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13 September 2019
Legislators in Sacramento are mulling over one of the most (if not the most) troubling state and local tax bills of the past decade. AB 1270, introduced earlier this year and passed by the Assembly in late May, would amend the California False Claims Act (CFCA) to remove the "tax bar," a prohibition that exists in the federal False Claims Act and the vast majority of states with similar laws.
If enacted, this bill will open the door for a cottage industry of financially driven plaintiffs' lawyers to act as bounty hunters in the state and local tax arena. California taxpayers would be forced to defend themselves in high-stakes civil investigations and/or litigation—even when the Attorney General's Office (AG) declines to intervene. As seen in other states, this racket leads to abusive practices and undermines the goal of voluntary compliance in tax administration.
While the CFCA is intended to promote the discovery and prosecution of fraudulent behavior, the author (Assembly Member Mark Stone) introduced the bill specifically to "protect public dollars against fraud"—the enumerated list of acts that lead to a violation of the CFCA does not require a finding of civil fraud. In fact, a taxpayer who "knowingly and improperly . . . decreases an obligation to pay or transmit money or property to the state or to any political subdivision" would be in violation of the CFCA. See Cal. Gov't Code § 12651(a)(7).
This standard is particularly inappropriate in the tax context, and is tantamount to allowing vague accusations of noncompliance with law to lead taxpayers to be hailed into court. Once there, taxpayers would be held hostage between an expensive legal battle and paying an extortion fee to settle, as the CFCA is extremely punitive: violators would be subject to treble damages (i.e., three times the amount of the underreported tax, interest and penalties), an additional civil penalty of $5,500 to $11,000 for each violation, plus the costs of the civil action to recover the damages and penalties (attorneys' fees).
To the extent the action was raised by a private plaintiff (or relator) in a qui tam action, the recovered damages or settlement proceeds would be divided between the state and the relator, with the relator permitted to recover up to 50% of the proceeds. See Cal. Gov't Code § 12652(g)(3). If the state AG or a local government attorney initiates the investigation or suit, a fixed 33% of the damages or settlement proceeds would be allotted to their office to support the ongoing investigation and prosecution of false claims. See Cal. Gov't Code § 12652(g)(1).
Adding further insult to injury, the CFCA has its own statute of limitations completely independent of the tax laws. Specifically, the CFCA allows claims to be pursued for up to 10 years after the date the violation was committed. See Cal. Gov't Code § 12654(a). This statute is argued to trump the tax statutes of limitations. Additionally, the elements of a violation under the CFCA must only be shown "by a preponderance of the evidence." Cal. Gov't Code § 12654(c).
While AB 1270 was amended during the legislative process to retroactively apply to prior claims, records, or statements made under the Revenue and Taxation Code, the most recent amendment to the bill expressly prohibited "retroactive application to any claims, records, or statements made under the Revenue and Taxation Code before January 1, 2020."
Absent amendment, AB 1270, would put every significant California taxpayer in jeopardy when the company takes a legitimate tax return position on a gray area of the state or local tax law, even when the position was resolved through the California Department of Tax and Fee Administration, the State Board of Equalization, the Franchise Tax Board or a local government. Settlement agreements, voluntary disclosure agreements and audit closing agreements all would be disrupted if the AG or a plaintiffs' lawyer believes the underlying tax dispute or uncertainty is worth pursuing under the CFCA.
In countless cases in Illinois and New York, we have seen companies face False Claims Act shakedowns and be forced to pay nuisance-value settlements after the company already has been audited, has entered into settlement with the state, or when the tax statutes of limitation have long been closed. AB 1270 would bring the horrors experienced in Illinois and New York to taxpayers doing business in California. We have written about some of our litigation experience here, though there are many more investigations and cases that are not publicly disclosed.
Fundamentally, AB 1270 threatens to open the litigation floodgates and undermine the authority of California tax administrators—instead, putting tax administration in the hands of for-profit bounty hunters. As we indicated when similar legislation was considered by the District of Columbia, the goal of motivating whistleblowers and addressing tax fraud can be accomplished by simply adopting (and funding) a tax whistleblower program similar to the very successful programs offered by the IRS and many other states. (Paradoxically, California has an established reward program for information resulting in the identification of underreported or unreported income, which has not been funded for years….)
While ideally AB 1270 will be rejected in full or deferred for further consideration by an interim/study committee, we are hearing that the legislation is likely to advance. With this in mind, we encourage those with resources on the ground in Sacramento to support a number of critical amendments to ease the most severe abuses that stem from False Claims Act application to tax.
First, eliminating the ability of private plaintiffs to bring qui tam suits without the involvement of the AG would significantly reduce the number of frivolous claims and give the state its sovereign right to decide whether a claim should be pursued under the CFCA. If this amendment is not accepted, companies that introduce new technology and innovative products will be at the greatest risk of being targeted for qui tam litigation. It is always the case that tax law does not keep up with technological advances—thus the gray areas of tax law will be most prevalent for high-tech taxpayers.
Second, the CFCA should be limited such that it would allow taxpayers to take reasonable tax return positions and exercise good-faith interpretation of the tax law. Tax law is notoriously murky, and good-faith disputes are what keep lawyers and accountants employed worldwide. No CFCA exposure should exist when a company has taken a reasonable return position or otherwise attempted to comply with a reasonable view of the law, though that view may eventually be proven incorrect. The proper approach under the CFCA should be to make taxpayers liable only where they have engaged in actual civil fraud or reckless disregard of the law.
Third, the CFCA should defer to the applicable burden of proof and statute of limitations contained in the Revenue and Taxation Code. The CFCA also should continue to be limited in application to prospective matters (i.e., claims for taxable years beginning on or after January 1, 2020). Doing otherwise would raise serious constitutional questions, and would subject taxpayers to retroactive liability for trying their best to comply with the state's muddled tax laws.
Last week, AB 1270 was sent to the Suspense File by the Senate Appropriations Committee, which scheduled a hearing to vote on the bill (among a host of others) this Friday, August 30 upon adjournment of session in the John L. Burton Hearing Room (4203). If your company has not yet voiced its objection to this troubling legislation, now is to the time to do so. If advanced by the Senate Appropriations Committee, the bill will be sent to the Senate Floor for further consideration. If the bill clears the Senate, it will need to be concurred in by the Assembly before being sent to Governor Gavin Newsom since it was amended during the Senate committee process.
For further information on this topic please contact Stephen P Kranz or Diann Smith at McDermott Will & Emery's Washington DC office by telephone (+1 202 756 8000) or email (email@example.com or firstname.lastname@example.org). Alternatively, please contact Charles Moll or Troy Van Dongen at McDermott Will & Emery's San Francisco office by telephone (+1 628 218 3800) or email (email@example.com or firstname.lastname@example.org). The McDermott Will & Emery website can be accessed at www.mwe.com.
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