‘Bounty hunting’ for tax violators: Qui tam claims

By Donna R. Scaffidi, CPA, Milwaukee, and Gail Miller, J.D., LL.M., New York (not affiliated with Baker Tilly)

Editor: Mark Heroux, J.D.

A qui tam action is a relatively unknown tool in the toolbox of tax enforcement that is growing in importance in some states. Qui tam is short for the Latin phrase qui tam pro domino rege quam pro se ipso in hac parte sequitur, which means "who brings the action for the king as well as for himself" (Black's Law Dictionary (8th ed. West 2004)). A qui tam action is a type of whistleblower lawsuit brought by a private party, called a relator, on the government's behalf to prevent fraud and assist the government in recovering funds that have been "stolen" from the government. The relator, who files the suit under a statute known as a false claims act (FCA), usually receives a share of the monetary damages recovered by the government as a result of the qui tam action. A qui tam lawsuit can be costly for a taxpayer accused of wrongdoing since damages may include three times the amount of the actual losses to the state, plus attorneys' fees.

While the federal FCA expressly excludes claims under the Internal Revenue Code, many states have adopted their own FCAs. Some states specifically prohibit tax actions in general or exclude specific tax types.

New York

As of this writing, New York's FCA is the only state statute that broadly authorizes lawsuits against taxpayers for false tax claims (compare federal False Claims Act §3729(d) (31 U.S.C. §3729(d)) to N.Y. Fin. Law §189(4); see also N.Y. Attorney General, Press Release (12/21/18)). The New York FCA was amended in 2010 to include "claims . . . made under the tax law" (N.Y. L. 2010, ch. 379, §3). As a result, the New York FCA became a powerful tool, enhancing the state's tax collection capabilities.

To date, the largest recovery of taxes fraudulently withheld from New York state resulted from the attorney general's (AG's) civil enforcement action commenced in 2012 against Sprint Nextel Corp., which grew out of a 2011 qui tam suit by a private company; both lawsuits were filed under the New York FCA (People v. Sprint Nextel Corp., 26 N.Y.3d 98 (2015)) and alleged that Sprint had unlawfully avoided paying certain sales taxes. In affirming a lower court's decision denying Sprint's motion to dismiss the AG's complaint, the court concluded, among other things, that damages recoverable under the New York FCA are not barred by the U.S. Constitution's ex post facto clause (which addresses the unfairness of a new law's penalizing prior conduct after the fact). This decision permits the retroactive application of the New York FCA to allow for the collection of taxes due before the statute's 2010 amendment to include tax claims. In reaching its conclusion, the court stated the AG has a high burden in proving a civil action pursuant to the New York FCA, noting the statute does not apply to every tax case where taxes are not paid, and the taxpayer's taking a position that is contrary to an administrative position is not enough to prove fraud or recklessness, as required by the FCA.

This Court of Appeals decision ultimately led to a record-breaking $330 million settlement of the New York FCA lawsuit brought by the AG against Sprint. The whistleblower who filed the qui tam lawsuit received $62.7 million in accordance with the terms of the New York FCA, which provides whistleblowers who report fraud with a share of the state's recovery.

Fresh off its success in Sprint, the New York AG's office converted another qui tam lawsuit brought by a relator under the New York FCA into a civil enforcement action (see People v. B&H Foto & Electronics Corp.,No. 45210/2019 (N.Y. Sup. Ct. 11/14/19) (B&H Superseding Complaint ¶10-13)). The AG's suit was commenced after a lengthy investigation of the taxpayer. The AG alleged B&H failed to pay (or collect) sales tax, pursuant to N.Y. Tax Law Articles 28 and 29, on reimbursements B&H received from manufacturers for discounts that were passed on to B&H's customers as part of "instant rebate" sales promotion programs offered to vendors. Following the holding in Sprint regarding the retroactive application of the New York FCA, the suit alleges B&H failed to pay its required sales tax obligations totaling at least $7.3 million from 2006 (prior to New York's FCA amendment) through the third quarter of 2019.

In response, B&H filed a motion to dismiss the New York AG's lawsuit on the grounds the complaint failed to state a cause of action under the New York FCA. B&H disagreed with the New York AG's characterization of the "instant rebates" as receipts that are subject to sales tax. Instead B&H argued in pertinent part that the "instant rebates," which B&H referred to as "instant savings," were not taxable receipts but rather a cost of goods sold reduction to the wholesale price the retailer pays to the manufacturer.

B&H maintained it was correct on the law or, in the alternative, that its tax treatment was a reasonable interpretation of the law, citing various New York sales tax regulations and the published guidance of the New York State Department of Taxation and Finance. Therefore, B&H argued it could not have committed the fraud required to establish a claim under the New York FCA. As of this writing, a decision on B&H's motion to dismiss had not been issued by the court. Presumably, an appeal will be filed by whichever party is unsuccessful, thus resulting in a litigation process that could last several years.

Illinois

Unlike New York, Illinois limits the type of tax claims that can be brought by a relator pursuant to its FCA. While the state's FCA specifically excludes claims under the Illinois Income Tax Act (740 Ill. Comp. Stat. 175/3(c)), it does not prohibit claims under the Illinois Retailers' Occupation Tax. This exception has given rise to a large number of qui tam lawsuits by private parties on behalf of the state. No one has been more prolific in filing tax claims under the Illinois FCA than Chicago attorney Stephen B. Diamond, nicknamed the "king of qui tam." Recently, the Illinois Supreme Court dealt a significant blow to Diamond's practice of collecting both a portion of the damages and penalties as the relator bringing the qui tam suit, and attorneys' fees for the legal work performed by his firm on the qui tam suit (Illinois ex rel. Schad, Diamond & Shedden, P.C. v. My Pillow, Inc., 2018 IL 122487 (Ill. 9/20/18)).

The Illinois high court held that despite the significant revenue Diamond recovered on behalf of the state, he could not be paid twice for the same work — once as the relator and a second time as the lawyer for the relator. The court equated the situation to that of a pro selitigant.

California

The California FCA differs from the New York and Illinois FCAs, as it currently bars use of the FCA in all tax matters (Cal. Gov't Code §12651(f)). However, this absolute prohibition may soon disappear. Recently, a bill strongly supported by the California AG cleared the California Assembly that would authorize private lawsuits alleging false claims made under the California Revenue and Taxation Code (A.B. 2570 (2/20/20); Cal. Attorney General Press Release (2/20/20)). The bill would amend the California FCA to permit qui tam claims under the state's tax code if the damages pleaded exceed $200,000. A prior proposed amendment to include tax claims under the California FCA was met with resistance and failed to be enacted.

Coming changes

While the proposed change to the California FCA currently has a way to go before becoming law, Michigan and the District of Columbia are considering similar amendments to their statutes. This renewed focus may represent a change in the view of tax claims' inclusion in a state's FCA. This additional collection tool may become more attractive as states experience considerable budget gaps due to a significant reduction in revenue collections resulting from the economic downturn and exploding expenses caused by the COVID-19 pandemic. If the focus by states on qui tam tax claims continues to increase, then the role of a tax practitioner in providing valuable advice to clients, like taking reasonable tax positions and using a state's voluntary disclosure program, will grow in importance.

EditorNotes

Mark Heroux, J.D., is a tax principal and leader of the Tax Advocacy and Controversy Services practice at Baker Tilly US, LLP in Chicago.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or mark.heroux@bakertilly.com.

Unless otherwise noted, contributors are members of or associated with Baker Tilly US, LLP.

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