Overview
On June 1, 2023, in United States v. Liberty Global, Inc.[1], the US District Court for the District of Colorado held that the US Department of Justice (DOJ) can assert and seek judgment for federal income tax deficiencies using a common law right of action, bypassing the usual statutory tax deficiency procedures outlined in the Internal Revenue Code (IRC). This decision might encourage the DOJ to seek tax collections through court judgments moving forward without following the IRC’s deficiency procedures.
In Depth
On its 2018 income tax return, Liberty Global, Inc. (LGI), a multinational telecommunications company, took the position that income earned by some of its controlled foreign corporations (CFCs) between January 1 and the close of the CFCs’ respective non-calendar tax years was not subject to certain IRC sections, including 951A (global intangible low-taxed income) and 965 (repatriation tax), and distributions of income from its CFCs during such period were tax-free under IRC Section 245A. LGI undertook a series of transactions that triggered CFC income and repatriated CFC profits during this period. The Internal Revenue Service (IRS) introduced retroactive temporary regulations to deny the benefits of this tax planning.[2]
LGI originally filed its 2018 tax return in accordance with the temporary regulations,[3] but later filed an amended return claiming a refund. The amended return took the position that the temporary regulations were invalid under the Administrative Procedure Act (APA).[4] LGI prevailed on that position before the district court after filing a refund action.
The DOJ subsequently filed (and later amended) a separate complaint against LGI seeking to recover approximately $237 million in tax and $47 million in penalties, asserting that the transactions at issue lacked economic substance, and the substance of the transactions should be recognized over the form.[5] The complaint was filed four days prior to the expiration of the three-year period prohibiting assessments.[6]
LGI moved to dismiss the amended complaint on the ground that the IRS did not issue a notice of deficiency pursuant to IRC Section 6213(a). A notice of deficiency is a prerequisite to assessing income tax.[7] The government objected to the motion on the ground that it had a common law right to sue for an outstanding tax debt independent of the deficiency procedures.
The district court denied the motion to dismiss in a strongly worded order, concluding that “dual avenues of tax collection exist and are well recognized” and finding that the LGI’s interpretation of IRC Section 6213(a) was erroneous.[8] To reach its conclusion, the district court had to determine that (1) there was sufficient support for the DOJ’s asserted common law right to sue on a tax deficiency and (2) that IRC Section 6213 does not prohibit such an action.
Regarding the first point, the district court acknowledged that this was a question of first impression in the US Court of Appeals for the Tenth Circuit but relied on a group of cases that, while distinguishable on various grounds, arguably endorsed the notion that the DOJ had such a right. The court also relied on the fact that neither it nor the parties could find any case law that explicitly rejected a dual process for tax collection. Regarding the second point, the court concluded that IRC Section 6123 was not a bar to the DOJ’s common law action and thereby rejected the key basis for LGI’s motion:
Defendant’s argument that section 6213(a) requires a notice of deficiency to issue before any recovery of unpaid income taxes can occur is based on a misleading alteration of the cited provision. The section provides in relevant part that “no assessment of a deficiency in respect of any tax imposed by subtitle A, or B, chapter 41, 42, 43, or 44 and no levy or proceeding in court for its collection shall be made, begun, or prosecuted until such notice has been mailed to the taxpayer” and the taxpayer has had the opportunity to challenge that assessment in Tax Court if desired. See 26 U.S.C. § 6213(a). Defendant, purporting to quote this provision, asserts that “no levy or proceeding in court for [the collection of a tax deficiency] shall be made, begun or prosecuted until such notice has been mailed to the taxpayer.
The bracketed substitution of the phrase “collection of a tax deficiency” for “assessment of a deficiency” does nothing to enhance the clarity of the quoted language and in fact contorts its meaning. Defendant would rework the notice requirement to apply not only after administrative assessment but presumably to any recovery of unpaid income taxes. Section 6213 applies to the IRS’s assessment and collection of tax deficiencies; it does not refer to the government’s full panoply of remedies for recovery of unpaid taxes.[9]
The district court interpreted the statute as requiring Section 6213(a) notice before collecting the assessed taxes. An “assessment” is a formal recording of a tax debt by the IRS.[10] According to the court, it’s not the exclusive means through which the government can seek to obtain a judgment against a taxpayer for asserted deficiencies. Thus, because the government’s amended complaint did not operate to make an assessment, the court concluded that it is not barred by IRC Section 6213(a).
Although raised in LGI’s motion to dismiss, the LGI order declined to consider the implications of IRC Section 7422(e). This section allows a taxpayer to challenge a notice of deficiency in the US Tax Court after initiating a refund suit and gives the Tax Court jurisdiction over both the deficiency and refund suit. Is the common law right of action inconsistent with IRC Section 7422(e) in that it avoids the need for a notice of deficiency and eliminates the taxpayer’s ability to move their refund action to the Tax Court, or is the common law right more akin to the government’s right to offset in refund court? Under what circumstances might a taxpayer want to convert a common law action where the government has the burden of proof into a deficiency proceeding where the taxpayer would then have the burden of proof?
Practice Point: Liberty Global may embolden the DOJ to attempt to collect tax deficiencies by way of court judgment outside of the deficiency procedures provided by the IRC. We will closely monitor this case as it develops because it may require a new strategy when considering disputing a tax issue in courts other than the Tax Court.
Olivia Sica, a summer associate in the Miami office, also contributed to this article.
