New York’s False Positive: Reforming the False Claims Act
Jeffrey A. Friedman is a partner in the Washington office of Eversheds Sutherland (US) LLP, and Cyavash N. Ahmadi is an associate in the firm’s New York office.
In this installment of A Pinch of SALT, Friedman and Ahmadi argue that based on its recent history of costly and protracted litigation, New York’s application of the False Claims Act to tax matters should be reformed or eliminated.
Copyright 2022 Jeffrey A. Friedman and Cyavash N. Ahmadi.
All rights reserved.
More than a decade after passing legislation applying New York’s False Claims Act (FCA) to “claims, records, or statements made under” New York’s tax law, the New York State Legislature passed another bill1 seeking to expand the FCA to apply to “knowingly or illegally failing to file” a tax return.2
The bill was ultimately — and in our view, wisely — vetoed.3 Undeterred, New York legislators have renewed their proposal to expand the FCA by introducing S. 8815/A. 9975, which again seeks to expand liability under the FCA to wealthy taxpayers who knowingly and illegally fail to file New York tax returns. And again, the latest iteration suffers from the same defects as its predecessor.
This article examines why New York’s application of the FCA to tax matters should be reformed — or eliminated. At a minimum, reforms are necessary to prevent costly and unnecessary litigation, and to ensure that the New York State Department of Taxation and Finance — the agency charged with enforcing the state’s tax laws — is not sidelined from determining the proper application of those laws.
I. Overview of New York’s FCA4
Generally, false claims act statutes deputize private persons (referred to as “relators”) and allow them to bring civil actions against alleged wrongdoers on behalf of the government. Federal False Claims Act claims commonly address allegations of Medicaid fraud.5 Notably, the federal law contains a “tax bar” that prohibits allegations related to the Internal Revenue Code.6 Instead, private persons may bring information regarding alleged tax violations to the IRS through its whistleblower program.7
Many states have their own false claims acts, some of which also have a tax bar.8 Before its amendment in 2010, New York’s FCA also did “not apply to claims, records, or statements made under the tax law.”9 But the 2010 amendments to the FCA flipped the script, so that the New York FCA “shall apply to claims, records, or statements made under the tax law” if: (i) the net income or sales of the taxpayer against whom an FCA action is brought equals or exceeds $1 million in any tax years subject to the action, and (ii) alleged damages exceed $350,000.10
A. Fraud Not Required
Despite its moniker, the FCA does not require a finding of actual fraud to establish a taxpayer’s liability. Rather, the target of an FCA claim — including a tax claim — is subject to liability when it knowingly does any of the following:
presents or causes to be presented a false or fraudulent claim for payment or approval;
makes, uses, or causes to be made or used a false record or statement material to a false or fraudulent claim;
makes, uses, or causes to be made or used a false record or statement material to an obligation to pay or transmit money or property to the state or a local government; or
conspires to commit any of the foregoing.11
For FCA purposes, the “knowingly” standard is applied to determine liability. It is broadly defined to mean that a taxpayer has actual knowledge of the information, acts in deliberate ignorance of the truth or falsity of the information, or acts in reckless disregard of the truth or falsity of the information.12 Further, the FCA provides that a relator is not required to provide proof of specific intent to defraud the state.13
B. FCA Procedural Considerations
A relator who initiates a New York FCA matter must file a complaint under seal14 and must serve a copy of a complaint — along with a written disclosure of “substantially all material evidence and information” the relator possesses — to the New York attorney general.15 The public is often kept in the dark about FCA tax cases unless the attorney general issues a press release, which typically portrays a taxpayer in the worst light possible.
