Economic Substance Doctrine Tax Felonies (6/1/11)

I write today to provide viewers access to Jasper Cummings' article, Jasper L. Cummings, Jr., Economic Substance Doctrine Felonies, 131 Tax Notes 977 (May 30, 2011) and 2011 TNT 104-10 (5/31/11). (This article is provided with the permission of Tax Analysts.)  Mr. Cummings writes on the use of the economic substance doctrine in criminal tax cases. Most particularly, he writes about Mr. R. J. Ruble who was convicted in the first round of Son-of-Boss criminal prosecutions. In that case, Ruble, a tax lawyer, was convicted along with John Larson and Bob Pfaff who provided financial services in the conceptualization and implementation of the shelters. Two prominent subsequent shelter prosecutions have also used the economic substance doctrine in the charges to the jury.

First, let me disclose that I represented one of the dismissed defendants in the sprawling prosecution that ended up in the conviction of Messrs. Ruble, Larson and Pfaff. Once my client was dismissed along with 12 others before trial, I no longer had an immediate interest in the case but I did observe the progress of the proceedings through conviction and appeal and now pending petition for certiorari in the Supreme Court. I was particularly interested in whether and how the economic substance doctrine would be presented to the jury.
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Petitions for Cert in US v. Pfaff, Ruble & Larson

Petitions for certiorari have been filed in the criminal convictions of John Larson, Robert Pfaff and R.J. Ruble in the massive KPMG-related criminal case which drew fame in an earlier iteration (United States v. Stein before 13 defendants were dismissed for prosecutorial abuse). The Second Circuit summary affirmance of the convictions of Larson, Pfaff and Ruble is here. The petition for John Larson and Robert Pfaff is here. The petition for R. J. Ruble is here..
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Fourth Circuit says Factual Uncertainty Is Not Legal Uncertainty for James-Critzer-Mallas Defense

I have written in other blogs about uncertainty in law and the legal principle, emanating from the seminal decision in James v. United States, 366 U.S. 213 (1961) that uncertainty as to the law's commands precludes criminal prosecution. (For my prior blog discussions, see here.)  There are two key Fourth Circuit cases on that issue -- United States v. Critzer, 498 F.2d 1160 (4th Cir. 1974) and United States v. Mallas, 762 F.2d 361 (4th Cir. 1985). The Fourth Circuit recently addressed the issue again in in United States v. Cole, 631 F.3d 146 (4th Cir. 2011). Unfortunately the facts were very bad for the defendant, so it was clear that the Court of Appeals was not inclined to want to help him.

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Another Set Back for the Remaining Daugerdas Defendants - Economic Substance is Sufficiently Malleable to Establish a Line a Citizen Could Know

Judge Pauley, USDC SDNY, served up a loss for the Daugerdas defendants just before Christmas. The opinion in United States v. Daugerdas, 759 F. Supp. 2d 461 (SD NY 2010) is here. The defendants made the now standard argument in complex tax shelters, particularly those based on extrapolations of Helmer, that, given Helmer, the law was not sufficiently clear to establish a legal duty that the defendants could know. I have previously blogged on facets of this issue before. See here.

As occurs frequently, Judge Pauley conflates two distinct -- albeit related -- concepts. The threshold issue is whether the duty was knowable -- a legal inquiry that is separate from what the defendants might have known or intended. James and its progeny establish that the duty must be sufficiently clear that a citizen (not necessarily the actual defendant in the dock) could know the duty. Only if that question is answered in the affirmative is the Cheek issue reached -- did the defendant know the knowable legal duty? That is an issue for the jury to determine after trial so long as the prosecutors have enough evidence to survive a motion for acquittal.

Without citing James or its progeny, Judge Pauley does address the James threshold issue. Bottom line, he holds that the economic interest concept as a bar to claimed benefits and as interpreted by the courts (it is a judicial doctrine, after all) was sufficiently certain to give the hypothetical citizen a line that could be crossed (aka was knowable), leaving the issue for trial of whether these particular defendants knew the line they allegedly crossed. Could have known is not sufficient for a criminal conviction. The Government will have to prove that the did know. But that is another chapter.

