On March 31, 2015, the Appellate Court of Illinois, First District in a Rule 23 Order,1 upheld the dismissal of a False Claims Act (“FCA”) case against QVC, Inc. (“QVC”).2 In the dismissed case, the qui tam plaintiff had alleged that QVC had fraudulently failed to collect and remit Illinois Retailers’ Occupation Tax/Use Tax (“sales tax”) on shipping and delivery charges. The court also denied the qui tam plaintiff’s claim for an award of proceeds since the lawsuit was dismissed and did not result in any monies collected by the state. Although the ruling is in one of the very few early qui tam cases involving shipping and delivery charges in which the Illinois attorney general intervened to dismiss based on prosecutorial discretion, this is nevertheless a taxpayer-friendly ruling that may help stem the tide of frivolous and abusive qui tam suits being filed in Illinois and other states.
Background Illinois law regarding the taxation of shipping or delivery charges is uncertain. Regulations promulgated by the Illinois Department of Revenue (“the Department”) specify that shipping or delivery charges imposed by a remote retail seller are deemed to be separately negotiated and, thus, not taxable, as long as the charges are separately stated. In late 2009, however, the Illinois Supreme Court decided Kean v. Wal-Mart Stores, Inc.3 , which, in the context of a consumer protection action, held that an online sale necessarily includes shipping, allowing no room for shipping charges to be separately negotiated. As a result of the decision in Kean, shipping charges associated with online sales became taxable, regardless of whether they were separately stated. However, the Department has yet to revise its regulations in response to Kean. Taxpayers who have continued to rely on the Department’s regulation on shipping and delivery charges have been portrayed in hundreds of FCA filings as engaged in fraudulent conduct punishable by treble damages and penalties of up to $11,000 per violation.
In 2011, the Schad, Diamond and Shedden, P.C. law firm (“Schad”) filed a complaint under the Illinois FCA alleging that QVC failed to collect sales taxes on shipping charges. Schad has become notorious for filing qui tam actions against Illinois taxpayers since 2002. The Illinois attorney general initially declined to intervene in the QVC case, thus, allowing Schad to prosecute the action on its own.
Previous audit grounds for dismissal In 2006, the Department conducted a sales tax audit of QVC. During the audit, QVC provided documents showing that it did not collect sales tax on shipping and handling charges. QVC also listed shipping and handling charges as “non-taxable” on an internally produced taxability chart. On November 2, 2006, the Department concluded its audit and found QVC’s sales and use tax compliance “in order” and required no adjustments.
QVC filed a motion to dismiss Schad’s qui tam suit based on the 2006 sales tax audit conducted by the Department. Once the attorney general became aware of the 2006 audit—and the fact that the Department tacitly approved of QVC not collecting sales tax on delivery charges—it intervened and moved to dismiss the case. On May 22, 2013, the Circuit Court of Cook County granted the state’s motion to dismiss Schad’s complaint.
Dismissal upheld On appeal, Schad argued, among other things, that the state was wrong to intervene and move to dismiss the case. This argument was rejected. Under Illinois law there is a presumption that the state acts in good faith, and “barring glaring evidence of fraud or bad faith by the State, it is the State’s prerogative to decide which case to pursue, not the court’s.” Schad was unable to produce glaring evidence of fraud or bad faith. On the contrary, the state dismissed the action in good faith when it found that the Department had approved of QVC’s sales tax collection practices at the conclusion of the 2006 audit.
The court further emphasized that an Illinois statute bars qui tam suits based upon transactions “which are the subject of an administrative civil money penalty proceeding in which the State is already a party.” The state concluded in good faith that the Department’s 2006 audit of QVC was “an administrative civil money proceeding to which the State was a party” and, therefore, the 2006 audit barred Schad’s qui tam action. The Appellate Court said it did not need to decide whether an audit was indeed an administrative civil money proceeding, because “the State did not act in bad faith when it decided, 6 years after it completed an audit in which it approved QVC’s explicit practice of not charging use tax on shipping and handling charges, that it would not seek to penalize QVC for acting in accord with the procedures the State approved.”
Plaintiff not entitled to any proceeds Schad contended that, even if its case were dismissed, it should still receive proceeds as the relator of a qui tam case, because QVC began collecting and remitting sales tax on delivery charges shortly after Schad brought suit. The court wrote that for a qui tam plaintiff to recover funds, it must be the prevailing party in the lawsuit. Schad’s suit against QVC was dismissed, so Schad was not a prevailing party and did not qualify for an award of any proceeds. In reaching this conclusion, the court emphasized that the state would not recover any sales tax, penalty, or interest allegedly owed by QVC at the time the action was commenced.
A win for taxpayers The QVC case illustrates the potential for abuse when qui tam actions are allowed to be brought on tax issues, and it highlights the untenable position in which the state has placed taxpayers. Because of the pending appeal in QVC, the attorney general ceased intervening to dismiss in cases where taxpayers had prior and pending tax audits, and the lower court refused to stay those actions pending a ruling from the Appellate Court in QVC. Consequently, taxpayers similarly situated to QVC have been forced to pay hundreds of thousands of dollars or more in settlements and attorneys’ fees to Schad and to the state.
The Appellate Court’s decision to uphold the dismissal of Schad’s case against QVC is a good first step toward combatting abusive tax qui tam claims and the chilling effect that such claims have on the Department’s ability to guide tax policy in Illinois. However, the next steps that the attorney general should take are: (i) to intervene to dismiss in all pending tax qui tam cases in which the Department would not assess negligence or fraud penalties; (ii) to cease approving similar sealed cases from going forward; and (iii) to support the taxpayer community’s ongoing legislative efforts to amend the FCA to bar its application to tax cases