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Companies Argue That Disclosures to Japanese National Tax Administration Are Actionable

AUG. 28, 2007

Aloe Vera of America Inc. v. United States

DATED AUG. 28, 2007
DOCUMENT ATTRIBUTES
  • Case Name
    ALOE VERA OF AMERICA, INC., A TEXAS CORPORATION, REX G. MAUGHAN, HUSBAND, RUTH G. MAUGHAN, WIFE, MAUGHAN HOLDINGS, INC., AN ARIZONA CORPORATION, AND GENE YAMAGATA, AN INDIVIDUAL, AND YAMAGATA HOLDINGS, INC., A NEVADA CORPORATION, Plaintiffs-Appellants, v. UNITED STATES OF AMERICA, Defendant-Appellee.
  • Court
    United States Court of Appeals for the Ninth Circuit
  • Docket
    No. 07-15577
  • Authors
    Grant, Merwin D.
    Vaughn, Kenneth B.
    Woolston, Terence D.
    Tarter, Tim A.
    Wainscott, Edwin B.
    Ryan, James A.
  • Institutional Authors
    Grant & Vaughn PC
    Woolston & Tarter PC
    Quarles & Brady LLP
  • Cross-Reference
    For the district court opinion in Aloe Vera of America Inc. v.

    United States, No. CV99-1794 (D. Ariz. Feb. 2, 2007), see Doc

    2007-2967 [PDF] or 2007 TNT 26-9 2007 TNT 26-9: Court Opinions.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2007-23008
  • Tax Analysts Electronic Citation
    2007 TNT 200-9

Aloe Vera of America Inc. v. United States

 

IN THE

 

UNITED STATES COURT OF APPEALS

 

FOR THE

 

NINTH CIRCUIT

 

 

APPEAL FROM A DECISION OF THE UNITED STATES DISTRICT COURT FOR

 

THE DISTRICT OF ARIZONA (PHOENIX),

 

NO. 99-CV-01794 -- HONORABLE JAMES A. TEILBORG

 

 

CORRECTED BRIEF OF APPELLANTS

 

 

Terence D. Woolston, Esq.

 

Tim A. Tarter, Esq.

 

Woolston & Tarter, P.C.

 

2400 East Arizona Biltmore Circle, Suite 1430

 

Phoenix, Arizona 85016-2114

 

(602) 532-9199 Telephone

 

 

Edwin B. Wainscott, Esq.

 

James A. Ryan, Esq.

 

Quarles & Brady, L.L.P.

 

Renaissance One

 

Two North Central Avenue

 

Phoenix, Arizona 85004-2391

 

(602) 229-5704 Telephone

 

 

Attorneys for Appellants,

 

Aloe Vera of America, Inc., Rex G. Maughan,

 

Ruth G. Maughan and Maughan Holdings, Inc.

 

 

Merwin D. Grant, Esq.

 

Kenneth B. Vaughn, Esq.

 

Grant & Vaughn, P.C.

 

6225 North 24th Street, Suite 125

 

Phoenix, Arizona 85016

 

(602) 393-4322 Telephone

 

 

Attorneys for Appellants,

 

Gene Yamagata and Yamagata Holdings, Inc.

 

 

CORPORATE DISCLOSURE STATEMENT

 

PURSUANT TO FED. R. APP. P. 26.1

 

 

There are no parent corporations of Appellants, Aloe Vera of America, Inc., Maughan Holdings, Inc. or Yamagata Holdings, Inc. No publicly held corporation owns 10% or more of the stock of Aloe Vera of America, Inc., Maughan Holdings, Inc. or Yamagata Holdings, Inc.

 TABLE OF CONTENTS

 

 

 CORPORATE DISCLOSURE STATEMENT

 

 

 TABLE OF AUTHORITIES

 

 

 JURISDICTIONAL STATEMENT

 

 

 ISSUES PRESENTED FOR REVIEW

 

 

 STATEMENT OF THE CASE

 

 

 STATEMENT OF FACTS

 

 

      A. The IRS Verified That Taxpayers Properly Reported Their

 

      Income

 

 

      B. The IRS's False Unreported Income Statement

 

 

      C. The IRS's False Price Versus Commission Statement

 

 

      D. The IRS Conceals the SEP From Taxpayers

 

 

      E. The Leaks of Taxpayers' Return Information

 

 

 SUMMARY OF ARGUMENT

 

 

 STANDARD OF REVIEW

 

 

 ARGUMENT

 

 

      A. Basis of Taxpayers' Claims

 

 

      B. The IRS Knowingly Made False Statements of Taxpayers' Return

 

      Information to the NTA (TAC Count I)

 

 

           1. "Estimated" Unreported Income False Statement

 

 

                a. An Estimate Without a Factual Basis is a Basis for

 

                Liability

 

 

                b. The Estimates Were Improper Under IRS Procedures,

 

                Knowingly False and not Made in Good Faith

 

 

           2. "Commission Versus Price" False Statement

 

 

                a. The IRS Knew Commissions did not Remain Constant

 

                When the Product Price Changed

 

 

                b. The District Court Erred by Weighing the Evidence

 

 

      C. The IRS Knew the NTA to be an Insecure Recipient of Return

 

      Information

 

 

           1. The District Court Incorrectly Ruled that Evidence of

 

           Prior NTA Leaks in Cases Other Than Simultaneous

 

           Examinations is Irrelevant

 

 

           2. Alternatively, Sufficient Evidence of Routine Leaks of

 

           Tax Treaty Information Exists to Require Denial of Summary

 

           Judgment

 

 

                a. Taxpayers Presented Admissions Showing that the IRS

 

                Knew the NTA was an Insecure Recipient of Taxpayer

 

                Return Information

 

 

                     i. IRS Admissions that It Knew the NTA was an

 

                     Insecure Recipient

 

 

                          1. IRS Admissions Following 1997 Media

 

                          Reports: Mason's Notes

 

 

                          2. IRS Admissions Following 1997 Media

 

                          Reports: Hedgpeth's email

 

 

                          3. IRS Admissions: CA Lyons' Deposition

 

                          Testimony

 

 

                          4. IRS Admissions: CA Analyst Johnson's

 

                          Deposition Testimony

 

 

                b. Government's Expert Provided Evidence of IRS

 

                Knowledge of NTA Leaks; District Court Failed to Draw

 

                Appropriate Inferences

 

 

                c. The District Court Ignored Relevant Evidence

 

                Presented by Taxpayers

 

 

                     i. CA Analyst Johnson's Notes of Leaks

 

 

                     ii. Mgr. Mason: The NTA Leaked

 

 

                     iii. Widespread IRS Knowledge of NTA Leaks

 

 

                d. Conclusion on IRS' Knowledge of NTA Leaks

 

 

                e. Admissions are Admissible as Substantive Evidence

 

                of Facts

 

 

 CONCLUSION

 

 

 CERTIFICATE OF COMPLIANCE

 

 

 REQUEST FOR ORAL ARGUMENT

 

 

 STATEMENT OF RELATED CASES

 

 

 ADDENDUM

 

 

 DECLARATION OF SERVICE

 

 

                      TABLE OF AUTHORITIES

 

 

 CASES

 

 

 Abdul-Jabbar v. General Motors Corp., 85 F.3d 407, 410 (9th

 

 Cir. 1996)

 

 

 Adickes v. S.H. Kress & Co., 398 U.S. 144 (1970)

 

 

 Aloe Vera of America, Inc. v. United States, 128 F. Supp. 2d 1235

 

 (D. Ariz. 2000)

 

 

 Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986)

 

 

 Blackburn v. United Parcel Service, Inc., 179 F.3d 81 (3rd

 

 Cir. 1999)

 

 

 Chuang v. Univ. of Col. Davis, Bd. of Trustees, 225 F.3d 1115

 

 (9th Cir. 2000)

 

 

 Ellison v. Robertson, 357 F.3d 1072 (9th Cir. 2004)

 

 

 Grace United Methodist Church v. City of Cheyenne, 451 F.3d 643

 

 (10th Cir. 2006)

 

 

 Groder v. United States, 816 F.2d 139 (4th Cir.1987)

 

 

 Harrison v. Westinghouse Savannah River Co., 176 F.3d 776

 

 (4th Cir. 1999)

 

 

 Horphag Research Ltd. v. Garcia, 475 F.3d 1029 (9th Cir.

