On October 20, 2015, the New York Court of Appeals issued a ruling that could prove important to corporate counsel as they provide advice on tax positions. In The People of the State of New York v. Sprint Nextel Corp., No. 127 (N.Y. October 20, 2015), New York's highest court ruled that Sprint could be held liable under New York's False Claims Act ("NY FCA") for adopting an interpretation of state tax law that was contrary to an unambiguous statutory provision and agency guidance. Additionally, the court allowed the NY FCA to be applied retroactively after concluding that retroactive application of the NY FCA to tax years before it was specifically amended to cover tax claims was not barred by the Ex Post Facto Clause of the United States Constitution. This decision should alert companies to the potential for challenges to their state tax compliance not only from state taxing authorities but also from state Attorneys General, as well as from private relators, seeking penalties in addition to unpaid tax.
The Sprint Case
Under New York law, a tax is imposed on mobile telephone providers for the sale of certain communications services. The alleged false claim in the Sprintcase depends on whether New York Tax Law § 1105(b) requires providers that charge flat rates to their customers (i.e., without distinguishing between intrastate and interstate calls) to collect sales tax only on the portion of their sales that they attribute to the customers' intrastate calls or instead on both intrastate and interstate calls. Sprint argued that New York law requires it to collect sales tax only on the portion of its sales that it attributes to its customers' intrastate calling. The New York Attorney General ("AG") (who intervened in the qui tam action and filed a superseding complaint) argued that Sprint must collect sales tax for all customers' calls under flat-rate plans.
With respect to the false claims issues, the court examined whether the AG had sufficiently pleaded a cause of action under the FCA. According to the AG, Sprint violated the FCA by "knowingly" making or using a "false record or statement" that was "material to an obligation to pay or transmit money or property" to the state of New York. (State Finance Law § 189(1)(g).) The FCA provides that a defendant in a false claims case acts "knowingly" when that "defendant has 'actual knowledge' of a record's or statement's truth or falsity or 'acts in deliberate indifference' or 'reckless disregard' of its truth or falsity." (Op. at 4 (citing State Finance Law § 188(3)(a)).) Thus, the AG argued that even if Sprint did not actually know that its sales tax collection practices were incorrect, it may still be found liable under the FCA if its efforts to comply with the law were "deliberately indifferent" or its actions were taken with a "reckless disregard" as to the meaning of the tax law. In support of his contentions, the AG noted the existence of official administrative guidance on the law's interpretation from as early as 2002 (when the law was enacted) that is contrary to Sprint's position. (Op. at 6.) Furthermore, the AG cited the fact that Sprint had adopted the AG's interpretation of the tax law from 2002 to 2005. (Op. at 6.) Finally, the AG noted that the majority of the cell phone industry had followed the administrative guidance. (Op. at 7.) Sprint countered that its interpretation of the tax laws is reasonable, and, therefore, it could not be held liable for "knowingly" submitting any false claims. (Op. at 13.)
Court of Appeals Opinion States that AG Faces "High Burden"
First, the court interpreted the relevant tax statute and determined that the AG's interpretation is correct. (Op. at 8–11.) According to the court, the statute is unambiguous and the AG's interpretation of the statute gives purpose and effect to all of the statute's language. (Id.) Furthermore, the court determined that the AG's interpretation is supported by other provisions in New York tax law and a recent ruling by the New York Tax Appeals Tribunal (see Matter of Helio, LLC, 2015 WL 4192425 (July 22, 2015).) The court also dispatched arguments by Sprint that the AG's interpretation is preempted by federal law. (Op. at 12.) Thus, the court held that the law required Sprint to collect sales tax for all of its customers' calls "unless they are separately stated on a customer's bill." (Id. at 9.)
