information with foreign governments. The taxpayers in Zhang appealed the decision from the US District Court for the Northern District of California denying their petition to quash an IRS summons for information. The summons was at the request of the Canadian tax authority pursuant to a bilateral tax treaty between the United States and Canada. The US Court of Appeals for the Ninth Circuit reaffirmed that the IRS can seek information for, and on behalf of, a foreign government as long as the request satisfies the accepted guidelines of requesting information in the United States—for example, the “good faith” requirement announced in United States v. Powell, 379 U.S. 48, 57-58 (1964).

So why do we highlight Zhang for you? In this ever-increasing world of tax information transparency, taxpayers need to be mindful of the ability of tax authorities to share information with each other and adjust their taxes accordingly. During a tax audit, it’s a strategic decision as to what tax information to share and what not to share with each tax authority. Telling different stories to different tax authorities could lead to more intrusive audits/scrutiny and higher overall tax bills and could even lead to criminal prosecution. Below are some basic principles to keep in mind:

There are three primary methods as to how countries share tax information with each other:
- Automatic Exchanges
- Spontaneous Exchanges
- Targeted Requests
Automatic exchanges are becoming increasingly used by countries (g., BEPS Action 5 and the Foreign Account Tax Compliance Act) because they are automatic and routine and usually associated with standardized financial/bank transactions.
A spontaneous exchange occurs when one country sees something of interest and alerts another country about a potential tax issue or as part of a joint audit by the countries.
- These exchanges are usually facilitated by provisions in bilateral tax treaties.
- The IRS’s Internal Revenue Manual (g., IRM 4.60.1.3) has detailed instructions for IRS employees on how to handle these treaty exchanges.
Targeted requests (like in Zhang) are typically initiated by one country that is a party to an information exchange treaty to seek information needed by that country in its tax investigation of its resident or citizen.
- In such a case where a foreign government makes a request of the US government through a treaty, the IRS Office of the Competent Authority on the US side handles the request. (See, e.g., IRM 4.60.1.2.2.4.)
- If the US taxpayer does not comply with the IRS request for information made by the foreign government (usually in the form of an “Information Document Request”), the IRS can use its administrative summons power to enforce the summons in court (which is what happened in Zhang).

Practice Point: It is crucial to be strategic [...]

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Courts Split on Supervisory Approval Requirement for Tax Penalties

by Kevin Spencer, Sarah M. Raben and McDermott Will & Emery | Sep 28, 2022 | Appellate Courts, Court Procedure Matters, IRS Audits, Trial Courts

Since Chai v. Commissioner, an opinion by the US Court of Appeals for the Second Circuit subsequently followed by the US Tax Court in several opinions, there has been a substantial number of cases litigating issues involving supervisory approval of federal civil tax penalties. Two recent additions to that list include decisions from the Ninth and Eleventh Circuits, where both Courts departed from the Tax Court’s analysis and ruling on the issue. The disagreement centers on when approval must occur. (Some of our prior discussions on this topic are linked below.)

LAIDLAW’S AND THE NINTH CIRCUIT

In Laidlaw’s Harley-Davidson Sales, Inc. v. Commissioner, the Ninth Circuit, reversing the Tax Court’s ruling, applied a textualist approach and held that approval is required only before the assessment of a tax penalty and not before the Internal Revenue Service (IRS) communicates a proposed penalty to the taxpayer. The Court reasoned that the “language of [Internal Revenue Code (Code) section 6571(b)] provides no reason to conclude that an ‘initial determination’ is transformed into ‘something more like a final determination’ simply because the revenue agent who made the initial determination subsequently mailed a letter to the taxpayer describing it.” While the Court was “troubled” by the manner in which the IRS communicated the potential imposition of the penalty, it explained that a court’s role is to “apply the law as it is written, not to devise alternative language.” In reaching its decision, the Ninth Circuit disagreed with the position developed by the Tax Court in recent years.