 

 2007)

 

 

 In re Homestore.com, Inc. Securities Litigation, 347 F. Supp. 2d

 

 769 (C.D. Cal. 2004)

 

 

 Jewell v. CSX Transp., Inc., 135 F.3d 361 (6th Cir. 1998)

 

 

 Jones v. U.S., 97 F.3d 1121 (8th Cir. 1996)

 

 

 Jones v. United States, 9 F. Supp. 2d 1119 (D. Neb. 1998)

 

 

 Jones v. United States, 207 F.3d 508 (8th Cir. 2000)

 

 

 Mallas v. Kolak, 721 F. Supp. 748 (M.D.N.C. 1989)

 

 

 Mallas v. United States, 993 F.2d 1111 (4th Cir. 1993)

 

 

 Nekolny v. Painter, 653 F.2d 1164 (7th Cir. 1981)

 

 

 Sana v. Hawaiian Cruises, Ltd., 181 F.3d 1041 (9th Cir. 1999)

 

 

 Siddiqui v. United States, 359 F.3d 1200 (9th Cir. 2004)

 

 

 Simkins v. NevadaCare, Inc., 229 F.3d 729 (9th Cir. 2000)

 

 

 Snider v. United States, 468 F.3d 500 (8th Cir. 2006)

 

 

 United States ex rel. Bettis v. Odebrecht Contractors of Calif., Inc.,

 

 297 F. Supp. 2d 272 (D.D.C. 2004), aff'd, 393 F.3d 1321 (D.C. Cir. 2005)

 

 

 United States ex rel. Siewick v. Jamieson Science & Eng'g, Inc., 214

 

 F.3d 1372 (D.C. Cir. 2000)

 

 

 United States v. Porter, 544 F.2d 936 (8th Cir. 1976)

 

 

 Wilkerson v. Columbus Separate Sch. Dist., 985 F.2d 815 (5th

 

 Cir. 1993)

 

 

 Wilkerson v. United States, 839 F. Supp. 440 (E.D. Tex. 1993)

 

 

 STATUTES AND RULES

 

 

 Fed. R. App. P. 4(a)(1)(B)

 

 

 Fed. R. App. P. 28(a)(9)(B)

 

 

 Fed. R. Evid. 201

 

 

 Fed. R. Evid. 401

 

 

 Fed. R. Evid. 402

 

 

 Fed. R. Evid. 801(d)(2)

 

 

 5 U.S.C. § 552

 

 

 26 U.S.C. § 6103

 

 

 26 U.S.C. § 6103(b)(2)

 

 

 26 U.S.C. § 6103(b)(2)(A)

 

 

 26 U.S.C. § 6103(b)(8)

 

 

 26 U.S.C. § 7431

 

 

 26 U.S.C. § 7431(a)(1)

 

 

 26 U.S.C. § 7431(c)(1)(B)(ii)

 

 

 28 U.S.C. § 1291

 

 

 28 U.S.C. § 1331

 

 

 28 U.S.C. § 13401

 

 

 OTHER AUTHORITIES

 

 

 Internal Revenue Manual § 4.60.1.3.1

 

 

 Rev. Proc. 2006-54, 2006-49 I.R.B. 1035 at § 18.1.01

 

 

 W. Page Keeton, et al., Prosser & Keeton on the Law of Torts

 

 (5th ed. 1984)

 

 

 2 McCormick on Evidence § 254 (Kenneth S. Braun ed.,

 

 6th ed. 2006)

 

JURISDICTIONAL STATEMENT

 

 

This is a civil action for damages for the unauthorized disclosure of Plaintiffs'/Appellants' (sometimes collectively "Taxpayers") tax return information by the Internal Revenue Service ("IRS") in violation of 26 U.S.C. § 6103. (See Order at 1-2 (the "Order") (ER 2-3).) The district court had subject matter jurisdiction under 26 U.S.C. § 7431(a)(1), and under 28 U.S.C. §§ 1331 and 1340.

Taxpayers appeal from the district court's February 2, 2007 Order and final judgment in favor of Defendant (the "government") disposing of all parties' claims. (ER 1, 2.) The Maughan Appellants1 and the Yamagata Appellants2 each timely filed a Notice of Appeal on March 30, 2007. (ER 48, 55.) See Fed. R. App. P. 4(a)(1)(B). This Court has jurisdiction under 28 U.S.C. § 1291.

 

ISSUES PRESENTED FOR REVIEW

 

 

1. Did the district court err in granting summary judgment on Count I of Taxpayers' Third Amended Complaint ("TAC")? Specifically, when evaluating Taxpayers' evidence that IRS employees knowingly made false statements about Taxpayers' tax return information to the Japanese tax authority did the court:

 

A. Err in ruling as a matter of law that an "estimate" can never serve as a predicate for liability in the tax context; or

B. Err in applying summary judgment standards by:

 

i. Failing to accept Taxpayers' evidence as true;

ii. Failing to draw all justifiable inferences in favor of Taxpayers;

iii. Weighing the evidence;

iv. Making credibility determinations; or

v. Failing to consider Taxpayers' relevant evidence.

2. Did the district court err in granting summary judgment on Count II of the TAC? Specifically, when evaluating Taxpayers' evidence that the IRS knew or should have known that the Japanese tax authority was an insecure recipient of confidential tax return information did the court:

 

A. Err in excluding Taxpayers' relevant evidence; or

B. Err in applying summary judgment standards by:

 

i. Failing to accept Taxpayers' evidence as true;

ii. Failing to draw all justifiable inferences in favor of Taxpayers;

iii. Weighing the evidence;

iv. Making credibility determinations; or

v. Failing to consider Taxpayers' relevant evidence.

STATEMENT OF THE CASE

 

 

Taxpayers sued under 26 U.S.C. § 7431(a)(1)3 for the government's unauthorized disclosure of certain of their tax return information in violation of the confidentiality provisions of 26 U.S.C. § 6103.4 (See Order at 1-2 (ER 2-3).) The IRS made the disclosures to its Japanese counterpart, the Japanese National Tax Administration ("NTA"), in 1996, prior to, and during the course of, a simultaneous examination5 of the Maughan Appellants by the IRS and NTA. (Id.) The simultaneous examination also involved the Yamagata Appellants. (Answer to Third Amended Complaint ¶ 17 (ER 571).)

In October 1997, after the IRS's disclosures to the NTA, stories discussing the simultaneous examination were published in multiple Japanese newspapers and broadcast on Japanese television. The reports falsely characterized Taxpayers and their related Japanese company, Forever Living Products Japan, Inc. ("FLPJ"), as fraudulent tax evaders as more fully described in the Statement of Facts. (See ER 120-128 (includes English translations of Japanese articles).) Taxpayers allege that these public news reports caused substantial economic damages. (See Plaintiffs' Third Amended Complaint ("TAC") at ¶¶ 72-76 & 85-91 (FER 29-33).) Taxpayers claim that (1) the IRS knowingly made false statements about Taxpayers' return information to the NTA (TAC Count I); and (2) the IRS disclosed return information to the NTA knowing or having reason to know that the NTA would not maintain the confidentiality of the information and, indeed, could be expected to leak it to the press (TAC Count II). (Order at 3, 8 (ER 4, 9).)

The government filed a motion for summary judgment. (ER 323.) Taxpayers opposed the motion, incorporating their own Motions for Partial Summary Judgment in their opposition papers. (See Opposition to government's motion for summary judgment ("Opposition") at 27 (ER 310).) The district court granted the government's motion and this timely appeal follows. (Order at 13 (ER 14).)6

 

STATEMENT OF FACTS

 

 

On October 10, 1997, Rex Maughan and Gene Yamagata were awakened by frantic telephone calls from Tokyo, Japan. FLPJ officers had just heard news reports of an IRS-NTA investigation into Taxpayers' finances. The reports stated that FLPJ had concealed 7.7 billion yen from tax authorities, that hidden monies were sent to U.S. affiliates and that directors of the U.S. companies had diverted funds for their personal use. (ER 120-128.) In the wake of these reports, FLPJ's sales plummeted, and its reputation was stained.

These news reports were false. Money had been neither concealed nor diverted; no case was ever brought against the parties. The investigation the reports described was confidential. Tax authorities illegally leaked the sensitive and erroneous information. This case is about how that happened.

Rex Maughan and Gene Yamagata, were, at relevant times, co-owners of FLPJ. (TAC at ¶¶ 5-8 (FER 17-18).) Rex Maughan owns AVA. (TAC at ¶ 4 (FER 17).) During the relevant tax years, AVA reported on its tax returns the sales and royalty-based income it received from selling its aloe vera and other products to FLPJ; in turn, AVA paid commission and royalty-based income to Maughan and Yamagata. (ER 337 at ¶¶ 16-18, ref. Exs. 25-27 (ER 414-421).)

A. The IRS Verified That Taxpayers Properly Reported Their Income.

Beginning in March 1995, the IRS examined the Maughan Appellants' 1991 and 1992 tax returns to verify, inter alia, that Taxpayers correctly reported the commission and royalty amounts as income. (Id.) By July 16, 1995, the IRS completed its review of those amounts reported for 1991, and verified those amounts as correct. (Id.) And, by February 5, 1996, the IRS verified those amounts reported for 1992 as correct. (Id.) The IRS also verified that the Yamagata Taxpayers' commission and royalty amounts were correctly reported for 1991 and 1992. (Opposition SOF at ¶¶ 217-222 (ER 113-116).) In April 1996, despite having just verified the accuracy of the FLPJ-related income reported on Taxpayers' 1991 and 1992 returns, the IRS sent a simultaneous examination proposal letter (the "SEP") to the NTA, suggesting that the two tax authorities conduct a simultaneous examination involving AVA, Rex Maughan, Gene Yamagata and FLPJ. (ER 337 at ¶ 20, ref. Ex. 9 (ER 350-356).)