Larson, Pfaff, Ruble Convictions In KPMG Tax Shelters Case Affirmed

The Second Circuit issued a Summary Order today affirming the convictions of Larson, Pfaff and Ruble the remnants of the larger KPMG criminal tax prosecution previously gutted in United States v. Stein, 541 F.3d 130 (2d Cir. 2008)(dismissal of 13 defendants because prosecutors improperly forced KPMG to stop paying their attorneys fees). The summary order for the affirmance of the convictions (I call this the Substantive Order) is here and the companion decision regarding Pfaff's bail (I call this the Bail Order), a precedential full opinion, is here.

At the outset, I am surprised, given the public interest in the convictions, that the Court relegated its substantive disposition to a Summary Order. Moreover, the case was the Government's first major initiative in the abusive tax shelter context and there are other similar tax shelter prosecutions and investigations in the pipe line that could be informed by some of the issues presented in the case.  The Second Circuit's Internal Operating Procedure Rule 32.1.1 says:
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More on Legal Uncertainty and, More Importantly, the Subjective Prong of the Economic Substance Test

I have previously discussed here the economic substance instruction that Judge Kaplan gave in the skinnied down KPMG trial that resulted convicted three defendants of multiple tax evasion crimes and is currently on appeal to the Second Circuit. I blogged about the Government’s outsized brief filed last Friday (see the brief here). My topic of focus was the effect of legal uncertainty in the law.

Today, I carry that discussion further in the context of the Government’s claims about the role of the economic substance doctrine in a criminal tax case. To set the stage, there clearly is some uncertainty in the civil cases about the economic substance doctrine. Two tests have been developed, which the Government calls (Br. 55) and most practitioners call a subjective prong and an objective prong. The subjective prong is whether the taxpayer engaging in the transaction had a nontax profit or business objective. Under this test, tax can be a consideration but the taxpayer must have an actual business or profit object or intent; further, there is no requirement that the taxpayer's objective be reasonable. The objective prong is whether the transaction has some – perhaps limited to some reasonable – possibility of profit. The major uncertainty from the civil cases is whether the tests are in the conjunctive or disjunctive. That is, whether a taxpayer desiring to sustain his claim of tax benefits must prove (i) both that he had the profit objective (however unreasonable) and that it was a reasonable profit or business objective or (ii) either of those prongs. (For tax coneheads (among whom I number myself), this objective / subjective inquiry, if indeed conjunctive, may be analogized to the relief from the substantial understatement penalty for tax shelter transactions if the taxpayer had a belief that the transaction will more likely prevail and the belief is objectively reasonable.) The courts in the civil cases are split on that conjunctive / disjunctive issue for the economic substance test.

To state the obvious, criminal cases are not civil cases and different policies are implicated that requires some role reversal. The criminal case asks whether the Government has proved beyond a reasonable doubt that the civil tax result is certain and was willfully violated. Accordingly, in instructing the jury, as he should in a criminal case, Judge Kaplan adopted the most defendant friendly version of the split – that is, he advised the jury that the Government had to both that there was no taxpayer profit or business objective and no reasonable profit or business objective. I have doubts about turning over the economic substance test under either formulation to a jury in a criminal case, but if it must be turned over (and Second Circuit authority says it must), I think Judge Kaplan made the right choice by requiring the conjunctive application of the test. (It is important at this stage to note that the Government argued to Judge Kaplan that the jury should be instructed in the disjunctive – i.e., the jury can convict if either (i) under the subjective prong, the Government proved beyond a reasonable doubt that the taxpayers involved had no profit or business motive, or (ii) under the objective prong, the Government proved beyond a reasonable doubt that there was no possibility – or, in the Government’s mind reasonable possibility -- of profit; that notion is just goofy in a criminal case, but I won't digress further here.)

I want to return shortly to the subjective prong that, in my view, was transformed in this case to an objective inquiry (although I will continue to call it the subjective prong in order to differentiate it from the subpart of the economic substance test that really is supposed to be objective). As to the objective prong, the parties dispute at length in their brief as to whether the possibility of profit is limited by the adjective “reasonable.” I think much of this discussion is semantics echoing Bill Clinton’s famous line – “It depends on what the meaning of the word 'is' is.” (In this semantical game, the Government easily sets up a strawman only to knock it down.) I don’t want to enter that fray right now, but I want to return and address the so-called subjective prong of the economic substance test as it played out in the case.

