Tax Court Won't Reconsider Order Compelling Document Production

The disposition of a motion for reconsideration rests within the discretion of the Court. Vaughn v. Commissioner, 87 T.C. 164, 166 (1986). A motion for reconsideration is usually denied unless the moving party can show unusual circumstances or substantial error. Estate of Quick v. Commissioner, 110 T.C. 440, 441 (1998).

Section 6662(e)(1)(B)(ii) provides that there is a substantial valuation misstatement if the net section 482 transfer price adjustment for the taxable year exceeds the lesser of $5,000,000 or 10% of the taxpayer's gross receipts. Section 6662(e)(3)(B)(ii) provides in relevant part that for purposes of determining whether the threshold requirements of paragraph (1)(B)(ii) are met, the net section 482 transfer price adjustment does not include any portion of the net increase in taxable income which is attributable to a redetermination of price, where such price was not determined in accordance with a specific pricing method, if the taxpayer establishes that no specified pricing method was likely to result in a price that would clearly reflect income, the taxpayer used another method to determine such price, and such other pricing method was likely to result in a price that would clearly reflect income.⁴ Section 6662(e)(3)(D) provides that, for purposes of section 6664(c), a taxpayer shall be not be treated as having reasonable cause for any portion of an underpayment attributable to a net section 482 transfer pricing adjustment unless such taxpayer meets the requirements of clause (i), (ii), or (iii) of subparagraph (B) with respect to such portion.

As petitioner notes, section 1.6662-6(d)(3), Income Tax Regs., prescribes the criteria that must be satisfied in connection with a defense under section 6662(e)(3)(B)(ii). To paraphrase, section 1.6662-6(d)(3)(ii)(B) provides that a taxpayer will be considered to have met the unspecified pricing method requirement if the taxpayer makes a reasonable effort to evaluate the potential applicability of specified pricing methods and reasonably concludes, given available data, that none of the specified methods was likely to provide a reliable measure of an arm's length result. The regulation provides in pertinent part: "Whether the taxpayer's conclusion was reasonable must be determined from all the facts and circumstances. The factors relevant to this conclusion include those set forth in paragraph (d)(2)(ii) of this section." Id. The same factors are relevant if the transaction is of a type for which no pricing methods are specified in the regulations under section 482. See sec. 1.6662-6(d)(3)(ii)(C), Income Tax Regs.

Section 1.6662-6(d)(2)(ii)(A), Income Tax Regs., lists a number of factors that are relevant to determining whether the taxpayer's decision to adopt a particular transfer pricing methodology was reasonable. Those factors include (but are not limited to) "The experience and knowledge of the taxpayer, including all members of the taxpayer's controlled group" and "The extent to which the taxpayer reasonably relied on a study or other analysis performed by a professional qualified to conduct such a study or analysis, including an attorney, accountant, or economist." Sec. 1.6662-6(d)(2)(ii)(A)(1), (4), Income Tax Regs.

Petitioner asserts that none of the factors prescribed in section 1.6662-6(d)(2)(ii)(A)(1)-(7), Income Tax Regs., concern the subjective intent or state of mind of those who acted for petitioner in this matter. We disagree.

Although the reasonable cause defense under section 6662(e)(3) is an objective one, it ultimately turns on all the facts and circumstances, including a number of factors that are particular to the taxpayer asserting the defense. As outlined above, two subjective factors that are relevant to determining whether the taxpayer reasonably concluded that a particular transfer pricing method provided a reliable measure of an arm's length result are the taxpayer's experience and knowledge and the extent to which the taxpayer relied on a study or other analysis performed by a qualified attorney, accountant, or economist. In context, these factors require an examination of petitioner's experience and knowledge in respect of specific transfer pricing methodologies set forth in regulations prescribed in section 482, other pricing methods, the data that was available to petitioner, and how petitioner analyzed that data in selecting and applying what it viewed as a reliable arm's length transfer pricing method.

By asserting a reasonable cause defense, petitioner has put at issue otherwise protected information that would reveal the experience and knowledge and state of mind of those who acted on its behalf in this matter. As explained in the Court's earlier Order, and consistent with the Court's holding in AD Inv. 2000 Fund LLC v. Commissioner, 142 T.C. 248, 254 (2014), it is beside the point that petitioner believes that it can prosecute its penalty defense without making factual allegations related to its state of mind or without relying on the advice it received from attorneys and tax practitioners. In sum, the documents that respondent seeks are directly relevant to petitioner's penalty defense in that they provide some evidence of petitioner's experience and knowledge, the data that petitioner relied upon, and how that data was analyzed. It would be unfair to permit petitioner to proceed with this defense while denying respondent access to information and communications that would tend to show the state of mind and experience and knowledge of the persons who acted on its behalf and whether those persons reasonably believed the advance pricing agreements in dispute to be binding and valid.