B. The IRS's False Unreported Income Statement.

The SEP falsely represented to the NTA that the IRS "estimated" that Taxpayers had unreported commission and royalty income for 1991 and 1992 from AVA product sales to FLPJ totaling more than $32 million. (ER 339 at ¶ 30, ref. Ex. 9 (ER 350-356).) Of course, the IRS knew that was not true at the time. Not surprisingly, the IRS officials who authored the SEP could provide no basis for the fictitious "estimate." (ER 338-340 at ¶¶ 26, 32, 34.) One of them later admitted that Maughan and Yamagata had, in fact, previously reported the allegedly "unreported" income mentioned in the SEP. (ER 340 at ¶ 35, ref. Ex. 21 at 76:2-77:8 (ER 380-381); Opposition SOF ¶ 221 (ER 114).)

The false return information disclosed about the Yamagata Appellants included not only the alleged $32 million in unreported income, but also false allegations (that the IRS knew were false) about Yamagata evading taxes, "siphon[ing] money out of FLPJ for the benefit of . . . Yamagata without taxation of the money in either Japan or the U.S." and alleged involvement in "a scheme designed to keep payments for the benefit of . . . Yamagata from taxation." (Opposition SOF ¶ 217-228 (ER 113-117).) Yamagata is mentioned more than 20 times in the SEP. (Id. ¶ 218 (ER 113).) The references to Yamagata share the underlying theme that Yamagata was engaged in tax wrongdoing. (See id. ¶ 219 (ER 113).) The IRS personnel admit that Yamagata was not involved in any scheme to avoid taxes and had no unreported income. (See id. ¶ 222 (ER 114).) The reasonable inference from these facts is that the IRS, for reasons known only to it, knowingly made false and pejorative statements deliberately to entice the NTA into believing that Taxpayers were tax cheats and ensure the NTA would examine Taxpayers.

In disclosing the "estimated" $32 million of alleged unreported income to the NTA, the IRS violated its own procedures. The Internal Revenue Manual ("IRM") directives for preparing an SEP provide that the "examination may not have progressed to a point where specific amounts, either of tax or adjustments to income, can be estimated. In such cases, it should be plainly stated that no estimate can be made at this stage of the examination. If an estimate is given, a brief description of how the estimate was arrived at should be provided." (ER 338 at ¶ 25, ref. Ex. 33 at 30157 (ER 472).)

A draft of the SEP reflects that the basis for the estimate for potential additional tax for the IRS was "unreported income." (ER 337 at ¶ 20, ref. Ex. 29 (ER 422).) Handwritten annotations near this "unreported income" entry state: "Need to add details." (ER 427.) Obviously, IRS personnel involved here knew the IRM rules for estimates presented in a simultaneous examination proposal. (Id) Despite knowledge of the IRM requirements, the unreported income estimate of $32,116,000 was inserted into the SEP without description or justification. (ER 338 at ¶¶ 21-24.) The IRS employees who authored the SEP could not articulate any basis for their "estimates" of unreported income. (ER 338-340 at ¶¶ 26, 32, 34.) The final SEP the IRS sent to the NTA before a joint IRS/NTA meeting to discuss the simultaneous examination included the same estimate. (ER 350, 356.)

C. The IRS's False Price Versus Commission Statement.

At the joint IRS/NTA meeting in August 1996, concerning the product prices that AVA charged to FLPJ and commissions, the IRS further deceived the NTA. IRS International Examiner ("IE") Rick Smith falsely told the NTA that, while the sales price of product that AVA sold to FLPJ had declined between 1985 and 1989 "from over $30" to "$15, approximately," the "commission always stayed the same." (ER 343 at ¶¶ 54-57, ref. Ex. 56 at 7 (ER 552); Order at 7 (ER 8).) IE Smith made these false statements even though he already had seen the IRS workpapers verifying that both product prices and commissions had changed over the relevant time. (ER 342 at ¶ 53.) The IRS had previously verified that AVA had charged product prices to FLPJ that ranged from $33.91 to $18.00 per gallon during the years 1985 through 1989. (ER 342 at ¶¶ 47-50; ER 561.) The IRS also knew that commissions during that same period had ranged from $14.64 to $8.10 per gallon. (ER 342 at ¶¶ 49-50.)

While a layperson may not recognize the significance of this false statement, to a tax examiner, falling product prices and constant commission amounts are indicators of possible tax wrongdoing. No other reason appears for IE Smith's false statement.

Notes taken by other attendees of the joint meeting memorialized that the false statements were made. IRS Manager Sturgis' notes of the meeting recorded IE Smith's statement that the cost of product to Japan from AVA changed over the years from over $30 to $15, approximately, but the commissions always stayed the same at $8.10. (ER 343 at ¶¶ 54-55.) IRS Analyst Warner also took notes at this same meeting: "Through the years the sales price of the product changed quite a bit. The commission always stayed the same." (ER 343 at ¶¶ 56-57, ref. Ex. 56 at 7 (ER 552).)

In her deposition, IRS Analyst Warner recalled IE Smith's statement as described in Manager Sturgis' notes, that the cost of product changed over the years (from over $30 to $15) but the commission always stayed the same ($8.10). (Deposition at 155:17-156:3 (ER 497-498).) Warner's independent recollection corroborates both her own notes and Manager Sturgis' notes regarding the "commission versus price" false statement.

D. The IRS Conceals the SEP From Taxpayers.

In 1997, Rex Maughan made a request to the IRS under the Freedom of Information Act7 ("FOIA") for records relating to the simultaneous examination. In response, the IRS deliberately and secretly withheld the SEP despite the absence of any exemption from disclosure. (ER 340-341 at ¶¶ 36-41, 46, ref. Ex. 43 at 12968 (ER 514).)

In 1998, Maughan sued the IRS in the District of Arizona under FOIA. In that case, the IRS deceived Maughan and the district court by telling the court falsely that the only records withheld from disclosure were "inbound" records from Japan. (ER 341 at ¶ 45.) But the SEP was an "outbound" record prepared by the IRS and sent to the NTA. Both authors of the SEP took affirmative steps to prevent discovery of the SEP in response to the FOIA request. (ER 340-341 at ¶¶ 36-41.) IRS Manager Mason stated that: [The SEP] "should not be released to [Taxpayers until the] . . . Japanese matter is resolved fully. . . ." (ER 341 ¶ 41, ref. Ex. 43 at 12968 (ER 514).) The inference is that IRS knew that disclosure of the SEP would reveal the false statements that the IRS had made to the NTA, but the IRS wanted to conceal them. The government did not disclose the SEP until discovery in this case. (ER 341 ¶ 46.)

E. The Leaks of Taxpayers' Return Information

In October 1997, before the FOIA litigation, news reports appeared in the Japanese media disclosing details of the simultaneous examination that were known only to the IRS and the NTA. (ER 122, 123 & 127.) The various reports included the shocking allegation that Taxpayers had 7.7 billion yen (about $60 million)8 of "concealed income." (ER 120-128.) Some media reports attributed the source of the story to "sources involved," "tax sources" and to the IRS. (Id.) Taxpayers have not been charged with any tax offense by either the IRS or the NTA to this day -- because the reports were false.

When news of the leak reached the United States, IRS officials involved in exchanging taxpayer information with the NTA admitted that "disclosures continue," "disclosures seem to happen in every large high-profile case," and "[a]ny multinational or important case seems to get out." (ER 94 at ¶ 74, ref. Ex. 72 (ER 233); ER 97-98 at ¶¶ 93 & 96.) On October 19, 1997, a senior IRS official involved in the exchange of information with the NTA reported that complaints about the leaks relating to the simultaneous examination, "combined with past episodes of U.S. taxpayer information being improperly disclosed in Japan," had caused the IRS to suspend all exchanges of taxpayer information with Japan. (ER 94-95 at ¶ 75, ref. Ex. 73 (ER 235).)

On October 24, 1997, IRS Competent Authority ("CA")9 Lyons informed the NTA that "before exchanges are resumed we will have to receive some type of assurance that Japan has taken the actions necessary to ensure this does not occur again." (ER 95 at ¶ 77, ref. Ex. 75 (ER 255).) CA senior official Hedgpeth confirmed the accuracy of Lyons' statements. (Hedgpeth Deposition at 78-82 (ER 246-250).) The only reasonable inference to be drawn is that the IRS believed the NTA was the source of the leak in this case.

Indeed, the IRS had known for some time that the NTA could not be relied upon to preserve the confidentiality of taxpayer information. Prior to 1997, IRS personnel had made "snide" comments to IRS personnel stationed in Tokyo about the NTA's leaks to the press. (ER 97 at ¶ 91, ref. Ex. 64 at 38 (ER 199).) CA Analyst Johnson knew that there had been more than one instance prior to 1997 of "transfer pricing examinations and the results of an NTA proposed adjustment being disclosed in the press, in the Japanese press." (ER 97 at ¶ 92, ref. Ex. 77 at 80-83 (ER 259-262).)

