The New York False Claims Act (NYFCA)1 has permitted tax claims for over 10 years, but the legal standards for these claims are still developing. The Office of the New York Attorney General (OAG) has not yet taken a tax claim all the way to trial. Up to now, the OAG has had success settling tax claims on the outcome of a motion to dismiss, if not earlier, at the conclusion of an investigation. The necessary body of case law is still emerging as a result. This is an issue because claims are arising when a relator or the government asserts fraud or recklessness, but the Tax Law is nevertheless unclear. Understanding the application of the NYFCA to these types of claims requires more judicial guidance—and subtle aspects of recent decisions have the potential to shed new light on the application of the NYFCA to tax claims in court.
In State v. B&H Foto & Electronics Corp., the OAG lost a motion to dismiss tax claims for the first time.2 This was bound to occur as the OAG probes the boundaries of the NYFCA. It highlights factors that may increase the chances of success for a motion to dismiss and may help in evaluating responses to a complaint. As of the date of this publication, the OAG has not filed an appeal; however, we think it is likely an appeal will be filed. In Saric v. GFI Breslin, LLC,3 the court granted the defendants' motion to dismiss an allegation of avoidance of New York State (NYS) and New York City (NYC) transfer taxes when it determined that defendants had not acquired a controlling interest in property, and thus had not engaged in a taxable transaction. The OAG had declined to intervene or file a superseding complaint in Saric, and the relator proceeded on its own complaint. As one might expect, relators have not been as successful as the OAG in defeating motions to dismiss.
For context, tax claims generally arise under N.Y. State Finance Law § 189(1)(g). Under that section, the NYFCA subjects any person to liability for knowingly making a false record or statement material to a false or fraudulent claim or material to an obligation to pay or transmit money or property to the state or a local government.4 However, certain limitations apply. In particular, the net income or sales of the person against whom the claim is brought must be at least $1,000,000 for any taxable year subject to the action, and the damages asserted must exceed $350,000.5 If the government or a relator proves a violation within these boundaries, the state or local government is entitled to damages. We generally consider the statute to require five elements: (i) false statement, (ii) knowledge or intent, (iii) materiality, (iv) damages and (v) monetary thresholds.
Here are a few things we have learned from B&H Foto and Saric:
Focus on the Tax Law, if possible.
Even though false claims are very fact-sensitive matters, B&H Foto shows motions to dismiss can succeed where the basic facts are not seriously in dispute, but the application of the Tax Law to those facts is contested. This is consistent with the outcome of the recent taxpayer victory against a relator in Saric. In both cases, the taxpayer won on the Tax Law.
In B&H Foto, the OAG argued that manufacturer rebates and manufacturer coupons were equivalent for purposes of a retailer calculating NY sales tax, such that manufacturer rebates should be included in the tax base. Fundamentally, it made an argument of "substance over form" and that the retailer violated the Tax Law and NYFCA because it did not calculate sales tax consistently with the OAG's perspective of the substance. Some contemporary communications and documents suggested that the retailer was concerned about the issue the OAG raised, but it ultimately decided to file without including manufacturer rebates in the sales price based on its reading of the Tax Law. Both the retailer and the OAG cited NY Department of Taxation and Finance guidance as support for their respective positions.
Ultimately, the court concluded that manufacturer rebates issued to retailers, however they operated in practice, were fundamentally different from manufacturer coupons issued to customers, and the retailer did not violate the Tax Law. The court reasoned:
A manufacturer's coupon is a negotiable instrument created by the manufacturer for the customer to use; manufacturer Instant Savings are not intended to create a direct benefit to provide to the consumer. Since there is no privity between the manufacturer and the customer, B&H's Instant Savings program cannot be considered a manufacturer's coupon.6
It is important that the court reached this conclusion without seeking further development of the facts, in particular, the OAG's substance-over-form position. A motion to dismiss based on the absence of knowledge or intent would have been more difficult to win because it would involve a more fact-sensitive element of the underlying false claim.
In Saric, the claim also involved a substance-over-form argument. The relator argued that the members of an LLC structured a transaction to avoid the NYS and NYC transfer taxes that apply to transfers of controlling interests in entities that own real estate. One member acquired a 49-percent interest from another, concurrently with negotiating terms for the potential future acquisition or redemption of the selling member's remaining 31-percent interest in the LLC. The relator's core argument was that the acquisition and restructuring, when considered as a whole, amounted to the selling member disposing of its entire 80-percent interest, which would constitute a "controlling interest" that would render the transaction taxable under both NYS and NYC law.
