Strategies for Settling Tax Disputes

Transcription

1 Strategies for Settling Tax Disputes Scott M. Stewart Partner, Chicago John T. Hildy Partner, Chicago

2 Agenda Discuss our recent experience settling large, contentious disputes in Tyco and Guidant Tactics to create opportunities to settle favorably: Prepare for litigation in Exam Signal trial strength at Appeals Use offensive discovery in the Tax Court, both informal and formal Use summary judgment to shape the issues Lead the stipulation process Know when to initiate and reignite settlement talks 2

3 Recent Tax Controversy Developments: and Tax Reform Introduction

4 Settlement is often preferable to trial: Risk mitigation Lower legal expenses Certainty with respect to reserves and cash flows Earlier is better: Avoid entrenched positions Introduction Settlement Incentives Interest is always running Reputational concerns IRS Incentives: Budget and limited resources Settling to preserve a legal point/precedent 4

5 Introduction IRS Litigation Focus Litigation Focus: The IRS continues to aggressively audit multinational companies. IRS enforcement efforts are focused on transfer pricing, intercompany debt, repatriation strategies and other international tax issues. IRS Exam Teams have been conducting audits with an eye towards future litigation, including: Requesting employee interviews and site visits, and Retaining third-party experts to support adjustments. IRS Chief Counsel Wilkins recently stated that the IRS s current pursuit of litigation appears likely to persist for a number of years to come. This presentation is meant to address strategies for settling issues that have a substantial probability of ending up in litigation or that are particularly contentious. 5

6 Introduction A Tale of Two Settlements Tyco Elec. Corp. v. Comm r tax years Debt-equity $2.9 billion adjustment Settlement $220 million adjustment 8% of proposed adjustment Results roll forward to later audit cycles with larger interest deductions at stake Guidant Corp. v. Comm r 1999, tax years Transfer pricing $3.5 billion adjustment Purchase price allocation $702 million adjustment Settlement $975 million adjustment 23% of proposed adjustment Lower royalty rates than result in Medtronic Results roll forward to later audit cycle 6

7 Introduction A Tale of Two Settlements Tyco and Guidant Large, factually complex cases 15 dockets in Tyco 6 dockets in Guidant Opportunity to establish precedent, overcome prior IRS losses Lack of serious settlement offers (starting in Appeals) followed by Collapse of IRS positions Settlement at or below IRS hazards of litigation Settlements contingent on consistent application in subsequent years Early preparation and careful execution of zealous litigation strategies were key to favorable outcomes. 7

8 Introduction Simplified Litigation Timeline (Tax Court Route) Administrative Stages Litigation 30-Day Letter/RAR NOPA Protest Notice of Deficiency IRS Answer Petition Trial Exam 30 days Appeals* ~ 1-2 years 90 days 60 days Informal Discovery Formal Discovery Stipulation Negotiations * Assumes traditional, pre-notice Appeals 8 ~ 2-3 years for large cases Expert Report Development (starting point varied)

9 Recent Tax Controversy Developments: and Tax Reform Exam

10 Exam Strategies Administrative Stages Litigation 30-Day Letter/RAR NOPA Protest Notice of Deficiency IRS Answer Petition Trial Exam 30 days Appeals ~ 1-2 years 90 days 60 days Develop an Audit Plan Reach out to Non-Tax Witnesses Engage Key Experts Early Informal Discovery Formal Discovery Stipulation Negotiations ~ 2-3 years for large cases Expert Report Development 10

11 Exam Early Preparation Treating a contentious audit as if it will go to trial will best position a taxpayer for settlement. Proactivity is key to gaining strategic advantages throughout the dispute. Pre-Exam Preparation: Gather and review opinion from important transactions Review FIN 48 reserves and analyses Review prior audit cycle issues Understand if you have any issues that are targeted by an IRS directive or practice unit 11

12 Exam Early Preparation Early audit preparation is key to: Setting the tone of the audit; Controlling the case narrative; and Preparing for Appeals. Develop a plan based on the key facts and arguments that will be presented in the Appeals protest. Under the IRS Appeals Judicial Approach and Culture (AJAC) Project, the factual record must be developed and presented during exam. Key document and witness identification should begin before the audit. Maintain legal issue and argument outline in anticipation of Protest. 12

13 Exam Key Exam Opportunities IDR Process LB&I guidance requires IDRs to be issue-focused and developed in consultation with the taxpayer. Taxpayers should use this process to shape IDRs with an eye toward building the record for Appeals. Consider overall case strategy when negotiating audit response timelines. Taxpayers should demonstrate they are well-prepared to defend their positions. Front-load IDR responses that provide the most favorable facts. 13

14 Exam Key Exam Opportunities IDR Responses DOs: Use IDR responses as an opportunity to ensure that helpful facts are part of the audit record. Design responses with an eye towards making your case. You should understand who the audience is.counsel? IRS specialist? coordinated issue team? Engage in careful analysis of privilege issues to avoid waivers Penalty defenses IRS 14