The government's expert, Mr. Komamiya, testified that the attribution phrases, "taxation sources," "Japanese government sources," and "Japanese tax authorities" as used in Japanese media reports referred to the NTA, the Tokyo Regional Tax Bureau ("TRTB"), Ministry of Finance, or other Japanese government sources. (ER 98 at ¶ 100, ref. Ex. 68 at 74-76 (ER 220-222).) Komamiya testified that media attributions to "taxation sources" refer to the NTA or the Regional Taxation Bureaus. (Komamiya Deposition at 75 (ER 221).)

Twenty Japanese news articles attached to Komamiya's expert report as Packet #2 contain direct attribution of the source of confidential tax information to Japanese government sources. (ER 99 at ¶ 101; ER 266-289.) Three of these articles are particularly noteworthy. The April 1994 article in The Asian Wall Street Journal reports on a U.S. CA settlement of a transfer pricing case and the story is attributed directly to the TRTB. (Bates 007110 (ER 266).) The November 1993 article in The Japan Times reports on the resolution of another transfer pricing case in CA talks, a story attributed to Japanese government sources. (Bates 024391 (ER 268).) Another transfer pricing case involving Coca-Cola® was reported in a May 1994 issue of The Financial Times, a story attributed to the Japanese tax authorities. (Bates 007111 (ER 267).)

 

SUMMARY OF ARGUMENT

 

 

Application of de novo review inexorably leads to the conclusion that the Order and judgment should be reversed. The district court misapplied the law applicable to summary judgment.

The nonmoving party's evidence is to be believed and all justifiable inferences are to be drawn in favor of the nonmoving party. E.g., Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986); Adickes v. S.H. Kress & Co., 398 U.S. 144, 158-159 (1970). The moving party bears the burden of proving the absence of a genuine issue of material fact for trial. Ellison v. Robertson, 357 F.3d 1072, 1075 (9th Cir. 2004).

Taxpayers presented sufficient facts to the district court that IRS employees or officers made knowing false statements to the Japanese NTA asserting that Maughan and Yamagata had underreported their U.S. income by $32 million. Taxpayers' evidence also shows that the IRS made a knowing false statement to the NTA that AVA commission payments to Maughan and Yamagata on AVA sales to FLPJ remained unchanged over the years although the cost of product to FLPJ varied significantly.

Maughan and Yamagata also presented sufficient facts to the district court that the IRS knew or should have known that the NTA routinely failed to comply with conditions of secrecy mandated by the tax treaty between the United States and Japan, Convention between the United States of America and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, July 9, 1972, TIAS 7365, 1973-1 C.B. 630 (the "Convention" or "treaty"), when it provided the NTA with Taxpayers' tax return information in April 1996 and thereafter.

Instead of believing Taxpayers' evidence, as it was required to do, the district court rejected Taxpayers' evidence while accepting as true virtually all of the government's evidence and argument. Instead of making all justifiable and reasonable inferences in favor of Taxpayers, the nonmoving parties, the district court went to great lengths to draw inferences against Taxpayers and in favor of the government, the moving party.

The district court weighed the evidence before it and made credibility determinations without hearing from a single live witness or viewing the witness's demeanor. Instead of viewing the undisputed facts and resolving all disputed facts in the light most favorable to Taxpayers, the district court did the reverse.

Viewing all disputed facts in the light most favorable to Taxpayers, it was error for the district court to grant summary judgment. Taxpayers have established the existence of genuine issues of material fact for trial. The district court's grant of summary judgment should be reversed.

Along with its failure to apply appropriate summary judgment standards, the district court made two erroneous conclusions of law.

First, the district court ruled that an estimate -- even one made contrary to known facts -- can never be considered false. Consequently, the court concluded an estimate can never be the basis of liability in the tax context. This novel ruling contravenes precedent and other authorities. It also opens the door for IRS abuse. The district court's determination is erroneous and should be reversed. An estimate without any foundation is false and can be the basis of liability.

Second, Taxpayers provided the district court with a body of evidence regarding the NTA's leaks of taxpayer return information, but the court ruled that much of Taxpayers' evidence was irrelevant. In part, the court determined that "alleged leaks of Japanese domestic audits, even of American companies, are irrelevant." (Order at 8 (ER 9).) However, that conclusion contradicts the district court's own prior ruling. It also contradicts the Federal Rules of Evidence. Taxpayers' evidence has a tendency to make the existence of (1) the NTA's untrustworthiness, and (2) the IRS's knowledge of the same, more probable than without the evidence. The evidence is relevant and should be considered.

 

STANDARD OF REVIEW

 

 

This Court's review of a district court's grant of summary judgment and its interpretation of the Internal Revenue Code is de novo. Siddiqui v. United States, 359 F.3d 1200, 1202 n.2 (9th Cir. 2004) (Section 7431 case). This standard of review applies to all issues presented. See Fed. R. App. P. 28(a)(9)(B).

 

ARGUMENT

 

 

The argument necessarily begins with the appropriate standards for this Court's review of a grant of summary judgment. "Viewing the evidence in the light most favorable to the nonmoving party and drawing all reasonable inferences in its favor, an appellate court must determine whether the district court correctly applied the relevant substantive law and whether there are any genuine issues of material fact." Simkins v. NevadaCare, Inc., 229 F.3d 729, 733 (9th Cir. 2000). "The evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in his favor." Liberty Lobby, 477 U.S. at 255.

"In reviewing an order granting summary judgment, this court may not weigh the evidence or pass on the credibility of witnesses but is instead limited to determining whether there is any genuine issue for trial." Horphag Research Ltd. v. Garcia, 475 F.3d 1029, 1035 (9th Cir. 2007). A trial court commits reversible error when it "spins" the evidence in favor of the movant. See Chuang v. Univ. of Cal. Davis, Bd. of Trustees, 225 F.3d 1115, 1129 (9th Cir. 2000) ("It is not the province of a court to spin such evidence in [a moving party's] favor when evaluating its motion for summary judgment. To the contrary, all inferences must be drawn in favor of the non-moving party.") (reversing grant of summary judgment). The trial court is not to pass on the truth of the matters before it, but only decide whether there is a genuine issue for trial. E.g., Abdul-Jabbar v. General Motors Corp., 85 F.3d 407, 410 (9th Cir. 1996) ("We are not to weigh the evidence or determine the truth of the matter, but only to determine whether there is a genuine issue for trial."). Application of these standards to the district court's decision compels the conclusion that the district court's Order should be reversed.

A. Basis of Taxpayers' Claims.

A brief explanation of the basis of Taxpayers' claims affords a useful perspective for review of the district court's ruling. Congress created a civil action against the government for an IRS employee's knowing or negligent unauthorized disclosure of a taxpayer's "return information." See 26 U.S.C. § 7431.10 Unauthorized disclosure of return information is prohibited to protect a person's privacy and reputation from economic harm -- like that visited upon Taxpayers here. "[T]he obvious purpose of prohibiting disclosures is to protect the personal and business reputations of taxpayers. In other words, a reasonable IRS agent would know that 'even without an actual conviction, the suggestion of criminal activity can transform and devastate an individual's life. Diamond v. United States, 944 F.2d 431, 434 (8th Cir. 1991)." Jones v. United States, 9 F. Supp. 2d 1119, 1143 (D. Neb. 1998) (emphasis added). Section 7431 is designed and intended to curtail IRS abuse of taxpayers and should be construed and enforced accordingly. Here, the false disclosures suggested criminal activity and Taxpayers should have a remedy.

"Return information" is very broadly defined. E.g., Snider v. United States, 468 F.3d 500, 507 (8th Cir. 2006) ("The IRC broadly defines 'return information' [quoting 26 U.S.C. § 6103(b)(2)(A)].") (holding taxpayers entitled to damages and attorneys' fees for government's unauthorized disclosure of return information). Return information includes

 

a taxpayer's identity, the nature, source, or amount of his income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments, whether the taxpayer's return was, is being, or will be examined or subject to other investigation or processing, or any other data, received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return or with respect to the determination of the existence, or possible existence, of liability (or the amount thereof) of any person under this title for any tax, penalty, interest, fine, forfeiture, or other imposition, or offense. . . .

 

26 U.S.C. § 6103(b)(2). The unauthorized disclosure of return information can occur regardless of whether the disclosed information is that of a taxpayer under examination or investigation or of another. Mallas v. United States, 993 F.2d 1111, 1118 (4th Cir. 1993) ("Taxpayer information obtained or prepared by the IRS . . . is 'return information' regardless of the person with respect to whom it was obtained or prepared.") (emphasis added); Wilkerson v. United States, 839 F. Supp. 440, 443-44 (E.D. Tex. 1993) ("The source of the return information therefore need not be the return or investigation of the specific taxpayer whose information is disclosed") (emphasis added). Similarly, "disclosure" is broadly defined as "the making known to any person in any manner whatever a return or return information." 26 U.S.C. § 6103(b)(8) (emphasis added).

There is no dispute that the IRS disclosed the Maughan Appellants' return information to the NTA. The IRS also disclosed the Yamagata Appellants' return information in the context of the simultaneous examination of the Maughan Appellants.