After receiving the relator’s information and complaint, the attorney general’s office investigates (through its Taxpayer Protection Unit) to determine whether and how to proceed. The attorney general has broad authority to investigate taxpayers, including the power to issue subpoenas.16 The attorney general’s office generally must consult with — but need not defer to — the tax department.17
At the conclusion of an investigation, the attorney general’s office has several options, including:
superseding the relator, meaning that the state substitutes itself as the plaintiff, giving the government full control over the case,18 or intervening in the action such that the relator and the government share responsibility for prosecuting the action against the taxpayer;19
refusing to supersede or intervene in the case, but allowing the relator to proceed independently;20
reaching a settlement with the taxpayer;21 or
seeking to dismiss a relator’s action, but in doing so the attorney general must serve the relator with the state’s motion to dismiss, and the court must provide the relator with an opportunity to be heard.22
A taxpayer found liable under the FCA is subject to treble damages — that is, a penalty of three times the amount of damages (unpaid tax) sustained by the government,23 and must pay the costs, including attorney fees, for bringing the action.24 Further, the FCA has a statute of limitations of 10 years.25 For a frame of reference, the general statute of limitations for most New York tax purposes is three years, which is expanded to six years if there is a substantial underpayment of tax. 26
II. False Narrative: Expanding on New York’s Flawed Regime
Recent legislation (S. 4730) would have expanded the scope of the FCA to cases in which no New York tax return had been filed by a person alleged to have New York tax liability.27 In her veto message, Gov. Kathy Hochul (D) wrote that “the language in [S. 4730] . . . would implicate more tax filing controversies . . . than just non-filers.”28 According to the governor, such an expansion would be “incongruent with the way other states and the federal government pursue False Claims Act violations, and could have the effect of incentivizing private parties to bring unjustified claims under the law.”29
But instead of limiting FCA liability applicable to nonfilers, S. 8815 would create additional confusion. For example, the legislation would establish an FCA exception in limited tax cases for mistakes or “mere” negligence. But the FCA’s existing definitions of “knowing” and “knowingly” provide that acts occurring by mistake or as a result of mere negligence are outside the scope of the FCA.30 So it is unclear how the bill language helps. S. 8815 would also apply to all claims arising before its passage, potentially exposing taxpayers to failure-to-file claims (and added confusion) from 2012.
New York’s experience shows that rather than blindly expanding the FCA’s reach, fundamental reforms are needed to address the inequities created when it first became applicable to tax cases.
The Legislature should reform the FCA to reinforce three fundamental tenets:
Proportional Penalties: The FCA currently subjects taxpayers to substantially increased liability (that is, treble damages and costs and attorney fees) in circumstances when a taxpayer has not committed fraud.
Uniform Administration of the Tax Code: The FCA largely relegates New York tax authorities at the Department of Taxation and Finance to subordinate status.
Freedom From Tax Nuisance Actions: The FCA allows specious claims against taxpayers to drag on for years.
Taxpayers also do not have ready recourse to reclaim their costs associated with defending against meritless claims.31
A. Falsely Accused: Attacking Taxpayers’ Reasonable Positions
Rather than rooting out actual fraud, relators and the attorney general’s office at times have used New York’s FCA to pursue taxpayers who applied the tax law in good faith. As a result, some taxpayers have been forced to defend against FCA claims when it is unlikely that even the most aggressive tax auditor would seek adjustments.
1. Citigroup: Attempt to Overturn Federal Tax Guidance at the State Level
Citigroup involved an attempt by an out-of-state professor to apply his personal interpretation of federal tax law — contrary to the IRS’s interpretation — for purposes of calculating a corporation’s New York tax liability.32 During the 2008 recession, Citigroup (like many U.S. banks) participated in the federal Troubled Asset Relief Program (TARP), selling $45 billion of equity interests to the U.S. Treasury. In 2010 Citigroup repurchased $20 billion of the equity interests, while the remaining $25 billion of interests were sold by the U.S. Treasury. Some entities participating in TARP had net operating losses that could be used to offset future taxable income. But the sale of equity interests as part of TARP raised the question whether IRC limitations on the use of NOLs applicable to changes in ownership would apply to businesses that participated in TARP.
The IRS issued multiple notices confirming that the restrictions on the use of NOLs did not apply to companies that benefited under TARP.33 Nevertheless, the professor pursued his case even though New York’s franchise tax law generally conformed to federal taxable income. The relator/professor claimed Citigroup was barred from using NOLs from 2010 through 2012. The relator filed his claim based on his beliefs that (1) New York incorporated the federal limitation on NOL carryovers but did not adopt or incorporate the IRS notices, and (2) the IRS notices were improperly promulgated.
The relator acknowledged that he pursued litigation against Citigroup using New York’s FCA because he had an axe to grind with the IRS. The relator wrote in a blog post that he brought his FCA case in New York because he was “outraged” by the IRS’s interpretation of the IRC in its notices, but thought “nobody could do anything about it” until he “came across the New York State False Claims Act” — deciding it was the best available avenue for him to pursue his federal tax law interpretations.34
2. Starbucks: Using the FCA to Target Major Companies With Minor Tax Faults
In Starbucks, the ubiquitous coffee chain was hit with an FCA claim brought by a pair of attorneys. The claims were made after one of the attorneys noticed that he was not charged the full amount of sales tax on his orders at a Manhattan location.35 The pair then set out and surveyed about 80 Starbucks locations in the state, including licensed locations (like those you might see in a supermarket, which Starbucks does not operate) to explore Starbucks’ sales tax practices of pastry sales.36 Eleven months, 100 pastries, and $218.25 later, the attorneys advanced claims that Starbucks had undercollected sales tax by $15.28.37 Based on their results, the attorneys alleged that Starbucks engaged in “longstanding, widespread, and flagrant tax evasion.”38 They also claimed that the law was clear, but Starbucks “just [chose] to ignore it.”39 The duo estimated that over the FCA’s 10-year statute of limitations period, the state was shortchanged by approximately $10 million.40 Had they prevailed, the attorneys might have netted at least $2.5 million.
