On April 9, 2018, the New York State Supreme Court granted Starbucks’ motion to dismiss claims that it had failed to collect more than $10 million of sales tax at its New York stores. Lawyers from McDermott’s State and Local Tax (SALT) group and its White Collar and Securities Defense team handled the matter.

A unique feature of New York law is that the attorney general and private qui tam plaintiffs are permitted to bring New York False Claims Act (NYFCA) actions under New York Financial Law for “claims, records, or statements made under the tax law.” Fin. L. 198(4)(a)(i)-(iii). Under federal law and the law of most states, there is no False Claims Act liability for tax issues. But in New York, the attorney general and private plaintiffs can pursue False Claims Act cases for failure to comply with tax law. There have been numerous large settlements and judgments issued against major companies under the NYFCA, including one settlement for $40 million. See A.G. Schneiderman Announces $40 Million Settlement With Investment Management Company for Tax Abuses, Marking Largest Whistleblower Recovery in Office’s History (April 18, 2017). If successful, qui tam plaintiffs can recover a 25 – 30 percent share of the amount recovered, together with costs and attorneys’ fees. Fin. L. § 190(6)(b).

In this case, two private relator plaintiffs alleged that Starbucks failed to collect sales tax on warmed and “to-go” food items over a 10-year period. The relators filed a complaint, under seal, on or about June 11, 2015, with the New York Attorney General (AG). The AG declined to intervene. On June 30, 2017, the relators elected to proceed on their own with the lawsuit and filed a complaint seeking a judgment for at least $10 million in allegedly unpaid sales tax, as well as treble damages, civil penalties and attorneys’ fees. There was no allegation that Starbucks had failed to properly pay New York taxes that it had previously collected and was holding improperly. The relators’ allegations were solely based on their claim that Starbucks had under-collected sales tax from its New York customers.

On behalf of Starbucks, McDermott filed a motion to dismiss, arguing that Starbucks properly collects and pays its taxes to the State of New York and that Starbucks has consistently worked cooperatively with auditors from the New York State Department of Taxation and Finance. McDermott further argued that the relators “survey” of purchases at Starbucks locations and anecdotal conversations with Starbucks employees failed to properly allege that Starbucks violated the tax law or engaged in any fraud.

On November 10, 2017, the court held oral argument. On April 9, 2018, the Honorable James d’Auguste agreed with McDermott’s arguments and dismissed the case. See State of New York ex rel. James A. Hunter & Keenan D. Kmiec v. Starbucks Corporation, No. 101069/15, Dkt No. 40 (Sup Ct. April 9, 2018). The court held that the relators failed to properly allege that Starbucks had knowingly avoided or recklessly disregarded the law. Id. at 15. The court also opined that “the Survey was not scientifically performed and plaintiffs’ Survey was unsupported by any expert review or report.” Id. at 17. Finally, the court concluded that “plaintiffs’ allegations that Starbucks’ illegal practices were ongoing for a decade before this action was started and that it suffered $10 million in damages are based purely on speculation.” Id. at 17.

McDermott’s SALT and White Collar and Securities Defense teams joined forces in representing Starbucks in connection with this matter. The team consisted of Todd Harrison, Steve Kranz, Mark Yopp, Joseph B. Evans, Kathleen Quinn and Samuel Ashworth.

Full Case Name:          State of New York ex rel. James A. Hunter & Keenan D. Kmiec v. Starbucks Corporation, No. 101069/15 (Sup Ct. April 9, 2018)

Court:                           New York State Supreme Court

Justice:                         James E. d’Auguste

Opposing Counsel:     Hunter and Kmiec

In a bombshell opinion, the Illinois Appellate Court held that a law firm serving both as client and attorney may not recover statutory attorneys’ fees under the Illinois False Claims Act (the Act). In People ex rel. Schad, Diamond & Shedden, P.C. v. My Pillow, Inc., 2017 IL App (1st) 152668 (June 15, 2017), the Illinois Appellate Court, First District, reversed the trial court’s award of attorney fees in excess of $600,000 for work performed by Diamond’s law firm on behalf of itself as the relator. McDermott represents My Pillow in this matter.