The district court here previously and correctly held that disclosure of inaccurate or false information may be return information. Aloe Vera of America, Inc. v. United States, 128 F. Supp. 2d 1235, 1247 (D. Ariz. 2000). Disclosure of false, inaccurate return information is not authorized. See Mallas v. Kolak, 721 F. Supp. 748, 755 (M.D.N.C. 1989) (stating that (1) disclosure of information that was "not accurate" was not authorized; and (2) disclosure of information "without making reasonable efforts to obtain accurate information" violates section 6103), aff'd in relevant part sub nom., Mallas v. United States, 993 F.2d 1111 (4th Cir. 1993).

Further, the disclosure of return information to a recipient who the government knows or should know will not maintain its secrecy is actionable. See, See, e.g., Jones v. U.S., 97 F.3d 1121, 1124 (8th Cir. 1996) (IRS agent's disclosure of impending search of taxpayer's premises to a confidential informant who was hostile to taxpayer was an unauthorized disclosure).11 The government had long believed that the Japanese tax authorities, particularly the NTA, had a practice of publicly disclosing return information. After the October 1997 media reports, contemporaneous internal IRS e-mail communications and memoranda stated "disclosures continue," "disclosures seem to happen in every large high-profile case," and "[a]ny multinational or important case seems to get out." (ER 94 at ¶ 74, ref. Ex. 72 (ER 233); ER 97, 98 at ¶¶ 93, 96.) The NTA was an insecure recipient of return information -- and the IRS knew or believed that to be the case.

Because of the IRS's disclosure of false return information to an insecure recipient, Taxpayers filed this civil action.

B. The IRS Knowingly Made False Statements of Taxpayers' Return Information to the NTA (TAC Count I).

 

1. "Estimated" Unreported Income False Statement.

 

In the SEP, the government falsely represented to the NTA that Maughan and Yamagata had unreported income in the U.S., based on AVA sales of aloe vera gel to Japanese company, FLPJ, in the amounts of $10,616,000 for 1991 and $21,500,000 for 1992. (ER 339 at ¶ 30; ER 356.) The government argued that the amounts were only estimates and, by their very nature, not true or false. (Order at 6 (ER 7).) The district court agreed with the government that an estimate under these circumstances can not be categorized as either false or true. (Id.) The court further found that in the tax context, an estimate cannot serve as a predicate for liability for a knowingly false disclosure. (Id.) The court ruled that "negligently providing incorrect information in the course of a simultaneous examination does not rise to the level of actionable conduct." (Id. at 5 (ER 6).) And the court did not stop there. The court went on to hold that, as a matter of law, an estimate can never be the basis for liability in the tax context. (Order at 6 (ER 7).) The district court erred, both on the law and the facts.
a. An Estimate Without a Factual Basis is a Basis for Liability.
An estimate without any basis can constitute a falsehood. United States ex rel. Siewick v. Jamieson Science & Eng'g, Inc., 214 F.3d 1372, 1378 (D.C. Cir. 2000); Harrison v. Westinghouse Savannah River Co., 176 F.3d 776, 792 (4th Cir. 1999); United States ex rel. Bettis v. Odebrecht Contractors of Calif., Inc., 297 F. Supp. 2d 272, 287 (D.D.C. 2004), aff'd, 393 F.3d 1321 (D.C. Cir. 2005). The district court attempted to distinguish the Harrison case as one involving estimates submitted with contract bids that were relied on to award contracts. (Order at 6 (ER 7).) This distinction is erroneous and illusory; the IRS estimate here was submitted to the NTA for its consideration and was part of the basis for the initiation of the simultaneous examination. Further, an "estimate carries with it an implied assertion not only that the speaker knows no facts which would preclude such an opinion, but that he does know facts which justify it." Harrison, 176 F.3d at 792, quoting W. Page Keeton, et al., Prosser & Keeton on the Law of Torts, § 109, at 760 (5th ed. 1984). Legally, an estimate can constitute a false statement.

Here, the false statement was the IRS's estimate that Taxpayers had failed to report $32 million of income. From its inception in March 1995, the IRS examination for tax years 1991 and 1992 focused on the commission and royalty income issues related to FLPJ. (See ER 342-343.) By February 1996, the IRS already had verified the amount of commission and royalty-based income reported on AVA's returns and the commission/royalty amounts paid as AVA expenses to Maughan and Yamagata for the years 1991 and 1992 (ER 337 at ¶¶ 16-18, ref. Exs. 25-27 (ER 414-421).) The IRS had no factual basis to claim that Maughan and Yamagata had failed to report their commission or royalty income. (ER 339-340 at ¶¶ 32-35.) In fact, the IRS had already determined that there was no such unreported income.

In April 1996, despite its total lack of a basis to claim that Maughan and Yamagata had underreported income, the IRS sent the SEP to the NTA. (ER 339 at ¶ 28, ref. Ex. 9 (ER 350).) In that document, the IRS "estimated" Maughan and Yamagata had unreported income of $10,616,000 for 1991, and $21,500,000 for 1992. Contrary to IRM requirements (discussed below), there is no explanation supporting the "estimate." IRS agents who prepared the SEP could not explain how they determined these amounts. Tellingly, the supposed unreported income amounts are mathematically equal to the sum of two other amounts in the SEP. They are equal to the commission and the royalty received and reported by Taxpayers. These amounts, however, had been previously reported to the IRS, and the IRS had verified the amounts as properly reported. The IRS had no basis to claim Yamagata and Maughan had failed to report income.

An author of the SEP admitted that the commission expense amounts set forth in the SEP had previously been reported by Taxpayers. (ER 340 at ¶ 35.) Under the Harrison legal standard, construing the facts in the light most favorable to Taxpayers, as required by law, e.g., Ellison, 357 F.3d at 1075, the unreported income "estimate" is undeniably false and the IRS knew no facts to justify it.

The unauthorized disclosure of inaccurate information by reason of negligence is actionable under section 7431. See Mallas, 721 F. Supp. at 745; aff'd in relevant part sub nom., Mallas, 993 F.2d at 1124, n.17. The unauthorized willful disclosure of return information is actionable, too. 26 U.S.C. § 7431.

Taxpayers' evidence concerning the false statements in the SEP creates genuine issues of material fact. The district court's ruling should be reversed.

b. The Estimates Were Improper Under IRS Procedures, Knowingly False and not Made in Good Faith.
The IRS's $32 million unreported income estimates were not only knowingly false, but also not made in good faith. First, the estimates were made in violation of standard IRS procedures in its IRM. Second, the IRS deliberately and wrongfully withheld evidence of the unreported income false statements in the previous FOIA action. Third, as demonstrated above, the IRS already had verified that Taxpayers had reported all commission and royalty income. All three scenarios support justifiable inferences (which must be drawn in Taxpayers' favor) of knowing falsity.

The IRM instructions for preparation of a SEP provide that the

 

examination may not have progressed to a point where specific amounts, either of tax or adjustments to income, can be estimated. In such cases, it should be plainly stated that no estimate can be made at this stage of the examination. If an estimate is given, a brief description of how the estimate was arrived at should be provided.

 

(ER 338 at ¶ 25, ref. Ex. 33 at 30157 (ER 472).) Despite knowledge of the IRM provisions, the IRS inserted the estimate of $32,116,000 in the SEP without explanation.12 (ER 338 at ¶¶ 21-24.) Neither author of the SEP could provide a reasonable explanation for the unreported income estimates. (ER 338-340 at ¶¶ 26, 32, 34.)

The government did not disclose the SEP until discovery in this case. (ER 341 at ¶ 46.) Both authors of the SEP took active steps to prevent earlier discovery of the SEP in response to Rex Maughan's 1997 FOIA request. (ER 340-341 at ¶¶ 36-41.) The IRS represented to the district court in the FOIA litigation mat the only documents withheld and not produced contained information received by the IRS from the NTA. (ER 341 at ¶ 45.) This was a false representation to the court. The SEP should have been turned over. This (unfortunately successful) attempt to conceal evidence supports an inference that the unreported income estimates were knowingly false when made.

The district court ignored both the IRS's failure to follow its IRM procedures and the attempts to conceal the income estimates. Failure to follow applicable regulations is relevant to whether the IRS acted in bad faith. See Groder v. United States, 816 F.2d 139, 142 (4th Cir. 1987) ("A[n Internal Revenue Manual] violation may be relevant to this showing [of bad faith] but it is not conclusive."). Concealment is relevant to bad faith conduct. The district court's failure to draw justifiable inferences supporting the knowing falsity of the unreported income amounts is reversible error. Construed in the light most favorable to Taxpayers, the record creates genuine issues of material fact for trial.

 

2. "Commission Versus Price" False Statement.

 

In a second false statement, the IRS disclosed to the NTA that AVA's commission payments to Maughan and Yamagata on sales of aloe vera products to FLPJ remained unchanged over the years, although the cost of products to FLPJ varied significantly. (ER 556.) The implication is that something was untoward about the commissions remaining constant when the price of the product changed.
a. The IRS Knew Commissions did not Remain Constant When the Product Price Changed.
IE Smith made a presentation to the NTA regarding, inter alia, the commission issue, in August 1996. (ER 343 at ¶¶ 54-55.) Manager Sturgis' notes of the meeting reflect IE Smith's statement that the cost of product to Japan from AVA changed over the years from over $30 to $15, approximately, but the commissions always stayed the same at $8.10. (ER 343 at ¶ 55; ER 8.) Analyst Warner also took notes at the August 1996 meeting that: "Through the years the sales price of the product changed quite a bit. The commission always stayed the same." (ER 343 at ¶¶ 56-57, ref. Ex. 56 at 7 (ER 552).)