Respondent maintains that the elements that justify the application of the doctrine of collateral estoppel are not present here. Respondent points out that the Ohio case arose in the context of a summary summons enforcement proceeding and concerned documents that were created in 2005 and 2006, whereas the documents in dispute in this case were prepared before April 14, 2004, and related specifically to petitioner's request for and negotiation of the advance pricing agreement that the parties executed for the taxable years 2001 to 2005. Respondent further asserts that petitioner's collateral estoppel argument is misleading given that petitioner fails to discuss the disposition of a second Ohio case.⁶

For collateral estoppel to apply, the issue presented in the present case must in substance be the same issue that was decided in the first suit. See Montana v. United States, 440 U.S. 147, 155 (1979). Recognizing that the doctrine places termination of litigation ahead of the correct result, the application of collateral estoppel has been narrowly tailored to ensure that it applies only where the circumstances indicate the issue estopped from further consideration was thoroughly explored in the prior proceeding and that the resulting judgment thus has some indicia of correctness. See Gelb v. Royal Globe Ins. Co., 798 F.2d 38, 44 (2d Cir. 1986), cert. denied, 480 U.S. 948 (1987); see also Johnston v. Commissioner, 119 T.C. 27, 44 (2002), quoting Monahan v. Commissioner, 109 T.C. 235, 242 (1997).

We agree with respondent that the issue presented in this case is not in substance the same issue that was decided by the district court in the Ohio case. Petitioner conceded in its Response to Respondent's Motion to Compel Production of Documents, filed January 29, 2015, that "To be clear, the documents at issue in the Ohio Case are not the same documents that are subject to Respondent's motion to compel, as the documents in the Ohio Case were dated from 2005-2007, whereas the documents at issue here are dated from 2002-2004." Not only are the documents in dispute in this case different from those under review in the Ohio case, but the district court was concerned in that case with the proper application of the Commissioner's summons authority under section 7602. The district court did not address the narrow question presented in this case, i.e., whether in the context of a suit to redetermine a tax deficiency, the specific allegations underlying petitioner's penalty defense result in a waiver of privileges and protections that otherwise would permit petitioner to withhold the documents in question from disclosure. Considering all the circumstances, we conclude that it is inappropriate to apply the doctrine of collateral estoppel in this matter. See Johnston v. Commissioner, 119 T.C. at 43-44.

To recapitulate, the Court concludes that petitioner waived privilege and work product protections to withhold the documents in dispute from discovery as a consequence of its penalty defense (whether that defense is prosecuted under sections 6664(c) or 6662(e)(3)). Taking petitioner at its word that, in any event, it does not intend to produce the documents in question, there is no point in again directing petitioner to produce the documents. Rather, with the aim of expediting any further review of this matter, the Court will grant so much of respondent's Motion to Compel Production of Documents as seeks an appropriate sanction by striking relevant portions of the petition and barring the introduction of evidence related thereto.

Upon due consideration and for cause, it is

ORDERED that petitioner's Motion for Reconsideration, filed April 21, 2015, is denied. It is further

ORDERED that so much of respondent's Motion to Compel Production of Documents that requests sanctions is granted in that paragraphs 5.d.2 and 5.d.2.A of the petition are deemed stricken. It is further

ORDERED that petitioner is barred from presenting any evidence at the trial of this case in support of a penalty defense under sections 6664(c) or 6662(e)(3).

² Respondent determined that if the net sec. 482 transfer price adjustments in the notice of deficiency are sustained, petitioner will be liable for a gross valuation misstatement penalty as defined in sec. 6662(h)(2)(A)(ii).

³ Petitioner alleged in the petition that respondent erroneously determined that it is liable for accuracy-related penalties under sec. 6662(h) and expressly stated that it "had reasonable cause for and acted in good faith in reporting its tax treatment related to the parts of the proposed deficiencies attributable to * * * [transfer pricing] adjustments" and that it "reasonably relied on * * * binding and valid [advance pricing] agreements in reporting its income." Petitioner did not cite in its petition any particular statutory authority underlying its penalty defense. The averments in the petition quoted above bear the hallmarks of the defense prescribed in sec. 6664(c).

⁴ Although there may be a question whether the transfer pricing method that petitioner used during the years in issue is a specified pricing method or some other method, we need not resolve that question for purposes of disposing of petitioner's motion for reconsideration.

⁵See United States v. Eaton Corp., 110 A.F.T.R. 2d 2012-5638 (N.D. Ohio 2012).

⁶See United States v. Eaton Corp., Case No. 1:13-MC-102 (N.D. Ohio 2014).