The action was eventually dismissed for failure to state a claim about three years after it was filed under seal.41 A New York State Supreme Court justice observed that the pleadings did not permit a reasonable inference that Starbucks had actual knowledge of, or acted in deliberate ignorance or reckless disregard of, its employees’ alleged noncompliance with the tax law.42 Starbucks had also been under audit since at least 2006, the court added, noting that Starbucks had sought guidance on whether it was properly collecting tax on its sales.43 And there was no indication that it was Starbucks’ policy to not collect sales tax on warmed pastries or some to-go items consumed on its premises.44 As a result, the court dismissed the claims, going so far as to write that the plaintiffs’ allegations were based “purely on speculation.”45 Starbucks’ legal fees likely far exceeded the $15.28 in uncollected sales tax.
3. B&H Foto: Using the FCA to Undermine Prior Departmental Guidance
B&H Foto, a New York City retailer, was recently subject to an FCA case regarding its treatment of manufacturer incentives for sales and use tax purposes.46 The attorney general’s office (which intervened in the case) alleged that B&H should have included in the sales tax base specific manufacturers’ reimbursements, which B&H received from manufacturers as an incentive to provide discounts.47 The AG’s allegation turned on whether the manufacturer incentives are the equivalent of a manufacturer’s coupon, which is subject to sales tax under New York law, or a nontaxable discount of a retailer’s wholesale price.
In a statement to Tax Notes, a B&H representative called the position taken by the relator and attorney general’s office “flat wrong” and an attempt to “create a tax on discounts in order to make New Yorkers pay more.”48 B&H argued in its court filings that the reimbursements do not constitute taxable receipts, but rather a reduction to the cost of goods sold from the wholesale price the retailer (B&H) pays the manufacturer.49 Further, the attorney general’s own filings acknowledged that B&H Foto was not required to pass on the manufacturer reimbursements it received to its customers.50
The attorney general’s (mis)interpretation of the tax law motivated recent legislation likely foreclosing the AG from pursuing this position. S. 6301A, signed into law August 20, 2021, codifies what its sponsor called a “long-standing policy” of the department to exclude “vendor funding” like that received by B&H from receipts subject to sales tax.51 Apparently mindful of the B&H Foto case, the legislation provided that it applied to all periods for which any claim could be made under the New York FCA.
After the governor signed S. 6301A, a New York trial court judge dismissed the AG’s case against B&H. The judge’s decision stated that “the Attorney General’s position that ‘Instant Savings’ disbursements are ‘receipts’ does not properly take into account how the transaction between the manufacturer and the retailer works.”52 The judge found that the instant savings was not the equivalent of a manufacturer’s coupon, the amount of which must be included in a taxable sales price. In reaching his decision, the judge cited two advisory opinions by the tax department, which he characterized as “persuasive support” for B&H Foto’s position.53
B. False Appearance: Privatizing Tax Enforcement Undermines Tax Administration
In its recent attempt to expand the FCA to include tax claims, the Legislature brought private parties looking to line their own pockets to the forefront of tax enforcement. However, our colleagues have recognized that allowing private parties to enforce taxes is a measure of last resort.54 And recent FCA tax cases show that tax administration is undermined by people lacking the tax expertise or experience to determine the proper application of tax law.
While the Starbucks and Citigroup cases were dismissed, they highlight the inefficiencies associated with New York’s application of the FCA to tax actions. For example, in Starbucks, the relators challenged transactions that the department had already examined, making the FCA case unnecessary and wasteful.
Those risks were heightened in the Citigroup case, where the relator sought to grind an axe — overturn IRS tax guidance in a state tax controversy. But after the attorney general’s office refused to get involved in Citigroup, 18 Assembly members wrote to then-Attorney General Eric Schneiderman to question his decision to decline the case.55 Highlighting the unfortunate politicization of tax enforcement, these lawmakers focused on the “large amount at stake” — which they said could be used to fund infrastructure projects or pay tax rebates to New York households.