15 Exam Key Exam Opportunities IDR Responses DON Ts: Don t default to playing hardball with the exam team on IDRs. Do not miss response deadlines without communicating with the exam team. Do not provide best guesses or estimates without full disclosure. Avoid absolute statements regarding the availability (or lack thereof) of responsive data. Avoid making legal and factual arguments in IDR responses. 15

16 Exam Key Exam Opportunities Early Fact Witness Development The exam team s audit plan will often indicate whether the IRS intends to conduct interviews and site visits. Witness interviews are a key sources of facts for Appeals protest. Taxpayers should actively identify key witnesses to fill any gaps in the IRS audit plan. Socialize witnesses (outside of tax function) with key themes by involving them in responses narrative and document requests. Consider using key witnesses as presenters at site visits. IRS will often become focused on these witnesses (e.g., subpoenaing the same personnel at trial). Informal IRS interviews should not be treated informally. Witnesses must be prepared on topics and documents that the IRS may raise in interviews. Weigh the benefits and burdens of on the record informal interviews. 16

17 Exam Key Exam Opportunities Early Expert Witness Development Experts who supported the return position are not always the best experts to defend those positions in litigation, but Exam may be suspicious if return experts are jettisoned early. For factually complex issues, the IRS is now retaining third-party experts earlier in the exam process. Consider doing the same for key issues. Early investment can lead to long-term savings. Typical key areas include transfer pricing, valuation, forensic accounting. Early mastery of key financial and accounting data is critical. Taxpayers must thoroughly understand their own systems including accounting systems, order entry, inventory management, etc. Identify your internal accounting experts: Who can decipher complex account mappings, reconciliations, consolidations? 17

18 Exam Key Exam Opportunities Early Expert Witness Development (continued) Identify thought leaders in expert-driven areas early; expert quality varies dramatically and can be hard to gauge without prior experience Consider providing exam team with the factual bases for key expert analyses. Waiting until Appeals to disclose these supporting materials may lead to Appeals returning the case to exam under the AJAC initiative. If expert analyses cannot be provided until after the Appeals protest is filed, taxpayers should foreshadow the expert s conclusions in the protest and consider providing an opinion letter. This will give exam an opportunity to rebut the expert and potentially avoid Appeals returning the case to them. 18

19 Recent Tax Controversy Developments: and Tax Reform Appeals

20 Appeals Strategies Administrative Stages Litigation 30-Day Letter/RAR NOPA Protest Notice of Deficiency IRS Answer Petition Trial Exam 30 days Appeals Continue Developing Expert Support Use Protest and Conferences to Demonstrate Litigation Hazards Capitalize on Delay ~ 1-2 years 90 days 60 days Informal Discovery Formal Discovery Stipulation Negotiations ~ 2-3 years for large cases Expert Report Development 20

21 Appeals Key Appeals Opportunities Appeals is the taxpayer s first meaningful chance to settle a dispute based on the hazards of litigation. However, taxpayers should consider potential strategic advantages of skipping Appeals altogether. Taxpayers must maintain credibility and reasonableness in the eyes of the Appeals officer while demonstrating they are prepared to take the case to trial. Expert support in the Appeals process can support both goals. A fresh, leading expert supporting the return position can lend credibility. This same expert can be presented as a testifying expert the taxpayer will use in the event of trial. Showing your level of preparation at Appeals The ex-parte/opening conference provides the taxpayer with the opportunity to show the depth and breadth of its trial team. 21

22 Appeals Key Appeals Opportunities Elements of an effective Appeals protest Executive summary Complete set of facts Avoid AJAC return to exam if possible Tell a story Address weaknesses head-on to build credibility with Appeals Call out RAR errors Computation and other facts Establish the hazards of litigation Set forth broader implications for exam s position (where appropriate) Bare-bones protests may occasionally be appropriate, but they signal to Appeals that the taxpayer isn t serious about settlement 22

23 Appeals Capitalizing on Administrative Delay Take advantage of the delay between Appeals and the Notice of Deficiency (NOD) Tyco: two years; Guidant: one year Consider making FOIA requests for the administrative file to date. In disputes over the timeliness of discovery responses, the FOIA request date can be cited as evidence of unreasonable delay. The request effectively gives notice of potential litigation. Collect universe of relevant documents, building on IDR process. Convert audit plan and Appeals protest into an issues memo and trial plan. Identify key trial witnesses and documents, continue developing expert analyses. Consider a final last ditch effort to settle post-appeals Formal: Post-Appeals mediation Informal: Reinitiate dialogue with Appeals officer 23

