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What Is New York Trying to Hide?

Posted on Jan. 27, 2020

There are times when I have a feeling that something isn’t right. It’s just a feeling and often nothing I can prove. And then there are other times when I can prove my feeling correct, and I think, “I just knew it.” That must be how Moody’s Corp. felt when it realized that its skepticism about the New York Division of Taxation’s alleged hard-line policy on sourcing credit rating receipts was correct. The division had treated two similarly situated taxpayers quite differently, and Moody’s could prove it. But could Moody’s prove that the division’s dishonesty rose to the level of fraud, malfeasance, or misrepresentation of a material fact — the standard needed to set aside its closing agreement with the state? Not likely without further proof.

That’s what began a saga that has moved through various avenues of disclosure. To date, Moody’s has hit brick walls trying to get the division to produce internal communications about its policy for sourcing credit rating receipts. Moody’s case is still ongoing, and likely won’t be over anytime soon. As it moves its way through the court system, the case will bring attention to several important concepts regarding disclosure: the deliberative process exemption, the public interest privilege, taxpayer privacy, and the need for more structured transparency.

The Saga: Matter of Moody’s

Moody’s is a credit rating agency that analyzes financial information and produces opinions about debt instruments and securities. Moody’s was under audit by the New York Division of Taxation for the period January 1, 2004, through December 31, 2010. The audit focused on the sourcing method for Moody’s credit rating receipts. Moody’s wanted to source its receipts on a destination basis, whereas the state asserted that Moody’s had to source on an origination basis, or where the service giving rise to the receipts was performed based upon the costs of performance. Moody’s requested an advisory opinion from the division on the issue and, to cover all its bases, also submitted a request for alternative apportionment.

The division declined to issue the advisory opinion, and the audit proceeded. Ultimately, after allegedly being told by the division that it was required to source its credit rating receipts on an origination basis and that the division did not permit credit rating agencies to source receipts on a destination basis, in 2012 Moody’s entered into a closing agreement with the state and paid tax accordingly.

Nonetheless, Moody’s had a sneaking suspicion that the division wasn’t being entirely honest when it said it didn’t permit credit rating agencies to source credit rating receipts on a destination basis. That suspicion turned out to be correct. In 2014 and 2015, determinations in two matters involving Moody’s direct competitor, S&P Global Inc. (formerly known as McGraw-Hill Cos.), were released that indicated S&P had been allowed to source its credit rating receipts on a destination basis (Matter of McGraw-Hill Cos., TAT [H] 10-19 [GC] et al. (NYC Admin. Law Div., Feb. 24, 2014); and Matter of McGraw-Hill Cos., DTA No. 825598 (NYS Div. of Tax App., Feb. 12, 2015)).

Moody’s alleges it would not have entered into the closing agreement had the division not expressly represented that it did not allow market sourcing for any credit rating agencies regarding credit rating receipts. Moody’s said it relied on the division’s representations, and those representations led it to enter into a closing agreement that was not in its best interests.

Moody’s sought to have the closing agreement set aside, which requires a showing of fraud, malfeasance, or misrepresentations. To prove that the division concealed the existence of an agreement with a similar taxpayer that allowed destination sourcing, Moody’s requested the disclosure of some documents and other information, including internal division communications about the sourcing of credit rating receipts. Moody’s later limited its request to documents that did not contain confidential taxpayer information or attorney-client privileged information.

Initially, Moody’s filed requests under the New York Freedom of Information Law (FOIL) for documents regarding the division’s sourcing of credit rating receipts for tax years 2004 to present. Several years of litigation later, much of the requested information was withheld as “non-final inter-or-intra-agency materials that were deliberative in nature” (Pub. Off. Law section 87(2)(g)). This is known as the deliberative process exemption. It was designed to protect the free and frank exchange of opinions during the policymaking process.

After having been unsuccessful in using FOIL to obtain the information, Moody’s requested that the Division of Tax Appeals issue a subpoena duces tecum ordering the release of the information on the division’s sourcing of credit rating receipts. The deliberative process exemption does not explicitly apply to subpoenas in New York, so this provided an alternative means of obtaining records that were exempt under FOIL.