Much like its federal counterpart, the Act allows private citizens (referred to as relators) to file fraud claims on behalf of the state of Illinois. If successful, relators can collect up to 30 percent of the damages award plus attorneys’ fees. The Diamond firm is hardly a traditional “whistleblower” with “inside knowledge,” as it has filed approximately 1,000 different qui tam actions as the relator over the last 15 years. The firm initially focused its suits on out-of-state businesses for allegedly knowingly failing to collect Illinois use tax on merchandise delivered to Illinois customers, then expanded its dragnet to allege a knowing failure to collect tax on shipping and handling charges associated with merchandise shipped to Illinois. The firm then targeted out-of-state liquor retailers for alleged knowing nonpayment of certain taxes on the sale of alcoholic beverages to Illinois residents and, most recently, the firm filed over 80 lawsuits targeting tailors based in Hong Kong and London, making similar claims for not collecting Illinois use tax.

Continue Reading Illinois Appellate Court Blows the Whistle on Serial Relator

On May 31, the Illinois General Assembly closed its regular legislative session, without a budget agreement.

Senate Bill 9

As we previously reported, the Senate passed a modified version of Senate Bill 9 (Bill), a tax proposal that is part of the Illinois “Grand Bargain” that we described in a previous post. The version of Senate Bill 9 that passed out of the Senate passed the House Revenue Committee on May 29 on a partisan vote. The House has extended the Bill’s final action deadline to June 30.

The current version of the Bill is similar but not identical to the version that we have previously described. Some of the more significant amendments include the following:

Two New Taxes. The Bill now proposes to create two new taxes. The “Video Service Tax Modernization Act” purports to impose a tax on satellite television and streaming television services at a rate of 5 percent of the gross revenues that a provider earns from its Illinois customers. The Bill also creates the “Entertainment Tax Fairness Act” which seeks to tax viewing “entertainment,” defined as “paid video programming whether transmitted by cable service, direct-to-home satellite service, direct broadcast satellite service, digital audio-visual works service, or video service.” The tax rate is 1 percent of charges paid by the customer. Both taxes exempt satellite or subscription radio services and can be passed-through and collected from customers.

Income Tax. The Bill now proposes to increase income tax rates for individuals, trusts and estates to 4.95 percent (rather than the previously proposed 4.99 percent rate). Also, the tax rate increases, including the increase to 7 percent for corporations (corporate increase unchanged from the Bill’s prior version), continue to be permanent.

Sales Tax Base Expansion. The current version of the Bill removes repair and maintenance services, landscaping services, cable television services (but see “Two New Taxes” described above) and some personal care services (including nails and hair removal) from the Bill’s expansion of the Illinois sales tax base.

It is difficult to predict whether any portion of Senate Bill 9 will be enacted. Since the Illinois General Assembly’s regular sessions have now ended, legislative approval will require a three-fifths majority and, to date, the governor has refused to endorse the legislation.

Senate Bill 1577

We have previously reported on Senate Bill 1577, which proposes to increase the penalty amounts imposed for violation of the Illinois False Claims Act. The bill passed the House on May 30 with the exception for certain low dollar tax claims as previously described.

Just days away from the May 31 close of its regular legislative session, the Illinois General Assembly has yet to enact the comprehensive series of tax and budget reforms that were first proposed by the Illinois Senate leadership late last year. Yesterday, the Senate passed a modified version of Senate Bill (SB) 9, the tax proposal we described in a previous post, without any Republican support. SB 9 now moves to the Democratically-controlled House for consideration. Even if approved by the House, it seems likely that Illinois’ Republican Governor will veto the legislation. Continue Reading Illinois Bills to Watch

Last month, a bill (The False Claims Amendment Act of 2017, B22-0166) was introduced by District of Columbia Councilmember Mary Cheh that would allow tax-related false claims against large taxpayers. Co-sponsors of the bill include Chairman Jack Evans and Councilmember Anita Bonds. Specifically, the bill would amend the existing false claims statute to expressly authorize tax-related false claims actions against persons that reported net income, sales, or revenue totaling $1 million or more in the tax filing to which the claim pertained, and the damages pleaded in the action total $350,000 or more. The bill was referred to the Committee of the Whole upon introduction, but has not advanced or been taken up since then. Nearly identical bills were introduced by Councilmember Cheh in 2013 and 2016. Continue Reading DC Council Introduces False Claims Expansion – Taxpayers Beware!