24 Recent Tax Controversy Developments: and Tax Reform Tax Court

25 Litigation Strategies 30-Day Letter/RAR NOPA Administrative Stages Protest Litigation Notice of Deficiency IRS Answer Petition Narrative Pleadings Build Credibility Offensive Discovery Trial Exam 30 days Appeals ~ 1-2 years 90 days 60 days Informal Discovery Formal Discovery Stipulation Negotiations ~ 2 years for large cases Expert Report Development (starting point varied) 25

26 Tax Court Key Opportunities for Petition Taxpayers have 90 days following the receipt of the NOD to petition the Tax Court. Waiting until the receipt of the NOD may limit opportunities to use the petition for offensive gains. Offensive use of Tax Court petitions First opportunity for the taxpayer to tell its story to the judge. The IRS is required to admit or deny every factual allegation in the petition. Example: In its Answers in the Guidant dockets, the IRS was forced to clarify what method its economist was actually using. The economist s report had been intentionally vague. Admitted factual allegations are facts in the record. Strategic pleading can be used to force the IRS to admit to facts. The petition can frame the first settlement discussions with IRS trial counsel (initiated after Answer filed) 26

27 Tax Court Key Opportunities for Petition Offensive use of Tax Court petitions (continued) Narrative petitions can simplify cases and shorten discovery. The IRS Answer in the second Altera case admitted that the 2009 and 2011 costsharing rules requiring the sharing of stock-based compensation are materially the same as the 2003 rule that was invalidated in the first Altera case (now on appeal). The Answer further admitted that Treasury did not possess, or even look for, many types of evidence concerning unrelated parties treatment of stock-based compensation in these later rulemakings. IRS denials and denials for lack of knowledge can be revealing and inform a taxpayer s discovery and stipulation strategies. The IRS Answers in the Tyco dockets repeatedly denied the taxpayer s favorable facts for lack of knowledge. These denials highlighted the IRS s weak points. 27

28 Tax Court Managing Informal Discovery Both the IRS and the taxpayer are permitted to seek any information that appears reasonably calculated to lead to the discovery of admissible evidence. Parties are required to pursue discovery informally before resorting to the formal discovery procedures of the Court. Tax Ct. Rule 70(a)(1) requires the parties to engage in informal consultation or communication. Taxpayers should minimize being subjected to formal discovery. Informal discovery is a negotiating process; maintain open communication with opposing counsel regarding outstanding discovery requests. Rolling productions can help ward off formal discovery. Consider voluntary mock Rule 26 production, modeled on Federal Rules But formal discovery rules provide some opportunity for strategic advantages. Example: limited interrogatories vs. unlimited requests for production 28

29 Tax Court Managing Informal Discovery Recognize IRS privilege-claim errors and shortcuts, while avoiding committing errors of your own. Winning privilege skirmishes can nudge the IRS back to the settlement table. Documents withheld under claims of privilege must be listed on a privilege log that describes the nature of the withheld documents. At a minimum, log must provide: Author(s) of the document; Recipient(s) of the document; The date(s) that the document was prepared; A brief description of the general subject matter of the withheld document; The facts establishing each element of the privilege claim. An inadequate privilege log can lead the Tax Court to order production. Taxpayers must maintain clean hands in discovery to position themselves to capitalize on IRS missteps. 29

30 Tax Court Managing Informal Discovery The IRS will request interviews with taxpayer employees through the informal discovery process. Like other informal discovery processes, this is a negotiation. Depositions are an extraordinary discovery method in the Tax Court, but are becoming more common. IRS may develop tunnel-vision and focus on the witnesses they already know. The IRS often seeks to interview former employees without notifying the taxpayer. Make a written request to the IRS that they notify you prior to contact being made. Anticipate and contact likely former employee interviewees. Taxpayer s counsel can seek to represent the former employee to help prepare for the interview and participate in the interview. Consider preserving testimony from employees (often retired) who have valuable recollections, but who may not be available later due to health or other reasons. This is a sensitive issue, but important to address proactively. We have used formal depositions for this purpose successfully. 30

31 Tax Court Offensive Discovery Taxpayers should pursue offensive discovery against the IRS whenever possible. The Tax Court will not look behind a deficiency notice to examine the evidence used or the propriety of [the Commissioner s] motives or of the administrative policy or procedure involved in making his determination. Greenberg s Express, Inc. v. Comm r, 62 T.C. 324, 327 (1974). The Tax Court review is de novo for most matters and the IRS often argues that facts regarding how the determination was made are not relevant and not discoverable. However, where the taxpayer must prove the IRS abused its discretion, the Tax Court will allow discovery on how the IRS made its determination. Transfer pricing; bad-debt reserves; filing extensions; changes in accounting methods. Forcing IRS counsel to review the Exam team s records will force counsel to take a fresh look at IRS s hazards of litigation. In our experience, the IRS often provides administrative file records in informal discovery even in de novo cases. 31