The falsity of the IE Smith "commission v. price" statement, as recorded in IRS internal file documents, is obvious. It is undisputed that earlier IRS audit analysis and workpapers verified that the price charged by AVA to FLPJ varied from $33.91 ("from over $30") to $18 ("to $15, approximately").13 (ER 342 at ¶¶ 47-50; ER 561.) IE Smith recalls seeing these workpapers. (ER 342 at ¶ 53.) It is also undisputed that the commissions over this same 1985-1989 time period varied from $14.64 to $8.10 per gallon. (ER 342 at ¶¶ 49-50.)

b. The District Court Erred by Weighing the Evidence.
The government disputed the accuracy of its own files and challenged the accuracy of IE Smith's statements. (ER 320-322.) The government asserted that Sturgis testified that her notes of Smith's statements were not completely accurate and her notes regarding this specific statement were poor. (ER 321.) The government asserted that Sturgis questioned whether she understood what Smith was saying. (ER 317 at ¶ 54.) The government also asserted that Sturgis was taking notes strictly for her own benefit. (Id.) The government further asserted that IE Smith testified that he did not recall making the statement attributed to him. (ER 331-32.) The district court adopted all of these government assertions. (Order at 7 (ER 8).)

The government also challenged Warner's notes. It asserted that the notes do not appear to be discussing sales to FLPJ. (ER 321, 318 at ¶ 57.) The court adopted this assertion, i.e.: "It is unclear whether this note refers to sales to FLPJ." (Order at 7 (ER 8).) The government asserted that Warner alluded to weakness in her transcripts. (ER 322.) The court adopted this analysis. (Order at 7 (ER 8).) The government asserted that Warner testified that her emphasis was on recording what the NTA wanted, not what the U.S. representatives were saying. (ER 318 at ¶ 56.) The court adopted this assertion. (Order at 7 (ER 8).) The court also referred to a fax transmitting Warner's notes which indicates: "As you will be able to see, there are some weak spots. . . ." (Order at 7 (ER 8).) But all of these notes were made in the August 1996 simultaneous examination meeting between IRS and NTA giving rise to this case and the only conceivable sales discussed were those to FLPJ -- at least, that is a reasonable inference.

After weighing the evidence, the district court then refused "to hold Defendant liable for intentional falsehoods based on notes of two different attendees of a meeting -- attendees who admitted to the weakness of their notes." (Order at 7 (ER 8).) Standing alone, without any further evidence or inferences, the district court's error is obvious. The court construed the disputed facts in the light most favorable to the government, the moving party. The IRS's own file documents make out the factual case for the "commission versus price" false statement. The government used the deposition testimony of IRS employee Sturgis in an attempt to undercut the plain meaning of the documents. But this is the essence of a factual dispute. The court also failed to consider other relevant evidence as described below.

In her deposition, Analyst Warner recalled the commission versus price statement IE Smith made as memorialized in Manager Sturgis' notes, that the cost of product changed over the years (from over $30 to $15) but the commission always stayed the same ($8.10). (ER 58-59 at ¶ 55.) Warner's recollection, therefore, independently corroborates both her own notes and Manager Sturgis' notes regarding the "commission versus price" false statement.

Manager Sturgis testified that what she put in her notes is as accurate as she was able to make them or as she understood it. (ER 58 at ¶ 54.) She simply could not recall the IE Smith statement. (Id.) Manager Sturgis took notes for her benefit as an IRS manager to give her an outline of the case and as a reminder of follow-up items. (Id.) Analyst Warner's weak spots in her notes did not affect the IE Smith statement at issue and are obvious from a review of her notes. (ER 59 at ¶ 56.) IE Smith agreed that the statement, if made, was erroneous. (ER 343 at ¶ 59.)

The district court erred by weighing the evidence, by ignoring relevant evidence on the issue, by construing the evidence and inferences therefrom against Taxpayers rather than in the light most favorable to them. Manager Sturgis' notes, corroborated by Analyst Warner's notes, recollection and testimony, establish the over $30 product price in IE Smith's statement. The over $30 price fixes both the correct time frame (1985-1989) and the falsity of the statement (ER 342 at ¶¶ 47-50.) A genuine issue of material fact exists, precluding summary judgment.

C. The IRS Knew the NTA to be an Insecure Recipient of Return information.

Count II of Taxpayers' TAC is based on the IRS's knowledge prior to 1997 that the NTA routinely leaked confidential taxpayer information to the media. Taxpayers presented sufficient evidence on this issue to preclude summary judgment; but the court, through a novel legal ruling and the failure to properly apply summary judgment standards, granted summary judgment on Count II.

 

1. The District Court Incorrectly Ruled that Evidence of Prior NTA Leaks in Cases Other Than Simultaneous Examinations is Irrelevant.

 

The district court ruled that Taxpayers must show that, before October 1997, the IRS knew that the NTA leaked taxpayer information in simultaneous examination cases under the Convention. (See Order at 8 (ER 9).) In reaching the decision, the district court stated:

 

Plaintiffs argue the Court should consider NTA leaks of domestic tax information because Japan has the same obligation to keep domestic tax information confidential. This argument ignores the express language of the September 20, 2000 Order that allowed Plaintiffs to survive a failure to state a claim challenge. The Court found that the Plaintiffs would state a cause of action for disclosing any information to the NTA only if they demonstrated the NTA 'routinely failed to comply with the terms and conditions of secrecy mandated by the Convention'"

 

(Order at 8-9, n.4 (emphasis in original) (ER 9-10).) The district court then concluded "that alleged leaks of Japanese domestic audits, even of American companies, are irrelevant." (Order at 8 (ER 9).) Based on this conclusion, the court ignored IRS testimony regarding Japanese domestic audit leaks and evidence of the leaks attached to one of the government's expert reports. (Order at 10 & 12 (ER 11 & 13).) But the district court's characterization of the September 21, 2000 order, of its own prior order, and its conclusion all are wrong. Contrary to the district court's determination, all evidence of NTA leaks is relevant.

A previous order from the district court and the judge in this case specifically held:

 

Thus, this Court agrees with Judge Silver that if Japan routinely violated its domestic secrecy laws, a term of the treaty under Article 26 for Japan, then Japan was not complying with the terms of the Convention. If Japan was not complying with the terms of the Convention, under § 6103(k)(4) the disclosure was not authorized.

 

(June 20, 2001 Order at 5 (Doc. 65) (ER 19) (emphasis added).)15 The previous order is correct -- routine domestic leaks violate the secrecy required by the Convention. Evidence of routine NTA leaks, whether in the domestic or international context, is relevant because, if true, the disclosures in this case were not authorized.

Beyond the district court's prior order, relevant evidence is "evidence having any tendency to make the existence of a fact of consequence to the determination of the action more probable or less probable than it would be without the evidence." Fed. R. Evid. 401 (emphasis added). Evidence that the NTA leaked confidential taxpayer information in any context prior to 1997 has a tendency to make the existence of (1) the NTA's failure to maintain required confidentiality, and (2) the IRS's knowledge of the NTA's failure to maintain confidentiality, more probable than without the evidence. Thus, evidence of prior disclosures in contexts other than simultaneous examinations is relevant and the district court erred in holding otherwise.

Because of its erroneous conclusion, the district court excluded significant evidence presented by Taxpayers. Such evidence included testimony by IRS officials based in Tokyo about leaks of Japanese domestic audit information regarding American companies. (Ward Deposition, ref. Ex. 63 at 58-61 (ER 160-163), 109-112 (ER 167-170), 117-121 (175-179), 125 (ER 183); Tsujimoto Deposition, ref. Ex. 64 at 39-40 (ER 200-201).) The erroneously excluded evidence also included news articles about Japanese domestic audit information leaked by the Japanese government sources and directly attributed to the Japanese tax authorities. (ER 266-289.) The articles were attached to one of the government's expert reports. The district court should have considered this evidence, drawn all reasonable inferences from it in favor of Taxpayers and concluded that a genuine issue of material fact precluded summary judgment.

 

2. Alternatively, Sufficient Evidence of Routine Leaks of Tax Treaty Information Exists to Require Denial of Summary Judgment.

 

In the alternative to the preceding argument, even were a narrow construction of the district court's 2001 order correct, Taxpayers met the strictures of proof so demanded. Even under the narrow evidentiary standard set forth in the Order, the court erred by not viewing the evidence in the light most favorable to Taxpayers, failing to believe Taxpayers' evidence and failing to make justifiable inferences in favor of Taxpayers. Instead, the district court did the opposite and weighed the evidence, construed the evidence against Taxpayers and made all inferences in favor of the government.
a. Taxpayers Presented Admissions Showing that the IRS Knew the NTA was an Insecure Recipient of Taxpayer Return Information.
Taxpayers presented evidence that the IRS knew the NTA was an insecure recipient of taxpayer return information. This included numerous IRS admissions. The district court wrongly treated much of this evidence by inappropriately weighing the evidence, failing to draw inferences in favor of the Taxpayers, and altogether ignoring significant testimony and documents.

