Cic Services, Llc et al v. Internal Revenue Service et al

MOTION to Dismiss

E.D. Tenn.May 30, 2017

1 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TENNESSEE NORTHERN DIVISION CIC SERVICES, LLC, et al., ) ) Plaintiffs, ) ) v. ) ) INTERNAL REVENUE SERVICE, et al., ) ) Defendant. ) _______________________________________) Case No. 3:17-cv-00110-TRM-HBG DEFENDANTS’ MOTION TO DISMISS Defendants, the Internal Revenue Service, the Department of the Treasury, and the United States, move to dismiss plaintiffs’ complaint pursuant to Fed. R. Civ. P. 12(b)(1) for lack of subject-matter jurisdiction. First, plaintiffs’ complaint is barred by the Anti-Injunction Act, 26 U.S.C. § 7421(a), and the tax exception to the Declaratory Judgment Act, 28 U.S.C. § 2201, because plaintiffs seek relief that would restrain the assessment and collection of federal taxes. Second, plaintiffs lack standing because they do not allege that they have or will participate in any specific captive insurance transactions within the scope of the challenged IRS Notices, and most of the purported harm from which they seek relief is not redressable through this suit. Third, Count II is not reviewable under the Administrative Procedure Act, 5 U.S.C. §§ 701 et seq., because the United States has not waived sovereign immunity for challenges to the Internal Revenue Service’s exercise of enforcement discretion to designate potentially tax-avoidant transactions as “Transactions of Interest.” Fourth, the Court lacks jurisdiction to grant relief under the Congressional Review Act because, by its terms, that statute does not constitute a jurisdictional grant and does not contain a waiver of sovereign immunity. Case 3:17-cv-00110-TRM-HBG Document 25 Filed 05/30/17 Page 1 of 3 PageID #: 454 2 The government also moves to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6) for failure to state a claim for relief. Counts I and IV fail to state a claim for relief because it is undisputed that the IRS released the Notices using the procedures set forth under the governing statutory and regulatory framework. Count II should be dismissed because it is undisputed that captive insurance transactions have a potential for tax avoidance or evasion. Count III should be dismissed because the Congressional Review Act does not provide for a cognizable claim. This motion is supported by the attached memorandum and the proposed order. DATE: May 30, 2017 Respectfully submitted NANCY S. HARR Acting United States Attorney DAVID A. HUBBERT Acting Assistant Attorney General /s/ Richard J. Hagerman RICHARD J. HAGERMAN NY Bar 5113303 KYLE L. BISHOP Trial Attorneys, Tax Division U.S. Department of Justice P.O. Box 227 Washington, D.C. 20044 202-616-9832 (v) 202-514-6866 (f) Richard.J.Hagerman@usdoj.gov Kyle.L.Bishop@usdoj.gov Case 3:17-cv-00110-TRM-HBG Document 25 Filed 05/30/17 Page 2 of 3 PageID #: 455 3 CERTIFICATE OF SERVICE I hereby certify that on this 30th day of May, 2017, I electronically filed the foregoing document with the Clerk of Court using the CM/ECF system, which will send notification of such filing to counsel of record. /s Richard J. Hagerman RICHARD J. HAGERMAN Trial Attorney United States Department of Justice, Tax Division Case 3:17-cv-00110-TRM-HBG Document 25 Filed 05/30/17 Page 3 of 3 PageID #: 456 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TENNESSEE NORTHERN DIVISION CIC SERVICES, LLC, et al., ) ) Plaintiffs, ) ) v. ) ) INTERNAL REVENUE SERVICE, et al., ) ) Defendants. ) _______________________________________) Case No. 3:17-cv-00110-TRM-HBG MEMORANDUM IN SUPPORT OF THE DEFENDANTS’ MOTION TO DISMISS Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 1 of 31 PageID #: 457 i I. BACKGROUND .................................................................................................................... 3 A. Statutory and Regulatory Background ............................................................................ 3 B. IRS Notices 2016-66 and 2017-08 ..................................................................................... 3 C. The Instant Litigation ........................................................................................................ 5 II. ARGUMENT ......................................................................................................................... 6 A. The Court Should Dismiss the Complaint for Lack of Subject Matter Jurisdiction ... 6 1. Standard of review for 12(b)(1) Motion ........................................................................... 6 2. The Anti-Injunction Act and Tax Exception to the Declaratory Judgment Act Deprive the Court of Subject-Matter Jurisdiction ................................................................................. 7 3. On its Face, the Complaint Does not Establish Article III Standing .............................. 10 4. There Are No Judicially-Manageable Standards to Review the IRS’s Decision to Designate a subset of Captive Insurance as “Transactions of Interest” ................................ 16 5. The Congressional Review Act is Neither a Jurisdictional Grant nor a Waiver of Sovereign Immunity.............................................................................................................. 18 B. Counts I and II Should Be Dismissed for Failure to State a Claim for Relief Under the APA .................................................................................................................................... 19 1. Count I Fails to State a Claim for Relief Under the APA Because the IRS Complied with the Governing Statutory and Regulatory Framework when Releasing the Notices ..... 19 2. Count II Fails to State a Claim for Relief Under the APA Because It was Rational for the IRS to Conclude that Captive Insurance Transactions Have the Potential for Tax Avoidance or Evasion ........................................................................................................... 22 III. CONCLUSION ................................................................................................................... 