Opinion ID: 2371812
Heading Depth: 1
Heading Rank: 2

Heading: equitable recoupment

Text: We turn next to the plaintiffs' claim that the trial court improperly refused to exercise its equitable powers to allow them to offset their past overpayments of income taxes against the deficiencies later assessed by the defendant. [12] Both parties agree that the plaintiffs' treatment of the net operating losses was incorrect under the applicable statutes, which resulted in the plaintiffs' paying more than their share of taxes in 1990 and less than their share of taxes in 1995 and 1996. The plaintiffs argue that, because both the overpayments and the deficiencies arose out of their mistaken treatment of the same net operating losses, they have satisfied the requirements of the doctrine of equitable recoupment as outlined by the United States Supreme Court in Bull v. United States, 295 U.S. 247, 262-63, 55 S.Ct. 695, 79 L.Ed. 1421 (1935), and are, therefore, entitled to offset the amount owed to the defendant by the amount overpaid. The defendant contends, in essence, that the doctrine does not apply to the facts of this case because the events in question constitute more than one transaction, and thus fail to satisfy the requirements of Bull. [13] Our review of the doctrine of equitable recoupment leads us to conclude that, even if we were to adopt the doctrine in its broadest sense, it is not applicable to the facts of this case. Consequently, we agree with the defendant. Ordinarily, we apply a deferential standard of review to a trial court's equitable determinations: The determination of what equity requires in a particular case, the balancing of the equities, is a matter for the discretion of the trial court. . . . Our standard of review is whether the trial court abused its discretion. . . . In determining whether the trial court has abused its discretion, we must make every reasonable presumption in favor of the correctness of its action. (Internal quotation marks omitted.) Fernandes v. Rodriguez, 90 Conn.App. 601, 609, 879 A.2d 897, cert. denied, 275 Conn. 927, 883 A.2d 1243 (2005), cert. denied, ___ U.S. ___, 126 S.Ct. 1585, 164 L.Ed.2d 312 (2006). The defendant's argument, however, requires us first to determine whether Connecticut courts have adopted the common-law doctrine of equitable recoupment as it has been applied by the federal judiciary to tax appeals, which presents a question of law to which the plenary standard of review applies. Recoupment . . . refers to the defendant's right, in the same action, to cut down the plaintiff's demand, either because the plaintiff has not complied with some cross obligation of the contract on which he or she sues or because the plaintiff has violated some legal duty in the making or performance of that contract. . . . The practice serves to avoid needless delay and unnecessary litigation by permitting a court to examine all aspects of the transaction that is the subject of the action. (Internal quotation marks omitted.) Premier Capital, Inc. v. Grossman, 68 Conn.App. 51, 58, 789 A.2d 565, cert. denied, 260 Conn. 917, 797 A.2d 514 (2002). Although recoupment has been employed by our courts as a tool of equity despite statutes of limitations since at least the nineteenth century, [14] particularly in contract and probate disputes, no Connecticut court to date has addressed the applicability of that doctrine to tax disputes. [15] The equitable recoupment doctrine is a form of relief developed by the federal courts and adopted by some state courts. Equitable recoupment is a narrow exception to the legislative policy of barring claims in tax matters by statutes of limitations. It was first applied by the United States Supreme Court in Bull v. United States, supra, 295 U.S. at 247, 55 S.Ct. 695, a case involving a probated estate. In Bull, the taxpayer had paid estate taxes on the decedent's interest in a partnership, and later was assessed a deficiency by the federal government on the basis of its determination that the money should have been classified and taxed as income. Id., at 251-52, 55 S.Ct. 695. The Supreme Court, by applying the doctrine of equitable recoupment, permitted the taxpayer to use its previously paid taxes to offset the assessed deficiency despite the passage of the statute of limitations on the taxpayer's claim for a refund. Id., at 263, 55 S.Ct. 695. The court chose to exercise its equitable powers because the retention by the government of money that it is not entitled to is against morality and conscience; id., at 260, 55 S.Ct. 695; as well as immoral and amounts in law to a fraud on the taxpayer's rights. Id., at 261, 55 S.Ct. 695. Subsequent Supreme Court cases summarize the doctrine as applicable in situations in which the taxing authority has applied two inconsistent tax theories to the same transaction, and that inconsistency has been challenged as a defense to a timely