Part of Taxpayers' evidence and the district court's analysis thereof is presented below for this Court's consideration.

i. IRS Admissions that It Knew the NTA was an Insecure Recipient.
Taxpayers presented IRS admissions that it knew the NTA was an insecure recipient of taxpayer return information. These admissions were in the form of notes, e-mails, testimony and the government's expert's report. (See generally Opposition SOF ¶ 117-146 (ER 101-105).) Statements or admissions made by a party opponent are relevant and admissible as substantive evidence against that party, and this rule applies to the government. Fed. R. Evid. 401, 402 & 801(d)(2). These admissions create genuine issues of material fact and preclude summary judgment.
1. IRS Admissions Following 1997 Media Reports: Mason's Notes.
In the wake of the October 1997 Japanese news leaks, IE Manager Mason made notes which admit that:
  • NTA "disclosures continue"

  • "[Disclosures continue. . . . Seems to happen oneverylarge high-profile case," and

  • "Any multinational or important case seems to get out." (ER 94 at 74, ref. Ex. 72

 

(ER 233) (emphasis added).)

Manager Mason made these notes while describing conversations with and messages from IRS officials Hedgpeth, DeGrosky and Ng. They clearly indicate that the IRS knew the NTA was an insecure recipient of taxpayer return information.

Despite this clear meaning, the district court failed to draw the reasonable inference that the referenced "high-profile" cases were tax treaty cases and, therefore, rejected the relevance of his admissions. This comment was made by CA official Hedgpeth. Hedgpeth would be involved with the Japanese NTA only under the Convention. (See n.9, supra.) It is an eminently reasonable inference that the high-profile cases Hedgpeth was referring to were tax treaty cases under the Convention. Indeed, this conclusion is virtually unavoidable.

The court also failed to draw the reasonable inference from "every . . . case." "Every," quite simply, means "every" including tax treaty cases.

Along with failing to draw the appropriate inferences, the district court weighed this evidence by noting that the attributions are not a direct statement by Hedgpeth. (Order at 9 (ER 10).)

The court similarly erred when it weighed Mason's notes regarding Tokyo-based IRS official Ng's statement that: "Any multi-national or important case seems to get out." (ER 233.) The district court observed: "Assuming these notes accurately reflect what RSR Ng said they still do not indicate how the cases 'get out,' i.e., the notes do not state the NTA leaks every important case." (Order at 9 (ER 10).) The court should have drawn the justifiable inference that the NTA was the source of the leaks in every multi-national or important case.

2. IRS Admissions Following 1997 Media Reports: Hedgpeth's email.
The court again erred in dealing with the October 19, 1997 Hedgpeth email sent to eight senior IRS officials. In the e-mail, Hedgpeth stated the AVA/FLPJ leak in Japan, "combined with past episodes of U.S. taxpayers' information being improperly disclosed in Japan," caused the IRS to suspend all exchange of information activity under the treaty with Japan. (ER 235.) The court complained that the email does not provide details regarding the "past episodes." (Order at 9 (ER 10).) The court ignores the plain meaning of this "smoking gun" with Hedgpeth's attempt at his deposition to "explain" that he intended the unstated qualifying caveat "as reported by practitioners." (Id.) None of the recipient IRS officials disagreed with the substance of the email regarding past episodes of wrongful disclosure by the Japanese. (ER 95 at ¶ 76.) The logical and reasonable inference from the IRS's suspension of treaty or convention exchanges of information is that the IRS believed the NTA was the source of the leak here.

Hedgpeth's written admission stands, inferentially corroborated by the lack of response from the recipient officials. That Hedgpeth and Ng believed that NTA press leaks happened on every "high-profile" case is further corroborated by the deposition testimony of CA Lyons. (ER 97-98 at ¶ 93.) Hedgpeth's self-serving explanation, made years later, creates a genuine issue of material fact.

3. IRS Admissions: CA Lyons' Deposition Testimony.
"CA Lyons testified that someone [Tokyo RSR Tsujimoto] approached him in October 1995 and suggested [said] that the NTA might have leaked some confidential information." (Order at 11 (ER 12); Lyons Deposition at 138-141 (ER 139-142).) [Lyon's testified that . . .] There had been an article in a Japanese publication "that was along a similar vein to what is alleged here." (Id.) The court noted that it was unclear if the October 1995 article discussed treaty information. (Order at 11 (ER 12).)15 The obvious inference is to the contrary -- that the 1995 case involved an NTA leak of U.S. tax treaty information as alleged in this case. However, the court gives credence to Lyons' deposition testimony: "But Lyons testified that no one ever proved to him that the NTA was the source of the October 1995 leaks or any other leak." (Order at 11 (ER 12); Defendant's Reply ¶ 93 (ER 67).) With this, the court discards another piece of Taxpayers' relevant evidence. Again, it erred in doing so.16
4. IRS Admissions: CA Analyst Johnson's Deposition Testimony.
CA Analyst Johnson testified that he knew of the leak of a transfer pricing examination and an NTA proposed adjustment in Japan. (Order at 10 (ER 11).) The court again refused to make an inference that linked the NTA to the leak.
b. Government's Expert Provided Evidence of IRS Knowledge of NTA Leaks; District Court Failed to Draw Appropriate Inferences.
The government's designated expert on liability, Mr. Komamiya, attached 20 press articles to his expert report that included direct attribution of confidential tax information to Japanese government sources. (Order at 12 (ER 13).) While the articles discussed leaks prior to October 1997, the court found that the articles did not make specific attribution to the NTA, which the court said was necessary for the evidence to support Taxpayers' case. (Id.) This, too, was error.

Komamiya testified that "taxation sources" would either be the NTA or the TRTB. (ER 98 at ¶ 100.)17 "Japanese tax authorities" would be a high ranking tax official. (Id. "Japanese government sources" would be someone in the government other than the NTA or Ministry of Finance. (Id.)

Three of the articles are particularly noteworthy. The April 1994 article in The Asian Wall Street Journal reports on a U.S. CA settlement of a transfer pricing case, and the story is attributed directly to the TRTB. (Bates 007110 (ER 266).) The November 1993 article in The Japan Times discloses the resolution of another transfer pricing case in CA talks, and the story is attributed to Japanese government sources.18 (Bates 024391 (ER 268).) Another transfer pricing case regarding Coca-Cola® was reported in a May 1994 issue of The Financial Times and the story is attributed to Japanese tax authorities. (Bates 007111 (ER 267).)

The foregoing evidence of newspaper attribution to the NTA further supports Taxpayers' claims that the IRS knew that the NTA was an insecure recipient of confidential taxpayer information when it disclosed Maughan's and Yamagata's tax return information to the NTA.

c. The District Court Ignored Relevant Evidence Presented by Taxpayers.
The district court also ignored significant evidence presented by Taxpayers.
i. CA Analyst Johnson's Notes of Leaks.
Taxpayers presented evidence related to CA Analyst Johnson, who made notes regarding CA Lyons' comments that the simultaneous examination procedure was vulnerable to leaks due to disclosure by Japan. (Opposition SOF ¶ 126 (ER 102).) CA Lyons had many discussions with Johnson about this vulnerability. (Opposition SOF ¶ 127 (ER 102).) In 1999, the issue of whether there had been an unlawful disclosure by Japan was part of the negotiating tactics to be used with Japan by the US CA. (Opposition SOF ¶ 128 (ER 102).) Sometime after March 1999, Johnson prepared a Summary of Case Events regarding AVA and noted that in 10/97, the NTA leaked information to the press concerning their audit of FLPJ. (Opposition SOF ¶ 129 (ER 102).)

The district court failed to address all of this evidence.

ii. Mgr. Mason: The NTA Leaked.
After September 1999, Mason create a document entitled "Leaks of Information to the Press" containing statements that on October 9, 1997 the NTA leaked the story which was carried on the news. (Opposition SOF ¶ 132 (ER 103).)

The court also failed to consider this evidence.

iii. Widespread IRS Knowledge of NTA Leaks.
The district court also ignored evidence that the IRS's knowledge of the NTA leaks was widespread. Prior to 1997, IRS personnel in Washington made snide remarks to IRS's Tokyo RSR, Tsujimoto, about the NTA leaking U.S. tax treaty information to the press. (ER 97 at ¶ 91.) The court did not address this evidence which showed the IRS' s prior knowledge of routine NTA leaks.
d. Conclusion on IRS' Knowledge of NTA Leaks.
All of the above evidence, much of it ignored by the district court, shows that the IRS knew or should have known that the NTA was an insecure recipient. The district court's order should be reversed.
e. Admissions are Admissible as Substantive Evidence of Facts.
The government argued that the admissions discussed above are without foundation, are rumor/innuendo, are conclusory, and are unsupported by factual data or other foundation. The district court apparently accepted those arguments. (ER 62-64.) But none of these elements or characteristics is required for admission of the evidence; an admission is received into evidence based on the fact that it is unlikely that an individual will make a statement damaging to the employer unless true. Nekolny v. Painter, 653 F.2d 1164, 1172 (7th Cir. 1981). No personal or firsthand knowledge is needed to support an admission, and no guarantee of trustworthiness is required; the admission can be mere opinion. Fed. R. Evid. 801(d)(2), Notes of Advisory Committee on Proposed Rules; Grace United Methodist Church v. City of Cheyenne, 451 F.3d 643, 667-8 (10th Cir. 2006); Jewell v. CSX Transp., Inc., 135 F.3d 361, 365 (6th Cir. 1998); United States v. Porter, 544 F.2d 936, 938 (8th Cir. 1976).