24 Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 2 of 31 PageID #: 458 ii Cases Allen v. Wright, 468 U.S. 737 (1984) .................................................................................................................. 14 Ashcroft v. Iqbal, 556 U.S. 662 (2009) .................................................................................................................. 11 Bennett v. Spear, 520 U.S. 154 (1997) .................................................................................................................. 10 Binno v. American Bar Ass’n, 826 F.3d 338 (6th Cir. 2016) .................................................................................................... 11 Bob Jones, 416 U.S., n. 7 .............................................................................................................................. 7 Carrier Corp. v. Outokumpu Oyj, 673 F.3d 430 (6th Cir. 2012) ...................................................................................................... 6 Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011) .................................................................................................... 8 Coyne v. Am. Tobacco Co., 183 F.3d 488 (6th Cir. 1999) .................................................................................................... 11 Crawford v. U.S. Dept. of Treasury, Case No. 3:15-cv-00250, 2016 WL 1642968 (S.D. Ohio Apr. 26, 2016) ................................ 13 Daubenmire v. City of Columbus, 507 F.3d 383 (6th Cir. 2007) .................................................................................................... 11 Daulton v. United States, 76 F. App’x 652 (6th Cir. 2003) ................................................................................................. 8 Debt Buyers’ Ass’n v. Snow, 481 F. Supp. 2d 1 (D.D.C. 2006) ................................................................................................ 8 Diamond v. Charles, 476 U.S. 54 (1986) .................................................................................................................... 10 Dickens v. United States, 671 F.2d 969 (6th Cir. 1982) ...................................................................................................... 7 Ecclesiastical Order of the ISM of AM, Inc., 725 F. 2d 398 (6th Cir. 1984) ..................................................................................................... 7 Endeavor Partners Fund, LLC v. CIR, 111 T.C.M. (CCH) 1055 ............................................................................................................. 9 Enochs v. Williams Packing & Navigation Co., 370 U.S. 1 (1962) ........................................................................................................................ 7 Ethyl Corp. v. Envtl. Prot. Agency, 541 F.2d 1 (D.C. Cir. 1976) ...................................................................................................... 23 Florida Bankers Ass’n v. U.S. Dep’t of the Treasury, 799 F.3d 1065 (D.C. Cir. 2015) .............................................................................................. 8, 9 Friends of the Earth, Inc. v. Laidlaw Environmental Services (TOC), Inc., 528 U.S. 167 (2000) .................................................................................................................. 10 Heckler v. Chaney, 470 U.S. 821 (1985) .................................................................................................................. 17 Hollingsworth v. Perry, 133 S.Ct. 2652 (2013) ............................................................................................................... 10 Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 3 of 31 PageID #: 459 iii Kemlon Prod. & Dev. Co. v. United States, 638 F.2d 1315 (5th Cir. 1981) .................................................................................................... 8 Kowalski v. Tesmer, 543 U.S. 125 (2004) .................................................................................................................. 16 Latin Americans for Soc. & Econ. Dev. v. Adm'r of Fed. Highway Admin., 756 F.3d 447 (6th Cir. 2014) .................................................................................................... 23 Latin Americans for Soc. & Econ. Dev., 756 F.2d .................................................................................................................................... 23 Lexmark Int’l, Inc. v. Static Control Components, Inc., 134 S.Ct. 1377 (2013) ............................................................................................................... 11 LNV Corp. v. Hook, 638 F. App’x 667 (10th Cir. 2015) ............................................................................................. 9 Loren v. Blue Cross & Blue Shield of Mich., 505 F.3d 598 (6th Cir. 2007) ...................................................................................................... 6 Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992) ............................................................................................................ 10, 14 Lutz v. United States, 919 F.2d 738 (6th Cir. 1990) ...................................................................................................... 8 Lynch v. Leis, 382 F.3d 642 (6th Cir. 2004) .............................................................................................. 15, 16 Madison-Hughes, 80 F.3d ...................................................................................................................................... 17 May v. United States, Appeal No. 15-16599, 2017 WL 2196755 (9th Cir. May 16, 2017) ........................................ 23 Maze v. Internal Revenue Serv., 206 F. Supp. 3d 1 (D.D.C. 2016) ................................................................................................ 