proceeding. [16] United States v. Dalm, 494 U.S. 596, 608, 110 S.Ct. 1361, 108 L.Ed.2d 548 (1990) (a party litigating a tax claim in a timely proceeding may, in that proceeding, seek recoupment of a related, and inconsistent, but now time-barred tax claim relating to the same transaction); Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 299, 67 S.Ct. 271, 91 L.Ed. 296 (1946) (recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiff's action is grounded [internal quotation marks omitted]). These cases also make it clear that the government, as well as taxpayers, may use equitable recoupment as a defense; Stone v. White, 301 U.S. 532, 539, 57 S.Ct. 851, 81 L.Ed. 1265 (1937); and that the taxpayer may be treated as a defendant even though he was the party who filed the action. United States v. Dalm, supra, at 617, 110 S.Ct. 1361 (in a refund action based on the multiple and inconsistent taxation of a single transaction, the taxpayer is to be treated as though she were the defendant even though she is actually the plaintiff). Thus, in the federal courts, recoupment has never been thought to allow one transaction to be offset against another, but only to permit a transaction which is made the subject of suit by a plaintiff to be examined in all its aspects, and judgment to be rendered that does justice in view of the one transaction as a whole. Rothensies v. Electric Storage Battery Co., supra, 329 U.S. at 299, 67 S.Ct. 271. The doctrine applies only in cases that satisfy three elements. First, a single transaction must be the taxable event to be considered in recoupment. Second, the single transaction must be subject to two taxes based upon inconsistent legal theories. Finally, the statute of limitations must bar recoupment, while either the government's asserted deficiency or the taxpayer's claim for a refund must be timely. Catalano v. Commissioner of Internal Revenue, 240 F.3d 842, 844 (9th Cir.2001); see also Rothensies v. Electric Storage Battery Co., supra, at 299-300, 67 S.Ct. 271; Kolom v. United States, 791 F.2d 762, 767 (9th Cir. 1986). [17] Several of our sister states have adopted the federal judiciary's doctrine of equitable recoupment. See Dept. of State Revenue v. Estate of Smith, 473 N.E.2d 611, 615 (Ind.1985); Superior Air Products International, Inc. v. Director, Division of Taxation, 9 N.J.Tax 463, 470, 476 (1988), aff'd per curiam, 10 N.J.Tax 238 (App.Div.1988); Vivigen, Inc. v. Minzner, 117 N.M. 224, 231, 870 P.2d 1382 (1994); National Cash Register Co. v. Joseph, 299 N.Y. 200, 203, 86 N.E.2d 561(1949); Estate of Kasishke v. Tax Commission, 541 P.2d 848, 852-53 (Okla.1975); Allied Timber Co. v. Dept. of Revenue, 296 Or. 412, 415, 677 P.2d 33 (1984); American Motors Corp. v. Dept. of Revenue, 64 Wis.2d 337, 351-53, 219 N.W.2d 300 (1974). Other state courts have declined to apply the doctrine of equitable recoupment to the facts of cases before them, but seemingly have left open the question of whether their state recognizes the doctrine. See Independent Iron Works, Inc. v. State Board of Equalization, 167 Cal. App.2d 318, 326, 334 P.2d 236 (1959) (For the purposes of this opinion, but without deciding the issue, it may be assumed that the doctrine of equitable recoupment exists in this state. Such an assumption would not assist the appellant, because, under the facts of this case, the doctrine, even in its broadest application, is not applicable.); Harman's of Idaho, Inc. v. State Tax Commission, 114 Idaho 740, 742, 760 P.2d 1156 (1988) (The taxpayer contends that this is an appropriate case for the application of the doctrine of equitable recoupment. This is a case of first impression for the application of this doctrine by this [c]ourt. Without determining whether equitable recoupment will be applicable in other cases in this state, we hold that it is not appropriate in this case.); American Life & Accident Ins. Co. of Kentucky, Inc. v. Revenue Cabinet, 173 S.W.3d 910, 915 (Ky.App.2004) (while it is arguable that Kentucky has implicitly recognized equitable recoupment . . . it has also been held that if equitable relief is not provided for by statute then it is unavailable [citation omitted]), review denied, 2005 Ky. Lexis 320 (October 12, 2005); May Dept. Stores Co. v. Pittsburgh, 31 Pa.Cmwlth. 398, 406, 376 A.2d 309 (1977) (describing equitable recoupment as a creature of the federal judiciary but concluding same transaction requirement not met). At least one state has specifically declined to adopt the doctrine of equitable recoupment. See General Motors Corp. v. Limbach, 67 Ohio St.3d 90, 92-93, 616 N.E.2d 204 (1993) (rejecting doctrine based on courts' lack of jurisdiction to grant equitable remedies in tax cases). In the present case, we need not decide whether to adopt the doctrine of equitable recoupment, because it applies only where the [g]overnment has taxed a single transaction, item, or taxable event under two inconsistent theories. (Emphasis added.) United States v. Dalm, supra, 494 U.S. at 605 n. 5, 110 S.Ct. 1361. The threshold issue with respect to whether the doctrine of equitable recoupment is applicable to the facts of this case is, therefore, whether the events in question constitute more than one taxable event. The plaintiffs claim that the taxable event in question is the treatment of the net operating losses, which necessarily affects more than one tax year. The defendant argues in response that the plaintiffs are attempting to offset [a] 1995 and 1996 assessment with a claim that relates to 1990 and not to the 1995 and 1996 tax years. Under the defendant's reasoning, the taxable event is the imposition of the income tax. [18] Because we agree with the defendant, we leave for another day the question of whether to adopt the doctrine of equitable recoupment. There are two approaches to defining transaction in the equitable recoupment case law. The first is followed by the majority of state jurisdictions that have adopted equitable recoupment and is modeled on the federal doctrine, which requires that the same transaction, literally, must be the basis for both the claim for refund and the claim of deficiency. See, e.g., United States v. Dalm, supra, 494 U.S. at 605-606, 110 S.Ct. 1361; Rothensies v. Electric Storage Battery Co., supra, 329 U.S. at 300-301, 67 S.Ct. 271; Boyle v. United States, 355 F.2d 233, 236 (3d Cir. 1965); Superior Air Products International, Inc. v. Director, Division of Taxation, supra, 9 N.J.Tax at 474-75; Vivigen, Inc. v. Minzner, supra, 117 N.M. at 231, 870 P.2d 1382; see also Twitchco, Inc. v. United States, 348 F.Supp. 330, 336 (N.D.Ala.1972) (the existing state of the law requires that the single transaction test be used to narrowly confine the doctrine of equitable recoupment). We note that a minority of state courts, including the Wisconsin Supreme Court, which has had the opportunity to examine the doctrine of equitable recoupment on several occasions, have adopted a broader definition of `same transaction,' so that the term encompasses any transaction in the tax period involved in either a claim by the taxpayer for refund or by the state for additional assessment. . . . [19] American Motors Corp. v. Dept. of Revenue, supra, 64 Wis.2d at 353, 219 N.W.2d 300; see also Estate of Kasishke v. Tax Commission, supra, 541 P.2d at 853 (concluding, on basis of reasoning of American Motors Corp., that payment of estate tax constitutes single transaction); Dept. of Revenue v. Van Engel, 230 Wis.2d 607, 614-16, 601 N.W.2d 830 (acknowledging Wisconsin's adoption of broadened definition of same transaction), review denied, 231 Wis.2d 374, 607 N.W.2d 290 (1999). Under either definition of transaction, however, the question of whether the net operating losses in the present case constitute more than one taxable event is unclear. Our research has revealed little case law on this specific question. No federal court has determined squarely whether treatment of net operating losses over a period of more than one tax year meets the same transaction requirement. [20] The two state appellate level courts that directly have addressed this issue support the defendant's claim that the transaction in question is the imposition of the income tax, not the treatment of the net operating losses. In Harman's of Idaho, Inc. v. State Tax Commission, supra, 114 Idaho at 741, 760 P.2d 1156, the defendant tax commission assessed a tax deficiency after it determined that the taxpayer improperly had carried forward certain net operating losses without first carrying them back for three years, as required by the applicable statute. The taxpayer claimed that the amount that it had overpaid in the years when it should have carried back the losses, should have been used to offset the subsequent deficiency assessment. Id. The Idaho Supreme Court determined that the taxpayer's claim for refund was barred by the three year statute of limitations, which was specifically targeted to claims for credit or refund relating to overpayment attributable to a net operating loss carryback. Id., at 742, 760 P.2d 1156. The court rejected the claim that the deficiency assessment reopened the time period for making a refund claim relating to the years in which the taxpayer should have claimed the net operating losses. Id., at 741-42, 760 P.2d 1156. The court also concluded that the doctrine of equitable recoupment did not apply because [t]he [net operating losses] are not a taxable event, but merely the basis for deductions. The [net operating losses] do not generate a tax, but are only a means of avoiding the payment of some tax. The [net operating losses] were not subjected to two taxes based on inconsistent theories. Id., at 743, 760 P.2d 1156. Similarly, in Aetna Casualty & Surety Co. v. Tax Appeals Tribunal, 214 App. Div.2d 238, 242-43, 633 N.Y.S.2d 