The D.C. Council is once again preparing to consider legislation (B23-0035; the False Claims Amendment Act of 2019) that would authorize tax-based false claims actions, allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—a practice that is prohibited under current law consistent with the vast majority of other states with similar laws.
The Committee of the Whole is expected to consider the bill at its committee mark-up meeting on Tuesday, January 21, and we understand that it will closely resemble the bill that was introduced early last year, which in turn closely resembles prior iterations of the legislative proposal (e.g., the False Claims Amendment Act of 2013, the False Claims Amendment Act of 2016 and the False Claims Amendment Act of 2017).
Most taxpayers and their advisors understand just how problematic this proposal is. As we have seen in jurisdictions like New York and Illinois, opening the door (even a crack) to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving the state Attorney General in tax enforcement decisions. One Chicago-based law firm has filed over a thousand qui tam actions under the Illinois statute. Few of these cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, the cases usually involve inadvertent errors or good-faith interpretations of murky tax law. Many of the defendants accused of improperly administering provisions of Illinois’s sales and use tax law even proactively sought guidance from and were audited by the tax authority.
Summary of the Proposal
The bill would amend the existing false claims act in the District of Columbia (D.C. Code Ann. § 2-381.01 et seq.) to expressly authorize tax-related false claims actions against a person so long as they “reported net income, sales, or revenue totaling $1 million or more in a tax filing to which that claim, record, or statement pertained, and the damages pleaded in the action total $350,000 or more.” Because the current false claims statute includes a bright-line tax claim prohibition (consistent with a majority of jurisdictions with similar laws), this bill would represent a major policy departure in the District. See D.C. Code § 2-381.02(d) (stating that “[t]his section shall not apply to claims, records, or statements made pursuant to those portions of Title 47 that refer or relate to taxation”).
Unlike the typical three to six year statute of limitations for tax audits and enforcement, the statute of limitations for false claims to be alleged is 10 years after the date on which the violation occurs. See D.C. Code § 2-381.05(a). Additionally, treble damages would be authorized against taxpayers for violations, meaning District taxpayers would be liable for three times the amount of any damages sustained by the District (including tax, interest and penalties). See D.C. Code § 2-381.02(a). A private party who files a successful claim may receive between 15–25 percent of any recovery to the District if the District’s AG intervenes in the matter. However, if the private party successfully prosecutes the case on their own, in what are known as qui tam actions, they may receive between 25–30% of the amount recovered. This financial incentive encourages profit-motivated bounty hunters to develop and pursue theories of liability not established or approved by—or perhaps even at odds with—the agency responsible for tax administration.
Such a shift in policy would completely open the floodgates to the local plaintiffs’ bar (which, let’s be honest, is already very robust in DC and doesn’t need much enticing) and benefit them and high-priced defense attorneys at the expense of (among others): (1) the DC courts, which will be forced to entertain a litany of frivolous large-dollar tax allegations; (2) Office of the Attorney General (OAG), which will be forced to be involved in the sea of allegations—at least initially; (3) Office of Tax and Revenue (OTR), which will have its autonomy to interpret and administer the District’s tax laws trampled on by private parties and attorneys that do not specialize in tax; and (4) DC taxpayers, which will be forced to pay high-priced defense attorneys to defend against the claims or pay unmerited settlements to avoid the costs of litigation and potentially crippling press that can result from mislabeling a company interpreting a grey area of the law as a “tax cheat” or “fraudster.” Armed with all the leverage needed to squeeze a few dollars (or in many cases, millions of dollars due to the false claims damages and penalty calculation described below) out of unsuspecting District taxpayers, the proposal would create a toxic tax environment in DC that would be driven by legal fear of private plaintiffs—not compliance with OTR or DC law.
Case Studies: Illinois and New York
As all seasoned tax professionals know, not every state and local tax is clear and many require some degree of administrative interpretation by the revenue department. So what happens when an otherwise compliant taxpayer is told by a tax official to comply one way but then has to defend against a false claims action that asserts the taxpayer should have complied a different way? Unfortunately, this is exactly what has happened to many of our clients. In a system based on voluntary compliance, a level of trust and certainty should not be thrown out the door in favor of technical interpretations by those that have no place being responsible for administering the tax law. While providing a transparent environment where whistleblowers can come forward in good faith and report a tax violation (and not be punished for doing so) is an admirable policy to support, such a procedure already exists under DC law. See D.C. Code Ann. § 47-4111 (providing up to a 10% reward on any recovery to tax informants). If the Council believes this procedure is not adequate or is not properly being enforced by OTR, there are countless ways to legislatively reinvigorate existing law without a blanket removal of the tax bar in the false claims act.
In a hearing before the Illinois House Revenue and Finance Committee, former Illinois Revenue Director Brian Hamer described the Illinois cases as being brought by a financially motivated third party adept at manipulating the qui tam process to victimize businesses that at most made an inadvertent mistake. At that hearing, several witnesses described being forced into settlements for amounts far exceeding any tax owed because the costs of litigation are so high. While there is often a false assumption that most tax false claims actions are brought by “by-the-books” whistleblowers acting in the interest of the taxing jurisdiction, claims in the tax realm are primarily developed and driven by a cottage industry of plaintiffs’ law firms with profit-motivated incentives seeking to exploit an area of the law that leans in their favor. Mark Dyckman, the former General Counsel for the Illinois Department of Revenue, has said that “the cases have clearly interfered with the administration and enforcement of tax law and may have even ultimately cost the state money, though it’s impossible to quantify how much.”
Allowing private parties to intervene in the administration, interpretation or enforcement of the tax law commandeers the authority of the tax agency, creates uncertainty and can result in inequitable tax treatment. OTR testified against both the 2017 and 2019 bills, citing that FCA expansion would “infringe on the Chief Financial Officer’s exclusive authority for levying and collection of all taxes” and “could create parallel enforcement actions for tax cases.” The American Bar Association (ABA) has rejected a false claims approach for tax claims, acknowledging the unique tax risks faced by sellers. The Council on State Taxation (COST): “Because tax laws are complex and subject to differing interpretations, each state has established a revenue agency charged with administering the laws and applying them uniformly to taxpayers. The state or local tax agency, and not outside parties such as private litigants, should initiate examinations and enforce the tax laws the agency administers. While attorneys general enforce the states’ laws and may assist a state tax agency in litigation and/or appeals, they should not be involved in processes such as false claims act suits that usurp the state tax appeals system and negate taxpayers’ rights.”
The only winners in the proposal before the Council is the cottage industry of money hungry plaintiffs’ attorneys that will descend on the District and burden local government infrastructure and harass good-faith taxpayers in an effort to pad their own pockets. We are hopeful that the D.C. Council will fully consider the countless negative externalities that removing the false claims act tax bar will create.