Alan J. Bozer and Erin C. Borek Co-Author White Collar Column in The Daily Record

White Collar Corner: Reasonable Interpretation vs. Knowing Lie

How tax fraud is enforced as a false claim in New York

As one of only two things that are certain in this world, everyone must pay taxes, and if a person fails to pay on time, he is subject to penalties and interest, even if the failure to pay was an honest mistake.

However, under a relatively new feature of the New York False Claims Act, a person (or entity) who fails to pay taxes can be liable for treble damages, civil penalties, costs, and attorneys’ fees if he knows that he is not paying his taxes properly. Under the Act, a person “knowingly” makes a false statement to the government if he has “actual knowledge of the information” or “acts in deliberate ignorance [or] reckless disregard of the truth or falsity of the information,” N.Y. State Fin. Law § 188(3)(a).

The scienter element is an important piece of establishing liability under the NYFCA, but, after a recent Court of Appeals case which addressed the NYFCA’s tax enforcement provision for the first time, it is unclear how the AG can prove this element for false statements under the tax law.

When the NYFCA was enacted in 2007, it mirrored the federal False Claims Act and specifically exempted tax fraud from its ambit. In August 2010, the New York State Legislature passed the New York Fraud, Enforcement and Recovery Act, spearheaded by then-state Sen. Eric Schneiderman, which amended the NYFCA to impose liability for state tax fraud. According to the NY AG’s Office, 30 states have false claims acts, but New York’s Act is the only one that expressly covers tax fraud, (see Press Release, N.Y. State Office of the Atty Gen., A.G. Schneiderman Announces $6.2 Million Settlement with Lantheus Medical Imaging & Bristol-Myers Squibb For Failing To Pay New York Corporate Income Taxes (Mar. 14, 2014), available at www.ag.ny.gov/press-release/ag-schneidermanannounces-62-million-settlementwith-lantheus-medical-imaging-bristol; see also Franziska Hertel, Qui Tam for Tax?: Lessons from the States, 113 Colum. L. Rev. 1897, 1915 (2013) (reviewing various states’ false claims acts as of 2013).

The NYFCA can be enforced through civil actions filed by either the AG or a local government or through a qui tam action, whereby a person or entity called a relator (or, more fondly, a whistleblower) brings the action on behalf of the government and people of the State. Relators receive up to 25 or 30 percent of the proceeds recovered, in addition to costs and attorneys’ fees.

Since the creation of the tax enforcement provision in 2010, AG Schneiderman has not hesitated to put it to use. The AG’s Office has announced the settlement of over $13 million in tax fraud cases initiated by whistleblowers under the NYFCA, with huge payouts going to the person or entity who first brought the case as a qui tam action. For example, in March 2014, the AG’s Office announced a $6.2 million settlement of a whistleblower case alleging that Lantheus Medical Imaging Inc. knowingly evaded New York state and city taxes. The whistleblower, a tax services provider, received over $1.1 million from the settlement proceeds.

In October, the New York Court of Appeals addressed this new feature of the NYFCA when it reviewed the first NYFCA tax enforcement action filed by the AG, see People v. Sprint Nextel Corp., No. 127, 2015 WL 6128709 (N.Y. Oct. 20, 2015). The relator, a limited liability company, brought a qui tam action alleging that Sprint Nextel Corporation failed to collect or to pay state sales tax on part of its monthly charges for wireless voice services. In April 2012, the AG intervened, filing a superseding complaint and converting the action into an AG civil enforcement action.

The AG asserted that Sprint knowingly filed false tax returns and intentionally avoided more than $100 million in New York sales tax obligations, see People ex rel. Schneiderman v. Sprint Nextel Corp., 41 Misc. 3d 511, 514 (Sup. Ct., New York County 2013). Sprint filed a motion to dismiss, which the Supreme Court denied. The Appellate Division affirmed, but also certified a question to the Court of Appeals, asking whether the order on the motion to dismiss was properly made.

The Court of Appeals affirmed the order, holding New York tax law imposed sales tax on the services at issue, the sales tax statute was not preempted by federal law, the NYFCA tax enforcement provision could apply retroactively, and the AG’s complaint sufficiently pleaded a cause of action under the NYFCA.

Importantly, the court addressed the “knowingly” standard of the NYFCA. Sprint asserted that its interpretation of the tax law was reasonable given the wording of the tax statute, and therefore, it could not have knowingly submitted a false record or statement, defeating a NYFCA claim. The Court responded that even if Sprint’s alleged interpretation was reasonable, it was not shielded from liability if it did not act on that interpretation, which the AG alleged in the complaint. Otherwise, a defendant could submit a claim knowing it is false, but avoid liability by arguing the claim reflected a reasonable interpretation of the requirements.

Of course, “ignorance of the law is no excuse” is an important legal principal of criminal law. The NYFCA, however, is a civil statute with a scienter element, and the court made clear that a mistake of the law can be a defense as long as the party actually acted upon a “reasonable interpretation” of that law. The court even went one step further, stating that the AG must prove (1) “that Sprint knew the AG’s interpretation of the statute was proper,” and (2) “that Sprint did not actually rely on a reasonable interpretation of the statute in good faith,” see Sprint Nextel, 2015 WL 6128709.

Interestingly, the court did not address what exactly makes the AG’s interpretation “proper” or how Sprint would “know” the AG’s interpretation met that standard. The court also did not address which of two interpretations a party can rely upon (either the AG’s or the party’s) when both interpretations are objectively reasonable, acknowledging that “notice of a contrary administrative position alone is not nearly enough to prove fraud or recklessness under the FCA,” Id. Given the recent challenge to the AG’s interpretation of New York gambling laws as it applies to fantasy sports, it seems possible that a party can purposely disregard the AG’s interpretation of the law and still avoid liability as long as the party’s interpretation of the law, upon which it actually relies, is “reasonable.”

In any event, once the case goes back to the Supreme Court, Sprint could be found liable for over $300 million under the FCA’s treble clause, resulting in the largest recovery under the tax enforcement provisions of the NYFCA so far. Even more astounding, the relator can receive up to 25 percent of that $300 million simply for being the party who filed the complaint first.

Under the NYFCA, liability exists only if the defendant knew he was doing something wrong at the time he did it, and, given the Sprint Nextel decision, liability may not exist if, at the time he did the wrong, all he knew was that he didn’t know.