At the American Bar Association Section of Taxation Meeting in September of 2017, a member of the Taxpayer Protection Bureau of the New York State Office of the Attorney General (“AG”) stated that the AG’s role in False Claims Act (“FCA”) suits is to “investigate false statements to the government. We are not auditors. We don’t audit. . . . The [New York State Department of Taxation and Finance] has a different mission.”1 This statement captures the dual purposes of tax FCA suits: they arise at the intersection of general litigation and state tax litigation – an intersection with which many companies’ state tax departments (and even many state tax practitioners) may not be familiar. While the AG’s primary concern may be the false statement element of the matter, the suit requires a full and nuanced understanding of the state tax issues that serve as the basis for the FCA allegations.
In the first part of this two part series, we explored the complexity engendered by these dual purposes and the basics of tax FCA suits, as well as some of the initial questions companies and practitioners encounter when faced with FCA claims.2 In this second part, we explore in greater detail some of the difficulties that arise in actually litigating tax FCA suits.
In the eight years since the New York FCA was made applicable to tax claims, People v. Sprint Communications, Inc. has been the most publicly litigated tax FCA matter, and has not yet even reached a decision on the merits.3 In Sprint, a qui tam relator filed a suit in 2011 alleging that Sprint Nextel Corp. (“Sprint”) submitted false statements by failing to collect, remit and report “sales taxes on the full amount of fixed periodic charges for wireless voice services,” as required by the New York sales tax law.4 The AG took over the action and filed an amended complaint in 2012, exercising its authority under the FCA to take control of litigating actions filed by qui tam relators.5 Sprint filed a motion to dismiss for failure to state a claim, but New York’s highest appellate court, the Court of Appeals, upheld the denial of Sprint’s motion.6 The Court’s decision did not resolve the case on the merits, but merely found that the AG’s amended complaint sufficiently pleaded a cause of action under the New York FCA, and that the case could move forward to discovery and trial.7
Two aspects of the Court’s decision have an impact on taxpayers facing New York FCA litigation. First, the Court held that an FCA defendant’s reasonable interpretation of the tax law is not sufficient to sustain a motion to dismiss.8 This makes it more difficult for taxpayers that have reasonably interpreted the tax law to avoid costly and lengthy litigation. Indeed, Sprint noted in its arguments to the Court that another taxpayer had litigated the identical legal issue before the New York State Tax Appeals Tribunal, and while the taxpayer lost on the merits, the Department of Taxation and Finance (“DTF”) had imposed minimum interest and no penalties because it concluded reasonable cause had existed for the filing position.9 Nonetheless, in the FCA case the AG sought to impose liability against Sprint based on a theory of fraud.10 The Court denied Sprint’s motion to dismiss and allowed the case to proceed.11
Second, and more importantly, the Court held that the AG “has a high burden” in FCA matters, and that the “FCA is certainly not to be applied in every case where taxes were not paid.”12 In order to meet its burden, the AG cannot merely point to “notice of a contrary administrative position,” but instead must affirmatively prove allegations of fraud.13 Thus, while taxpayers that reasonably interpret the tax law may not be able to secure an early dismissal of an FCA matter, the ensuing litigation process may provide opportunities for taxpayers to leverage their reasonable interpretations of the tax law against the AG’s “high burden” of proof. This burden is different from the one that applies in a typical administrative state tax proceeding, which generally falls squarely on the taxpayer to prove that a tax assessment is incorrect.14 If an FCA matter moves beyond a motion to dismiss, the AG must prove that his/her own interpretation of the statute is proper, that the taxpayer knew its interpretation was wrong and that the taxpayer did not actually rely in good faith on a reasonable interpretation of the statute.15
Following the denial of its motion to dismiss, Sprint secured an important procedural victory in its defense against the AG’s FCA suit. In a discovery dispute, Sprint moved to compel the AG to disclose “a taxpayer’s or DTF’s opinions” about the substantive tax issues raised in the FCA matter.16 The Supreme Court, Appellate Division granted Sprint’s motion to compel, holding that the documents could not be shielded from disclosure.17 In so holding, the court took note of the fact that Sprint sought this information to defend itself “in a tax collection case brought by the People” and that “the People are relying, at least in part, on other cell phone companies’ conduct to show that [Sprint’s] conduct was unreasonable.”18 The court rejected the AG’s arguments that it would only use third-party discovery material and material it had disclosed to defendants in the prosecution of the case.19 The court instead focused on Sprint’s defense, stating that “the fact that the People have chosen to restrict the materials they will use to prosecute [Sprint] does not mean that [Sprint] must restrict the materials” it will use to defend itself.20 While litigation in the Sprint matter is ongoing, Sprint’s victory in this discovery dispute should indicate to other companies facing FCA claims that they are entitled to a fulsome production of information that enables them to adequately prepare a defense.