8 Miller v. City of Wickliffe, Ohio, 852 F.3d 497 (6th Cir. 2017) .................................................................................................... 14 Montanans for Multiple Use v. Barbouletos, 568 F.3d 225 (D.C. Cir. 2009) .................................................................................................. 19 Moody v. Michigan Gaming Control Board, 847 F.3d 399 (6th Cir. 2017) .................................................................................................... 15 Nat’l Fed’n of Indep. Bus. v. Sebelius, 132 S. Ct. 2566 (2012) ............................................................................................................ 7, 9 Parsons v. United States Dep’t of Justice, No. 14-10071, 2016 WL 5476284 (E.D. Mich. Sept. 29, 2016)............................................... 22 Pflum v. United States, No. 99-4170-SAC, 2002 WL 1334857 (D. Kan. May 15, 2002) ............................................... 8 RYO Mach., LLC v. U.S. Dep’t of Treasury, 696 F.3d 467 (6th Cir. 2012) .................................................................................................. 8, 9 Sheldon v. Vilsack, 538 F. App’x 644 (6th Cir. 2013) ............................................................................................. 22 Sierra Club v. U.S. Fish & Wildlife Serv., 930 F. Supp. 2d 198 (D.D.C. 2013) .......................................................................................... 17 Smith v. Jefferson Cty. Bd. Of Sch. Comm’rs, 641 F.3d 197 (6th Cir. 2011) .................................................................................................... 16 Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 4 of 31 PageID #: 460 iv Stew Farm, Ltd. v. Nat. Res. Conservation Serv., 767 F.3d 554 (6th Cir. 2014) .................................................................................................... 17 Tennessee Valley Auth. v. Jones, No. 1:14-CV-356, 2016 WL 7799315 (E.D. Tenn. Mar. 22, 2016) ......................................... 18 Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310 (1985) .................................................................................................................. 23 Warth v. Seldin, 422 U.S. 490 (1975) ...................................................................................................... 11, 12, 13 Washington v. United States, No. CV 15-2360-DSF (AGR), 2016 WL 6995355 (C.D. Cal. Mar. 31, 2016) .................... 9, 10 Wayside Church v. Van Buren Cty., 847 F.3d 812 (6th Cir. 2017) ...................................................................................................... 6 Webster v. Doe, 486 U.S. 592 (1988) .................................................................................................................. 17 Statutes 26 U.S.C. § 162(a) .......................................................................................................................... 4 26 U.S.C. § 6671 ............................................................................................................................. 9 26 U.S.C. § 6707 ....................................................................................................................... 9, 21 26 U.S.C. § 7421 ......................................................................................................................... 2, 7 26 U.S.C. § 831(b) .......................................................................................................................... 4 26 U.S.C. § 6011 ................................................................................................................. 9, 17, 18 26 U.S.C. § 6111 ............................................................................................................... 11, 12, 21 26 U.S.C. § 6707A ................................................................................................................. passim 26 U.S.C. § 7601 ........................................................................................................................... 17 28 U.S.C. § 2201 ............................................................................................................................. 1 5 U.S.C. § 701 ................................................................................................................................. 1 5 U.S.C. § 702 ............................................................................................................................... 11 5 U.S.C. § 805 ............................................................................................................................... 18 5 U.S.C. § 801 ................................................................................................................................. 1 Regulations 26 C.F.R. § 1.1162-1(a) .................................................................................................................. 4 26 C.F.R. §§ 1.6011-4 ............................................................................................................ passim 26 C.F.R. § 1.6011-4(b)(2) (2003) ................................................................................................ 21 Treas. Reg. § 1.6011-4(b)(2) (2003) ............................................................................................. 20 Other Authorities IRS Notice 2017-08, 2017-3 I.R.B. 423 ......................................................................................... 5 IRS Notices 2016-66 .............................................................................................................. passim 68 Fed. Reg. 10161 ....................................................................................................................... 20 72 Fed. Reg. 43147 ....................................................................................................................... 22 H.R. Conf. Rep. 108-755 ........................................................................................................ 