C. New York FCA Complaints Are Inefficient and Prolonged
Even when a taxpayer has a winning defense against an FCA claim, cases can take years and vast resources to defend. Starbucks, for example, extended for more than three years and was ultimately dismissed because the claims were found to be conclusory and speculative despite the attorney-relators’ efforts to buttress their claims with their 100-pastry survey.56 The Citigroup and B&H cases lasted approximately five years before they were dismissed.
III. The Big Fallacy: Reject Efforts to Expand the FCA
The foregoing cases demonstrate that it is time to reform — not expand — the FCA. New York’s experiment with permitting tax claims under the FCA has shown that it can be used to harass taxpayers. And the governor’s veto message recognized that the Legislature’s most recent attempt “could have the effect of incentivizing private parties to bring unjustified claims under the law.”57 The best solution to this problem would be to repeal the prior expansion of New York’s FCA to tax claims.
Rather than using the FCA as the vehicle for tax whistleblower claims, such matters should be reported to the tax department. Taking this route in New York would ensure that the agency vested with the experience and understanding of the nuances of tax law would be responsible to administer it. And as the enactment of S. 6301A demonstrates, asking the attorney general — not the department — to interpret tax laws risks undermining the department’s efforts to administer New York’s taxes.
If New York lawmakers wish to continue allowing FCA cases to include tax claims, we recommend the following reforms:
Provide Attorney’s Fee Parity: Allow taxpayers to collect attorney fees from relators who lose their cases.
The new legislation provides that if the attorney general or local government does not proceed with the claim, a court may (not shall) award to the defendant reasonable attorney fees and expenses if the defendant prevails and the court finds that the claim was “clearly frivolous,” “clearly vexatious,” or brought primarily to harass the taxpayer. We applaud the bill’s sponsor for acknowledging the misaligned incentives inherent in the FCA enforcement regime. But the bar for recouping attorney fees and expenses in the latest iteration is too high. It is unclear under what circumstances a court would apply the proposed standard, even in circumstances presented in cases like Citigroup. Requiring such a high standard leaves the scales unjustifiably tipped in the relator’s favor.
A true “loser pays” rule would discourage relators from bringing cases in which they are attempting to extract a settlement from a deep-pocketed taxpayer. A loser pays rule is equitable. If prevailing relators are entitled to attorney fees in FCA cases, so should prevailing taxpayers.
Allow for More Efficient Termination of Baseless Suits: Tax FCA cases should not be allowed to survive without the department’s participation. Requiring its involvement would help limit (but not eliminate) meritless cases, such as Starbucks and Citigroup, which dragged on long after the attorney general’s office declined to supersede as plaintiff or intervene, signaling a determination that the relators’ cases lacked merit.
1 S. 4730 (introduced Feb. 10, 2021).
2 Sponsor Memo, S. 4730 (Feb. 11, 2021).
3 See Governor’s Veto Message No. 83.
4 This portion of our article liberally borrows from our prior article, Jack Trachtenberg, Jeffrey A. Friedman, and Eric S. Tresh, “Applying False Claims Acts in State Taxation,” State Tax Notes, May 7, 2012, p. 373.
5 31 U.S.C. sections 3729 through 3733.
6 31 U.S.C. section 3729(d).
7 See IRC section 7623.
8 See, e.g., Iowa Code section 685.2(5); Mass. Gen. Laws Ann. ch. 12, section 5B(d).
9 N.Y. State Fin. Law section 189(4) (before amendment by L. 2010, ch. 379).
10 N.Y. State Fin. Law section 189(4)(a) (as amended by L. 2010, ch. 379).
11 N.Y. State Fin. Law section 189(1)(a), (b), (c), and (g).
12 N.Y. State Fin. Law section 188(3)(a).
13 N.Y. State Fin. Law section 188(3)(b).
15 N.Y. State Fin. Law section 190(2)(b).
16 N.Y. Comp. Codes R. & Regs. tit. 13, section 400.2(b).
17 N.Y. State Fin. Law section 189(4)(b).
18 N.Y. State Fin. Law section 190(2)(c)(i).
19 N.Y. State Fin. Law section 190(2)(c)(i)(ii).
20 N.Y. State Fin. Law section 190(2)(f).
21 N.Y. State Fin. Law section 190(5)(b)(ii).
22 N.Y. State Fin. Law section 190(5)(b)(i).
23 N.Y. State Fin. Law section 189(1)(h).
24 N.Y. State Fin. Law section 189(3).
25 N.Y. State Fin. Law section 192(1).
26 See e.g., N.Y. Tax Law section 683(a), (d).
27 Sponsor Memo, S. 4730 (Feb. 11, 2021).
As noted by the New York City Bar Association State and Local Tax Committee, the attorney general’s office has settled FCA claims brought against defendants who did not file New York tax returns. See, e.g., New York State Office of the Attorney General, “A.G. Schneiderman Announces $1.56 Million Settlement With New Jersey Appliance Retailer for Failing to Pay New York Taxes,” Aug. 22, 2014. Further, New York courts have rejected a defendant’s argument that an FCA claim may only “be brought . . . against those who filed a taxrelated document with New York State.” See, e.g., State of N.Y. ex rel Campagna v. Post Integrations Inc., 162 A.D.3d 592 (1st Dep’t 2018).