But there was yet another roadblock when an administrative law judge agreed to the division’s request to withdraw the subpoena on the basis that the information was protected by the judicially created public interest privilege. This privilege protects from disclosure confidential communications to public officers and between public officers regarding their official duties when the public interest requires that the communication or source of the communication remain confidential.

Ultimately, the ALJ concluded that “any general public interest in ordering disclosure of the documents sought herein . . . is outweighed by the policy considerations supporting the public interest privilege, to wit, ensuring full, frank, and candid discussions between agency personnel.” Disclosure, the ALJ said, would chill or inhibit internal candor in the division’s “audit functions, its negotiation processes, and its policy formulation activities.”

Moody’s is left with the existence of two opinions that show a similar taxpayer received dissimilar tax treatment, but has nothing else to establish fraud, malfeasance, or misrepresentations. The saga of Matter of Moody’s Corp. is unlikely to be over. Still, the twists and turns in Moody’s present a useful backdrop to discuss several issues: the deliberative process exemption under the Freedom of Information Act and FOIL, the public interest privilege, the importance of taxpayer privacy, and the disparate treatment of similar taxpayers.

Deliberative Process Exemption

In general, New York’s FOIL, like the federal FOIA, is based on a presumption of access. The laws grant access to the records of government agencies unless those records or portions thereof fall within specific exemptions. Courts have consistently interpreted FOIL and FOIA to provide maximum access, and exemptions to disclosure have been interpreted narrowly.

The New York Court of Appeals said the “balance is presumptively struck in favor of disclosure, but in eight specific, narrowly constructed instances where the governmental agency convincingly demonstrates its need, disclosure will not be ordered” (Fink v. Lefkowitz, 47 N.Y.2d 567 (1979)). An agency does not have carte blanche to withhold records, but rather must provide particularized and specific justification, and only when the records fall squarely within one of the statutory exemptions may disclosure be withheld.

The FOIL deliberative process exemption parallels the deliberative process exemption in the federal FOIA. Both were designed “to protect the pre-decisional process by which government agencies formulate original policy” (NLRB v. Sears, Roebuck & Co., 421 U.S. 132 (1975)). The exemption affords government agencies the freedom to explore a variety of actions and to engage in robust internal debates without public scrutiny before a final policy is announced.

The exemption does not exempt all communications between government personnel. It is designed to protect suggestions and recommendations made while policy is being developed with the understanding that at some point, deliberation ends and policy implementation begins. The deliberative process exemption also assumes an end date. Once policy is made and the agency is implementing that policy, it is creating its “working law,” which will provide “substantive guidance in future decisions” (Arthur Anderson & Co. v. IRS, 679 F.2d 254 (D.C. Cir. 1982)).

In Moody’s, the requested records are not pre-decisional, and they were not deliberative. According to the division’s representations to Moody’s, there is an already determined policy on sourcing of credit rating receipts: Destination sourcing is not permitted for credit rating receipts. The records between agency personnel should be merely the application of a set of standards to Moody’s fact pattern. Had the division not made the representation to Moody’s that it has a policy and was adhering to that policy, the requested records might have properly been withheld if, for example, a change in policy was under consideration. While there are limits to the deliberative process exemption, it may protect internal emails between agency personnel if the emails were written to help the agency arrive at a policy or decision.

The agency is not, however, permitted to develop a body of “secret law” (Coastal States Gas Corp. v. Department of Energy, 617 F.2d 854 (D.C. Cir. 1980)). If the communications between agency personnel did not include ideas and theories that would go into the making of law or policy, they should be disclosed. An agency is not permitted to use the deliberative process exemption as a “veil of privilege” to shield all communications from public disclosure. Yet that is how the exemption was interpreted in New York.

Public Interest Privilege

In the legal context, privilege is a powerful word. The concept of privilege is based on the common law doctrine that some documents can and should be withheld from disclosure. The public interest privilege prevents the disclosure of documents or information if disclosure is against the public interest. The exact definition of what is in the public interest appears to be determined on an “I’ll know it when I see it” type of standard.

