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California's False Claims Act may encourage persecution of lawful tax mitigation

Tuesday, 3 September, 2019

California's state legislature is debating a Bill that would remove the “tax bar” from the state's False Claims Act (CFCA), thereby enabling lawyers to bring civil claims against taxpayers who have mitigated their tax liabilities by lawful behavior.

Other states, notably Illinois and New York, have False Claims Acts, as does the US federal government, with the laudable intention of promoting the discovery and prosecution of fraudulent behavior. But they explicitly prohibit FCA litigation in the tax context, because of the risk of abuse by “bounty hunters” or the state itself.

However, AB 1270, introduced by assembly member Mark Stone earlier this year and passed by the Assembly in late May, would amend the existing bill to remove this bar. With its declared intent of “protecting public dollars against fraud”, it lists a number of actions that would expose the actor to a CFCA lawsuit without there having been any finding of civil fraud. A taxpayer who “knowingly and improperly … decreases an obligation to pay or transmit money or property to the state or to any political subdivision” would be in violation of the CFCA.

The danger is that private plaintiffs can launch litigation under CFCA, and such a plaintiff stands to receive half the proceeds if the defendant were found to have violated the Act. This, says law firm McDermott Will & Emery, would “open the door for a cottage industry of financially driven plaintiffs’ lawyers to act as bounty hunters in the state and local tax arena.”

Moreover the stakes are high, with violators subject to treble damages (three times the amount of the under-reported tax, interest and penalties); an additional civil penalty of USD5,500 to USD11,000 for each violation; plus the legal costs of the civil action. Even worse, the CFCA has its own statute of limitations completely independent of the tax laws, allowing claims to be pursued for up to ten years after the date the alleged violation was committed.

The effect, says MWE, would be “vague accusations of non-compliance with law leading California taxpayers to be hauled into court and held hostage between an expensive legal battle and paying an extortion fee to settle the investigation and/or litigation.”

“AB 1270 threatens to open the litigation floodgates and undermine the authority of California tax administrators, instead putting tax administration in the hands of for-profit bounty hunters,” says MWE. “In countless cases in Illinois and New York, we have seen companies face False Claims Act shakedowns and be forced to pay nuisance-value settlements after the company already has been audited, has entered into settlement with the state, or when the tax statutes of limitation have long been closed. Absent amendment, AB 1270 would put every significant California taxpayer in jeopardy when the company takes a legitimate tax return position on a grey area of the state or local tax law ... Settlement agreements, voluntary disclosure agreements and audit closing agreements all would be disrupted if the Attorney General or a plaintiffs’ lawyer believes the underlying tax dispute or uncertainty is worth pursuing under the CFCA.”

Last Friday (August 30), the state Senate Appropriations Committee voted to hold the bill under submission. The amendment could yet be advanced by the Committee, in which case it will be sent to the Senate floor and then approved by the Assembly in its amended form before being sent to the state governor. There are thus plenty of opportunities for the amendment to fall, but it has the tax advice industry worried.

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