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Vultures Circling as Bill to Expand California FCA to Tax Looms in Legislature

Legislators in Sacramento are mulling over one of the most (if not the most) troubling state and local tax bills of the past decade. AB 1270, introduced earlier this year and passed by the Assembly in late May, would amend the California False Claims Act (CFCA) to remove the “tax bar,” a prohibition that exists in the federal False Claims Act and the vast majority of states with similar laws.

If enacted, this bill will open the door for a cottage industry of financially driven plaintiffs’ lawyers to act as bounty hunters in the state and local tax arena. California taxpayers would be forced to defend themselves in high-stakes civil investigations and/or litigation—even when the Attorney General’s Office (AG) declines to intervene. As seen in other states, this racket leads to abusive practices and undermines the goal of voluntary compliance in tax administration. (more…)




California Bill Would Remove Tax Bar to False Claims Act

California legislators have recently introduced a bill, AB 1270, that would amend the False Claims Act (Act) to strike the tax bar. As introduced, the bill would amend the existing false claims statute in the state of California to expressly authorize tax-related false claims actions against a person whose reported taxable income, net income, or sales totaled $500,000 or more in to which the claim pertained, and the damages pleaded in the action total $200,000 or more. Also, “[t]he bill would authorize the Attorney General or the prosecuting authority, but not the qui tam plaintiff, to obtain otherwise confidential records relating to taxes, fees, or other obligations under the Revenue and Taxation Code. The bill would prohibit the disclosure of federal tax information to the Attorney General or the prosecuting authority without authorization from the Internal Revenue Service.”

Under current California law, those making false or fraudulent claims to state or local governments can be liable to the state or locality for treble damages, including consequential damages, attorneys’ fees and a civil penalty of between $5,500 and $11,000 for each violation. The False Claims Act does not apply to claims made under the Revenue and Taxation Code.

In addition to repealing the exception for false claims made under the Revenue and Taxation code, the bill would expand the definition of “prosecuting authority” to include “counsel retained by a political subdivision to act on its behalf.” This opens a wide door to the use of contingent fee “bounty hunters” by localities for the prosecution of false tax claims.  The bill makes no provision for review of the allegedly false tax claims by any of the governmental agencies charged with interpretation of the Revenue and Tax Code, such as the Franchise Tax Board or the California Department of Tax and Fee Administration.

As we have seen in jurisdictions like New York and Illinois, opening the door to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving profit-motivated private parties and the state Attorney General in tax enforcement decisions. Allowing private parties to intervene in the administration, interpretation or enforcement of the tax law commandeers the authority of the tax agency, compounded by the use by local governments of contingent-fee outside attorneys, creates uncertainty and can result in inequitable tax treatment. While many other problems exist with application of false claims to tax matters, those issues are beyond the scope of this blog.




Hearing Scheduled for DC False Claims Expansion – Taxpayers Beware!

DC Council Chairman Phil Mendelson recently announced that a public hearing will take place later this month before the Committee of the Whole to consider a bill (The False Claims Amendment Act of 2017, B22-0166) that would allow tax-related false claims against large taxpayers. The hearing will begin at 9:30 am on Thursday, December 20, 2018, in Room 412 of the John A. Wilson Building. More details on the hearing and opportunity to testify are available here. The bill is sponsored by Councilmember Mary Cheh, and co-sponsors of the bill include Committee on Finance and Revenue Chairman Jack Evans and Councilmember Anita Bonds. Nearly identical bills were introduced by Councilmember Cheh in 2013 and 2016, but did not advance.

As introduced, the bill would amend the existing false claims statute in the District of Columbia to expressly authorize tax-related false claims actions against a person 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.”

Practice Note:

Because the current false claims statute includes an express tax bar, 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”). As we have seen in jurisdictions like New York and Illinois, opening the door to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving profit motivated private parties and the state Attorney General in tax enforcement decisions.

Because the statute of limitations for false claims is 10 years after the date on which the violation occurs, the typical tax statute of limitations for audit and enforcement may not protect taxpayers from false claims actions. See D.C. Code § 2-381.05(a). Treble damages would also be permitted against taxpayers for violations, meaning District taxpayers would be liable for three times the amount of any damages sustained by the District. 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. If the private party successfully prosecutes the case on their own, they may receive between 25–30 percent of the amount recovered. This financial incentive encourages profit motivated bounty hunters to develop theories of liability not established or approved by the agency responsible for tax administration. 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. While many other problems exist with application of false claims to tax matters, those issues are beyond the scope of this blog.




News of Wayfair Decision Breaks during Tax in the City® New York

The first New York meeting of McDermott’s Tax in the City® initiative in 2018 coincided with the June 21 issuance of the US Supreme Court’s (SCOTUS) highly anticipated Wayfair decision. Just before our meeting, SCOTUS issued its opinion determining that remote sellers that do not have a physical presence in a state can be required to collect sales tax on sales to customers in that state. McDermott SALT partner Diann Smith relayed the decision and its impact on online retailers to a captivated audience. Click here to read McDermott’s insight about the decision.

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McDermott Defeats New York False Claims Act Case Alleging Starbucks Failed to Collect and Remit Sales Tax

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 [...]

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Illinois Appellate Court Blows the Whistle on Serial Relator

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.

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Update on Illinois Legislative Session

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.




Illinois Bills to Watch

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. (more…)




DC Council Introduces False Claims Expansion – Taxpayers Beware!

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. (more…)




Tax Highlights of Proposed Illinois “Grand Bargain”

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: (more…)




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