20, 21 Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 5 of 31 PageID #: 461 1 PRELIMINARY STATEMENT Plaintiffs CIC Services, LLC and Ryan, LLC challenge the IRS’s decision to designate a subset of captive insurance transactions as “Transactions of Interest” via IRS Notices 2016-66 and 2017-08 (“the Notices”). This designation, which reflects the IRS’s determination that such transactions have a potential for tax evasion, requires participants (and their material advisors) to disclose details about each of their transactions that fall within the scope of the Notices. The IRS is authorized to assess tax penalties against those who fail to make the required disclosures. Plaintiffs’ four-count complaint asks this Court to set aside the Notices as procedurally and substantively invalid. Count I contends that the Notices are procedurally invalid under the Administrative Procedure Act, (“APA”), 5 U.S.C. § 701 et seq., because they allegedly constitute legislative rules that were not the product of notice-and-comment rulemaking. Count II contends that the Notices are arbitrary and capricious under the APA because it was allegedly irrational for the IRS to require disclosures from advisors or participants in potentially abusive captive insurance transactions. Count III contends that that the Notices are procedurally invalid because the IRS allegedly failed to submit them to Congress and the Comptroller General in accordance with the Congressional Review Act (“CRA”), 5 U.S.C. §§ 801 et seq. Count IV requests a declaration under the Declaratory Judgment Act (“DJA”), 28 U.S.C. § 2201, that the Notices are invalid because they were not the product of notice-and-comment rulemaking. Plaintiffs request an injunction to prohibit the IRS from enforcing the Notices, with the practical effect of preventing the IRS from assessing or collecting tax penalties from participants and material advisors that do not disclose their participation in the covered captive insurance transactions. For the reasons discussed below, the Court should dismiss the complaint for lack of subject matter jurisdiction and for failure to state a claim for relief. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 6 of 31 PageID #: 462 2 The Court should dismiss the complaint for lack of jurisdiction under Fed. R. Civ. P. 12(b)(1) for at least four reasons. First, the Anti-Injunction Act (“AIA”), 26 U.S.C. § 7421, and the tax exception to the Declaratory Judgment Act withdraw jurisdiction over pre-enforcement regulatory challenges, such as this case, which would have the purpose or effect of restraining the IRS from assessing or collecting federal taxes. Second, plaintiffs lack standing because they do not allege that they have or will likely participate in any captive insurance transaction(s) that actually fall within the scope of the Notices; and much of the alleged harm from which they seek relief is not redressable through this suit. Third, the United States has not waived its sovereign immunity to permit challenges, such as Count II, to the IRS’s enforcement decision to designate potential tax-avoidance transactions as Transactions of Interest. Fourth, the Court lacks jurisdiction over Count III because, by its terms, the CRA does not grant jurisdiction or waive the government’s sovereign immunity. Accordingly, the Court should dismiss the complaint for lack of jurisdiction. Even if the Court were to exercise jurisdiction over some of the complaint, the Court should dismiss the complaint for failure to state a claim for relief. Counts I and IV fail to state a claim for relief because it is undisputed that the IRS released the Notices using the procedures set forth under the governing statutory and regulatory framework. Count II does not state a valid APA claim because it is not “arbitrary or capricious” for the IRS to designate as a “Transaction of Interest” transactions that plaintiffs admit have the potential for tax avoidance or evasion. As noted above, Count III does not state a claim for relief because the CRA does not create any legal rights on the part of the plaintiffs. For all these reasons, the Court should dismiss the complaint with prejudice for lack of jurisdiction and failure to state a claim. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 7 of 31 PageID #: 463 3 I. BACKGROUND A. Statutory and Regulatory Background1 Congress has granted the IRS broad authority to establish procedures for investigating transactions that generally are (or have the potential for being) used for the purpose of tax avoidance or evasion. See infra, Section II.B.1 (discussing 26 U.S.C. §§ 6707A, 6708, 6011, 6111 and 6112). Of relevance here, Congress empowered the IRS to create regulations for designating “Reportable Transactions,” which are transactions that must be reported to the IRS because they are “of a type which the Secretary determines as having a potential for tax avoidance or evasion.” 26 U.S.C. § 6707A(c)(1). Through notice-and-comment rulemaking, the IRS created a sub-category of Reportable Transaction known as “Transactions of Interest.” The regulations contemplate that the IRS will identify specific “Transactions of Interest” by, inter alia, notice or published guidance. See 26 C.F.R § 1.6011-4(b)(6). Under the statutory framework, this designation does not prohibit the designated transactions. Instead, the transaction’s participants and material advisors must make disclosures to the IRS. Congress authorized the IRS to assess penalties against participants (or their material advisors) for failing to file the required disclosures. 26 U.S.C. §§ 6707(a) and 6708(a) (for material advisors); 26 U.S.C. § 6707A (for taxpayers). B. IRS Notices 2016-66 and 2017-08 On November 1, 2016, the IRS released IRS Notice 2016-66, which designated a subset of so-called captive insurance transactions as a Transaction of Interest. IRS Notice 2016-66, 2016-47 I.R.B. 745, at 1-2. Captive insurers are companies whose sole purpose is to issue 1 Although the legislative and regulatory history is discussed in detail in section II.B.1, infra, a brief overview of the IRS’s process for designating “Reportable Transactions” provides helpful context. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 8 of 31 PageID #: 464 4 insurance to their parent company (or its affiliates). When a business creates a “captive” insurance company to protect against certain risks, the Internal Revenue Code permits the insured business to deduct from their income the premium payments made to the captive, thereby lowering their tax liability. 26 U.S.C. § 162(a); 26 C.F.R. § 1.1162-1(a). If the captive that receives those payments elects to be taxed under 26 U.S.C. § 831(b), it can exclude those premiums from income, which reduces the captive’s tax liability. Because the tax treatment of captive insurers departs from the traditional rule that a payment deductible by one party is includible in income by the recipient, taxpayers can derive an improper tax benefit if “the [insurance] contracts are interpreted, administered, and applied” in a manner inconsistent with the arm’s-length standard and sound business practices.2 IRS Notice 2016-66 at 1. The risk to the public fisc increases when the taxpayers that engage in such transactions can rely on the inability of the IRS to audit all taxpayers or to identify such 2 For instance, a captive insurer engaged in such a scheme might “sell” insurance to a company in eastern Tennessee that insured its offices in Johnson City against volcano damage. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 9 of 31 PageID #: 465 5 transactions from the face of an income tax return without an intrusive examination. This risk increases further when material advisors are compensated for arranging such transactions, but under no obligation to report the transactions. Through the Notices, the IRS designated a subset of captive insurance transactions as Transactions of Interest in order to “define the characteristics that distinguish the tax avoidance transactions from other § 831(b) related-party transactions.” Id. The Notices direct captives and their material advisors to disclose certain information if the captive insurance arrangement meets specific criteria, such as the ratio of the captive’s insured losses to the captive’s received premium payments, less dividends. IRS Notice 2016-66 at § 2.01. Material advisors are also required to maintain a list of clients that enter into these transactions, and penalties are imposed on those who fail to do so. 26 U.S.C. §§ 6707A and 6708. IRS Notice 2016-66 required captives and their material advisors to begin reporting on January 30, 2017. IRS Notice 2016-66 at § 3.03. However, in late 2016 the IRS extended that deadline by 90 days to May 1, 2017. See IRS Notice 2017-08, 2017-3 I.R.B. 423, at § 3.03. C. The Instant Litigation Plaintiffs filed the instant four-count complaint on March 27, 2017.3 In their complaint, which adds Ryan, LLC as a complainant, plaintiffs allege that they manage captive insurance companies, Compl. at ¶¶ 3-4, and that the Notices would result in “actual damages that are concrete and particularized in nature.” Id. at ¶ 39. Plaintiffs also allege that the Notices would 3 On December 28, 2016, CIC Services filed its first complaint challenging IRS Notice 2016-66. CIC Services, LLC v. IRS, 3:16-cv-809 (E.D. Tenn.). Rather than press its claims in that case, however, CIC Services voluntarily dismissed its complaint on December 30, 2016. See id., ECF No. 7. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 10 of 31 PageID #: 466 6 require them to expend “substantial sums of money,” id. at ¶¶ 54-55, which they estimated as “in excess of $60,000 per year.” Id. at ¶ 40. Plaintiffs moved for a preliminary injunction and partial summary judgment as to Count II on March 30, 2017. ECF No. 9. After holding an evidentiary hearing, the Court denied plaintiffs’ motions. Memorandum Opinion and Order, ECF No. 24 at *9 (denying preliminary injunction and holding requested injunction “is likely barred by the Anti-Injunction Act”). II. ARGUMENT A. The Court Should Dismiss the Complaint for Lack of Subject Matter Jurisdiction 1. Standard of Review for 12(b)(1) Motion Plaintiffs bear the burden to show that jurisdiction exists, including that they have standing. See Wayside Church v. Van Buren Cty., 847 F.3d 812, 816 (6th Cir. 2017); Loren v. Blue Cross & Blue Shield of Mich., 505 F.3d 598, 607 (6th Cir. 2007). “Challenges to subject- matter jurisdiction under Federal Rule of Civil Procedure 12(b)(1) come in two varieties: a facial attack or a factual attack.” Wayside Church, 847 F.3d at 816. A facial attack on subject-matter jurisdiction challenges the sufficiency of the complaint, and assumes the truth of all factual allegations in the complaint. Id.; Carrier Corp. v. Outokumpu Oyj, 673 F.3d 430, 440 (6th Cir. 2012). By contrast, where a defendant raises a factual challenge to jurisdiction, the Court can receive and weigh evidence “to confirm the existence of the factual predicates for subject-matter jurisdiction.”4 Id. 4 If plaintiffs survive this facial challenge to jurisdiction, the defendants intend to seek jurisdictional discovery and, as appropriate, to move to dismiss the complaint for lack of jurisdiction under either Federal Rule of Civil Procedure 56 (summary judgment), or in the alternative request a preliminary hearing under Rule 12(i). Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 11 of 31 PageID #: 467 7 2. The Anti-Injunction Act and Tax Exception to the Declaratory Judgment Act Deprive the Court of Subject-Matter Jurisdiction The AIA provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person whether or not such person is the person against whom such tax was assessed.” 