Note that a coalition of 16 organizations, including the Business Council of New York State and the Partnership for New York City, has identified concerns that the statutory amendments prescribed by S. 4730 could allow “routine types of audit issues” to be subject to FCA claims by expanding the types of tax matters subject to the FCA to include situations in which a taxpayer “knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the state or a local government, or conspires to do the same.” Letter to Beth Garvey, “Re: S. 4730 (Krueger),” July 13, 2021. While we share these concerns, this article will not focus on the possible unintended consequences of S. 4730.
28 Supra note 3.
29 See id.
30 Supra note 13.
31 As noted later, S. 8815 appears to recognize that nuisance actions are incentivized under the current FCA framework, but does not go far enough to protect taxpayers from those claims.
32 See State of New York ex rel. Rasmusen v. Citigroup Inc., 162 A.D.3d 607 (N.Y. App. Div. 2018).
33 IRS Notice 2008-100, 2008-2 C.B. 1081; IRS Notice 2009-14, 2009-7 IRB 516; IRS Notice 2009-38, 2009-18 IRB 901; IRS Notice 2010-2, 2010-2 IRB 251.
34 Eric Rasmusen, “How I Came to Be Suing Citigroup for $2.4 Billion as a Tax Whistleblower,” TaxProf Blog, Oct. 21, 2015.
35 See People ex rel. Hunter v. Starbucks Corp., 60 Misc. 3d 204, 206-207 (N.Y. Sup. Ct. 2018).
36 See id. at 206-207.
37 See id. at 210.
38 See id.
39 See Complaint, People ex rel. Hunter v. Starbucks Corp., 60 Misc. 3d 204, at para. 4 (N.Y. Sup. Ct. 2018).
40 60 Misc. 3d 204 at 210.
41 See id. at 206.
42 See id. at 216.
43 Id. at 217.
44 Id. at 218.
45 See id. at 221.
46 Decision and Order on Motion, State of New York ex rel. RD Litigation Associates LLC v. B&H Foto & Electronics Corp., Index No. 452106/2019 (N.Y. Sup. Ct. Sept. 21, 2021).
47 See Superseding Complaint, State of New York ex rel. RD Litigation Associates LLC v. B&H Foto & Electronics Corp., Index No. 452106/2019 (Nov. 14, 2019).
48 Andrea Muse, “New York Sues Retailer for Millions in Sales Tax Tied to Rebates,” Tax Notes Today State, Nov. 15, 2019.
49 See Memorandum of Law in Support of Defendant’s Motion to Dismiss, State of New York ex rel. RD Litigation Associates LLC v. B&H Foto & Electronics Corp., Index No. 452106/2019 (Dec. 31, 2019).
50 Superseding Complaint, State of New York ex rel. RD Litigation Associates LLC v. B&H Foto & Electronics Corp., Index No. 452106/2019, at para. 85 (Nov. 14, 2019).
52 Decision and Order on Motion, State of New York ex rel. RD Litigation Associates LLC v. B&H Foto & Electronics Corp., Index No. 452106/2019, at 5 (N.Y. Sup. Ct. Sept. 21, 2021).
53 New York State Department of Taxation and Finance, Adv. Op. No. TSB-A-99(10)S (Mar. 1, 1999); New York State Department of Taxation and Finance, Adv. Op. No. TSB-A-98(88)S (Dec. 30, 1998).
54 See, e.g., Nikki E. Dobay and Stephanie T. Do, “A Conversation on False Claims Act Expansion — Does It Make Sense?” Tax Notes State, July 20, 2020, p. 293.
55 See Rick Karlin, “Western NY Lawmakers Want Citigroup to Pay,” Albany Times Union Capitol Confidential, Mar. 16, 2016.
56 See People ex rel. Hunter v. Starbucks Corp., 60 Misc. 3d 204, 218, 220-221 (N.Y. Sup. Ct. 2018).
57 Supra note 3.