KRONER AND THE ELEVENTH CIRCUIT

In Kroner v. Commissioner, the Eleventh Circuit followed Laidlaw’s Harley Davidson Sales and similarly concluded that the IRS satisfies Code Section 6751(b) so long as a supervisor approves the penalty before it is assessed. The Court explained that this was the best reading of the statute because (1) it is more consistent with the meaning of the phrase “initial determination of such assessment,” (2) it reflects the absence of any express timing requirement in the statute, and (3) it is a workable reading in the light of the statute’s purpose. The Court suggested that the IRS may be wise “to have a supervisor approve proposed tax penalties at an early juncture…but the text of the statute does not impose an earlier deadline.”

The Eleventh Circuit was explicit in its departure from Chai and Tax Court precedent, stating that “the Chai court missed an important aspect of the statute’s purpose: it is not just about bargaining, it is also a check on the imposition of erroneous penalties.” The Court also explained that “appropriate penalties should be assessed and collected. Chai’s analysis of these competing interests leaned heavily on the former to the detriment of the latter when justifying its departure from the statutory text.”

Practice Point: It remains to be seen whether this issue will make its way to the Supreme Court of the United States given the apparent circuit split on the issue as [...]

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Ninth Circuit Holds Tax Form is Substance

by Kevin Spencer and McDermott Will & Emery | Jun 4, 2021 | Appellate Courts, Court Procedure Matters, Trial Courts

The substance over form doctrine (and related step transaction and economic substance doctrines) are often invoked by courts to disallow tax consequences that seem too good to be true. Courts have struggled for years with how to properly apply these doctrines. Those advocating against application usually rely on the famous passage by Judge Learned Hand in Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934): “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Those advocating for this position seek shelter in cases like Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945), in which the Supreme Court of the United States stated, “the incidence of taxation depends upon the substance of a transaction. …. To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.” But ultimately, as the Supreme Court explained in Gregory v. Helvering, 293 U.S. 465, 469 (1935), “the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended.”

However, what the statute intended is not always easy to determine. In Mazzei v. Commissioner, No. 18-82451 (9th Cir. June 2, 2021), the US Court of Appeals for the Ninth Circuit answered this question in the context of tax motivated transactions involving the since-repealed foreign service corporation (FSC) regime that was complied with all the formalities required by the Internal Revenue Code but which the Internal Revenue Service (IRS) asserted should nonetheless be recharacterized under the substance over form doctrine. The Court noted it is a “black-letter principle” and courts follow “substance over form” in construing and applying the tax laws. However, this doctrine is not a “smell test” but rather a tool of statutory construction that must be applied based on the statutory framework at issue. Thus, in appropriate situations where Congress indicates that form should control, the substance over form doctrine is abrogated.

That is exactly what happened in Mazzei. Agreeing with the First, Second and Sixth Circuits, which had previously addressed similar issues, the Ninth Circuit found that the statutory framework and history indicated that Congress did not intend for the substance over form doctrine to apply to the FSC regime. While “[i]t may have been unwise for Congress to allow taxpayers to pay reduced taxes” under the statutory scheme, “it is not our role to save the [IRS] from the inescapable logical consequence of what Congress has plainly authorized.”

Practice Point: The distinction between tax avoidance (permissible) and tax avoidance (impermissible) is not always an obvious line. Taxpayers should be able to rely on the words used by Congress when enacting tax laws, but courts [...]

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IRS Opposes Granting of Certiorari in Cases Addressing Definition of Return

by McDermott Will & Emery and Roger J. Jones | Mar 16, 2017 | Appellate Courts, Court Procedure Matters, IRS Guidance, Uncategorized

Two petitions for certiorari pending before the Supreme Court of the United States ask the Court to resolve the question of whether a tax return filed after an assessment by the Internal Revenue Service (IRS) is a “return” for purposes of the Bankruptcy Code (BC). The answer to this question will determine whether a bankrupt taxpayer’s tax debts can be discharged or are permanently barred from discharge. According to these petitions, the courts of appeal are divided as to the answer.

BC § 523(a) generally allows a debtor to discharge unsecured debt, except for, inter alia, tax debts of debtors who: (1) failed to file tax returns; (2) filed fraudulent tax returns; or (3) filed late tax returns, where a bankruptcy petition is filed within two years of the date the late return was filed. See BC § 523(a)(1)(B)(i), (B)(ii), (C).

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