26 U.S.C. § 7421 (emphasis added). The AIA and the tax exception to the DJA5 together protect “the Government’s ability to collect a consistent stream of revenue” by requiring taxpayers to fully pay their liabilities before challenging them in district court. Nat’l Fed’n of Indep. Bus. v. Sebelius, 132 S. Ct. 2566, 2582 (2012), (hereinafter NFIB) (holding AIA did not apply because penalty at issue not found in Subchapter 68B); Ecclesiastical Order of the ISM of AM, Inc., 725 F. 2d 398, 402 (6th Cir. 1984) (“The federal tax exception to the Declaratory Judgment Act is at least as broad as the Anti-Injunction Act.”). The AIA’s principal purpose is “the protection of the Government’s need to assess and collect taxes as expeditiously as possible with a minimum of preenforcement judicial interference, ‘and to require that the legal right to the disputed sums be determined in a suit for refund.’” Bob Jones Univ. v. Simon, 416 U.S. 725, 736-37 (quoting Enochs v. Williams Packing & Navigation Co., 370 U.S. 1, 7 (1962)). The AIA has “almost literal effect,” Bob Jones, 416 U.S. at 737, and applies to both direct restraints on assessment or collection and “activities which are intended to or may culminate in the assessment or collection of taxes.” Dickens v. United States, 671 F.2d 969, 971 (6th Cir. 1982) (AIA barred suit to enjoin IRS from using particular types of evidence in 5 As codified, the DJA provides that a Court may declare the rights and other legal relations of any interested party seeking a declaration “except with respect to Federal taxes.” 28 U.S.C. § 2201 (jurisdictional bar applies except in circumstances not present here). Because the tax exception to the DJA is “at least as broad” as the AIA, Bob Jones, 416 U.S. at 732, n. 7, this memorandum should be read as arguing that, to the extent that the AIA deprives the Court of jurisdiction, so too does the tax exception to the DJA. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 12 of 31 PageID #: 468 8 assessing taxes); accord Daulton v. United States, 76 F. App’x 652, 654 (6th Cir. 2003) (AIA barred suit to enjoin IRS investigation because the investigation “may lead to the assessment and collection of taxes”); Kemlon Prod. & Dev. Co. v. United States, 638 F.2d 1315, 1320 (5th Cir. 1981) (AIA barred suit to restrain IRS from collecting information from taxpayer’s customers); Pflum v. United States, No. 99-4170-SAC, 2002 WL 1334857, at *2 (D. Kan. May 15, 2002) (collecting cases). Although the AIA does not “reach all disputes tangentially related to taxes,” Cohen v. United States, 650 F.3d 717, 727 (D.C. Cir. 2011), it bars suits like this when a post-payment remedy of a refund suit lies. Courts have routinely dismissed APA challenges that would have prematurely interfered with the IRS’s ability to assess or collect taxes and tax penalties. E.g., RYO Mach., LLC v. U.S. Dep’t of Treasury, 696 F.3d 467, 470 (6th Cir. 2012) (AIA barred challenge to Alcohol and Tobacco Tax and Trade Bureau ruling that subjected tobacco retailers to certain permitting requirements); Florida Bankers Ass’n v. U.S. Dep’t of the Treasury, 799 F.3d 1065, 1068 (D.C. Cir. 2015) (AIA barred challenge to IRS regulation that triggered a penalty on U.S. banks that failed to report certain interest payments), cert. denied, 136 S. Ct. 2429 (2016); Maze v. Internal Revenue Serv., 206 F. Supp. 3d 1, 19 (D.D.C. 2016) (AIA barred challenge to published IRS settlement procedures), appeal docketed, No. 16-5265 (Sept. 23, 2016); Debt Buyers’ Ass’n v. Snow, 481 F. Supp. 2d 1, 9 (D.D.C. 2006) (AIA barred challenge to requirement that lenders report information about their customers to IRS related to the discharge of debt); see also Lutz v. United States, 919 F.2d 738 (6th Cir. 1990) (unpublished) (APA does not waive sovereign immunity or replace jurisdiction withdrawn by AIA ). The injunction and declaration sought by plaintiffs’ complaint violate the AIA and tax exception to the DJA because they would directly restrain tax assessment and collection. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 13 of 31 PageID #: 469 9 Specifically, the requested relief would prevent the IRS from assessing a tax penalty against material advisors and captive insurers who do not file the disclosures required by the statutory and regulatory framework set forth by 26 U.S.C. §§ 6011, 6111, 6112, 6707, and 6707A; as well as 26 C.F.R. §§ 1.6011-4, 301.6111-3 and 301.6112-1. This framework authorizes the IRS to assess a penalty against plaintiffs if they (1) serve as material advisors with respect to a Transaction of Interest and (2) fail to make a return or file false or incomplete information with respect to such transaction. See 26 U.S.C. § 6707. These penalties are located in subchapter 68B of the Internal Revenue Code, which are “treated as taxes under Title 26, which includes the Anti-Injunction Act.” NFIB, 132 S. Ct. at 2583; accord 26 U.S.C. § 6671 (penalties in subchapter “shall be assessed and collected in the same manner as taxes”). The D.C. Circuit recently held, in a very similar case, that the AIA barred suits that would prevent the assessment of subchapter 68B penalties. Florida Bankers, 799 F.3d at 1068. In so holding, the court reaffirmed that plaintiffs cannot sidestep the AIA by ostensibly challenging only a reporting requirement and not the penalties imposed for violating that reporting requirement. Id. at 1072. The D.C. Circuit explained that a challenge to such a requirement is “necessarily also a challenge to the tax imposed for failure to comply with that reporting requirement” because “[i]f plaintiffs’ challenge were successful, the IRS would be unable to assess or collect that tax for failure to comply with the reporting requirement.” Id.; see also RYO Mach., 696 F.3d at 471–73; LNV Corp. v. Hook, 638 F. App’x 667, 672 (10th Cir. 2015) (applying NFIB and holding penalties treated as taxes for AIA purposes); Endeavor Partners Fund, LLC v. CIR, 111 T.C.M. (CCH) 1055 (Tax Ct. 2016) (AIA barred Taxpayer’s pre-enforcement challenge to prevent § 6707 penalty assessments); Washington v. United States, No. CV 15-2360-DSF (AGR), 2016 WL 6995355, at *3 (C.D. Cal. Mar. 31, 2016) (frivolous Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 14 of 31 PageID #: 470 10 filing penalties under 26 U.S.C. § 6702 constitute “taxes” for purposes of AIA), report and recommendation adopted, 2016 WL 6995357 (C.D. Cal. May 31, 2016). For all these reasons, the Court should hold that this suit is barred by the AIA and the tax exception to the DJA, and dismiss the complaint for lack of subject matter jurisdiction. 