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“Procedurally Taxing” post on “Court of Federal Claims Authorizes Deposition of Revenue Agent and Requires Production of Service Documents in Tax Refund Suit”

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We welcome back guest blogger Stu Bassin. Stu is a solo practitioner in Washington, D.C. who specializes in tax controversy work. Today he talks about a recent Court of Federal Claims case in which the Court rules on a discovery dispute that had several facets. The taxpayer in the case before the Court had not participated in the audit and she wanted information about what happened during the audit that a petitioner would not normally need and in another forum might not receive. The taxpayer wanted to depose the revenue agent concerning things he considered as a part of the audit. In some ways the issue sets up as a Greenberg Express issue if this were a Tax Court case and the taxpayer sought to go behind the notice of deficiency. In addition to the issue of whether discovery was appropriate to seek this type of information, the IRS also raised the issue of testimonial authorization. IRS employees, and employees of any federal agency, cannot be compelled to testify generally concerning matters related to their employment without an authorization from the agency from which they work. The authorization letters usually provide a fairly narrow authorization for the employee to testify and the agency requires the party seeking their testimony to provide a detailed description of the testimony sought after which the agency decides how much of the requested testimony the agency wishes to allow its employee to address through testimony. This dance regarding the testimony of a federal employee takes its form from the case of Touhy v US. Just as the Court of Federal Claims did not seem bothered by allowing discovery on a matter that “goes behind the notice” (I realize the case does not arise from a notice of deficiency) it also does not seem too concerned about the Touhy issue. Perhaps the case signals a broader approach to testimony of IRS agents than might previously have been anticipated. Keith

A recent Court of Federal Claims ruling illustrates several of the substantive and procedural concerns surrounding obtaining discovery from the Service and taking depositions of Service personnel in connection with the litigation of tax disputes.Herrmann v. United States, Fed. Cl. No. 14-941T (May 20, 2016, Judge Lettow).

The case’s unusual procedural history arose out of a bonus payment paid by a London-based partnership to Ms. Herrmann, a U.S. citizen living in London, employed by the partnership. Ms. Herrmann paid U.K. tax on the payment, but did not report the income on her U.S. return. The Service audited the partnership and determined that the bonus payment was a partnership distribution. Following the audit, the Service issued a Notice of Computational Adjustment to Ms. Herrmann, requiring her to pay additional tax based upon re-characterization of the bonus. Ms. Herrmann paid the tax, filed a refund claim, and later filed suit in the Court of Federal Claims.

As Ms. Herrmann was not involved in the audit of her employer’s partnership, she had much less knowledge of the facts and procedural history of the audit giving rise to her alleged tax liability than more typical taxpayers. Accordingly, she sought production of documents relating to the audit and a deposition of the revenue agent responsible for the partnership audit and the adjustment to her tax liability. The Service objected, challenging the relevance of the requested discovery, contending that it could limit the subject matter of the deposition, and that the taxpayer’s filing of a motion to compel the discovery was premature. In the recent order, the Court of Federal Claims granted Ms. Hermann much of the relief she sought.

The unique procedural posture of the case drove the court’s rejection of the Service’s relevance objection to production of the documents it obtained and generated during the partnership audit. Case law has always allowed discovery of the facts considered by the Service in making its audit determinations, but generally noted that the discovery was unnecessary because virtually all of the factual documentation underlying the determinations was already in the possession of the taxpayer. But, unlike the fact pattern in more typical suits, Ms. Herrmann did not participate in the audit and needed that documentation to prepare her case. The court’s decision requiring production of the documents therefore seems proper.

The Service’s attempt to restrict the scope of the revenue agent’s deposition presented another twist on the relevance question. The Service cited Treas. Reg. §301-9000 (the so-called Touhy regulations), under which agencies like the Service establish procedures authorizing a government employee to testify. Those regulations operate as a house-keeping procedure allowing the agency to supervise the testimony of their employees and protecting the employee from a contempt citation if the agency limits or prohibits the desired testimony. The regulations do not, however, establish a special right for government agencies to withhold relevant evidence or to prevent their employees from testifying about relevant information without consequence.

In this case, the Court of Federal Claims made its own determination on the relevance of the revenue agent’s testimony, determining that the deposition would go forward, subject to the terms of the testimony authorization. The issue not addressed in the opinion was what would happen if the Service asserted a non-meritorious relevance objection at the deposition. The Touhy regulations might insulate the Service employee from sanctions, but the agency would remain subject to court-ordered sanctions, just like any other litigant who refuse to provide testimony.

Resolution of the dispute about the deposition testimony was further complicated by the parties’ choice to litigate the dispute in the context of a list of approved topics for the deposition as set forth in the testimony authorization. The list of topics was necessarily somewhat general and left uncertainty regarding the specific questions which the taxpayer might ask at the deposition. In ruling on the motion, therefore, the court was required to anticipate the questions that the taxpayer might ask and could only rule in terms of broad principles. Later, when the parties conducted the deposition, they would inevitably have to apply those broad principles to specific questions which the court likely did not contemplate when it issued its ruling.

A better approach for litigating this type of dispute is for the court to allow the deposition to go forward, with government counsel instructing the witness not to answer questions beyond the testimony authorization, and for the taxpayer to file a motion to compel challenging any improper instructions from counsel. A court can then rule upon the propriety of specific questions and objections. Not only is this approach more likely to produce clear rulings on the precise dispute between the parties, but it allows the court to avoid trying to issue an advisory opinion upon a host of matters which may never require a rulin