backTax Court Denies Commissioner’s Motion to Compel After Predictive Coding Used to Identify Responsive Documents
On July 13, 2016, Judge Ronald Buch of the Tax Court denied the Commissioner’s motion to compel Dynamo Holdings Limited Partnership (“Dynamo”) and Beekman Vista Inc. (“Beekman”) to produce documents previously identified through the use of search terms that were not produced through the subsequent use of predictive coding. The court had previously granted a motion to compel Dynamo and Beekman (collectively “Dynamo”) to produce electronically stored information relating to adjustments and transfers between them, and permitted Dynamo to use predictive coding to respond.
The predictive coding was performed in accordance with procedures agreed to by Dynamo and the Commissioner or, with respect to the final steps of reviewing and returning the production set, an agreed order. After the process was complete, the Commissioner sought to compel the production of documents that had previously been identified using search terms provided by the Commissioner, and that were not included in the production set.
In denying the motion, the court noted that the Commissioner sought a “perfect response” to his discovery request, but that the Tax Court rules do not require perfection. Instead, Tax Court Rules 70(f), like Federal Rule of Civil Procedure 26(g), only requires that a party make a “reasonable inquiry” when responding to a discovery request. The fact that predictive coding is used “does not change the standard for measuring the completeness of the response,” and the court held that Dynamo made a reasonable inquiry by using predictive coding to respond to the Commissioner’s document request.
The case is Dynamo Holdings LP v Commissioner, 2685-11 (T.C.). To review the court’s order, click here.
Tax Court Holds That Reverse Exchange Qualifies As a Like-Kind Exchange Under Section 1031
On August 10, 2016, Judge Joseph Gale of the Tax Court held that a reverse exchange done by Bartell Drug, an S corporation that owned and operated a chain of retail drugstores in the Seattle, Washington area, qualified for non-recognition treatment under Section 1031 as a like-kind exchange. An exchange accommodation titleholder took title to the replacement property on August 1, 2000, before Rev. Proc. 2000-37, which addresses reverse exchanges, became effective, and the complete transaction took 17 months, beyond the 180 days that would have been allowed for closing the transaction if it applied.
The Commissioner argued that the transaction failed to qualify for Section 1031 treatment because the exchange intermediary did not possess the benefits and burdens of ownership. The Commissioner asserted that there was no transfer of property between owners because Bartell Drug owned the replacement property before the exchange occurred. Among the facts the Commissioner relied upon were that Bartell Drug had the capacity to benefit from appreciation in the property’s value, and the risk of loss from diminution in its value. The Commissioner also noted that the exchange intermediary had no equity interest in the property, had no economic risk because the financing for the property was nonrecourse as to it, the construction of improvements on the property were financed by Bartell Drug, and Bartell Drug had possession and control of the property during the time that the exchange intermediary held title.
The court rejected the Commissioner’s argument the exchange intermediary must assume the benefits and burdens of ownership. It noted that many cases have permitted taxpayers “to exercise any number of indicia of ownership and control over the replacement property before it is transferred to them, without jeopardizing section 1031 treatment,” and that the Court of Appeals for the Ninth Circuit, to which an appeal of the case would lie, had rejected the benefits and burdens of ownership requirement. The court also stated that given the inapplicability of Rev. Proc. 2000-37, “the caselaw provides no specific limit on the period in which a third-party exchange facilitator may hold title to the replacement property before the titles to the relinquished and replacement properties are transferred in a reverse exchange.”
The case is Estate of Bartell v. Commissioner, 147 T.C. 5 (2016). To review a copy of the court’s opinion, click here.
Tax Court Upholds IRS Deficiency Determination and Penalties Arising from Energy Company’s Attempted Like-Kind Exchange
On September 19, 2016, Judge David Laro of the Tax Court upheld the Commissioner’s deficiency determination of more than $435 million and penalties exceeding $85 million against Exelon Corporation, ruling that the transactions at issue did not qualify for Section 1031 like-kind exchange treatment.
Exelon, an electric power company, concluded in the late 1990s that because of electricity industry deregulation, it would be more profitable to sell some of its Illinois fossil fuel power plants than operate them. After executing a sale of the Illinois plants, Exelon entered into several “sale-in, lease-out” (“SILO”) transactions with tax-exempt public utility companies. Under the SILO transactions, Exelon signed long-term leases (treated as purchases for tax purposes) of the utility companies’ plants and then subleased the plants to the utilities under triple net leases. The utilities received a lump sum payment from Exelon, paying back a portion of that amount as pre-paid rent for the sublease, and the option to repurchase the power plants before the expiration of the lease. Exelon treated the transactions as Section 1031 like-kind exchanges and did not recognize any gain from the disposition of the Illinois plants.