In an effort to resolve Illinois’ 20-month budget impasse, the Illinois Senate leadership (Senate Majority Leader John Cullerton and Senate Minority Leader Christine Rodogno) have jointly proposed a series of bills to increase revenue, reduce spending, and respond to the Illinois Governor’s concerns regarding pension reforms, workers compensation reform and property tax relief.  A series of twelve bills have been introduced, all of which are interlinked for passage.  The bills are termed the Illinois “Grand Bargain.”  Most of the tax-related changes are found in Senate Bill 9.  The current version of the Senate Bill 9 (Amendment 3) (“Bill”) was submitted on March 3 and includes the following proposed changes: Continue Reading Tax Highlights of Proposed Illinois “Grand Bargain”

Illinois Legislators have recently introduced three bills that would amend the Illinois False Claims Act (“Act”) to restrict the ability to bring tax-related claims. Senate Bill 9, the proposed “grand bargain” to resolve Illinois’ budget stalemate, includes language that would eliminate the ability to use the Act to bring tax claims.  In addition, Representative Frank Wheeler and Senator Pam Althoff have introduced House Bill 1814 and Senate Bill 1250, respectively, which are identical pieces of legislation that would significantly restrict a private citizen’s right to bring tax-related claims. Senate Bill 9, if adopted in its current form, would eliminate the ability to bring a tax-related claim under the Act.  Currently, the Act only excludes the right to bring income tax-related claims. 740 ILCS 175/3(c).  This would effectively conform the Act to the federal False Claims Act, which does not extend to tax claims.  Rather, tax-related claims are brought before the Internal Revenue Service’s Whistleblower Office as whistleblower claims. House Bill 1814 and Senate Bill 1250 (“Bills 1814/1250”) preserve the right to bring tax claims under the Act, and they maintain the prohibition against income tax claims.  However, in a significant improvement over current practice, the Bills would amend the Act to restrict the ability of a whistleblower or its counsel to control or profit from the filing of tax claims.  In addition, they enhance the role played by the Department of Revenue (“Department”) in determining whether a whistleblower’s tax claim should be pursued.  Effectively, the Bills make the filing of state tax-related whistleblower claims more like the procedure for bringing a federal tax violation before the IRS. Currently, the Act authorizes private citizens, termed “relators,” to initiate litigation to force payment of tax allegedly owed to the State.  740 ILCS 175/4(b).  Hundreds of such claims have been filed in Illinois by whistleblowers claiming a failure to collect and remit sales tax on internet sales.  Relators file a complaint under seal with the circuit court and serve the complaint on the State.  Id. 175/4(b)(2).  The Illinois Attorney General’s office then has the opportunity to review the allegations and decide whether to intervene in the litigation.  Id. 175/4(b)(2), (3).  The Department is not named as a Defendant and there is no requirement to involve the Department in the litigation.  If the Attorney General declines to proceed with the litigation, the relator may proceed with the lawsuit on its own and, if successful, is entitled to an award of 25 percent to 30 percent of the proceeds or settlement of the action, plus its attorneys’ fees and costs.  Id. 175/4(d)(2).  Even if the State intervenes and proceeds with the litigation, eliminating the relator’s day-to-day involvement, the relator is entitled to an award of 15 percent to 25 percent of the proceeds of settlement, plus attorneys’ fees and costs.  Id. 175/4(d)(1). In contrast, Bills 1814/1250 provide that only the Attorney General (“AG”) and the Department have the right to initiate claims under the Act for taxes administered by the Department.  Whistleblowers are required to report an alleged tax violation to the Department.  The Department must investigate the allegations and make a recommendation to the AG as to whether or not the AG should file suit based on the allegations.  Bills 1814/1250, 740 ILCS 175/4.5(b).  The AG can accept or reject the Department’s recommendation.  It can also bring suit in the absence of a Department recommendation.  Id.  If the AG initiates litigation based on a whistleblower’s allegations, the whistleblower is entitled to an award of 15 percent to 30 percent of the collected proceeds of the action and “related actions” or settlement, but no attorneys’ fees.  Id., 740 ILCS 175/4.5(d).  The whistleblower has no ability to proceed with litigation on its own if the Department or AG find the litigation unworthy.  These changes would significantly reduce the ability of a whistleblower or its counsel to profit from the filing of nuisance value claims. Bills 1814/1250 also provide that the Department has discretion to initiate an audit based on a whistleblower’s allegations and affirm that the audited entity has all the rights available to any other taxpayer to dispute any additional assessment of tax, interest and/or penalty charges.  Id., 740 ILCS 175/4.5(c).  Whistleblowers may not participate in or challenge the Department’s audit determination.  If the Department initiates an administrative action based on a whistleblower’s allegations, the whistleblower is entitled to an award of 10 percent to 15 percent of the collected proceeds of the action or settlement.  Id., 740 ILCS 175/4.5(d). Bills 1814/1250 also provide the much-needed ability to reduce the percentage award to a whistleblower under certain circumstances.  First, the Department has the discretion to reduce the percentage award to a whistleblower to 10 percent of the proceeds or settlement if it determines that the action (administrative or judicial) against a taxpayer is based primarily on disclosures from other sources.  Id., 740 ILCS 175/4.5(e).  (This provision is in the present version of the Act, but is a right afforded to the AG, not the Department.)  In addition, the Department has discretion to reduce the whistleblower’s award without limitation if it determines the whistleblower planned and initiated the violation of the Act.  Id., 740 ILCS 175/4.5(f).  The latter change should significantly reduce the ability of whistleblowers to profit from the repetitive filing of tax claims based on transactions initiated by the whistleblower. Bills 1814/1250 also would reduce the burden on the Circuit Courts with respect to these claims by requiring a whistleblower to file its claim with the Department, rather than the Court in the first instance, and by providing that Department award determinations are appealable exclusively to the Court of Claims.  Id., 740 ILCS 175/4.5(g), 705 ILCS 505/8(j). This is not the first time bills have been introduced to amend the Act.  Similar efforts over the past several years have been stymied when the legislature failed to consider the bills in Committee hearings. Hopefully, the Illinois General Assembly will take action to enact one of these much-needed legislative changes this year.