Let’s go back to the test. It is supposedly an inquiry into the subjective thinking of the taxpayer(s) involved. And, the test as formulated is not an objective test; so long as the taxpayer(s) involved had a subjective profit motive, regardless of how unreasonable it may have been, the tax shelter passes this leg of the economic substance test in a civil case.  Transforming this test to a criminal setting, the Government would have to prove that the taxpayer(s) involved in the counts of conviction had no actual intent -- even if the intent were unreasonable.

As I shall note, at best at least for the absent, nontestifying taxpayers in the counts of conviction, all the Government may have proved beyond a reasonable doubt was that it may have been unreasonable for them to have a profit or business motive, but that is not the same as prove beyond a reasonable doubt that they did not have the motive.

I have asked before how the Government can make that stringent level of proof, at least as to taxpayers as to whom there was no evidence other than the fact that they claimed benefits alleged in the counts of convictions. These taxpayers did not testify and the Government introduced no evidence going to their actual intent. Judge Kaplan and the jury were left to infer that the taxpayers had no such intent solely from the objective evidence of their involvement and the further proof that Government had proved objectively that the shelters could not produce a profit (or at least a reasonable prospect of producing a reasonable profit). The net result is that, in my mind, the court and the jury just conflated two separate tests and turned them into a single objective test -- if the shelter transaction is objectively unreasonable, the presumption is that the taxpayers acted as reasonable persons and thus did not have the intent. This was virtually an irrebutable presumption becuase the taxpayers had no practical ability to prove what the taxpayers might have intended or to otherwise attack the presumption thus raised by the Government in meeting the objective prong of the test.

I ask this simple question: would the proof adduced at trial as to the absent taxpayers have alone sufficed in criminal prosecution of those taxpayers to prove beyond a reasonable doubt that they had no profit or business motive? Does that evidence prove beyond a doubt that the taxpayers could not have been mistaken? In a criminal prosecution of the taxpayers themselves, the Government would have proved a host of facts about the individual taxpayers (education, business savvy, etc.) that would have offered some basis to reasonably infer whether the taxpayers had the actual intent, however unreasonable, or not. At best, all the evidence proves -- perhaps even proves beyond a reasonable doubt -- is that a reasonable taxpayer would have had no such subjective profit motive. The test, however, is not a reasonable one but a subjective one testing whether the taxpayer actually had such intent regardless of whether it was reasonable or not.  (Certainly a diversion to my main point, but the even more startling thing here is that a necesssary conclusion from the Government's arguments is that it in fact proved beyond a reasonable doubt that they taxpayers themselves committed tax evasion, even though they were given no opportunity to defend themselves.)

Sure, Judge Kaplan mouthed the right words – the test is the intent of the taxpayers without qualifying whether it should be reasonable intent, but in the final analysis the jury had no specific evidence of the taxpayers’ intent and were left to conclude only that the taxpayers must not have had the intent because no reasonable taxpayer could have had such an intent. That is an objective test in the guise of a subjective one.

And, of course, the Government knows that it skirted the subjective nature of the subjective prong (that second subjective is not redundant here). I won’t pull out all the points in the brief where the Government fudges on this issue. But you can clearly see the bootstrap with reference to the Gibson Dunn memo. Gibson Dunn, a law firm, was engaged or more taxpayers to opine about the transaction. Gibson Dunn had some doubts and evidenced those doubts in a memo that the defendants were aware of contemporaneously. Notwithstanding Gibson Dunn’s concerns in the memo, some of the Gibson Dunn clients allegedly invested. The Government cites (br. 41-42) that memo as proof that the taxpayers’ “lack of a nontax motive was unquestionable.” I fail to see the logical connection there. I don’t think that the Government ever proved that each of the absent taxpayers in the counts of conviction ever read the memo. But even more breathtaking in its gall, is the Government’s claim that it is entitled to send people to jail on the assumption that the clients have to subjectively believe the same thing as a lawyer whose advice they did not follow. That is not the stuff, in my mind, of criminal tax cases.