The court then turned to the issue of whether a cause of action existed under the FCA. Although the court affirmed the denial of the motion to dismiss based on the facts pleaded by the AG supporting its allegations of fraud, the court cautioned that, "the AG has a high burden to surmount in this case." (Op. at 14 (emphasis added).) The court noted that not every underpayment of taxes constitutes a false claim under the NY FCA. (Id.) The court stated as follows:
The FCA is certainly not to be applied in every case where taxes were not paid. Further, notice of a contrary administrative position alone is not nearly enough to prove fraud or recklessness under the FCA. There can be no doubt the AG will have to prove the allegations of fraud, that Sprint knew the AG's interpretation of the statute was proper, and that Sprint did not actually rely on a reasonable interpretation of the statute in good faith. But, given the complaint's allegations about the agency guidance and industry compliance with the AG's position, Sprint's payment of the proper amount of sales tax between 2002 and 2005, Sprint's undisclosed reversal of its practices in 2005, and the explicit warnings that Sprint received from the Tax Department, the AG has stated a cause of action for a false claim.
(Id. (emphasis added).) The court noted that the AG alleged that Sprint came up with its "reasonable interpretation" after the fact and that Sprint did not base its decision to stop paying the tax on that interpretation. (Op. at 13-14.) The court stated that, "Even assuming there could be such a reasonable interpretation in the face of this unambiguous statute, it cannot shield a defendant from liability if, as the complaint alleged here, the defendant did not in fact act on that interpretation." (Op. at 13.)
In favor of its reasonableness argument, Sprint noted that in the case decided by the NYS Tax Appeals Tribunal, the Department of Taxation and Finance imposed only the minimum interest because the audit report stated that reasonable cause existed for the taxpayer's position involving the same tax provisions as in Sprint. (Op. at 13.) The court rejected that argument, stating that "here, the AG alleges that Sprint, which is a much larger service provider, did not act in good faith and that it did not rely on what it now calls 'its reasonable interpretation of the statute' when it made its decision to alter its tax practices. Importantly, although the Tax Appeals Tribunal stated that "[the taxpayer's] position was reasonable, that case did not involve the level of deception and fraud alleged on the part of Sprint here." (Op. at 13-14.)
Finally, the court considered whether applying the FCA to tax years prior to 2010 (when the FCA was amended to include false tax claims) violates the Ex Post Facto Clause of the United States Constitution. At its essence, the court's analysis focused on whether the state intended the FCA damages to be a civil penalty or, alternatively, whether the damages are "so punitive either in purpose or effect as to negate the State's intention to deem [them] civil." (Id. at 15 (citing Smith v. Doe, 538 US 84, 92 (2003).) New York's FCA allows for a civil penalty of between $6,000 and $12,000 as well as treble damages. (Id. at 15.) After reviewing several factors and considering federal case law on the issue, the court determined that the FCA provisions were not excessively punitive and that they could be applied retroactively without running afoul of the Constitution.
Dissenting in part, Judge Stein noted that because of the procedural posture of the case, any ambiguities in the tax law should be interpreted in favor of the taxpayer (Sprint). Because Judge Stein believed the tax statute to be ambiguous, she would have held that the AG cannot establish Sprint's interpretation was false, and, therefore, Sprint could not be held liable under the FCA, as a matter of law, for "knowingly" submitting any false claims. However, because the complaint did allege that Sprint's division of charges between intrastate and interstate or international calls was essentially "arbitrary," Judge Stein affirmed the lower court's decision. (Dissent at 12-15.)
Implications and Takeaways
Using the approach taken in the Sprint case, a state could not only seek to recover the allegedly unpaid tax amount, but also treble damages, penalties, and attorneys' fees under the NY FCA (and, in Sprint's case, the amount may total more than $300 million). According to the Sprintcase, the NY FCA suit may reach back further than would have been possible under the statute of limitations that applies for state tax purposes. Furthermore, private relators can also pursue what they allege to be their share. It remains to be seen whether Sprint will seek United States Supreme Court review of the decision, or how the case will develop as the parties proceed with discovery and the trial court rules on the merits, but the state's success may encourage other states and private relators to take a similar approach. Several other states have similar FCAs that allow actions to be taken based on false tax claims.
The court's opinion in Sprint is available here.