Source: https://info.taxnotes.com/seesalt_digest_pillsbury
Timestamp: 2019-04-22 21:07:44+00:00

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Pre-litigation pitfalls exist at all stages of the state or local tax controversy life cycle. Two principles warrant careful attention; otherwise, mistakes early on can result in a taxpayer not only waiving a valid tax suit for refund but also forfeiting necessary or otherwise valuable evidence. The first principle is the often overlooked and highly jurisdiction-dependent exhaustion of administrative remedies doctrine, which involves determining what levels of administrative challenge are required and how early the grounds on which a taxpayer can bring a suit for refund are established. The second principle is de novo review, in which variations among tax types and jurisdictions create critical decision points early in the controversy cycle regarding the evidentiary record should litigation be pursued down the road. While exhaustion of administrative remedies and de novo review are separate principles, each can have a significant impact — either separately or together — on the viability of the claim(s) brought in a suit for refund. This article examines the underpinnings of the exhaustion doctrine and the de novo review standard and why taxpayers should be aware of their collective importance long before administrative appeals and formal litigation are afoot.
When challenging an assessment or refund claim denial, the available administrative relief procedures and the taxpayer’s level of responsiveness during those procedures play an essential role in the success of the taxpayer’s challenge. All states, and many local governments, have specific administrative procedures that apply to tax controversies. While exhaustion rules vary from state to state, the general principles supporting the rules are the same.
The principle of exhaustion of administrative remedies has two main components. First is the requirement that administrative appeals be brought before the proper tax agency or raised at the proper administrative level before a court considers the taxpayer’s cause(s) of action. This issue can arise in class action sales tax cases in which the class seeks to proceed against an individual taxpayer responsible for collecting and remitting a tax rather than seek a refund from the tax agency or vice versa, depending on the jurisdiction.4 Second, the exhaustion of administrative remedies doctrine requires taxpayers to raise all issues before an administrative body before subsequent judicial review.5 Because exhausting administrative remedies is a “procedural prerequisite” to an action at law, failure to exhaust each challenge at the administrative level can result in a waiver of a claim in later complaints.6 Courts are without jurisdiction to consider grounds not set forth in a taxpayer’s challenge to an administrative decision.7 Generally, the administrative level is the taxpayer’s opportunity to present all the issues it may want the court to determine in the future,8which in turn puts the tax agency on notice of those grounds, satisfying the notice requirement established by the exhaustion doctrine.
A. What Administrative Remedies Must a Taxpayer Exhaust?
Often mistaken to be simple in theory, the exhaustion doctrine can be complicated once put into practice. State and local tax rules can be unclear regarding whether some levels of administrative review are required, as illustrated in the following examples.
A strong understanding of the exhaustion doctrine is essential to creating a successful case strategy. At the start of a tax controversy — typically at audit — taxpayers need to understand the exhaustion doctrine, its applicable exceptions, and how to apply it. Reassessment is then required at each new level of challenge. Even though a valid exception to the exhaustion doctrine exists, it may be in a taxpayer’s favor to proceed through the administrative process first, before filing a court action. But in other situations, it may make more sense to take advantage of an exception, forgo the administrative steps, and immediately file a court action. These decision-making pivot points are highly dependent on the legal issues and facts at play. Misunderstanding the application of the doctrine and its exceptions can be fatal to the taxpayer’s claim, as demonstrated in the In re 2009 Aircraft Tax Refund Cases decision. Also, as demonstrated in Hotels.com LP, it is essential that taxpayers be aware of the exhaustion requirements imposed on the state or local agencies as a defense to an unripe judicial proceeding. Not only does an assessment provide the purported tax due, but it may provide the taxpayer with essential information regarding the tax agency’s position, affording the taxpayer valuable insight to help determine whether to challenge the assessment.
The notion that issues must be preserved at the administrative level is not a new concept. In 2001 the California Supreme Court in Preston v. State Board of Equalization stated that a lawsuit must be based “on the grounds set forth in the claim for refund.”44 That is, a taxpayer’s claim for refund at the administrative level both “frames and restricts the issues for litigation.”45 Before Preston, the California Supreme Court established that the courts do not have jurisdiction to consider grounds not raised in the taxpayer’s administrative claim.46The pre-litigation pitfalls in this area typically involve confusion over how specific the grounds need to be for a given issue in a refund claim and how to preserve unknown claims that may later surface and become beneficial in framing the overall issues of the case.
Taxpayers should carefully consider relying on a de novo review process to preserve their right to introduce new evidence after the conclusion of an administrative challenge. Significant variations among jurisdictions have created confusion on exactly when the evidentiary record is established. Taxpayers may find themselves asking: Is the evidentiary record established at the administrative level? If so, at what level? Can a taxpayer introduce new evidence at the next level of appeal? Does failure to provide evidence at the administrative level preclude the taxpayer from later presenting the evidence at the next level of appeal?
