Bradley S. Waterman

Miscellaneous Tax Controversies

The firm served as special tax counsel in connection with litigation throughout the U.S. relating to the taxation of "modern" long distance service. The Internal Revenue Code provides that taxable long distance service is service the charges for which are based on the elapsed transmission time of calls and the distance between the parties to calls. The issue was whether "modern" long distance service the charges for which are based solely on elapsed transmission time, and not distance, is subject to Federal excise tax. We worked with telecommunications lawyers whose large corporate clients sought refunds of tax paid with respect to "modern" long distance service. As a consequence of our team's success in litigation, the Federal government conceded that "modern" long distance service is not taxable and refunded tax paid by our clients and millions of other taxpayers. With regard to appellate decisions, see American Bankers Insurance Group v. U.S., 408 F.3d 1328 (11th Cir. 2005), Fortis, Inc. v. U.S., 447 F.3d 190 (2nd Cir. 2006), OfficeMax, Inc. v. U.S., 428 F.3d 583 (6th Cir. 2005), and Reese Brothers, Inc. v. U.S., 447 F.3d 229 (3rd Cir. 2006).

Client 1 is a U.S. based multi-national corporation with approximately $4 billion of annual sales. Client 1 obtained a refund of $2.4 million of overpaid deficiency interest. The government contended that the statute of limitations limited Client 1's entitlement to $1.4 million, and it initiated erroneous refund litigation for the extra $1 million in a U.S. District Court. We represented Client 1 in the litigation. While preparing the case, we discovered that Client 1 was owed an additional $2 million. Although the government initially contended that refund of the additional $2 million was barred by the statute of limitations, it conceded the case based upon our motion for summary judgment, with the result that Client 1 kept the $1 million initially at issue and received an additional refund of $2 million.

Client 2 is a qualified profit-sharing trust. The IRS proposed to disqualify the trust and to impose income tax on the trust and income tax and prohibited transaction excise tax on its beneficiaries. The taxes, interest, and penalties asserted by the IRS aggregated approximately $10 million. We settled the case for approximately $95,000.

Client 3 invested in computer leasing tax shelters. Client 3 reported substantial tax benefits from these shelters for several years, and in later years reported and paid tax on "turnaround" income realized when the shelters "burned out." The IRS disallowed the tax benefits claimed by Client 3, who challenged the disallowance in the U.S. Tax Court. The Tax Court held for the government, with the result that Client 3 owed approximately $5 million in tax, interest, and penalties. However, the IRS neglected to take certain required steps, and as a result, assessment and collection of the liability were time-barred.

We represented Client 3 before the IRS Appeals Division ("Appeals") in his attempt to obtain refunds of the tax paid on the "turnaround" income. The Appeals officer to whom the case was assigned initially (and understandably) refused to allow the refunds. He observed that as a consequence of the IRS' mistake Client 3 enjoyed the full benefit of the tax shelters, and he contended that it would be inequitable to refund the "cost" of the benefit, namely the tax paid on the "turnaround" income. We settled the case on a basis that resulted in full refunds with interest (significantly in excess of $1 million).

Client 4 is a U.S. company that was wholly-owned by a large foreign manufacturer and that incurred substantial net operating losses. Client 4's parent sold all but a small portion of its stock to an unrelated party. Under the Internal Revenue Code, the change of ownership triggered a significant reduction in Client 4's loss carryovers. The IRS commenced an audit of related party transactions involving Client 4, its former parent, and other affiliated companies. We persuaded the IRS that the maximum possible adjustments simply would decrease client 4's loss carryovers and that the audit could not generate any additional tax revenue. The IRS dropped the audit.

Client 5 is a U.S. distributor that is wholly-owned by a large Japanese manufacturer. Client 5 and its subsidiaries were under audit continuously for 13 years. The audit focused principally on prices paid for products by the distributor to its foreign parent. Our team's work consisted of audit defense before the IRS Examination Division, proceedings before Appeals, and competent authority proceedings (government-to-government negotiations intended to avoid double taxation).

We negotiated an advance pricing/record-keeping agreement on behalf of Client 5. The agreement was designed to satisfy both the IRS and the Japanese tax authorities, and in particular, to avoid an on-going dispute between the U.S. and Japan regarding the application of the arm's-length standard in transfer pricing cases.

The IRS accepted, with only minor changes, our proposed transfer pricing methodology and comparables. Japan accepted a gross profits range that resulted from the application of our proposed methodology. As a consequence, 14 taxable years were closed without adjustment.