The Commissioner argued that Exelon’s transactions did not in substance involve the purchase of replacement properties and that the SILO transactions were simply low-risk loans from Exelon to the public utilities. The court held that the transactions failed to qualify as Section 1031 like-kind exchanges because Exelon did not exchange similar replacement property, but instead exchanged power plants for interests in financial instruments. The court also agreed that the transactions were in substance loans because the public utilities did not transfer to Exelon any of the benefits and burdens of ownership. While Exelon relied on professional tax advisors in structuring the Section 1031 transactions, the court further held that understatement penalties were appropriate because Exelon, “with its expertise and sophistication, knew or should have known that the conclusions in the tax opinions were inconsistent with the terms of the deal.”
The case is Exelon Corporation v. Commissioner, 147 T.C. 9 (2016). To review a copy of the court’s opinion, click here.
District Court for the District of Columbia Holds That Tax Court is a Court for Purposes of FOIA
On September 30, 2016, Judge Rudolph Contreras of the United States District Court for the District of Columbia dismissed a Freedom of Information Act (“FOIA”) action against the Tax Court brought by Ronald Byers. Relying primarily on the D.C. Circuit’s decision in Kuretski v. Commissioner, 755 F.3d 929 (D.C. Cir. 2014), Byers argued that the Tax Court is an agency of the federal government’s executive branch subject to FOIA.
In 1924, Congress created the Board of Tax Appeals as “an independent agency of the executive branch of the Government.” Congress changed the name of the Board to the Tax Court of the United States in 1942 and said that its members would be known as judges. The Tax Reform Act of 1969 later provided that “[t]here is hereby established, under Article I of the Constitution of the United States, a court of record to be known as the United States Tax Court.” The Act also stated that the Tax Court’s members “shall be the chief judge and the judges of the Tax Court.”
The court held that the decision in Kuretski, which found that the Tax Court was part of the executive branch and that the President’s power to remove Tax Court judges did not violate the Constitution’s separation of powers guarantee, was not dispositive. Instead, the court held that several factors, including the intention of Congress; the Supreme Court’s analysis of the Tax Court, which in Freytag v. Commissioner, 501 U.S. 868 (1991), was held to be a “Court of Law” for purposes of the Appointments Clause; and the Tax Court’s functions and procedures, demonstrate that the Tax Court is a court for purposes of FOIA and exempt from its provisions.
The case is Byers v. United States Tax Court, No 15-1605 (RC) (D.D.C.). To review a copy of the court’s opinion, click here.
Southern District of New York Denies Motion to Dismiss or Transfer Action Seeking Interest on Tax Overpayment
On October 31, 2016, Judge Lorna Schofield of the United States District Court for the Southern District of New York denied the government’s motion to dismiss for lack of subject matter jurisdiction an action brought by Pfizer, Inc. seeking to recover interest on a tax overpayment, or to transfer the action under 28 U.S.C. §1631.
When Pfizer filed its consolidated federal income tax return for the year ended December 31, 2008, it showed an overpayment of $769,665,651 and requested that $500,000,000 of the overpayment be refunded and that the balance be applied to its 2009 estimated tax. The refund was not made until March 19, 2009, and Pfizer then filed a claim for refund requesting allowable interest under 26 U.S.C. §6611. The IRS disallowed the claim, and Pfizer filed an action seeking $8,298,048 in interest for the period from March 15, 2009, when its tax return was due, until when it received the tax refund on March 19, 2010.
The court held that it had subject matter jurisdiction of the action under 28 U.S.C. §1346(a)(1), which provides district courts with original jurisdiction over “[a]ny civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.” The court held that a “recovery” includes “[t]he obtainment of a right to something … by a judgment of decree,” that a “sum” refers to “[a] quantity of money,” and that the overpayment interest sought was “a sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.” The court also noted that the weight of authority supports subject matter jurisdiction under Section 1346(a)(1) for actions seeking overpayment interest. Because it found that it had subject matter jurisdiction, the court also denied the motion to transfer under Section 1631.
The case is Pfizer, Inc. v. United States, 16 Civ. 1870 (LGS) (S.D.N.Y.). To review a copy of the court’s opinion and order, click here.