Generally, the public interest privilege “attaches to confidential communications between public officers, and to public officers, in the performance of their duties, where the public interest requires that such confidential communications or the sources should not be divulged” (Cirale v. 80 Pine St. Corp., 35 N.Y.2d 113 (1974)). The privilege permits some parties to protect information from ordinary disclosure (Matter of World Trade Center Bombing Litigation, 93 N.Y.2d 1, 8 (1999)). The justification for the public interest privilege is that nondisclosure is appropriate when the “public interest might otherwise be harmed if extremely sensitive material were to lose this special shield of confidentiality” (id.).

To establish the applicability of the public interest privilege, a government agency must “come forward and show that the public interest would indeed be jeopardized by a disclosure of information” (Cirale, 35 N.Y.2d at 118-119). The government agency must make a “particularized showing” that identifies “specific harm to the public” and explains how that harm outweighs disclosure of the information (Woodard v. City of New York, 2000 WL 516890, at *5 (E.D.N.Y. Mar. 10, 2000)).

In Moody’s, the ALJ permitted a broad application of the privilege. The ALJ was satisfied with the generalized concept that the public interest was served by protecting the division’s internal deliberative processes. Eliminating candor from the division’s internal discussions around “developing and formulating policy, including changing existing policy, conducting audits, and engaging in negotiations in the context of such audits” would negatively affect the division in the performance of audits and in policy development. The ALJ said Moody’s need for the requested documents “does not override the valid public interest in non-disclosure of internal audit and policy formulation discussions, absent a compelling reason.”

Yet, as noted above, it does not appear that the requested records are deliberative. That is, they would not be of the sort that were providing opinions or recommendations about the formulation of policy; they would be providing opinions on the implementation of an existing — relatively narrow — policy.

Exempting deliberative documents is a useful practice in theory. In practice, however, refusing to produce deliberative documents under the guise of the public interest privilege seems counterintuitive and self-serving for an agency. A government agency could refuse to produce most records on the basis that they are deliberative of something. Arguably, most records produced by an agency are addressing implementation of a policy.

Also, it seems a stretch to think that the public disclosure of records applying an existing policy would cause the division’s functions to come to a screeching halt. Back in 1972 when Tax Analysts sought release of IRS private letter rulings and technical advice memoranda, the D.C. Circuit said, “The IRS’s argument that publication would cause grave damage to its ruling system, then, is viewed by this court as a specter having little basis in fact” (Tax Analysts and Advocates v. IRS, 362 F. Supp. 1298 (D.D.C. 1973)).

Here, the division would not write an advisory opinion, it would not grant alternative apportionment, and it told the taxpayer that no one is permitted to source credit rating receipts on a destination basis, while at the same time granting alternative apportionment and permitting another similarly situated taxpayer to source credit rating receipts on a destination basis. Yet the ALJ gave little weight to the public interest in knowing whether the division is uniformly treating similarly situated taxpayers. The division is being allowed to hide behind several theories for nondisclosure.

Last, the ALJ noted that Moody’s didn’t need the documents it was requesting because the opinions in the S&P matters were publicly available. This argument isn’t compelling. Whether Moody’s could establish its case with publicly available documents is irrelevant to a conclusion of whether the requested documents should be disclosed. The availability of documents Moody’s is not requesting should have no relevance on the ALJ’s analysis of whether the public interest privilege properly protects the documents it is requesting.

Taxpayer Privacy

Moody’s is an interesting case. While it may appear to touch on the confidentiality of taxpayer information, that is not an issue in this case. Moody’s specifically tailored its document requests to exclude any information that included confidential taxpayer information or information that was protected by attorney-client privilege.

That being said, the case raises a question that deserves an answer: Should one taxpayer be able to see another taxpayer’s confidential information to establish that similar taxpayers are receiving disparate treatment? The short (and long) answer is no. Confidential taxpayer information has always been afforded protection under public records laws, as has attorney-client privileged information. Generally, section 6103 provides that tax returns and tax return information are confidential and not subject to public disclosure. For states, the IRS contains a provision prohibiting the sharing of federal tax return information with other state or local government agencies unless the agencies can protect the information in the same manner in which the IRS protects it.

