{"id":1393,"date":"2018-12-13T15:19:15","date_gmt":"2018-12-13T21:19:15","guid":{"rendered":"https:\/\/illinoistax.org\/?p=1393"},"modified":"2018-12-14T10:16:09","modified_gmt":"2018-12-14T16:16:09","slug":"the-use-of-the-illinois-false-claims-act-in-tax-matter-undermines-the-rule-of-law-michael-j-wynne","status":"publish","type":"post","link":"https:\/\/illinoistax.org\/?p=1393","title":{"rendered":"The Use of the Illinois False Claims Act in Tax Matters Undermines the Rule of Law – Michael J. Wynne"},"content":{"rendered":"

The Use of the Illinois False Claims Act in Tax Matters Undermines the Rule of Law<\/u><\/strong><\/h3>\n

 <\/p>\n

December 2018 (71.11)<\/strong><\/p>\n


\nMichael J. Wynne*<\/strong><\/p>\n

 <\/p>\n

Franz Kafka\u2019s novel The Trial<\/em> relates the parable \u201cBefore the Law,\u201d of a dying man who spends years by the open doorway of the Law asking a guard permission to pass through.\u00a0 The guard denies all his requests.\u00a0 Finally, the man beckons the guard, and asks:\u00a0 \u201cEveryone strives to attain the Law, how does it come about, then, that in all these years no one has come seeking admittance but me?’\u201d\u00a0 In response, the guard bellows: ‘No one else could ever be admitted here, since this gate was made only for you.\u00a0 I am now going to shut it.\u201d\u00a0 The parable is an apt simile to the experience of Illinois taxpayer defendants in Illinois False Claims Act (\u201cIFCA\u201d)[1]<\/a> proceedings.<\/p>\n

Consider this scenario.\u00a0 An Illinois business consults an accountant or an attorney on a rule of tax law, and can prove it followed the advice.\u00a0 The business is sued for fraud on that rule of law.\u00a0 The business may hoist the defense, or at least the cost of defense, to the advisor or it may sue the advisor.\u00a0\u00a0 In an IFCA scenario, consider instead that the business is an Illinois taxpayer, and the advice received and followed is in a regulation by the Department of Revenue (\u201cDepartment\u201d) \u2013 say, on the interstate commerce exemption of the Retailers\u2019 Occupation Tax Act (\u201cROTA\u201d).\u00a0 [2]<\/a>\u00a0 Based on an anonymous allegation of fraud, the Department audits the exempt transactions and finds no liability to assess.\u00a0 If the government were to assess tax, despite the taxpayer\u2019s compliance with the regulation, the liability would be abated in full, by law. <\/em>[3]<\/a>\u00a0 There is no similar statutory recourse, however, when the government allows a third party[4]<\/a> to sue alleging IFCA violations identical to, and for the same tax periods as, the anonymous allegations that triggered the audit that found no liability.<\/p>\n

An Illinois taxpayer has these options today: (a) stop the transactions at issue because each day of complying with the regulation accrues potential liability in excess of its daily receipts, and watch as customers take their business to\u00a0 competitors not facing an IFCA suit; (b) pay a costly settlement (in which the government will share), but disregard the regulation going forward and risk future liability for over collecting tax from consumers; or, (c) bankrupt itself in years of litigation defending a baseless lawsuit.\u00a0 There is no right, nor just option — that is the dilemma for every Illinois taxpayer.<\/p>\n

Why?<\/em><\/strong><\/p>\n

The government contends that its audits would not pick up communications between the retailer and its customers, and that a conversation, text or email, for example about shipping a purchased item to an out-of-state address, might<\/em> evidence a conspiracy.\u00a0 That justification for the dilemma created by using the IFCA nullifies the basis for the statutory requirement to keep books and records and to make them available for audit by the government. [5]<\/a>\u00a0 That position also turns on its head the government\u2019s litigation position that testimony alone does not outweigh contrary books and records. [6]<\/a>\u00a0 Respect for the rule of law is undermined when compliance with the law offers no shield against liability, for the following reasons.<\/p>\n

