State & Local Taxes
New York is using a relatively new type of tax enforcement mechanism against Sprint Nextel Corp.: a qui tam action. Qui tam is short for the Latin phrase, qui tam pro domino rege quam pro se ipso in hac parte sequitur, meaning, "who as well for the king as for himself sues in this matter" (Black's Law Dictionary (8th ed. West 2004)). In essence, a qui tam action is a suit an ordinary citizen brings on the government's behalf as a whistleblower. The incentive for the person, called the relator, to commence the suit is typically an award of a portion of the government's recovered funds.
The procedural history of New York v. Sprint Nextel Corp. is straightforward, but the case has been going on for three years and will likely continue for some time. In March 2011, a relator commenced a qui tam action under New York's False Claims Statute against Sprint Nextel Corp. The New York Attorney General, Eric Schneiderman, intervened on New York's behalf and filed a superseding complaint, effectively taking over the suit from the relator. The attorney general's superseded complaint alleged that Sprint knowingly and intentionally avoided more than $100 million of New York sales taxes by arbitrarily unbundling its cellphone charges. If Sprint is found liable, its total potential out-of-pocket tax liability may be more than $400 million, including interest and the effect of a punitive damages multiplier in the New York statute.
The New York attorney general alleged that, beginning in 2005, Sprint began to unbundle its wireless offerings for sales tax purposes (N.Y. Attorney General's Superseded Complaint ¶44). It also alleged that interstate calls were not subjected to sales tax, whereas intrastate calls were (id. ¶72). The complaint alleged that Sprint did this to gain an advantage over its competitors (id. ¶64).
Sprint subsequently filed a motion to dismiss the charges based on the failure to state a cause of action. On June 27, 2013, the New York Supreme Court of New York County denied the motion to dismiss (New York v. Sprint Nextel Corp., 970 N.Y.S.2d 164 (N.Y. Sup. Ct. 2013)). Sprint then appealed the decision, and the appeals court affirmed the lower court's decision on Feb. 27, 2014 (New York v. Sprint Nextel Corp., 980 N.Y.S.2d 769 (N.Y. App. Div. 2014)). On June 12, 2014, the same appellate division granted Sprint's appeal to the New York Court of Appeals, New York's highest court (New York v. Sprint Nextel Corp., No. 103917-2011 (N.Y. Sup. Ct. 6/12/14)). Sprint's appeal to the high court focuses on two issues. The first is whether the federal Mobile Telecommunications Sourcing Act preempts the state's sales tax law, and the second is whether the punitive nature of New York's False Claims Act penalties violated the Ex Post Facto Clause of the U.S. Constitution.
With cases like Sprint Nextel, the broader implication for taxpayers is that now in addition to state auditors, ordinary citizens can act as whistleblowers on the government's behalf. Many states and the federal government have false claims statutes. New York's law is unique in that it contains a specific provision relating to taxes and the requirements to bring a qui tam action (see New York Finance Law Section 189). In contrast, the Federal False Claims Act specifically excludes tax whistleblower actions (Section 3729(d)). Other state laws vary on whether they specifically include tax actions (see Illinois's False Claims Act, 740 Ill. Comp. Stat. 175, et seq. (which specifically prohibits tax actions under the Illinois Income Tax Act but does not exclude the Illinois retailer's occupation tax)).
A problematic area of any false claims act statute is that the taxpayer must have knowingly defrauded the government. Thus, he or she will have to establish the lack of fraudulent intent (see New York Finance Law Section 189; Federal False Claims Act, Section 3729(a); 740 Ill. Comp. Stat. 175/3). Proving lack of fraudulent intent typically requires costly depositions and, possibly, going to trial. This creates an issue for taxpayers who are trying to comply with the law but took a tax position in a gray area. This additional enforcement mechanism exposes taxpayers to potential harassment.
Another possible implication for taxpayers with audited financial statements is whether the qui tam action is considered a contingent liability under FASB ASC Topic 450, Contingencies. The taxpayer must determine whether the contingency has a remote, reasonably possible, or probable chance of resulting in a loss. If the contingency is considered both probable and reasonably estimated, the entity is required to record a liability on its financial statements. Estimating and identifying this risk with qui tam actions will add a new twist in determining not only a company's tax exposure, but the financial statement implications as well.
It is reasonable for a taxpayer to respond cautiously to a qui tam action statute like New York's, especially if its tax position is gray, by deciding to assess tax to be conservative and avoid whistleblower actions. In areas such as sales tax, this may mean higher costs for consumers purchasing certain goods and services in those states. Because the consumer pays the sales tax, the retailer has very little advantage in taking an aggressive tax position. While the Sprint case is still underway in New York, taxpayers should be aware of this relatively new type of enforcement mechanism and reevaluate their previous tax positions to avoid the qui tam tax enforcement trap.
Alan Wong is a senior manager–tax with Baker Tilly Virchow Krause LLP in New York City.
For additional information about these items, contact Mr. Wong at 212-792-4986 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP