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The Ninth Circuit Holds Equitable Recoupment Not Time-Barred

In a taxpayer win, the Ninth Circuit recently reversed the Tax Court and held equitable recoupment was not time barred.  Revah v. Comm’r, No. 11-70211 (9th Cir. Sept. 17, 2014) (unpublished opinion).  Relying on longstanding precedent, the Ninth Circuit held the taxpayers were not statutory barred from applying for equitable recoupment because it’s permitted even with respect to an untimely refund claim.  Thus, even though the taxpayers failed to timely file their refund claims, “untimeliness is not a ground upon which the tax court may deny equitable recoupment.”  Id.

Equitable recoupment is a judicial doctrine that applies where one transaction or event is subject to two taxes based on inconsistent theories.  The equitable recoupment doctrine “allows a litigant to avoid the bar of an expired statutory limitation period” and “prevents an inequitable windfall to a taxpayer or to the Government that would otherwise result from the inconsistent tax treatment of a single transaction, item, or event affecting the same taxpayer or a sufficiently related taxpayer.”  Menard, Inc. v. Comm’r, 130 T.C. 54, 62 (2008).  To establish equitable recoupment a taxpayer must prove: (1) the overpayment or deficiency for which recoupment is sought by way of offset is barred by an expired period of limitation, (2) the time-barred overpayment or deficiency arose out of the same transaction, item, or taxable event as the overpayment or deficiency before the Court, (3) the transaction, item, or taxable event has been inconsistently subjected to two taxes, and (4) if the transaction, item, or taxable event involves two or more taxpayers, there is sufficient identity of interest between the taxpayers subject to the two taxes that the taxpayers should be treated as one.  Id. at 62-63.  In practice, taxpayers often have difficulty mounting arguments of equitable recoupment against the IRS, although the Government typically has more success in this area.

The IRS audited and made adjustments to the Revahs’ 1999 and 2000 tax returns related to inventory and bad debt, and resulting in a decrease in the net operated losses the taxpayers reported on their 1997 and 1998 returns.  The taxpayers accepted the adjustments assuming that, as the examiner acknowledged, they would be able to reduce income in 2001 through amended returns.  After the exam and in 2005, the taxpayers filed amended returns in accordance with the examiner’s adjustments, but the refund claims were denied as untimely.  The taxpayers petitioned the Tax Court for relief asserting the equitable recoupment doctrine.  The Tax Court (Judge Cohen) found the taxpayers’ inability to use the NOLs to reduce tax liabilities was not the result of the inequitable application of inconsistent theories of taxation contemplated by the equitable recoupment doctrine, and thereby denied the petition.  The Ninth Circuit reversed and remanded in favor of the doctrine’s application, illustrating that there is hope for future taxpayers seeking to offset current IRS liabilities with past credits under the doctrine.

Can the IRS Circumvent U.S. Law by Issuing a Treaty Request?

Shortcuts to identifying the “soft spots” of a tax return have long tempted the IRS. Those shortcuts are generally quite controversial and have included the aggressive use of penalties to force a reasonable cause defense and the resulting disclosure of privileged materials and, as another example, transparency programs such as Schedule UTP that arguably strain the credibility of the IRS’s policy of restraint with regard to tax accrual workpapers. More recently, with the increasing prevalence of complex, cross-border transactions having multi-jurisdictional tax consequences, there is often a paper trail of tax analysis strewn around the world that is providing the IRS with a new temptation. Would the IRS be tempted to quietly make a treaty request in an attempt to circumvent U.S. privilege protections and obtain the materials without the fuss of a privilege fight? Unfortunately, the IRS and foreign taxing authorities have succumbed to this temptation, and it is something that practitioners should be aware of. The propriety of any such request must be carefully scrutinized and the appropriate interventions should be considered.

Indeed, the IRS has used treaty requests in lieu of following the administrative summons process (as well as its own internal directives) in order to bypass procedural safeguards for the taxpayer to attempt to obtain privileged and protected documents that would otherwise be unavailable to the IRS under U.S. law. This premature and improper use of treaty requests violates two core principles contained in most bilateral tax treaties, and in articles 18-26 of the Convention on Mutual Administrative Assistance in Tax Matters and article 26 of the OECD Model Tax Convention and its Commentary.