First,<\/em><\/strong> the statutory finality of audit results is compromised when audited compliance with regulations offers little protection from an IFCA action. [7]<\/a>\u00a0\u00a0 Indeed, that approach works to favor protesting audits that otherwise would be agreed, since that could bar a later action under the IFCA. [8]<\/a><\/p>\n

Second<\/em><\/strong>, this approach holds a retailer liable under the Retailers\u2019 Occupation Tax Act for post-sale (future<\/em>) actions of a customer<\/em> that, if <\/em>they occur, should have triggered Use Tax Act liability for the customer<\/em>.\u00a0 That unlawfully converts a retailer from a statutory collection agent into a guarantor of its customer\u2019s tax liability for the customer\u2019s own violations.\u00a0 The Supreme Court rejected such an approach in Hertz Corporation v. City of Chicago<\/em>. [9]<\/a> A seller\u2019s inability to predict a customer\u2019s future use of an item does not depend on whether a Chicago or State tax law applies.<\/p>\n

Third, <\/em><\/strong>this approach discriminates without a rational basis among taxpayers whose exemption depends on the customers\u2019 future use of the items purchased.\u00a0 A charitable organization may make a non-exempt use of an item purchased tax-free with an exempt organization number, or a purchaser with a resale certificate may have repurposed the item for its own use.\u00a0 For charitable and resale exemptions, however, there is a State-created protocol for claiming the exemptions that protects a retailer against liability from a customer\u2019s future taxable use of the item. [10]<\/a> There is no such protection for a retailer whose purchaser claims an interstate commerce or manufacturing machinery and equipment exemption for which the State has devised no protocol.\u00a0 It is the lack of a government protocol, rather than a retailer\u2019s conduct, which creates IFCA exposure for the retailer when a customer\u2019s future actions are what may give rise to what would otherwise be a customer\u2019s use tax liability.\u00a0 There is no rational basis to deny retailers protection for all<\/em> customer use-based exemptions. [11]<\/a><\/p>\n

Fourth<\/em><\/strong>, the point at which honoring a purchaser\u2019s claim of exemption crosses the line into a conspiracy to evade the purchaser\u2019s use tax is not discernible from a review of the Department\u2019s regulations.\u00a0 As a result,\u00a0 retailers do not know whether it may<\/em> be deemed a conspiracy for them : (a) to show a customer a copy of the exemption regulation because it prompts the customer to provide the basis to claim the exemption; (b) to ask the customer if there is an out-of-state address to ship the item, or whether the item will be used in manufacturing; or (c) to simply go through with the sale when there is any suspicion about the customer\u2019s future taxable use of the item.\u00a0 A fundamental principle of due process is that the law must not be so vague, i.e.<\/em> fail to give fair notice of what conduct is required or proscribed, that it leads to arbitrary prosecution, even if in civil, though punitive, matters. [12]<\/a><\/p>\n

Fifth<\/em><\/strong>, using IFCA prosecutions to fill in gaps in regulations is incompatible with the concept and definition of a \u201crule\u201d under the Administrative Procedure Act. [13]<\/a>\u00a0 The better policy is to amend the regulation for additional <\/em>steps retailers must take or document to avoid becoming defendants and guarantors of their customer\u2019s use tax obligations.\u00a0 The possible amendments could instruct retailers, for example, to: (a) record customer conversations and maintain the recordings; (b) script and maintain the script of conversations with customers (or obtain a Private Letter Ruling approving the scripted conversation); (c) archive all customer emails, voice-mails and text-messages; (d) print specific disclaimers or warnings on invoices that retailers do not provide tax or legal advice and that customers may owe taxes if they return shipped items to Illinois, or (e) simply send the business elsewhere if there is any suspicion \u2013 other than one based on race, gender, sexual-preference, religion, or any other actionable basis — of future taxable use by a customer.<\/p>\n