The court rejected that argument on the terms of the LLC operating agreement and the taxing statutes. The NYS and NYC transfer taxes include aggregation rules that combine separate transfers in measuring the transfer of a controlling interest, and the tax authorities have long considered the role of put options in that analysis, but the court was not inclined to take the relator's invitation to use the put option as a basis to apply the aggregation rules before the selling member had disposed of its remaining membership interest. The court concluded that if the member subsequently acquires the remaining 31-percent interest, then it would be liable for transfer taxes, but until then, its 49-percent interest is not controlling under the clear and unambiguous language of the Tax Law.7
The decision highlights that novel applications of the taxing statutes and implementing regulations, as well as hypothetical future violations based on contingencies like options, are not an appropriate basis for relators to assert false claims.
A violation of the Tax Law is a prerequisite to stating a claim.
That means thinking that you got it wrong, or suspecting that you got it wrong, isn't the same as getting it wrong and does not matter unless you actually got it wrong. This may seem obvious, but it highlights a subtle question that has been playing out in the OAG's investigations, namely, whether a demonstration of "bad" intent is sufficient to demonstrate a false statement. Merging the knowledge and falsity elements of an NYFCA claim would mean that evidence of intent could be used to evaluate the falsity of the filing itself, potentially leading to the conclusion that a statement is false if it is intended to be false, even if it is supported by legal authority or a reasonable basis. That could be particularly relevant where, as in B&H Foto, the OAG asserts that the substance of a transaction is different from its form for tax purposes. In B&H Foto, the court maintained the distinction between knowledge and falsity and concluded that B&H did not violate the Tax Law and therefore, in effect, did not file a false statement or commit fraud, whether or not it thought it was filing a false statement. The court wrote: "[T]he absence of a statutory violation means that persistent fraud or illegality was not committed even if [the Retailer] believed that it was acting unlawfully."8 The importance of this conclusion cannot be overstated, because it means that proving intent is not sufficient to prove a false claim.
Similarly, a potential future violation of the Tax Law is not sufficient. In Saric, the relator's claim that the member's acquisition of a non-controlling 49-percent interest was effectively a controlling interest due to its potential acquisition of an additional 31-percent interest under the membership agreement was dismissed. The court reasoned that "the relevant Tax Law and the Administrative Code provisions concern the actual transfer or acquisition of a controlling interest," rather than a hypothetical or contingent future transfer.9 "However, until such transfer occurs, it does not appear that a transfer tax may be imposed," the court concluded.10
The right expert can make a difference in NYFCA litigation.
The "fact" of a false filing itself involves questions of law (i.e., the proper application of the Tax Law) and means that an expert's legal opinion can be relevant to a factual issue. Moreover, because NYFCA claims appear before NY Supreme Court judges who are not experts in taxation, the perspective of an "expert" can be impactful. It provides an analysis that can be distinguished from pure advocacy itself. In B&H Foto, the retailer presented the opinion of Richard Pomp, a renowned professor of state and local taxation who has decades of experience serving as an expert witness in state and local tax matters on behalf of both taxpayers and states. In this instance, the court found his opinion on sales tax instructive for understanding whether the retailer misreported transactions that involved manufacturers' rebates. We don't know whether his opinion pushed the retailer over the hump, but the court's citation shows that it helped.
Further themes from OAG settlements and complaints.
As we know from recent settlements and complaints, the OAG is not afraid to investigate and bring claims based on uncertainties in the Tax Law. A few additional considerations are worth mentioning based on those matters: (i) "zeroing" out NYS and NYC tax liabilities will attract scrutiny when some income-producing activities occur in NYC; (ii) technical merit will not save tax positions from investigation if those positions appear to ignore the reality of NYS and NYC business activities; (iii) positions that conflict with NYS and NYC tax guidance will attract scrutiny; (iv) "window dressing" for reporting positions or activities may be perceived as fraud; and (v) a detailed, factually complete memo or opinion is one of the surest paths to confirming good-faith reliance on advisors, which prevents a false claim from being established.
The framework for tax claims under the NYFCA is now serving as a model for other jurisdictions to follow, such as Washington DC. The case law developing in New York courts therefore is likely to serve as guidance beyond the state's borders as more states include tax claims in their own false claims acts. This stage in the evolution of tax claims means that decisions such as B&H Foto have greater significance than other types of claims brought under the NYFCA, and require careful reading for their impact on current investigations and cases in New York, as well as their potential impact in other states.
1 N.Y. State Fin. Law §§ 187–194.
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