On Monday, October 17, the Illinois Appellate Court issued another taxpayer-friendly opinion in an Illinois False Claims Act case alleging a failure to collect and remit sales tax on internet and catalog sales to customers in Illinois (People ex. rel. Beeler, Schad & Diamond, P.C. v. Relax the Back Corp., 2016 IL App. (1st) 151580)). The opinion, partially overturned a Circuit Court trial verdict in favor of the Relator, Beeler, Schad & Diamond, PC (currently named Stephen B. Diamond, PC).

Continue Reading Illinois Appellate Court Delivers Another Blow to Relator in False Claims Act Litigation

At a hearing yesterday, Cook County Circuit Judge James Snyder granted the State of Illinois’ (State) Motion to Dismiss 201 Illinois False Claims Act (FCA) cases filed by the law firm of Stephen B. Diamond, PC (Relator) against out-of-state liquor retailers.  The lawsuits alleged that the defendants were obligated to collect and remit sales tax on their internet sales of alcohol shipped to Illinois customers.  The complaints admitted that the defendants lacked any physical presence in the state, and would not qualify for any Illinois liquor retail license, but nevertheless asserted a tax collection obligation for sales and a tax remission obligation for gallonage tax arising under the 21st Amendment of the US Constitution and the Supreme Court’s decision in Granholm v. Heald, 544 U.S. 460 (2005).