How did we get here? <\/em><\/strong><\/p>\n

The IFCA, under a different name at first, was enacted in 1993, and purposefully patterned on the federal False Claims Act.\u00a0 The federal FCA excludes from its scope violations of the Internal Revenue Code (\u201cIRC).\u00a0 Although the IRC contains many excise and other taxes not based on income, a layperson probably associates it only with the income tax.\u00a0 Unfortunately, the General Assembly\u2019s effort to mirror the federal FCA reflects that lay person\u2019s understanding, so it excludes only the Illinois Income Tax Act from its scope, creating from the outset a lack of symmetry with the federal FCA that leaves all other State non-income taxes open to privateer enforcement.[14]<\/a>\u00a0 That lack of symmetry puts Illinois taxpayers at greater risk than other IFCA defendants because it is federal case law that is often cited in Illinois for instances which, due to the federal FCA\u2019s exclusion of IRC matters, have never arisen under the federal law.\u00a0 For instance, there is one Cook County circuit court ruling holding that a prior disclosure to the Department is not a \u201cpublic\u201d disclosure because tax matters are statutorily confidential, i.e.<\/em> not public, and so remain confidential unless litigated.\u00a0 Such a disclosure to an agency charged with enforcement of the alleged violation is sufficient to support dismissal in some federal judicial districts,[15]<\/a> and in Illinois courts where the Illinois agency with oversight of the alleged subject matter is not subject to statutory confidentiality.\u00a0\u00a0 Illinois taxpayers therefore have fewer<\/em> defenses than other IFCA defendants solely because of this accidental (negligent) lack of symmetry.<\/p>\n

If there is a common thread to the hundreds of IFCA privateer actions filed for tax matters since 2003, it is the lack of a cohesive principle of tax enforcement from one case to the next.\u00a0 The first wave of tax IFCA cases alleged nexus use tax collection violations of Section 2 of the Illinois Use Tax Act.\u00a0 Litigation on these cases lasted over 10 years \u2013 the Department had no role in the selection of defendants nor in the arguments presented to the courts.\u00a0 In the second wave of IFCA cases hundreds of taxpayers felt coerced by the excessive costs of litigation to settle cases where, although they <\/em>collected taxes on internet sales, they did not do so on shipping charges because they followed<\/em> regulations allowing that treatment due to the Department\u2019s failure to update the regulation for contrary case law. [16]<\/a>\u00a0 In that instance, that door closed only after the Department and the Attorney General were sued by an industry group to cease IFCA prosecutions until the amendment of the regulations to reflect favorable private letter rulings – that amendment later allowed dismissal of the action. [17]<\/a> In another belated reaction, the Attorney General, having declined intervention in a case at the trial court, filed as an amicus <\/em>on appeal supporting denying the double recovery of a damages award and <\/em>attorney fees to an IFCA plaintiff acting as its own attorney. [18]<\/a>\u00a0 Yet, in the fifteen years preceding that high profile appeal the Attorney General had participated in, and received a statutory share of, hundreds<\/em> of settlements that required<\/em> payment of such a double recovery.<\/p>\n

Variations of IFCA prosecutions continue, such as those based on conversations rather than documents, or by competitors of defendants who engage in no transaction with the defendants – e.g. lack first-hand knowledge of, and books and records for, actual transactions – but allege the competitors\u2019 transactions are IFCA violations.\u00a0 No cohesive tax enforcement policy opened the doors to the courthouse for these cases, nor have cohesive policies arisen from these cases, other than a policy of accepting settlements, mostly on plaintiffs\u2019 terms, and a policy to take belated common-sense action when issues achieve a high profile in the courts.<\/p>\n

If you don\u2019t know where you\u2019re going, any road will take you there. [19]<\/a>\u00a0 It is time government pick a direction, or formulate rules of the road, and not simply follow wherever the next plaintiff may lead.<\/p>\n

The Road Forward<\/em><\/strong><\/p>\n

Absent legislation, Illinois taxpayers need \u2013 no, deserve<\/u> \u2013 that government formulate and publicize principles <\/em><\/strong>that guide its use of the IFCA for alleged tax violations.\u00a0 A public discussion of what those principles should be may be helpful.\u00a0 Here are some possible considerations:<\/p>\n