The tragedy of all this, in my mind, is that, if these defendants were guilty of some conduct for which criminal penalties are appropriate, the Government had plenty of tools to do it. Tax perjury, aiding and assisting, tax obstruction and even the Klein defraud conspiracy (oops, that's right the jury acquitted on that charge). According to the Government's claims in the briefs, the transactions were laced with lies and pretenses which could have easily been the proper fulcrum into one or more of the other tax crimes with penalties that would have produce ample incarceration periods for the gravity of the claimed misconduct, but the Government chose to make multiple evasion claims that, in my judgment, are seriously questionable.

That is the thread of my argument. Maybe I’ll write more on it in another forum, but it tests the limits of what I imagine is appropriate for a blog.

Epic Tales - the Government Brief in KPMG Criminal Case and Uncertainty in the Law

The Government's long awaited epic (209 pages to conclusion) brief to the Second Circuit in the KPMG criminal case is now out. Readers of the blog may review and download it here.

There is a lot in the brief. I quickly spotted length and healthy doses of what appears to be both wheat and chaff. I also found many rhetorical flourishes (probably chaff, but making for a good read to grab interest).  I am not yet certain whether the rhetorical flourishes have much substance, but that is beyond my pay grade anyway.

I did find one Government claim in the brief with hyperbole and error. The claim is (pp. 103-104):

Larson concedes that the trial evidence sufficed to demonstrate that he “subjectively did not believe that the BLIPS transaction had a ‘reasonable possibility of profit.’” (Larson Br. 16). He contends, however, that this concession is of no moment — that the jury, instructed as it was on “willfulness,” was nonetheless not entitled to find that he intentionally evaded taxes because his subjective intent to intentionally violate the tax laws was irrelevant. Larson asks this Court to hold that “as a matter of law. . . a defendant cannot intentionally violate a known legal duty if the substance of that duty would have been objectively unclear to a fully informed lawyer or judge at the time.” (Larson Br. 16, 38 emphasis added); see also Pfaff Br. 29-30; Ruble Br. 25-26). According to the defendants, the economic substance doctrine was sufficiently murky at the time of their conduct, objectively speaking, to foreclose willfulness.

Put simply, the defendants argue that the fact that they intentionally broke the law and knew that they were intentionally breaking the law — facts that the jury found beyond a reasonable doubt — are irrelevant, because in 1999 other people might not have known that their conduct was against the law. This breathtaking argument confounds law and common sense. This precise claim has been rejected by this Court and is hence foreclosed.

 I think that Government's claim is just flat out wrong. I have previously discussed this issue both in my book (pertinent portions here) and in some blogs here, so will not repeat the details. I just summarize my claim of hyperbole and error.

In James v. United States, 366 U.S. 213 (1961), the Supreme Court held that legal uncertainty -- i.e., actual uncertainty in the state of the law -- is a bar to prosecution for a tax crime which requires willfulness. In James, the defendant had been prosecuted and convicted, meaning that the jury had determined that he had intended to violate a known legal duty. The problem was that he only thought he knew the law he intended to violate. The Supreme Court held that, regardless of his intent to violate the law, the law in question was legal sufficiently uncertain that James could not be convicted regardless of his intent. 

That is pretty much it.  (The summary is heavily dependent upon understanding the intramural dispute among the Justices evidenced in the various opinions in James, so that is the best place to start.)

The Government's only reference to James is on page 109 to the fact that defendants cite the case and some notion that it is "nothing like this case" because it involved ambiguity "from dueling Supreme Court opinions, which were directly in conflict on the specific tax question at issue in that case."  The Government does not explain and I cannot fathom how the principle of James that uncertainty in the law is a legal barrier to prosecution and conviction is a special rule requiring uncertainty caused by the Supreme Court.  The issue is one of certainty in the law such that a citizen can be criminally prosecuted and proper notice to all citizens; that not dependent upon the Supreme Court's failings or timidity.

Unthinking Criminality - Where is the Line?

Thanks to the Tax Prof Blog, I picked up this article written by prolific tax lawyer and author, Robert W. Wood. The Article is "Ten Ways to Audit Proof Your Return" (published online by Forbes)

The strategies offered by Mr. Wood are variations on a theme I discuss in a recent article, John A. Townsend, Tax Obstruction Crimes: Is Making the IRS's Job Harder Enough, 9 Hous. Bus. & Tax. L.J. 255 (2009). Some of these strategies I present in more detail in the online appendix to the article.

