On June 30, 2016, the District of Columbia Court of Appeals held that the Office of Administrative Hearings (OAH) abused its discretion in applying offensive non-mutual collateral estoppel against the District of Columbia Office of Tax and Revenue (OTR) and granting summary judgment to three oil company taxpayers.1 The Court of Appeals remanded the case back to the OAH for reconsideration of whether offensive non-mutual collateral estoppel applied to these taxpayers, potentially setting up another substantive review of the Chainbridge methodology that has been used in addressing transfer pricing issues arising under the District's corporation franchise tax.
The OTR issued tax deficiency notices to three oil company taxpayers for their 2007-2009 tax years, which alleged underpayment of corporation franchise taxes resulting from the effects of intercompany transfer pricing agreements. The oil companies protested these assessments, asserting that the underlying methodology used to calculate the deficiencies, known as the Chainbridge methodology, "was contrary to applicable law." The oil companies each filed separate motions for summary judgment arguing that the OAH's decision in Microsoft Corp. v. Office of Tax & Revenue2 collaterally estopped the OTR from "defending the legality of the Chainbridge methodology."3 The OAH agreed and granted the oil companies summary judgment. The OTR subsequently filed petitions for review, which were consolidated by the District of Columbia Court of Appeals.
Proper Application of Offensive Non-Mutual Collateral Estoppel
The core determination before the Court of Appeals was whether the OAH properly applied offensive non-mutual collateral estoppel against the OTR. Offensive non-mutual collateral estoppel is "a version of the doctrine [of collateral estoppel] that arises when a plaintiff seeks to estop a defendant from relitigating an issue which the defendant previously litigated and lost against another plaintiff."4
The Court of Appeals explained that the resolution of this issue turned on whether it was bound by the decision in District of Columbia v. Gould.5 Gould "addressed the applicability of offensive non-mutual collateral estoppel against the District and its entities, such as OTR." The Court of Appeals ultimately concluded that it was "bound by Gould's discussion of the applicability of offensive non-mutual collateral estoppel against the District."
The Court of Appeals explained that, typically, the determination of whether offensive non-mutual collateral estoppel has been properly applied is a two-step inquiry.6 First, the trial court must ascertain whether the "traditional requirements for invoking collateral estoppel" have been met by the case. According to District case law, these traditional requirements include the determination of an issue that is litigated and resolved by a valid, final judgment on the merits, along with a full and fair opportunity for both parties to litigate under circumstances where the determination was essential to the judgment.7 Next, there must be "a discretionary balancing of a long list of factors to 'determin[e] whether the offensive use of non-mutual collateral estoppel would be fair.'"8
However, Gould requires a third step when offensive non-mutual collateral estoppel has been asserted against the District or one of its entities. Gould sets forth the proposition that "'[e]stoppels against the public are little favored' and 'should not be invoked except in rare and unusual, or exceptional, circumstances . . . , especially where their application would have an adverse impact on the public fisc.'" Thus, under Gould's third step, courts should only apply the doctrine in special cases where there exists "'exceptional circumstances,' 'where the interests of justice . . . clearly require it.'"9
The Court of Appeals explained that a determination of whether "exceptional circumstances" exist must first be made by the OAH, subject to deferential review by the Court of Appeals. The Court of Appeals noted that none of the parties raised Gould in the proceedings, and the OAH did not address Gould prior to applying offensive non-mutual collateral estoppel against the OTR.
The Court of Appeals concluded that the failure by the OAH to take into consideration Gould before applying offensive non-mutual collateral estoppel against the OTR was an abuse of discretion. Accordingly, the Court of Appeals vacated the orders granting summary judgment to the oil companies and remanded the cases back to the OAH for further consideration.
The use of transfer pricing studies generated by third-party audit firms has been the subject of numerous challenges. The fact that third-party audit firms have been compensated on a contingent fee basis has proved particularly troubling. Although the decision by the Court of Appeals revolved around the applicability of the procedural issue of non-mutual offensive collateral estoppel, the Court clearly stated that it was not ruling on the validity of the underlying Chainbridge methodology for assessing tax deficiencies.10 Thus, while the quality of Chainbridge's methodology continues to be criticized, it remains to be seen whether it will withstand further scrutiny. The fact that the Court of Appeals stressed that the doctrine of non-mutual offensive collateral estoppel should only be applied against a governmental entity in rare circumstances, as instructed by Gould, is telling. One could surmise that the OAH will be compelled to consider the substantive issue of how Chainbridge's methodology was applied to the oil company taxpayers involved in this litigation.
1 District of Columbia Office of Tax and Appeals v. ExxonMobil Oil Corporation, et al., District of Columbia Court of Appeals, Nos. 14-AA-1401, 14-AA-1403 & 14-AA-1404, June 30, 2016.
2 No. 2010-OTR-12 (D.C. Office of Admin. Hearings May 1, 2012).
3 In Microsoft Corp. v. Office of Tax & Revenue, the OAH reversed a tax deficiency assessment issued by the OTR against Microsoft Corporation that was based on a transfer pricing analysis conducted by Chainbridge Software. The OAH determined that the transfer pricing study was "arbitrary, capricious, and unreasonable" because it did not comport with appropriate transfer pricing methodology as allowed by the federal Treasury regulations interpreting Internal Revenue Code Section 482. The OTR subsequently voluntarily dismissed its petition for review in the District of Columbia Court of Appeals.
4 Collins v. D.R. Horton, Inc., 505 F.3d 874 (9th Cir. 2007) (citing Appling v. State Farm Mut. Auto. Ins. Co., 340 F.3d 769 (9th Cir. 2003) citing Parklane Hosiery Co. v. Shore, 439 U.S. 322 (1979)).
5 852 A.2d 50 (D.C. 2004).
6 Citing In re Wilde, 68 A.3d 749 (D.C. 2013).
7 Washington Med. Ctr., Inc. v. Holle, 573 A.2d 1269 (D.C. 1990).
8 Citing to K.H., Sr. v. R.H., 935 A.2d 328 (D.C. 2007).
9 Citing Gould, supra
10 Per the Court's opinion, "In so holding, we express no view as to how OAH should decide the oil companies' summary judgment motions on remand after conducting the exceptional circumstances inquiry. Furthermore, at this stage in the proceedings, considering neither OAH nor OTR addressed the merits of the underlying dispute in these cases (i.e., whether the Chainbridge methodology for assessing tax deficiencies is valid) in the proceedings below, we decline the oil companies' invitation to affirm OAH's orders on the alternate ground that the Chainbridge methodology is faulty as a matter of law."
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