In its motion to dismiss and at oral argument, the State relied upon the favorable standard for consideration of motions to dismiss False Claims Act cases filed by the State established by the Illinois Appellate Court in two prior cases:  State ex rel. Beeler, Schad & Diamond v. Burlington Coat Factory Warehouse Corp., 369 Ill. App. 3d 507 (1st Dist. 2006) and State ex rel. Schad, Diamond & Shedden, P.C. v. QVC, Inc., 2015 IL App (1st) 132999 (Apr. 21, 2015).  In both cases, the appellate court held that when the State moves to dismiss a qui tam action allegedly filed on its behalf, its motion should be granted absence evidence of “glaring bad faith” on the part of the State in moving to dismiss.  The State argued that it had concluded that the Relator’s claims were weak, based in part on the Relator’s admission that the defendants lacked nexus.  In response, the Relator argued that the State had acted in bad faith by relying on Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and other commerce clauses nexus rulings and, according to the Relator, ignoring the 21st Amendment and Granholm, which the Relator alleged supplanted any nexus analysis (a point the State and the defendants vigorously disputed in briefing prior to argument).

After hearing argument, Judge Snyder ruled from the bench that the Diamond firm had failed to meet its burden of proving bad faith by the State in moving to dismiss the 201 lawsuits.

The Diamond firm will have 30 days from the date of entry of the Circuit Court’s dismissal orders to either seek reconsideration or appeal from the trial court’s ruling.

The Illinois Department of Revenue (Department) has further revised its recently proposed amendments to the regulations governing the taxability of shipping and handling charges. See our prior coverage here. The revisions to the Proposed Amendments to 86 Ill. Admin. Code §§ 130.415 and 130.410 (Revised Proposed Amendments) were made in response to particular comments and concerns raised by industry groups, as explained by the Department in its Second Notice of Proposed Rulemaking. The Revised Proposed Amendments address the following topics:

  • Retroactivity of the Revised Proposed Amendments to November 19, 2009, the date of the Kean decision: The Department added a “safe harbor provision” for taxpayers that have complied with the existing regulation for time periods prior to the effective date of the Revised Proposed Amendments. Prop. 86 Ill. Admin. Code § 130.415(b)(1)(A)(i).  Taxpayers fitting within the safe harbor will be considered to be in compliance with Illinois law regarding the taxability of delivery charges.
  • Clarification of taxpayers subject to the Revised Proposed Amendments: The Department clarified that all persons making taxable sales or collecting or self-assessing Illinois use tax are subject to the Revised Proposed Amendments. Prop. § 130.415(b)(1)(A)(ii).
  • Free shipping option: The Department has added language expressly stating that when a seller offers customers free standard shipping or “qualified” free shipping (i.e., free shipping for purchases totaling at least a certain amount), any other separately stated shipping service for which a seller charges customers (i.e., expedited shipping) are separately contracted for and thus nontaxable. Rev. Prop. § 130.415(b)(1)(B)(ii), (C). For delivery charges to qualify as nontaxable because a seller offers “qualified” free shipping, the customer’s purchase must actually be eligible for free shipping (i.e., must total at least a specified dollar threshold). Rev. Prop. § 130.415(b)(1)(D)(v).
  • Taxability of delivery charges where taxability or tax rate of underlying property differs: The Revised Proposed Amendments also provide that sellers can elect to itemize delivery charges on sales of taxable and tax exempt items and low and high rate items and pay the associated tax on shipping charges as determined by the underlying item. Rev. Prop. 130.415(b)(1)(F)(i). In the absence of separately identifying the delivery charges, the “lump sum” rules as set forth in the original version of the Proposed Amendments will apply. Rev. Prop. § 130.415(b)(1)(F)(i).
  • Taxability of delivery charges where taxability of charges themselves differ: The Department also added a similar rule based on taxability of the delivery charges themselves, in a circumstance, for example, where some charges are taxable and others are not. The Revised Proposed Amendments mirror the rule expressed above, stating that that a seller can separately state delivery charges for each item sold and pay the associated tax as determined per item. Rev. Prop. 130.415(b)(1)(E)(i). If the invoice contains a lump sum of total delivery charges, the sum will not be taxable if the selling price of items with nontaxable delivery charges is greater than the selling price of items with taxable delivery charges. Rev. Prop. § 130.415(b)(1)(E)(ii).

The Revised Proposed Amendments were scheduled for consideration by the Illinois General Assembly’s Joint Committee on Administrative Rules (JCAR) on February 16. The Revised Proposed Amendments are currently in the Second Notice period, which can run for a maximum of 90 days. During this period, JCAR can make recommendations, which the Department has discretion to adopt.