The issue is whehter a tax obstruction crime exists when a taxpayer performs an otherwise legal act (illustrated by the strategies in Mr. Woods' article and in my article and appendix) with the intent to impair or impede the IRS's administration of the tax laws? Are Mr. Woods' and my examples which are specifically intended to lower the audit profile examples of conduct that should be subject to criminal punishment? Can readers discern a line between such conduct that is criminal and not criminal? Keep in mind that a bedrock principle of the tax law and other types of related crimes is that a hypothetical reasonable actor should be able to discern the line with clarity, otherwise there can be crime. If there is no discernable line, is there only prosecutorial discretion that keeps practitioners (including Mr. Wood and myself) who have engaged in variations on this theme over the years from prosecution? And, finally, would the courts cry foul as did Judge Kozinski in the Caldwell case?

I'll let my readers chew on those questions. I have already spoken ad nausuem. I would appreciate the readers' responses.

Have a great weekend!

Uncertainty in the Law and Willfulness

In an article in today's New York Times here, Adam Liptak discusses Justice Scalia's dissent from denial of certiorari in Sorich v. United States, 129 S.Ct. 1308 (2009). Justice Scalia's lament is that the "honest services" crime does not provide an intelligible standard for criminal conduct. This theme is presented in the tax cases from James forward requiring a knowable law for tax crimes. Since the tax law requires willfulness, defined as the intentional violation of a known legal duty, then the legal standard must be knowable so that the defendant -- any defendant, even the hypothetical reasonable defendant -- charged with the crime must be able to ascertain the legal standard in order to intend to violate the standard.

Mr. Liptak notes with respect to "honest services" that "If you can make sense of that phrase, you have achieved something that has so far eluded the nation’s appeals courts." As a result, it is fair to say that citizens cannot ascertain the legal standard with any certainty and, correspondingly, judges and juries cannot predictably hold them to that uncertain standard. This phenomenon, Justice Scalia notes, violates fundamental constitutional principles, and gives the prosecutors too much unchecked power to pick and choose their defendants in a wide swath of conduct. Liptak notes:
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Certainty of the Law's Command and Willfulness

In my last blog here, I concluded as follows:

In this proposed instruction, the court pre-empts the issue of uncertainty in the law. Once the court finds the uncertainty in the law, then, as in James, any conviction based on the defendant’s intent to violate the law is irrelevant. (I will discuss this aspect of James in my next blog.)

The James point is that, if the law is uncertain in some objective sense, the defendant can have the blackest, darkest, most evil specific subject intent to violate the law, and that will be irrelevant. Anglo-American jurisprudence simply does not permit convictions for evil intent alone. The following is from my recent article (John A. Townsend, Is Making the IRS's Job Harder Enough?, 9 Hous. & Bus. Tax L.J. 260, 263-4 (2009)):

In its third meaning - i.e., in the Cheek meaning applicable to substantive tax crimes generally [that the defendant know the law and intend to violate it] - the requirement of willfulness has both objective and subjective components. 47 Objectively, as a matter of law, the law's command must be knowable - the law's command is sufficiently certain that it is capable of being known by a citizen. 48 Subjectively, the defendant must have actually known the rule and have intended to violate it. 49

The objective component invokes the court's function to determine whether the law is sufficiently certain that it sets an appropriate standard to guide and judge conduct where the law requires that the defendant know that he or she is violating the law. If it does not, then even if the defendant clearly intended to violate some law that he mistakenly thought was certain, he cannot be tried for it. 50