First, the issuance of a treaty request to circumvent domestic law is improper and objectionable because the requested nation is not obligated to employ procedures or obtain information that is at variance with or not obtainable under the laws of either country. This means that, for example, where the U.S. issues a treaty request, the same procedural safeguards that exist in the U.S. would also effectively be available with respect to the request. Additionally, the privileges and protections that exist in the requested country also apply. Under U.S. law, the IRS has broad authority to issue a summons for the production of documents or testimony relevant to the purpose of ascertaining the correctness of a return or determining the liability of any person or any internal revenue tax. But the IRS is subject to specific limitations. Significantly, pursuant to United States v. Powell, 379 U.S. 48 (1964), a summons is not enforceable unless it is (1) issued for a legitimate purpose; (2) the material sought is relevant to that purpose; (3) the information sought is not already within the possession of the IRS; and (4) the administrative steps required by the Internal Revenue Code have been followed. Further, the IRS is limited to materials in the possession, custody, and control of the summonsed party and is not entitled to documents that are privileged or protected under U.S. law, including the attorney-client privilege, attorney work product protection, and the privilege against self-incrimination. A requested nation will not employ measures to circumvent these U.S. laws. As noted in the OECD Commentary, one nation cannot take advantage of its treaty partner’s information system merely because it is wider than its own. Thus, a treaty request at variance with the U.S. law, including those discussed above, should be denied.

Second, the issuance of a treaty request before exhausting domestic measures is a clear violation of the international authorities and is grounds for rejection of a request. Under U.S. law, a summons is not self-enforcing. Instead, if the summonsed party fails to comply with the summons, the U.S. government must bring an enforcement action in the appropriate federal district court. And, both the taxpayer and the recipient of a summons have the right to protest the enforcement of a summons by filing a petition to quash in federal district court. The administrative summons procedures thereby provide the prerequisite mechanisms for a court to review the legitimacy of the summons and/or whether the claims of privilege are well-founded. The IRS cannot circumvent a taxpayer’s privileges or right to have a court review these claims by simply pursuing the documents through a treaty request because a request made prior to exhausting the domestic administrative summons procedures should be denied.

The premature and improper issuance of a treaty request merely shifts the burden of potentially protracted and costly disputes to a foreign nation, attempting to force the foreign nation to interpret and decide U.S. law. In addition to the potentially resulting prejudice against the rights of the taxpayer, this shifting aspect is itself clearly an inappropriate imposition on a treaty partner. See article 26 of the OECD Model Tax Convention and its Commentary. Treaty partners are usually quite receptive to these arguments by the objecting taxpayer in intervention proceedings.

IRS Announces Third Special Offshore Voluntary Disclosure Initiative

The Internal Revenue Service (IRS) announced on January 9, 2012 that it has reopened its voluntary disclosure initiative for the third time, in response to the US government’s continuously widening investigation of foreign banks relating to unreported offshore accounts of US persons. This third special disclosure initiative follows the IRS’s 2009 and 2011 Offshore Voluntary Disclosure Programs (OVDPs) and is available to those taxpayers who did not file in time for the 2009 or 2011 OVDPs. As in the past the OVDPs are designed to bring offshore money back into the US tax system and help individuals with undisclosed income from hidden offshore financial accounts get current with their taxes. This program allows individuals with previously unreported foreign financial accounts to significantly reduce their exposure to substantial civil tax penalties and, in many cases, to eliminate the possibility of criminal prosecution. Foreign accounts include assets held in offshore trusts, foundations, corporations and other entities.

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“Strategies for Managing Parallel Proceedings with Fifth Amendment Implications,” Inside the Minds: Strategies for Criminal Tax Cases

The DOJ Tax Division has long recognized the efficacy of parallel criminal and civil proceedings and actively pursues them in its current endeavor at increased enforcement. Parallel proceedings often present complicated issues that create additional challenges for taxpayers and their attorneys. When a parallel proceeding is pending, the invocation of the Fifth Amendment by either the taxpayer, a tax advisor, or other non-party witness can create adverse implications in a subsequent proceeding.  Taxpayers and their attorneys must carefully navigate the risk of an adverse inference against the taxpayer under the circumstances of the particular case.  The well-informed attorney can prepare to face all of these issues and effectively navigate the specific facts of his or her case.  The following discussion will explain and analyze: the effect of a party’s invocation in independent proceedings, the effect of a party’s invocation in parallel proceedings, the implications of a non-party’s invocation, and whether an invoker can waive the privilege and later testify.

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