Criminal and Civil Tax Penalties and Other Criminal Matters Back to top

Client 6 is a regional airline that compromised its outstanding tax liabilities using funds generated from a private placement. Client 6 was preparing for a second private placement when its chief financial officer revealed that he had caused the client to file fraudulent tax returns and to underpay its taxes for various periods, some of which were covered by the prior compromise. We made a voluntary disclosure to the IRS Criminal Investigation Division on behalf of Client 6, thereby eliminating the risk of criminal prosecution. In addition, we persuaded the IRS Collection Division to refrain from enforced collection activities pending completion of our internal investigation; to allow the prior compromise to stand; to accept only $80,000 in full satisfaction of the liabilities not covered by the prior compromise (approximately $2 million); and to abate outstanding assessments and forego additional assessments against the client's officers (the taxes were "trust fund" taxes for which the officers were personally liable).

Client 7 is a successful businessman and public figure who was investigated for criminal tax violations by IRS Criminal Investigation Division and a Federal grand jury. Client 8 is a prominent research scientist who also was investigated for criminal tax violations by IRS Criminal Investigation Division. We successfully handled all aspects of these clients' defenses.

Client 9 claimed a $9 million loss from a business transaction based on the advice of a prominent tax lawyer in his community. Several years later, following an investigation by the IRS Criminal Investigation Division and the U.S. Department of Justice, the lawyer pled guilty to a charge that was based on his advice to various taxpayers that they were entitled to and thus should claim losses and deductions to which they clearly were not entitled. The IRS believed that client 9 knew that he was not entitled to the $9 million loss. Although the IRS believed that client 9 committed tax fraud in claiming the loss, it determined that it would have difficulty proving fraud because of the involvement of the lawyer. Consequently, it sought a penalty of approximately $1 million based on the client's alleged disregard of rules and regulations. We represented the client in litigation before the Tax Court. We persuaded the IRS that the client relied in good faith on the lawyer, and in particular, that the lawyer's advice that he was entitled to the loss was not "too good to be true." The IRS conceded that he should not be penalized.

Tax-Exempt Bonds Back to top

We have represented issuers of tax-exempt bonds, conduit borrowers, investment banking firms, law firms, and others before the IRS Tax-Exempt Bond function ("TEB"), Appeals, and the IRS Office of Chief Counsel in connection with dozens of examinations by TEB of tax-exempt bond issues and related matters. We also have represented issuers who sought to resolve issues with TEB pursuant to its Voluntary Closing Agreement Program and issuers and others before the Department of Justice, the Securities and Exchange Commission, and the Bureau of the Fiscal Service of the Department of the Treasury in connection with tax-exempt bond matters and related matters.

We discovered in connection with the representation of our first client – a school district finance cooperative – that the examination guidelines pertaining to tax-exempt bonds excluded Appeals from the process. This was surprising – in nearly all cases, a taxpayer is entitled to review by Appeals of an adverse determination made by an IRS examination function. In this regard, Appeals is independent of the IRS examination functions, including TEB. Its mission is take a "fresh look" at cases and to settle based on the hazards of litigation. We determined that the exclusion was intentional, not an oversight. We brought this to the attention of Appeals personnel, who persuaded senior IRS personnel that issuers should have access to Appeals. At the same time, our client sought legislation that would have entitled issuers to contest adverse IRS determinations in court. Although the legislation was not enacted, the Internal Revenue Service Restructuring and Reform Act of 1998 instructed the IRS to provide for Appeals review and thus "confirmed" the prior decision of senior IRS personnel to allow such review.

Matters have included examinations of:

• deals involving derivatives and other financial products and rights, including put options, forward float agreements, call rights, repurchase agreements, and reverse repurchase agreements;
• solid waste recycling deals;
• solid waste and sewage disposal deals;
• blind pool deals;
• other private activity bond deals, including healthcare deals, manufacturing facility deals, higher education deals, and a charter school deal;
• deals involving alleged yield burning via defeasance portfolios, float rights, escrow reinvestment rights, swaps, etc.;
• 63-20 financings;
• Indian tribal bonds;
• zero coupon bonds;
• tax and revenue anticipation notes;
• law firms and others pursuant to section 6700 of the Internal Revenue Code (the tax shelter promoter penalty);
• a financing of a continuing care retirement community — the IRS contended that revenue, including resident deposits, pledged pursuant to a general revenue pledge constitutes replacement proceeds the investment of which must be yield-restricted;
• Build America Bonds;
• prison/jail bonds;
• Midwest Disaster Area Bonds;
• student loan bonds/loan swapping; and;
• State and Local Government Series Securities trading strategies.