Admissions come into evidence as proof of the facts stated. E.g., 2 McCormick on Evidence § 254 (Kenneth S. Braun ed., 6th ed. 2006) ("admissions of a party are received as substantive evidence of the facts admitted and not merely to contradict the party"). A statement of an IRS employee reported by another IRS employee remains admissible non-hearsay. See Wilkerson v. Columbus Separate Sch. Dist, 985 F.2d 815, 818 n.11 (5th Cir. 1993); Sana v. Hawaiian Cruises, Ltd., 181 F.3d 1041, 1045-46 (9th Cir. 1999); Blackburn v. United Parcel Service, Inc., 179 F.3d 81, 96 (3rd Cir. 1999). And "emails written by a party are admissions of a party opponent and admissible as non-hearsay." In re Homestore.com, Inc. Securities Litigation, 347 F. Supp. 2d 769, 781 (CD. Cal. 2004).

Because it was required to believe Taxpayers' evidence and to construe evidence in favor of Taxpayers, the district court should have assumed that the government's admissions are accurate and should have drawn all reasonable inferences from them in favor of Taxpayers.19

The district court erred by weighing the admissions and other evidence, construing them against Taxpayers and drawing inferences from them against Taxpayers. Additionally, the district court's failure to consider significant evidence presented by Taxpayers further vitiates the district court's Order.

The factual disputes are genuine and material. The Order granting summary judgment was error. This Court should reverse.

 

CONCLUSION

 

 

Based on the foregoing, Maughan and Yamagata respectfully request this Court to enter an order (1) reversing the Order and judgment, (2) remanding the case to the district court, and (3) granting such other, further or different relief as the Court finds appropriate.

RESPECTFULLY SUBMITTED this 28th day of August, 2007.

Woolston & Tarter, P.C.

 

Suite 1430

 

2400 East Arizona Biltmore Circle

 

Phoenix, Arizona 85016-2114

 

And

 

Edwin B. Wainscott

 

James A. Ryan

 

Quarles & Brady, L.L.P.

 

Renaissance One

 

Two North Central Avenue

 

Phoenix, Arizona 85004-2391

 

 

Terence D Woolston

 

Tim A. Tarter

 

Attorneys for Appellants Aloe Vera

 

of America, Inc., Rex G. Maughan,

 

Ruth G. Maughan, and Maughan

 

Holdings, Inc.

 

Grant & Vaughn, P.C.

 

6225 North 24th Street, Suite 125

 

Phoenix, Arizona 85016

 

 

Merwin D. Grant

 

Kenneth B. Vaughn

 

Attorneys for Appellants

 

Gene Yamagata and Yamagata

 

Holdings, Inc.

 

CERTIFICATE OF COMPLIANCE

 

 

I certify that this brief complies with the type-volume limitation set forth in Rule 32(a)(7)(B) of the Federal Rules of Appellate Procedure. This brief uses a proportional typeface and 14-point font, and contains 10,389 words.

 

FOOTNOTES

 

 

1 Aloe Vera of America, Inc. ("AVA"), Rex G. and Ruth G. Maughan and Maughan Holdings, Inc. are sometimes collectively referred to as the "Maughan Appellants" or simply "Maughan."

2 Gene Yamagata and Yamagata Holdings, Inc. are sometimes collectively referred to as the "Yamagata Appellants" or simply "Yamagata."

3 This statute is included in the Addendum.

4 This statute also is included in the Addendum.

5 "Simultaneous Examinations involve the US and one or more of its Tax Treaty or TIEA partners conducting separate, independent examinations of the taxpayer or a related taxpayer within their jurisdiction. The purpose of the simultaneous examination is to determine the correct tax liabilities of the taxpayer and/or related entities." Internal Revenue Manual ("I.R.M.") § 4.60.1.3.1. This section is included in the Addendum.

6 Neither Maughan nor Yamagata appeal the district court's denial of their respective motions for partial summary judgment.

7 5 U.S.C. § 552.

8 In October 1997, the exchange rate was about 120 yen to the dollar. See Fed. R. Evid. 201.

9 The office of the U.S. Competent Authority assists taxpayers with respect to matters covered in the mutual agreement procedures of tax treaties. Rev. Proc. 2006-54, 2006-49 I.R.B. 1035 at § 18.1.01. Similarly, Tokyo-based Revenue Service Representatives ("RSRs") exchange information between the countries via treaty. (Tsujimoto Deposition at 23-24 (ER 188-189).) The Convention requires each country to designate a "competent authority" with authority to act pursuant to the treaty. In this Brief, CA refers both to the specific person designated as CA (here, Lyons) and to the office.

10 Punitive damages are available for an unauthorized disclosure that is willful or the result of gross negligence. 26 U.S.C. § 7431(c)(1)(B)(ii). This statute is included in the Addendum

11 After the unauthorized disclosure in the Jones case, an anonymous caller notified a local television station of the impending search, and the station then covered the search. 97 F.3d at 1123. Taxpayer was guilty of nothing. Thereafter, the taxpayer's business failed and ultimately the appellate court affirmed an award to the taxpayer of about $2.2 million in damages. Jones v. United States, 207 F.3d 508, 511-12 (8th Cir. 2000). The Jones case aptly demonstrates the real and foreseeable havoc unauthorized disclosures of return information may cause.

12 This was then a knowing violation of the IRM provisions. Alternatively, if the basis for the unreported income statements was the introductory phrase "estimates based on sales of AVA aloe vera gel to FLPJ during 1991 and 1992," then it was false per the prior IRS audit verification process discussed above.

13 The "from over $30 to $15, approximately" phrase fixes the applicable time frame, per the IRS work papers, as 1985 through 1989. (ER 342 at ¶¶ 47-50.)

15 The referenced Article 26 is included in the Addendum.

15 The Court refers to October 1995 press releases, although Lyons' testimony makes clear that the article was not the result of a press release -- rather a leak as alleged in the AVA case. (Lyons Deposition at 139:1-7 (ER 140).)

16 The district court's acceptance of Lyons' self-serving testimony is even more improper in light of Lyons' own concession that the NTA had a reputation for disclosing sensitive matters in high profile cases. (Lyons Deposition, ref. Ex. 61 at 143, 144 (see ER 144-145).)

17 The NTA by definition includes the Regional Taxation Bureaus. (Komamiya Deposition at 60-62 (ER 206-208).)

18 The article on its face attributes the source to Japanese government sources. From the context, it is a reasonable inference that information on an agreement in bilateral CA talks attributed to a government source must be from the Japanese CA. Komamiya's testimony to the contrary creates another layer to the factual dispute for trial. (Komamiya Deposition at 75-76 (ER 221-222).)

19 Another key fact affects the inferences that should be drawn from these IRS admissions: IRS employees who made the admissions -- Hedgpeth, Ng, Lyons, Ward, Tsujimoto and Johnson -- all worked for the CA or the IRS staff in the Tokyo Embassy. (ER 305-308.) All tax information exchanged with the NTA must be made under provisions allowed by treaty. (Tsujimoto Deposition at 23-24 (ER 188-189).) Therefore, it is certainly a reasonable inference that all cases and matters referenced in the IRS admissions involved bilateral U.S./Japan treaty cases.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Case Name
    ALOE VERA OF AMERICA, INC., A TEXAS CORPORATION, REX G. MAUGHAN, HUSBAND, RUTH G. MAUGHAN, WIFE, MAUGHAN HOLDINGS, INC., AN ARIZONA CORPORATION, AND GENE YAMAGATA, AN INDIVIDUAL, AND YAMAGATA HOLDINGS, INC., A NEVADA CORPORATION, Plaintiffs-Appellants, v. UNITED STATES OF AMERICA, Defendant-Appellee.
  • Court
    United States Court of Appeals for the Ninth Circuit
  • Docket
    No. 07-15577
  • Authors
    Grant, Merwin D.
    Vaughn, Kenneth B.
    Woolston, Terence D.
    Tarter, Tim A.
    Wainscott, Edwin B.
    Ryan, James A.
  • Institutional Authors
    Grant & Vaughn PC
    Woolston & Tarter PC
    Quarles & Brady LLP
  • Cross-Reference
    For the district court opinion in Aloe Vera of America Inc. v.

    United States, No. CV99-1794 (D. Ariz. Feb. 2, 2007), see Doc

    2007-2967 [PDF] or 2007 TNT 26-9 2007 TNT 26-9: Court Opinions.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2007-23008
  • Tax Analysts Electronic Citation
    2007 TNT 200-9
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