Earlier this week the Tax Court in Sotiropoulos v Commissioner considered the scope of its jurisdiction in a somewhat unusual context. The case involves a provision that allows the IRS to summarily assess a tax when a taxpayer pays foreign taxes, takes a US credit for those taxes, but then gets a refund from the foreign taxing jurisdiction and then notifies the IRS of the refund. In Sotiropoulos, the taxpayer claimed a foreign tax credit on taxes she arguably had refunded. She failed to notify the IRS about the refund, though the IRS found out about the refund, presumably from an information exchange. IRS claimed that it had mistakenly issued the taxpayer a notice of deficiency and had sought to deprive the taxpayer of the right to Tax Court review by filing a motion to dismiss for lack of jurisdiction despite issuing the stat notice and the taxpayer timely filing a petition to Tax Court. I will describe the context and facts and offer a brief analysis.
The taxpayer was living in the UK and working for Goldman Sachs. She filed tax returns in the UK and US. On her US tax returns she took substantial foreign tax credits reflective of her UK taxes paid….On her U.K. tax return for each year, petitioner claimed substantial deductions attributable to investments in U.K. film partnerships. She claimed these deductions under U.K. tax provisions that allowed investors in film partnerships to deduct highly leveraged investment costs against their earned income. In reliance on these deductions, petitioner applied for refunds on her U.K. returns of the tax that her employer had withheld and paid over to U.K. taxing authorities.
The US tax returns, and the credits she claimed, did not reflect her tax refunds, which were substantial $413,126 in 2003, $292,663 in 2004, and $239,202. She did not notify the IRS of the refunds she received; rather the IRS received information from UK taxing authorities, presumably through information exchange it has in place with the U.K. IRS examined the returns and then issued a notice of deficiency to reflect the additional tax it believed were due to the taxpayer erroneously claiming foreign tax credits in respect of UK taxes that the taxpayer received as refunds. In the stat notice, the IRS also proposed accuracy-related penalties. Taxpayer filed a petition, and then about a year after filing an answer, the IRS filed a motion to dismiss for lack of jurisdiction. Its argument was as follows:
Respondent contends that he erred in issuing the notice of deficiency; that section 905(c) authorizes him to redetermine petitioner’s 2003-05 tax and collect it upon notice and demand; and that foreign tax credit adjustments of the sort involved here “are expressly removed from deficiency procedures” by a cross-reference from section 6213(h)(2)(A) to section 905(c). Respondent acknowledges that the accuracy-related penalties determined in the notice of deficiency “properly fall under the jurisdiction of this Court.” However, respondent expresses his intention to concede these penalties if the Court grants his motion to dismiss as to the foreign tax credit adjustments.
The taxpayer naturally differed with the IRS’s vision of the applicability of Section 905(c):
[S]he contends that these payments were not “refunds” within the meaning of section 905(c)(1)(C) both because her entitlement to refunds remains under investigation by U.K. taxing authorities and because the application of section 905(c) is allegedly affected by provisions of the U.S./U.K. income tax treaty. As a result, petitioner did not file amended U.S. returns for 2003-05 reporting reduced foreign tax credits, nor did she otherwise notify the IRS pursuant to section 905(c)(1).
Analysis As an initial matter, that the IRS itself issued a notice of deficiency and then waited a year or so after filing its answer to the petition to file a motion to dismiss makes the IRS appear less than sympathetic. After all the taxpayer is disadvantaged and has incurred fees in teeing up the Tax Court dispute. Likewise, the alternative to Tax Court review, refund jurisdiction in federal district court or the Court of Federal Claims, would have required the taxpayer to fully pay under the Flora rule to get court review on the merits. Even for highly paid Goldman Sachs employees that can be a distinct disadvantage. But the issuance of the stat notice in and of itself is not sufficient to ensure Tax Court jurisdiction. Neither is the fact that the IRS waited a year following its answer to change its views. The Tax Court, as a court of limited jurisdiction, will look to the internal revenue code to see whether it can hear a case. In Sotiropoulos , the Tax Court cited to the case of Thompson v Commissioner to support the statement that the stat notice itself does not confer jurisdiction; I previously wrote about that case in TEFRA and Affected Items Notices of Deficiency. Thompson involved an audit relating to a TEFRA partnership and partner level adjustments with the IRS effectively issuing a protective notice of deficiency owing to the complexity of the TEFRA rules and uncertainty surrounding an adjustment that may or may not have been an adjustment that could generate an immediate partner-level assessment. As I described:
IRS proceeded to take two somewhat inconsistent actions. It issued an affected item statutory notice to Thompson individually making four adjustments—the main adjustment being a disallowance of the loss on liquidation of the partnership. The day after issuing the stat notice, IRS then assessed tax relating to the adjustments in the stat notice. Uh? This is inconsistent because the stat notice is supposed to allow the partner the opportunity to petition and get pre-assessment and pre-payment review of the adjustments in the affected item stat notice…. The majority Tax Court opinion concluded that even though a notice of deficiency had been timely issued and there was a timely filed petition, the Tax Court did not have jurisdiction because the partner level adjustments “follow directly from the treatment of partnership items determined in the partnership-level proceeding” and did not require any partner level determinations.