Clients have included:

• issuers — the Agua Caliente Band of Cahuilla Indians (California), Breckinridge County (Kentucky), the Capital Projects Finance Authority (Florida), the County of Clinton (Ohio), the County Commission of Pleasants County (West Virginia), the County of Henderson (Kentucky), the Davis School District (Utah), the East Bay Delta Housing & Finance Agency (California), the Forest Preserve District of DuPage County (Illinois), the Harrisonburg Redevelopment and Housing Authority (Virginia), the Hazleton Area School District (Pennsylvania), the Health, Educational and Housing Facilities Board of the County of Knox (Tennessee), the Health and Educational Facilities Board of the Metropolitan Government of Nashville and Davidson County (Tennessee), the Kentucky Economic Development Finance Authority, the Mid-Bay Bridge Authority (Florida), the Montana Facility Finance Authority, the Orange County Health Facilities Authority (Florida), the Payne County Economic Development Authority (Oklahoma), Pendleton County (Kentucky), the Port of Walla Walla Public Corporation (Washington), the San Diego Area Housing & Finance Agency (California), the Spokane Downtown Foundation (Washington), the Toledo - Lucas County Port Authority (Ohio), the Utah School District Finance Cooperative, the Water Reclamation District of Greater Chicago (Illinois), the West Contra Costa Unified School District (California), and the West Virginia Hospital Finance Authority.
• conduit borrowers — The Dow Chemical Company, Missions United, Inc., Norton Healthcare, Inc., Oklahoma State University, Paxar Corporation, Pratt Industries (USA), Inc., and The Timken Company.
• investment banking firms — Ferris, Baker Watts, George K. Baum & Co., and Herbert J. Sims & Co., Inc.
• various law firms.
• others — Greenbrier Corporation (Texas), the Kentucky Association of Counties Advance Revenue Program, the Kentucky Association of Counties Leasing Trust, the Kentucky Hospital Association, the Tennessee Hospital Association, and the Tennessee Municipal Bond Fund.

Native American Tribes and Tribal Members Back to top

We served as tax counsel to the Saint Regis Mohawk Tribe for 14 years. We also served as the Tribe's outside general counsel for approximately 7 years.

Our work on behalf of the Tribe included negotiations and litigation before the U.S. Supreme Court and other courts relating to attempts by New York State to prevent the sale within the Tribe's territory of untaxed cigarettes and fuel by Tribal retailers to non-natives. The retail business was and remains a cornerstone of the Mohawk economy. Moreover, it generates license fees for the Tribe that are the principal source of the Tribe's revenue (other than Federal grants and gaming revenue) and that are critical to the Tribe's exercise of its governmental functions.

In this regard, we designed and implemented the Tribe's license fee regime, and we were responsible for enforcement of that regime during the early years.

We successfully represented the Tribe before the IRS in connection with an attempt to impose income tax on off-territory income. This was the lead case in the U.S.

We successfully represented the Tribe in proceedings relating to an attempt by the IRS to hold the Tribe liable for the failure of the operator of its on-territory high stakes bingo game to collect back-up withholding tax from winners.

Many members of the Tribe refuse to pay Federal income, payroll, and excise taxes with respect to activities conducted within the boundaries of the Tribe's territory on the grounds that the taxing jurisdiction of the U.S. does not extend to these activities. As part of our work on behalf of the Tribe, we represented these individuals before the IRS.

Significant Non-Tax Matters Back to top

We represented the Saint Regis Mohawk Tribe in a dispute against the U.S. Bureau of Indian Affairs (the "BIA") over its failure to accept the results of Tribal referenda and elections relating to the Tribe's form of government and leadership, i.e., core sovereignty issues. We served as lead counsel in administrative proceedings before the BIA and the U.S. Department of the Interior Board of Indian Appeals. In our capacity as the Tribe's general counsel, we supervised and otherwise participated in litigation that resulted in the BIA's reversal of its position following a ruling by a U.S. District Court that the BIA acted arbitrarily, capriciously, and contrary to law and a finding by the court that the BIA was "derelict" and "disingenuous at best." See Ransom v. Babbitt, 69 F.Supp.2d 141 (D.D.C. 1999).

We served as lead counsel to the Tribe in connection with negotiations with the Federal government and New York State relating to an $830 million off-reservation casino/hotel project, resolution of the Tribe's land claims, and other matters. We also served as lead counsel in negotiations with the Tribe's partner, the gaming company that owned the Caesars Palace properties, the Hilton gaming properties, and other casino-hotel properties. We supervised a team that consisted of litigators, environmental lawyers and consultants, gaming lawyers, and governmental relations specialists.

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