Tax Policy – D.C. False Claims Act Bill Raises Legal and Practical Concerns
Legislation before the D.C. Council would allow private parties to file tax actions—a concept that has a superficial appeal (the potential for greater tax compliance without greater governmental enforcement expenses) but falls apart under greater scrutiny. If enacted, B23-0035 could be a boon to certain law firms, but not to the District or to D.C. taxpayers.
Both the federal government and many states have False Claims Acts (FCAs) on the books under which private parties can file actions on behalf of the government against those who defraud the government. A typical example would be a whistleblower who files what is known as a qui tam action against a government contractor, alleging fraud, but theoretically nonpayment or underpayment of taxes could qualify as well.
The federal False Claims Act contains a “tax bar,” prohibiting qui tam actions from being brought for alleged violations of the Internal Revenue Code, and most (but not all) states follow the federal government in excluding tax cases from their FCAs. The D.C. legislation would lift that tax bar, with the District of Columbia joining states like New York and Illinois in allowing private parties to take on a tax enforcement function typically restricted to government.
There are several reasons to be wary of opening that door, which has led to indiscriminate litigation elsewhere. And that’s assuming it’s even legal; in D.C., repealing the tax bar could well run afoul of the District Charter.
1. Not all tax disputes are fraud
The False Claims Act is primarily concerned with deliberate attempts to defraud the government, whereas tax disputes in which no fraud is involved can and often do show up in FCA cases. A qui tam action must demonstrate that the taxpayer knew or had reason to know of the issue, but in practice it has sometimes been sufficient, for purposes of this standard, to demonstrate that the taxpayer was wrong. Still worse, it has led to actions against taxpayers who took reasonable positions on unsettled areas of law, with their knowledge that there were different plausible interpretations of a statute or regulation deemed enough to justify a finding against the taxpayer.
Corporate taxation is complex, and even when companies are doing their best to comply with the law, they must deal with ambiguities and unsettled legal questions. Frequently these disputed points are out in the open, with companies seeking guidance or letter rulings from revenue departments or, in D.C., the Office of Tax and Revenue (OTR). They might even be working directly with the revenue office to resolve the dispute that gives rise to an action under the FCA. It makes little sense to allow these matters to be treated as fraud.
2. The False Claims Act’s remedies only make sense in fraud cases
Underpayment of taxes typically results in the imposition of a penalty, but a successful action brought under the False Claims Act imposes treble damages, meaning that a finding against a taxpayer requires them to pay three times what they were determined to owe in back taxes. This is wildly disproportionate to how underpayments are handled when pursued by the OTR and is inappropriate where no fraud is involved. The OTR operates under a three-year statute of limitations, moreover, whereas civil actions brought through a qui tam action have up to six years after the date of the alleged violation, or up to nine years provided that falls within three years of the filer (called a “relator”) learning of the violation. This means that taxpayers could be on the hook for up to nine years of back taxes, at three times the underpayment amount, should it be determined that a mistake had been made.
3. Repealing the tax bar is an invitation to frivolous or excessive litigation
In New York and Illinois, law firms have popped up filing dozens or even hundreds of qui tam cases, for instance filing against dozens of retailers prior to the Supreme Court’s decision in South Dakota v. Wayfair asserting a more aggressive theory of sales tax nexus than most retailers acknowledged. These firms, acting on their own behalf, had good reason to file: relators are entitled to a significant percentage of any recovery—up to 40 percent in the District of Columbia. This generous share of damages can lead some individuals or (more often) law firms on fishing expeditions, to the detriment of law-abiding taxpayers.
Each of these claims has to be vetted by government officials at significant cost, even if the government chooses not to join the suit. (The government may join the suit or allow the relator to proceed separately; if the latter, the relator is entitled to a larger award should they prevail.) The process imposes considerable costs on taxpayers—many of whom never underpaid in the first place—and government alike, and ties up both with often frivolous qui tam Ultimately, this approach favors “contingency fee ‘bounty hunting’” over proper tax administration, and may result in additional staffing by the Office of the Attorney General (OAG) to oversee qui tam cases, money that would be better spent on enforcement within the OTR.
4. Using the FCA undermines taxpayer privacy
Taxpayer information is generally confidential, but tax documents disclosed during an FCA hearing may ultimately become part of the public record. In fact, repealing the FCA bar opens the door to harassment for the express purpose of undermining tax confidentiality.
5. Private parties are not qualified to assist in tax administration and are likely barred from doing so under the D.C. Charter
Traditionally, revenue departments have possessed exclusive responsibility over tax assessments, and have an administrative process through which they can work with taxpayers to settle disputes or address ambiguities. Under the FCA, taxpayers attempting to resolve questions administratively must live under the threat of an adversarial proceeding in which a dispute they are working to resolve is treated as fraud and subjected to litigation that can result in the payment of treble damages.
This issue is particularly important in the District of Columbia, where representatives of the OAG and the OTR have testified that the repeal of the tax bar is contrary to the authority the District Charter confers on the Chief Financial Officer for “[s]upervising and assuming responsibility for the levying and collection of all taxes.” The Chief Financial Officer and the OTR are definitionally unable to supervise qui tam
Whatever the superficial appeal of allowing private parties to pursue tax cases on a contingency basis, in practice the repeal of the tax bar creates far more problems than it solves.
Source: Tax Policy – D.C. False Claims Act Bill Raises Legal and Practical Concerns
Upstate Tax Professionals