n47. See supra note 46 and accompanying text.
n48. See, e.g., United States v. Pirro, 212 F.3d 86, 91 (2000) ("Because only willful conduct is criminal under § 7206 and because willfulness requires a voluntary intentional violation of a known duty, the duty involved must be knowable.") (internal quotations omitted); see also James v. United States, 366 U.S. 213, 224, 82 S. Ct. 1052, 1058 (1961) (describing what a "knowable" legal duty is); United States v. Critzer, 498 F.2d 1160, 1162-63 (4th Cir. 1974); Garber v. United States, 607 F.2d 92, 97-98 (5th Cir. 1979) (en banc); United States v. Dahlstrom, 713 F.2d 1423, 1428 (9th Cir. 1983), cert. denied, 466 U.S. 980 (1984); United States v. Mallas, 762 F.2d 361, 363 (4th Cir. 1985); United States v. Harris, 942 F.2d 1125, 1131 (7th Cir. 1991). Uncertainty of the law's requirements, often the by-product of tax law complexity and ambiguity, can defeat willfulness as a matter of law. See, e.g., Harris, 942 F.2d at 1131. The civil penalty regime of the tax law includes concepts for analysis in dealing with uncertainty in the law. The tax world deals daily with concepts such as frivolous, non-frivolous but not reasonable, reasonable basis, substantial authority, more likely than not, should, will or what have you. See infra note 75. By analogy to the willfulness requirement of the criminal tax laws, only the frivolous position would seem to support an environment where, as a matter of law, the taxpayer or the practitioner could be willful. This knowability standard is closely related to the rule of lenity, discussed below. See infra Part VII.
n49. See Cheek, 498 U.S. at 201; Bryan, 524 U.S. at 193-94.
n50. This point is established by the majority, concurring, and dissenting opinions in James v. United States, 366 U.S. 213, 221-22, 224-25, 246 (1961), a tax evasion case. After trial, the jury found the defendant guilty, which necessarily meant that the jury found he intended to violate the tax law. Id. The Supreme Court said that the law was sufficiently uncertain that a defendant could not be held to the standard even if he may have intended to violate the law. Id.

New Tax Shelter Enabler Indictments - More About the Lie

On June 4, 2009, the Federal District Court in Seattle unsealed a previously sealed indictment of certain Quellos-related individuals. A Wall Street Law Blog article is here, and the indictment is here. Quellos was a bona fide investment company that got in the tax shelter business. The indictment contains the same pattern as the KPMG related indictment -- (1) conspiracy as the ubiquitous Count One and 8 Counts of Tax Evasion. But the indictment and goes beyond that pattern to add 3 counts of wire fraud and one count of money laundering conspiracy. Wire fraud and money laundering conspiracy often accompany traditional tax crimes (including the general defraud conspiracy), but are not often charged together in the same indictment. See Tax Division Directive No. 128. And, such piling on of charges addresses a concern that Congress recently stated in FERA (see the prior discussion here)).

I focus in this blog not on the charging decisions (how many crimes can a creative prosecutor imagine and charge), but rather upon the basic pattern of conduct that is reported to be behind the indictment. I have previously discussed here the common feature -- the lie -- of tax shelter crimes. See prior blogs here and here. If tax shelter crimes are really about the lie, who is the target of the lie? It is not a lie unless it is told to someone who might rely upon the lie. Let's take the quintessential lie that the Government claims in tax shelters -- that the taxpayer has a business or profit motive independent of the tax benefits. The lie is intended for IRS consumption to distract the IRS from the truth -- no profit motive and no right to the tax benefits claimed. In all events, it is imagined, the lie might avoid penalty relief if all else fails. The lie is also intended for persons in the tax shelter chain who might not know the truth otherwise and relies upon the lie as truth as a condition to their participation in the chain.

The WSJ Law Blog today asks the question of whether attorneys for the taxpayers entering Quellos shelters were also the intended targets of such lies in order to give them the comfort they needed to, in turn, give the taxpayers whatever comfort they needed. In other words, in the simple example posited above, the lie about the intended business or profit motive might be required for the taxpayers' lawyers to bless the deal. That is the focus of the WSJ Law Blog discussion.

But in the simple example I posit, what lie is being told? It is true that in these deals, the promoters require the taxpayer to make the independent business or profit motive representation. But who is making the representation? It is the taxpayer. The taxpayer has the relationship with his own counsel -- i.e., the taxpayer's lawyer is not in bed with the tax shelter promoters but truly an independent lawyer representing only one person, the taxpayer. The taxpayer's lawyer is supposed to understand the overall structure including any of its components relevant to the taxpayer's representation as to independent business or profit motive. If the taxpayer believes the representation and his lawyer believes that, properly counseled by that lawyer, the taxpayer believes the representation, there should be no criminal conduct on behalf of either the taxpayer or the lawyer. Of course, even if the taxpayer's lawyer believes that the taxpayer believes the representation and nevertheless, based on the lawyer'sw independent review of the structure, believes that the taxpayer is misguided as to the belief, the lawyer's job is to counsel the client that the facts do not support the belief, however sincerely held, and the taxpayer should reconsider. But, if the taxpayer persists in his belief after proper counseling, however misguided that belief may be, it is not the taxpayer's lawyer's job to call his client a lier. It is, after all, a subjective belief, and there is no litmus test of a subjective belief. (Of course, the lawyer will surely advise the taxpayer that the risk is that, if the belief is not credible, the lawyer and the taxpayer take the risk that no one -- specifically the IRS, a prosecutor or a juror -- will believe that the taxpayer really believed he had an independent business or profit motive or that the lawyer really believed that the taxpayer had that belief, and the Government may convict the taxpayer and the lawyer for hiding behind the known lie to particpate.)