3. On its Face, the Complaint Does not Establish Article III Standing Plaintiffs complaint fails to demonstrate that they have standing to pursue this case. Article III of the Constitution limits the judicial power of the federal courts to deciding actual “Cases” or “Controversies.” U.S. Const. Art. III, § 2; see also Hollingsworth v. Perry, 133 S.Ct. 2652, 2661 (2013). “The presence of a disagreement, however sharp and acrimonious it may be, is insufficient by itself to meet Art. III’s requirements.” Diamond v. Charles, 476 U.S. 54, 62 (1986). The standing doctrine places three requirements on the plaintiffs. First, plaintiffs must show they suffered an “injury in fact,” or “an invasion of a legally protected interest which is (a) concrete and particularized . . . and (b) actual or imminent, not conjectural or hypothetical.” Lujan v. Defenders of Wildlife, 504 U.S. 555, 560 (1992) (internal citations and quotations omitted). Plaintiffs must also show a “causal connection between the injury and the conduct complained of – the injury must be fairly traceable” to the action of the defendant the plaintiffs now challenge. Bennett v. Spear, 520 U.S. 154, 167 (1997) (citing Lujan, 504 U.S. at 560-61). Lastly, it must be “likely, as opposed to merely speculative, that the injury will be redressed by a favorable decision” of the court. Friends of the Earth, Inc. v. Laidlaw Environmental Services (TOC), Inc., 528 U.S. 167, 181 (2000) (citing Lujan, 504 U.S. at 560-61). Plaintiffs face additional hurdles when challenging administrative actions by federal agencies under the Administrative Procedure Act. That Act requires the plaintiff be a “person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 15 of 31 PageID #: 471 11 action within the meaning of a relevant statute.” 5 U.S.C. § 702. Furthermore, plaintiffs must show they fall within the “zone of interests” protected by the relevant underlying statute or statutes, which for these purposes are 26 U.S.C. §§ 6111 and 6112. See IRS Notice 2016-66 at 1-2; Lexmark Int’l, Inc. v. Static Control Components, Inc., 134 S.Ct. 1377, 1387 (2013).6 To survive a motion to dismiss for want of standing, the court “accepts as true all factual allegations, but the court does not apply the presumption of truth to conclusory or legal assertions.” Binno v. American Bar Ass’n, 826 F.3d 338, 345-46 (6th Cir. 2016) (citing Ashcroft v. Iqbal, 556 U.S. 662, 678-79 (2009)). As plaintiffs, CIC Services and Ryan LLC bear the burden to demonstrate standing, and “must plead its components with specificity.” Daubenmire v. City of Columbus, 507 F.3d 383, 388 (6th Cir. 2007) (quoting Coyne v. Am. Tobacco Co., 183 F.3d 488, 494 (6th Cir. 1999)). a) Plaintiffs Failed to Plead Standing With the Level of Specificity Required by Law Plaintiffs’ primary standing allegation rests upon a rote recitation of two of the three standing requirements. See Compl. ¶ 39 (claiming that they will “sustain actual damages that are concrete and particularized in nature”). This allegation does not suffice to grant this Court subject-matter jurisdiction over this action, because “[c]onclusory allegations do not satisfy the requirements of Article III.” Binno, 826 F.3d at 344 (citing Warth v. Seldin, 422 U.S. 490, 508 (1975)). Plaintiffs must instead carry their burden of “demonstrate[ing] standing and ‘must plead its components with specificity.’” Daubenmire, 507 F.3d at 388. 6 A challenge to whether plaintiffs meet the zone-of-interests test is a Rule 12(b)(6) challenge to whether they have stated a claim, not a challenge to standing under Rule 12(b)(1). Lexmark, 134 S.Ct. at 1387 (stating the zone-of-interests tests asks whether plaintiff has a cause of action under the statute). Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 16 of 31 PageID #: 472 12 The complaint fails to allege any facts (specific or otherwise) that tend to show that the Notices’ disclosure requirements will actually apply to plaintiffs. Plaintiffs fail to identify a single transaction that has or will likely trigger their disclosure requirements under the Notice. Although plaintiffs may allege that they “mange[] captive insurance companies,” see Compl. ¶¶ 3-4, plaintiffs scrupulously avoid any allegation that they have participated in a particular Reportable Transaction or served as material advisor.7 Indeed, the complaint does not even include a conclusory legal allegation that plaintiffs fall within the statutory definition of material advisor. Similarly, plaintiffs neither allege that they intend to comply with the notices nor assert specific facts that tend to support their $60,000 estimate of compliance costs “if compelled to comply with Notice 2016-66.” Compl. ¶ 40. In addition, because plaintiffs sought prospective relief at the time they filed their complaint, they must plead that they suffer an ongoing, present injury or an actual and imminent threat of future injury. See Warth, 422 U.S. at 508. In Warth, the Court considered a complaint where one of the plaintiffs made no specific allegation of why the challenged ordinance would cause its members harm. Id. at 516. It held that a home-developer association seeking to challenge residential zoning restrictions on behalf of its members lacked standing because it “refer[red] to no specific project of any of its members that is currently precluded either by the ordinance or by respondents’ action in enforcing it;” there was no averment that any of the members applied for “ a building permit or variance with respect to any current project;” and there was no indication the local government “delayed or thwarted any project currently 7 A material advisor is any person “who provides any material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying out any reportable transaction, and” who receives gross income for such activities in excess of certain thresholds ($50,000 when individuals reap the tax savings and $250,000 in all other cases). 