While the Sprint matter is the most well-developed example of FCA litigation in New York, no case has been fully litigated through trial, and many questions remain open. There are significant differences between a typical state tax administrative litigation and an FCA tax suit, in addition to the different burdens of proof, that companies should carefully examine when analyzing the prospects of litigation and possible settlement of FCA matters. For example, while administrative tax litigation in New York (and in most other states) takes place before a specialized tax tribunal and generally involves trials without juries, an FCA matter is generally heard before a court of general jurisdiction and may be heard by a jury. The presence of a jury as opposed to a specialized tax judge increases the possibility that the fraud claims raised in the FCA matter will dominate the jury’s considerations, and that the merits of the substantive tax issues may not be given the same consideration that they would be given in a tax tribunal.
On the other hand, because the AG bears the burden of proof, the AG must explain potentially complex tax concepts to a group of laypeople and convince them that a clear tax obligation was knowingly avoided. This presents opportunities to strengthen a company’s defense of an FCA action, especially in situations where it has taken a reasonable tax position on an issue that lends itself to multiple interpretations.
Even if the parties ultimately decide to settle the matter, the settlement process itself presents issues to consider that are markedly different from the typical administrative tax litigation. Settlements with state taxing authorities in non-FCA matters generally remain confidential, both as to the facts underlying the settlement and the amount of the settlement. No such confidentiality provisions apply to actions brought in state courts of general jurisdiction. In New York, the AG’s Taxpayer Protection Bureau routinely issues press releases that contain the identity of the taxpayer, the amount of the settlement and a recitation of the facts prepared by the AG (and, therefore, may be presented in a manner most favorable to the AG’s case) describing the alleged violation of the FCA.21 In some cases, a redacted version of the settlement agreement also may be released to the public.22
Following the New York AG’s announcement of a settlement of a non-FCA fraud case with Maurice R. Greenberg, the former chief executive of American International Group, Mr. Greenberg held a news conference to correct what he alleged were mischaracterizations in the AG’s description of the settlement.23 Despite the fact that the negotiated settlement statements did not use the word fraud and did not include any explicit admission of wrongdoing, the headline of the AG’s settlement announcement read “Greenberg Admits to Initiating, Participating and Approving Two Fraudulent Transactions.”24 Therefore, unlike in confidential non-FCA state tax matters, companies must think carefully in FCA suits about the impact that a widely disseminated press release might have on the company’s business.
The application of FCA statutes to tax matters is a developing area of the law both in New York and across the United States. For example, in New York, a complaint was recently unsealed in a case involving estate taxes – the first time the New York FCA has been applied to the estate tax.25 That same case also involves allegations brought under the personal income tax related to the decedent’s residency and whether a false claim had been made that the decedent’s domicile had been changed.26 In Illinois, another particularly active jurisdiction for FCA matters, an intermediate appellate court recently held that a Department of Revenue audit of a taxpayer does not preclude an action under the Illinois FCA against that taxpayer.27 In Minnesota, a case is pending before the State Supreme Court that presents the issue of whether telecom charges are statutory fees, in which case a claim for underpayment of those fees would be allowed under the Minnesota FCA, or taxes, in which case a claim under the Minnesota FCA would be barred.28
State tax FCA matters attract considerable attention and fuel ongoing policy debates about the merits of applying FCA statutes to tax matters. The Council on State Taxation has filed amicus briefs in both New York and Minnesota FCA matters arguing that FCA suits are not appropriate venues to resolve disputes concerning interpretations of tax codes.29 In Illinois, the legislature has proposed several reforms to the State’s FCA to limit the applicability of the FCA to tax claims, due in large part to the proliferation of qui tam suits brought under the Illinois FCA.30 While these policy debates continue, companies and tax practitioners alike should pay careful attention to this developing area of the law, as the unique combination of state tax litigation and general litigation presents both new risks to a company’s normal state tax defense strategies, as well as new opportunities to improve state tax defense strategies in a different forum.