This is all well and good. Making confidential taxpayer information subject to public disclosure comes with a host of issues. There’s the potential for unwarranted harassment and for the release of trade secrets and other sensitive information. More generally, releasing confidential information would undermine taxpayers’ confidence in the tax system. Taxing authorities should take seriously the need to protect taxpayer privacy by placing limits on access to and use and dissemination of confidential taxpayer information.

But how can taxpayers feel confident that states are applying the rules uniformly across similarly situated taxpayers?

The Solution: Transparency

Should the New York Division of Taxation establish and implement tax policy and apply it consistently? Or should it be allowed to interpret tax policy based on how much tax revenue can be raised from a taxpayer? One would hope the answer to the first question is yes, and the answer to the second a resounding no. It is not the function of a taxing agency to raise revenue by adjusting the law from one taxpayer to another. Government officials are public servants. They have a responsibility to be objective in uniformly applying law and policy. There should be no disparate treatment of similarly situated taxpayers. Period.

It’s a simple theory, but in practice, it’s quite difficult to enforce. As evidenced by Moody’s, taxpayers, even very similar taxpayers, are treated differently. Perhaps the difference is because of unique facts and circumstances, or because one taxpayer negotiates a better incentive package than another. Often, the method by which a taxpayer receives different treatment is because of the discretion that is afforded to taxing officials. State tax officials tend to have a lot of discretion, and where there is discretion, there must be guidance to indicate how and when that discretion will be used.

At the federal level, section 6110 provides that “the text of any written determination and any background file document relating to such written determination shall be open to public inspection.” Section 6110 codifies several lawsuits brought by Tax Analysts in the 1970s. Those lawsuits were brought because the organization believed guidance documents like private letter rulings and technical advice memoranda had become a sort of “secret law” whereby the IRS cut private deals with some taxpayers and then refused to make the terms public. This practice left other taxpayers at a disadvantage.

The result of the lawsuits was to require the public disclosure of letter rulings, technical advice memoranda, and determination letters. Chief counsel advice was later added to this list by virtue of amendments to section 6110 made by the Internal Revenue Service Restructuring and Reform Act of 1998. The legislative history of those amendments makes clear Congress’s intent:

Written documents issued by the National Office of Chief Counsel to its field components and field agents of the IRS should be subject to public release in a manner similar to technical advice memoranda or other written determinations. In this way, all taxpayers can be assured of access to the “considered view of the Chief Counsel’s national office on significant issues.” Creating a structured mechanism by which these types of legal memoranda are open to public inspection will increase the public’s confidence that the tax system operates fairly and in an even-handed manner with respect to all taxpayers.1

States do provide taxpayers with guidance, but in many states it is still lacking. A transparent tax system still seems to play second fiddle to the goal (and need) to raise revenue. But when it comes to collecting taxes, taxing authorities have the upper hand. They get to set and enforce the rules, and they get to determine the amount and type of guidance they provide to taxpayers. What taxing authorities need to remember is that when they withhold guidance and actively work to protect their “working law,” taxpayers and the system suffer.

In Moody’s case, perhaps the division’s policy is to require sourcing of credit rating receipts on an origination basis, and S&P’s treatment was the deviation from that policy. Perhaps there were legitimate reasons for S&P’s treatment. The division would have been wise to explain its reasoning and then continue with its standard policy. But it didn’t. It chose to nourish a culture of mistrust by not being transparent in how it was implementing its policies and then refuse to disclose records that might show how it was implementing its policies. It leaves taxpayers and practitioners wondering what’s going on at the division.

FOOTNOTES

1 Internal Revenue Service Restructuring and Reform Act of 1998, H.R. Conf. Rep. No. 599, 105th Cong., 2d Sess. 298-302 (June 24, 1998).

END FOOTNOTES

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