So in Sotiropoulos, the taxpayer and the Tax Court had to go beyond the IRS’s issuance of the stat notice to get the court to conclude that it had jurisdiction. The Tax Court looked primarily to Section 905(c) and Section 6213 and analyzed the relationship among the provisions to conclude that the IRS’s ability to immediately assess is dependent upon the taxpayer itself notifying the IRS of a refund of foreign tax credits.To get to that conclusion, the court discussed Section 6213 and its role in generally ensuring Tax Court review of taxes subject to deficiency procedures, including income tax:
Section 6213 also places important restrictions on the IRS’ ability to assess a deficiency and begin collecting the tax. As a rule, the IRS may not assess an in- come tax deficiency until it has mailed a notice of deficiency and the relevant period (90 or 150 days, as applicable) has elapsed. Sec. 6213(a). If the applicable time window closes and the taxpayer does not petition this Court, the IRS may proceed with assessment and collection. If a taxpayer timely petitions this Court, the IRS may not assess the tax or proceed to collect it “until the decision of the Tax Court has become final.
The court noted that there are exceptions, such as math error adjustments, that allow for IRS assessment without the normal procedures. It also noted how Section 905 intersects with deficiency procedures:
Once the IRS redetermines the taxpayer’s liability in accordance with section 905(c)(1), “[t]he amount of tax (if any) due * * * shall be paid by the taxpayer on notice and demand by the Secretary, and the amount of tax overpaid (if any) shall be credited or refunded to the taxpayer.” Sec. 905(c)(3). A cross-reference from section 6213 confirms that the usual restrictions on assessment do not apply to section 905(c) adjustments made by the IRS. See sec. 6213(h)(2) (“For assessments without regard to restrictions imposed by this section in the case of–(A) Recovery of foreign income taxes, see section 905(c).
The IRS argument was based principally on statutory construction, which the court rejected:
The problem with respondent’s position is that a plain reading of section 905(c) describes a circumstance that did not necessarily occur here. Section 905(c)(3) empowers the Commissioner to collect on notice and demand only in the case of a “redetermination under paragraph (1).” Paragraph 1 is structured as a conditional statement. As relevant here, it provides that if a foreign tax paid is refunded, then the taxpayer is required to notify the Secretary, who shall then redetermine the tax. Here, petitioner disputes that she received a “refund” of U.K. tax. She contends that the payments she received from U.K. taxing authorities were not “refunds” within the meaning of section 905(c)(1)(C), both because her entitlement to refunds remains under investigation in the U.K. and because the application of section 905(c) is allegedly affected by provisions of the U.S./U.K. income tax treaty. And because she allegedly received no “refunds,” she did not notify–and she contends that she had no obligation to notify–the Secretary under section 905(c)(1).
I think the Tax Court got this right. The court looked also to analogous cases under Section 905(c) where the parties and the court itself did not raise jurisdictional issues and considered the underlying merits of whether the taxpayer was entitled to foreign tax credits. The case is interesting because it considers a limited exception to the general rules on restrictions on assessment; those limitations should be read narrowly in light of the importance to taxpayers of ensuring a prepayment right to review of a substantive dispute. The exception in 905(c), as the court noted, is conditioned upon taxpayer notification and is analogous to the IRS’s right to immediate assessment of taxes that a taxpayer self-reports on tax returns.