As noted in the article, the taxpayers and their lawyers in the Quellos shelters have not been indicted, although they are pseudonymically identified in the indictment. In apparent explanation for why the taxpayers and their lawyers have not been indicted, a prosecutor is quoted as saying:

“It would be impossible to show that any of the taxpayers had knowledge that this was a criminal scheme,” said Mark Bartlett, an assistant U.S. attorney in Seattle. “What the evidence has shown is the lies that were told to the IRS were also told to the taxpayer, and also told to attorneys for the taxpayers.”

I am not familiar with the Quellos deals. Some do have the same acronyms of shelters I am familiar with, but my experience has been that they are variations of a common theme that I observed in other cases, particularly the KPMG indictments. In the KPMG indictments, the Government charged the promoters, but did not charge the taxpayers or their lawyers. In the particular shelters in which my client participated, the taxpayers were represented by highly competent lawyers who understood the deal and, so far as I know, were told no lies. On the business or profit motive issue, the promotoers may have made some generic general conclusions that the investment aspect of the deal was designed to permit a highly speculative profit after covering the all-in costs of the deal if some event, albeit unlikely, occurred. But the taxpayers and their attorneys and, in some cases, their financial advisors, were given the specifics of the trading strategy behind the generic general conclusions and thus were able to make their own assessments. The Government did believe that any representation of a business or profit motive could not be credibly made, but as I noted in an earlier blog I don't think the Government proved that, in fact, all of the taxpayers did not have the subjective belief, even if that belief was not justified. So, where was the lie, unless the promoters knew that the taxpayers were subjectively lieing, in which case their attorneys probably knew also or certainly should have known that their clients were lieing. In other words, the promoters could and did not make the representation that the Government claims is false; only the taxpayers could do that. Of course, if the promoters lied to the taxpayers about the potential for risks and rewards in the underlying investment program (e.g., in the case of BLIPS, if the promoters had assured the taxpayer that the chance of the Argentinan peg breaking being 50% rather than minor), that could be a problem for the promoters, but so far as I am aware in the KPMG deals there were no such lies told by the promoters. All of the taxpayers and their advisors (lawyers and financial advisors) knew the risks and the potential for reward and on that basis made their own independent determination of whether that permitted the taxpayers to represent that they had an independent business or profit motive.

And, to close the loop, if it is the lie that is really involved, people of reasonable intelligence and experience should be able to recognize the lie. If that is true, the taxpayers and their advisors (both lawyers and financial advisors) should have recognized the lie and the Government should be able to prove it. Yet the quote above from the Quellos prosecutor indicates that the Government knows it cannot prove the lie -- the taxpayer's own representation -- that was the central feature of all the Government imagines is bad about these shelters.

The underlying problem, I think, is that no one really knew the precise paramaters of the business or profit motive requirement. Did it mean a certain threshold probability over covering the all-in costs and have some profit potential beyond that? Does one who "invests" in a lottery ticket have a profit motive? Does the profit motive play in the deal have to relate directly to the tax play that produces the shelter? (For example, in some of the shelters, the investment aspect was really separate from the tax play, often based on Helmer, producing the shelter.) So different taxpayers even being counseled by competent lawyers and advisers might indeed reach a conclusion that, while not acceptable to the prosecutors, really was their conclusion based on the independent advice they received from their highly competent lawyers and, in some cases, independent financial advisors.

I hope that readers will also see in this level of confusion / uncertainty about the law's commands issues related to the certainty required in the law to set the legal duty (a la James/Critzer/Garber/Dahlstrom/Pirro), as well as issues of Cheek willfulness.