United States: Tax Court Issues Five Discovery Orders Addressing Admissibility Of Expert Reports

On July 13, 14, and 15, 2016, Judge Laro of the US Tax Court (Tax Court) ruled on five taxpayer-filed motions in limine to exclude expert reports in Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al. v. Commissioner. At issue in the case are a number of IRS transfer pricing adjustments to the taxpayer-corporation's income under Section 482.

In support of its adjustments, the IRS offered numerous expert reports to the Tax Court, and the taxpayer sought to exclude these reports. The taxpayer raised the following major arguments:

Argument: The IRS expert reports failed to contain opinions.

The taxpayer argued that three of the reports should be excluded because they did not comply with Tax Court Rule 143(g)(1), which requires that expert witnesses generally prepare written reports, and requires that expert reports include "a complete statement of all opinions the witness expresses and the basis and reasons for them." In federal district court practice (under somewhat different rules), this requirement generally means that an expert must separately state, and clearly delineate, his or her expert opinions in a written report—usually in a "conclusions" or "opinions" section. In Tax Court, the requirement for a clear and concise written expert report is even more significant than in federal district court practice because, under Rule 143(g)(1), expert reports are treated as direct testimony of the expert (although, in many cases, additional expert testimony and cross-examination may be helpful or necessary).

The taxpayer argued that the language of Rule 143(g)(1) requires all expert witness reports to contain stated opinions. The lack of stated opinions in the expert reports created prejudice, the taxpayer argued, because the taxpayer was left unable to determine the areas of an expert witness' actual expertise, and whether that expertise had actually been applied properly to the case. In addition, without clearly stated opinions, the taxpayer argued that it was left to guess at cross-examination which of the statements in the report may transform into an opinion at trial. Moreover, the taxpayer argued that the report failed to clearly distinguish between opinion and facts, potentially leading the IRS to rely upon the reports for fact finding based on inadmissible evidence. The taxpayer further argued that Daubert standards would support the Court's exclusion of the reports as unreliable.

In ruling against the taxpayer's argument, the Tax Court discussed Federal Rule of Evidence 702, which adopts Daubert standards. (See here for our recent discussion of changes in the law regarding the Tax Court's application of the Federal Rules of Evidence). For context, the Court looked to the 2000 Advisory Committee notes for the amendments to Rule 702, which indicated that an expert may educate the factfinder about general principles, without ever attempting to apply the principles to specific facts in the case. These notes also suggested that, under Daubert, rejection of expert testimony is the exception rather than the rule.

The Tax Court concluded that Rule 143(g)(1) does not require that a report prepared by an expert witness contain opinions. Instead, Rule 143(g)(1) requires only that, to the extent an expert witness renders opinions, those opinions must be included in the witness's report. The court concluded that the cross-examination and the adversarial process were adequate to afford the taxpayer the opportunity to challenge them. The court cautioned, however, that even upon admitting an expert's report into evidence, the court does not need to rely on it in deciding the case. Instead, the taxpayer could dispute the report at trial, and the court could weigh the report against the record as appropriate.

This conclusion is somewhat surprising, in that it appears to question the need for what many litigators consider to be a best practice in preparing expert reports—an unambiguous statement an expert's opinion. However, in our experience, the Tax Court generally allows more into evidence than many other courts and decides later what to rely upon.

The orders can be found here, here, and here.

Argument: The IRS expert reports contained methodological errors.

The taxpayer argued that another expert's reports should be excluded because, among other things, the reports contained methodological errors. Consistent with the court's rulings discussed above, the court cited the same Rule 702 advisory committee notes and Daubert for the proposition that the reports should be allowed into evidence. The court did note, however, that the taxpayer's arguments "speak more to the weight [to give the] report than its admissibility."

Interestingly, the court also stated that "[i]n a case as complicated and fact-intensive as this, we find it important to develop the factual record as extensively as possible." This supports the view, borne out by our experience, motions in limine related to expert reports are less likely to be granted in complex cases. However, these motions frequently serve a useful purpose in framing the issues before a trial begins.

The order can be found here.

Argument: Expert reports cannot opine on matters of law.

The taxpayer argued that an expert report (and rebuttal report) should be excluded because, among other things, the reports contained legal analysis and opinion. The Tax Court agreed, concluding that it was the court's job to analyze the law and granted the taxpayer's motion, in part. Per the court, all instances in the report that "venture beyond an objective statement of industry practice or its application . . . should be stricken." The court denied the motion in limine with respect to the remainder of the expert report.

The order can be found here.

New Development: The tax press reported this morning that the parties have reached a basis for settlement, contingent on the same settlement structure being applied to later tax years. Trial in the case was set to start next Monday.

We previously wrote about this case here and here.

Tax Court Issues Five Discovery Orders Addressing Admissibility Of Expert Reports

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