During administrative audits, petitions, protests, or other appeals, taxpayers often receive broad information requests from state or local tax agencies asking for “relevant” documentation. The broad scope of the requests can create uncertainty and may result in the taxpayer not providing all or part of the documentation requested. Too often taxpayers are quick to ignore or pay lip service to information and document requests by the tax authority, thinking they will have the opportunity to present the evidence when the dispute reaches a subsequent de novo forum. As evidenced by the string of cases below, however, de novo does not always mean de novo. The interplay between the exhaustion doctrine and the de novo principle often results in a trap for the unwary.
Failing to meet pre-litigation prerequisites such as exhausting available administrative remedies may cause a taxpayer to unknowingly waive valid challenges not raised at the administrative level. Also, in some jurisdictions the exhaustion doctrine can preclude the introduction of relevant evidence the taxpayer failed to produce during the administrative appeal process regardless of whether the case is heard de novo. In some jurisdictions, the rules can be misleading or nonexistent. All too often taxpayers with valid claims find themselves caught in the failure to exhaust trap. To avoid the trap, taxpayers should carefully vet all issues and evidence as early as possible in the controversy life cycle and continuously along the way. Whether a taxpayer has exhausted any given issue may be more complicated than the record itself reflects. Accordingly, all potential legal arguments and affirmative defenses should be strategically raised — or at a minimum fully considered — at the administrative level, whether at audit or the initial levels of administrative challenge.
1 Abelleira v. District Court of Appeal, 17 Cal. 2d 280, 292 (Cal. 1941). The court relied primarily on its understanding of the exhaustion doctrine at the federal level, including citation to many federal cases, in addition to reliance on several cases from other states and six law review articles.
2 Aronoff v. Franchise Tax Board, 60 Cal. 2d 177, 180-181 (Cal. 1963) (taxpayer did not exhaust his administrative remedy in which he filed a writ of prohibition against the Franchise Tax Board while a petition for rehearing was pending at the California State Board of Equalization).
3 However, a California trial court may determine whether a case falls within one of the few exceptions to the exhaustion rule, such as challenges to agency jurisdiction, inadequate administrative remedy, and alternative remedies granted by statute. See James E. Reed, “Exhaustion of Remedies,” 56 Calif. L. Rev. 1061 (1968).
4 See, e.g., Loeffler v. Target Corp., 58 Cal. 4th 1081 (Cal. 2014); and Larrieu v. Wal-Mart Stores Inc., 872 So. 2d 1157 (La. Ct. App. 2004).
5 For a further discussion of this issue, see infra notes 41-69 and accompanying text.
6 Holland v. Union Pacific Railroad Co., 154 Cal. App. 4th 940, 946 (Cal. Ct. App. 2007).
7 Preston v. State Board of Equalization, 25 Cal. 4th 197, 205-206 (Cal. 2001) (citing Atari Inc. v. State Board of Equalization, 170 Cal. App. 3d 665, 672 (Cal. Ct. App. 1985)).
8 A limited “futile” exception to the exhaustion doctrine exists when “the administrative agency is not empowered to correct the situation from which judicial relief is sought.” Park ‘N Fly of San Francisco v. City of South San Francisco, 188 Cal. App. 3d 1201, 1208-1209 (Cal. Ct. App. 1987) (citing to Knoff v. City etc. of San Francisco, 1 Cal. App. 3d 184, 199 (Cal. Ct. App. 1969)). For example, a taxpayer raising a constitutional challenge may skip administrative action and precede to the courts since an administrative agency lacks jurisdiction to decide a constitutional claim. Id.
9 See In re 2009 Aircraft Tax Refund Cases, Cal. Ct. App. (4th App. Dist.) Dkt. No. G053181 (Apr. 13, 2017) (not certified for publication).
14 Westinghouse Electric Corp. v. County of Los Angeles, 42 Cal. App. 3d 32 (Cal. Ct. App. 1974).
15 BOE, “Assessment Appeals Manual” (May 2003, reprinted Jan. 2015).
16 Westinghouse Electric Corp., 42 Cal. App. 3d at 37 (quoting BOE, “Assessment Appeals Manual,” at 109).
17 In re 2009 Aircraft Tax Refund Cases, at *3.
18 Id. The court also noted that “the primary purpose of the exhaustion of administrative remedies doctrine is to afford administrative tribunals the opportunity to decide in a final way matters within their area of expertise before judicial review,” a misunderstanding that was also fatal to the taxpayers.
19 Taxpayers claimed that the assessor failed to properly compute economic obsolescence using a statutorily established formula and therefore the assessments were void. In Re 2009 Aircraft Tax Refund Cases, at *1.
21 The court of appeal upheld the trial court’s decision sustaining the defendants’ demurrers without leave to amend on the ground plaintiffs had not exhausted their administrative remedy. Id.
22 Williams & Fickett v. County of Fresno, 2 Cal. 5th 1258 (Cal. 2017).
23 Id. at 1, 4.
24 Id. (quoting Stenocord v. San Francisco, 2 Cal. 3d 984, 987 (Cal. 1970)).
26 Id. at 12. The California Supreme Court applied its holding prospectively, explaining that in reaching its decision the court overturned its holding in Parr-Richmond Industrial Corp. v. Boyd, 43 Cal. 2d 157 (Cal. 1954), which the taxpayers could have relied on in opting not to pursue timely assessment appeal proceedings. Id.