226 (1995), appeal denied, 87 N.Y.2d 811, 666 N.E.2d 1058, 644 N.Y.S.2d 144 (1996), the court declined to apply principles of equitable recoupment to a company's attempt to offset part of a deficiency assessed against it for 1986 by the amount that it had overpaid in 1978, due to an error in its utilization of net operating losses. The New York court stated that the doctrine of equitable recoupment could not be applied because that doctrine only applies when the overpayment to be recouped was made during the period under review, and thus can be considered part of the same `transaction. . . .' Id. We find the reasoning of the Idaho and New York courts with regard to the definition of transaction convincing. Net operating losses are not, as the Idaho court noted, a taxable event, but merely the basis for deductions. Harman's of Idaho, Inc. v. State Tax Commission, supra, 114 Idaho at 743, 760 P.2d 1156. We, therefore, conclude that, even if we were to assume, without deciding, that the doctrine of equitable recoupment should be adopted, it is not applicable to the present case because the plaintiffs failed to satisfy the same transaction requirement under even the broader definition of transaction applied by a minority of courts. We note that, were we to hold for the plaintiffs, we would in effect be endorsing an even broader definition of transaction than that adopted by the minority of state courts. Such a result would all but eviscerate the statute of limitations on refund claims and the finality of tax settlements in our state. As the United States Supreme Court stated in Rothensies: It probably would be all but intolerable, at least Congress has regarded it as ill-advised, to have an income tax system under which there never would come a day of final settlement and which required both the taxpayer and the [g]overnment to stand ready forever and a day to produce vouchers, prove events, establish values and recall details of all that goes into an income tax contest. Hence, a statute of limitation is an almost indispensable element of fairness as well as of practical administration of an income tax policy. Rothensies v. Electric Storage Battery Co., supra, 329 U.S. at 301, 67 S.Ct. 271. The court also recognized that [a]s statutes of limitation are applied in the field of taxation, the taxpayer sometimes gets advantages and at other times the [g]overnment gets them. Both hardships to the taxpayers and losses to the revenues may be pointed out. They tempt the equity-minded judge to seek for ways of relief in individual cases. But if we should approve a doctrine of recoupment of the breadth here applied we would seriously undermine the statute of limitations in tax matters. In many, if not most, cases of asserted deficiency the items which occasion it relate to past years closed by statute, at least as closely as does the item involved here. . . . The same is true of items which form the basis of refund claims. Every assessment of deficiency and each claim for refund would invite a search of the taxpayer's entire tax history for items to recoup. . . . We cannot approve such encroachments on the policy of the statute out of consideration for a taxpayer who for many years failed to file or prosecute its refund claim. If there are to be exceptions to the statute of limitations, it is for Congress rather than for the courts to create and limit them. (Citations omitted.) Id., at 302-303, 67 S.Ct. 271. Adoption of a more expansive definition of transaction also would contravene our state's policy of encouraging finality of tax decisions, which ultimately serves both the taxpayer and the state. See, e.g., Chatterjee v. Commissioner of Revenue Services, 277 Conn. 681, 696, 894 A.2d 919 (2006) (income tax scheme's three year statute of limitations balances the state's important interest in financial stability with the plaintiffs' interest in recouping their allegedly improper payment of taxes); see also National CSS, Inc. v. Stamford, 195 Conn. 587, 597-98, 489 A.2d 1034 (1985) (noting with regard to one year statute of limitations for seeking refund of excess real property tax payments that [p]ublic policy requires . . . that this court not permit taxes collected or paid to be the subject of perpetual litigation, at any time, to suit the convenience of the taxpayer). Thus, in the context of net operating losses, which, as the plaintiffs note, necessarily affect multiple years of taxable income, the benefits of a narrower definition of same transaction are particularly significant. Our conclusion may not comport with the plaintiffs' notion of fairness and equity, but the application of the statute of limitations in tax matters is often not `fair.' Rather, it is applied for salutary reasons of predictability and repose. . . . Superior Air Products International, Inc. v. Director, Division of Taxation, supra, 9 N.J.Tax at 477. The judgment is affirmed.