Today’s returning guest blogger is Sean Akins. Sean is a partner at Covington & Burling, LLP. His practice includes representing corporations, partnerships, and individuals in tax controversy matters. Sean is a co-author of Kafka, Cavanagh & Akins: Litigation of Federal Civil Tax Controversies and a co-author of Effectively Representing Your Client Before the IRS, Chapter 7, Litigation in the Tax Court. Sean is also a Nolan Fellow (2014-2015) of the Section of Taxation of the American Bar Association, and an Associate Member of the J. Edgar Murdock American Inns of Court (U.S. Tax Court).
In this post, Sean writes about an important district court opinion addressing the time when the government can bring an erroneous refund suit. Les
Taxpayers who have been paid refunds by the IRS can breathe a little easier following last week’s decision in the Starr International case. Prior rulings in Starr have been covered by Les Book here, here, and here. This most recent, and perhaps final, aspect of the case relates to the application of the extended five-year period of limitations in erroneous refund actions brought by the Government.
In Starr’s case, the Government asserted that an erroneous refund action brought four years after a refund was paid to Starr was timely because section 6532(b)’s extended five-year period of limitations applied. The reason? According to the Government, Starr knew or should have known it was not entitled to the refund, and so when Starr filed its refund claim reporting on the face of the return that it was owed approximately $21 million, that representation constituted a misrepresentation of material fact that triggered the extended limitations period. The Government posited that Starr should have instead reported on the face of the return a $0 refund, and then later explained in the attached statement of facts and grounds that it was actually seeking a $21 million refund.
The district court, citing an amicus brief filed in the case by (shameless plug) Les Book, Fred Murray, and myself [Editor’s note: Sean was the principal drafter], rejected the Government’s argument, and held that no misrepresentation of material fact exists when a taxpayer reports on the face of the tax return the amount of refund to which the taxpayer reasonably believes it is entitled.
In 2007, Starr, a Swiss company, sought from the United States Competent Authority (“USCA”) a determination that it was entitled to a reduced rate of withholding on stock dividends it received. In 2010, the USCA denied that request, which lead Starr to file two claims for refund: one for its 2007 tax year, filed on an amended Form 1120-F, and one for its 2008 tax year, filed on an originally filed Form 1120-F. In 2011, the IRS granted and paid the 2008 refund claim, but took no action on the 2007 refund claim. Rather than seek immediate court review of the 2007 refund claim, Starr waited until 2014 to file suit. By that time, two important statutes of limitations had expired: (i) the three-year period within which the IRS could have assessed a deficiency of tax for the 2008 tax year, and (ii) the two-year period within which the IRS could have initiated an erroneous refund action to claw-back the refund it had previously paid.
After Starr filed suit with respect to the 2007 tax year refund, the Government counterclaimed, seeking a return of the $21 million the Government alleged was erroneously paid. The Government argued that the extended five-year period of limitations applied, rather than the standard two-year period. In order to secure the lengthier period of limitations, the Government was required to show that “the refund was induced by fraud or misrepresentation of a material fact.” Section 6532(b).
The Government asserted that Starr had misrepresented material facts in three ways: (i) Starr reported on line 9 of the Form 1120-F that it was entitled to a $21 million refund; (ii) Starr failed to notify the USCA that it was filing the 2008 refund claim; and (iii) Starr did not expressly notify the IRS service center that the service center lacked jurisdiction to issue a refund.
The district court rightly rejected all three of these as constituting misrepresentations of material fact, but I’ll focus on the first as the most significant of the bunch.
The District Court’s Decision
The district court does a good job of describing the Government’s theory regarding the first alleged misrepresentation (citations to the record omitted):
The Government argues that Starr’s “representation on line 9 of its return that it was due a refund of over $21 million was a misrepresentation of material fact.” In the Government’s view, even if Starr had to file the request to preserve its ability to seek judicial review of the USCA’s treaty benefits determination, it should have either requested $0 or left line 9 of the form blank. According to the Government, taking “this precaution would have allowed [Starr] to litigate the merits of the USCA denial determination in court” without inducing the Ogden Service Center to actually issue the refund.
There are a host of reasons why the Government’s position can’t be the right answer. First and foremost, the Code’s regulations and the Form 1120-F and its instructions require the taxpayer to state the amount of refund to which the taxpayer believes it is entitled. Specifically, Treasury Regulation section 301.6402-3(a)(5) provides that a refund claim must “contain a statement setting forth the amount determined as an overpayment.” Moreover, Lines 8 and 9 of the Form 1120-F state that the taxpayer must “enter the amount overpaid” and “that portion” being claimed as a refund. The instructions to Form 1120-F further confirm that an actual amount must be reported, stating that to claim a refund of withheld taxes, the taxpayer must enter on Line 9 “the amount to be refunded to you.” The Court rightly added that “[a]ccepting the Government’s argument would imply that taxpayers—many of whom are less sophisticated as Starr—should ignore this plain instruction, lest they be accused of making a misrepresentation.”
The district court also pointed out that the Government’s position was inapposite to its arguments in many other cases, where the Government has asserted (often successfully) that a taxpayer’s failure to fully inform the IRS of the amount and basis for its refund claim violate the variance doctrine and/or section 6402’s procedural requirement to report the refund amount. Moreover, the district court hypothesized that if Starr were to report that it was owed $0 on the face of its return, one of two untenable situations could arise:
(1) the IRS would ‘grant’ the $0 request, in which case Starr has no further right to seek the $21 million it believes it is owed; or (2) the IRS would deny the refund claim, in which case it could at least argue (as it has in the past) that Starr cannot seek more than it initially requested. Either way, Starr would have risked not being able to receive its $21 million refund . . . .”
Finally, the District Court recognized that the Government’s position would moot the standard two-year period of limitations for erroneous refund actions:
Under the Government’s theory, a taxpayer would be misrepresenting a material fact every time she asked for a refund the Government believed she was not entitled to. And if that were so, there would be no need for an extended limitations period for misrepresentations of material fact because every erroneously issued refund would be the product of a misrepresentation. That cannot be right.”
Based on the foregoing, the Court rejected the notion that Starr had misrepresented a material fact, and found the extended period of limitations for an erroneous refund action inapplicable.
Because the district court found that there was no misrepresentation of material fact, it was not required to evaluate whether any such misrepresentations induced the IRS to issue the $21 million refund. Notwithstanding this point, it’s worth noting that the Government claimed to have been induced to issue the refund, at least in part, because Starr’s refund claim was voluminous and the IRS lacked the resources to review such a lengthy tax return. Indeed, the Government had argued that Starr “had no basis to have ‘reasonably expected’ that the Service Center would review the over 100-pages of attachments” to its return. Reply in Support of the United States’ Motion for Summary Judgment on the Counterclaim at p. 7.
This is a troubling argument for the Government to make. Starr not only told the IRS, in its attached statement of facts and grounds, that the USCA had previously considered and rejected Starr’s treaty benefits request, but it also attached to its return the letter from USCA denying those treaty benefits. A review of these materials, even a cursory one, would have informed a service center agent that the refund claim should likely have been denied.
Yet it is these very documents the Government points to when arguing that Starr had buried a strained service center in voluminous detail, thereby inducing it to pay a $21 million refund rather than examine the return. Ironically, had Starr failed to make those disclosures, and had the service center paid the refund, Star would likely have faced a stronger argument from the Government that it had misrepresented material facts by failing to include those disclosures.
In short, the Government’s argument that Starr’s disclosures contributed to the service center issuing a refund is a troubling one, as it seeks to punish a taxpayer for over-disclosing, rather than under-disclosing, a return position.