27 MagicJack Vocaltec Ltd. v. City of Chicago Department of Finance, No. 1-17-1015 (Ill. App. 1st. Mar. 21, 2018).
32 City of Oakland v. Hotels.com LP, 572 F.3d 958 (9th Cir. 2009).
33 Id. at 960. The operator may appeal the assessment if it disagrees, and the tax administrator must provide a justification for it and conduct a hearing to determine the tax owed. Id. The operator may further appeal the hearing determination to the Oakland Taxation and Assessment Board of Review. Id.
41 In some jurisdictions, a taxpayer might be allowed to raise new issues after the record has been set. For example, the New York State Tax Appeals Tribunal will permit a taxpayer to raise a new legal issue, but not a new factual issue, after the record has been closed at the lower administrative law judge level. In the Matter of the Petition of Bayerische Beamtenkrankenkasse Ag, DTA 824762, at *6 (N.Y. Tax App. Trib., Sept. 11, 2017) (citing In the Matter of the Petition of Jeffrey S. Faupel, DTA 826255, at *16 (N.Y. Tax App. Trib., Dec. 23, 2015)). New factual claims are precluded as it “deprives the opposing party of the opportunity to offer evidence in opposition of the new factual claim.” In the Matter of the Petition of Faupel, at *16.
42 See, e.g., Preston, 25 Cal. 4th at 206; Wertin v. Franchise Tax Board, 68 Cal. App. 4th 961, 976-977 (Cal. Ct. App. 1998); and Newman v. Franchise Tax Board, 208 Cal. App. 3d 972, 980 (Cal. Ct. App 1989).
43 See, e.g., Atari Inc., 170 Cal. App. 3d at 673.
44 Preston, 25 Cal. 4th at 20 (internal quotations omitted).
45 Id. (internal quotations omitted).
46 Atari Inc., 170 Cal. App. 3d at 672.
50 Richard Boyd Industries Inc. v. State Board of Equalization, 89 Cal. App. 4th 706 (Cal. Ct. App. 2001).
54 Atari Inc., 170 Cal. App. 3d at 671.
60 Hibernia Bank v. State Board of Equalization, 166 Cal. App. 3d 393, 403 (Cal. Ct. App. 1985).
62 Id. The equal protection issues were decided by the U.S. Supreme Court in Diamond National v. State Equalization Board, 425 U.S. 268 (1976).
64 Delta Air Lines Inc. v. State Board of Equalization, 214 Cal. App. 3d 518, 529 (Cal. Ct. App. 1989).
69 In coming to this conclusion, the court relied on the California Supreme Court’s decision in Wallace Berrie & Co. In Wallace Berrie, the BOE argued that the taxpayer failed to challenge the validity of a regulation because the challenge was not articulated in its refund claim. Wallace Berrie & Co. v. State Board of Equalization, 40 Cal. 3d 60, 66 fn. 2 (Cal. 1985). The court explained that the taxpayer’s assertions in its claim for refund, while not specifically mentioning the regulation, “at least indirectly, launched a substantive attack” on the regulation. Id. Furthermore, the court found the BOE’s trial stance and failure to raise the “jurisdictional defect” during trial dispelled any question whether the refund claim raised the validity issue. Id. The BOE met the taxpayer’s validity argument “head on” and proposed an explicit finding, and therefore, while the taxpayer’s refund claim could have been more specific, the court found that the BOE was aware of the challenge and that therefore the taxpayer did not fail to exhaust its administrative remedies. Id.
70 See D.C. Code section 47-3303; and Thompson v. King Plow Co., 74 Ga. App. 758, 767 (Ga. Ct. App. 1947) (appeals of tax assessments are de novo proceedings).
71 State Tax Commissioner v. Wilmington Trust Co., 266 A.2d 419, 421 (Del. Super. Ct. 1968) (an appeal of an administrative decision to the superior court does not involve a trial de novo).
72 A “hearing de novo” is defined by Black’s Law Dictionary as “giving no deference to a lower court’s findings.” A “trial de novo” is defined by Black’s Law Dictionary as “a new trial on the entire case . . . conducted as if there had been no trial in the first instance.” Black’s Law Dictionary (2014).
73 M&J Leasing Co. v. Executive Director of Department of Revenue of State of Colorado, 796 P.2d 28, 30 (Colo. App. 1990); and Gracie LLC v. Idaho State Tax Commissioner, 237 P.3d 1196, 1198 (Idaho 2010).
74 E.C. Barnes v. State Board of Equalization, 118 Cal. App. 3d 994, 1001 (Cal. Ct. App. 1981).
75 Id. at 997-999 (internal quotations omitted).
79 See Wyoming Department of Revenue v. Qwest Corp., 263 P.3d 622 (Wyo. 2011).
85 American Chemical Corp. v. County of Los Angeles, 42 Cal. App. 3d 45, 55 (Cal. Ct. App. 1974). is a property tax appeal from a county board of equalization. In California property tax cases, the factual record is set at the county board level, but the legal record is reviewed de novo.
86 American Chemical Corp., 42 Cal. App. 3d 45, 55.
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