26 U.S.C. § 6111(b)(1). Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 17 of 31 PageID #: 473 13 proposed.” Warth, 422 U.S. at 516. The Supreme Court held in that case that the plaintiff’s prayer for relief failed because it failed to “show the existence of any injury to its members of sufficient immediacy and ripeness to warrant judicial intervention.” Id. (internal citations omitted). As noted above, plaintiffs’ complaint in this case suffers from these same flaws. Similarly, in Crawford v. U.S. Dept. of Treasury, the district court dismissed a suit brought by Senator Rand Paul and others challenging the Foreign Account Tax Compliance Act (“FATCA”), the same law considered by the Court of Appeals for the District of Columbia in Florida Bankers. Crawford v. U.S. Dept. of Treasury, Case No. 3:15-cv-00250, 2016 WL 1642968 (S.D. Ohio Apr. 26, 2016), appeal docketed, No. 16-3539 (6th Cir. May 23, 2016). There, the district court dismissed Senator Paul’s challenge where he “formulaically recite[d] the elements of standing” while failing to provide a specific injury sufficient to confer standing. Id. at *7. It further found that other plaintiffs could not obtain standing based merely upon their “discomfort with the information reporting requirements of FATCA. Id. at *9. The court also found that the “hypothetical imposition” of a fine was insufficient to confer standing. Id. at *9. The plaintiffs here find themselves in substantially the same position as those in Crawford – they have formulaically recited the elements of standing; expressed discomfort with information reporting requirements compelled by the Internal Revenue Code; and claim hypothetical costs that they would bear if required to comply with the law. This pleading is simply insufficient to permit them to proceed in this litigation. In sum, the complaint fails to (1) allege that the Notice requirements apply to plaintiffs as material advisors, (2) identify any particular transaction that triggers the Notice requirements, or (3) claim that plaintiffs will comply with the Notices if they apply to them. A complaint without these allegations simply does not plead an injury concrete enough to support standing. Where an Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 18 of 31 PageID #: 474 14 “injury is conjectural and hypothetical, rather than concrete and particularized,” it does not give rise to standing under Article III. Miller v. City of Wickliffe, Ohio, 852 F.3d 497, 503 (6th Cir. 2017) (citing Lujan, 504 U.S. at 560). b) Many Harms Alleged by Plaintiffs Cannot be Traced to the Challenged Notices or Redressed by This Lawsuit Plaintiffs also allege harms that they cannot trace to the Notices that plaintiffs seek to challenge in this litigation. These harms cannot serve to provide standing, as the plaintiffs must show that injuries that are “fairly traceable to the defendant’s allegedly unlawful conduct.” Allen v. Wright, 468 U.S. 737, 751 (1984). Moreover, the Court cannot redress these harms in this litigation, as the relief requested by plaintiffs would not cure these supposed injuries. Id. (internal citations omitted). Plaintiffs’ complaint includes a number of alleged injuries that cannot be traced to the challenged Notices and would not be redressed if the IRS did not enforce those Notices. For instance, plaintiffs claim that the IRS initiated a purportedly “broad-based, dragnet-style audit program” against captive insurers that allegedly “disparage[ed] hundreds, perhaps thousands, of insureds, their captives, their professional captive managers like the [plaintiffs], and other advisors.” Compl. ¶ 12. They further complain this supposed program “included sweeping document demands,” id. at ¶ 13, and “punish[ed] taxpayers for making the most of tax- minimizing opportunities that are lawfully enacted by Congress.” Id. at 14. Plaintiffs do not even attempt to show the Court how granting the relief sought in the complaint will remedy these supposed wrongs. The Notices do not include provisions that concern audit programs, and if this Court granted the plaintiffs the relief sought in their complaint, it would not impact the IRS’s audit procedures. Thus, these injuries do not serve to grant the plaintiffs standing to bring this suit. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 19 of 31 PageID #: 475 15 Plaintiffs also complain that the IRS has supposedly “tar-brushed all § 831(b) captives (and their related entities) by including them in the ‘Dirty Dozen’ list of ‘Tax Scams,’ implying the existence of widespread and egregious taxpayer abuse, scams, fraud, and the like and tainting legitimate captive managers like the Plaintiffs as ‘promoters’ of ‘tax avoidance schemes.’” Compl. ¶ 15 (quoting Abusive Tax Shelters Again on the IRS “Dirty Dozen” List of Tax Scams for the 2016 Filing Season, IR-2016-25, 2016 WL 727606 (Feb. 16, 2016)); see also Compl. ¶ 54 (alleging compliance with Notices will result in plaintiffs being “wrongfully and irrevocably harmed and aggrieved by the false implication that they are members of the IRS’s ‘Dirty Dozen’ and participants in a tax scam.”). But these complaints suffer the same defects as those related to the supposedly deficient audit programs. The Notices do not implicate the plaintiffs as members of the so-called “Dirty Dozen,” and a grant of the relief sought by plaintiffs in this suit would not redress the injuries the plaintiffs alleged they suffered by being characterized as such. Thus, these injuries do not and cannot serve to provide plaintiffs standing under Article III in this matter. c) Plaintiffs Have Not Sufficiently Pleaded Third-Party Standing Lastly, plaintiffs’ complaint alleges that the Notices “unfairly” implicate legitimate captives by “require[ing] burdensome and expensive filings by a substantial number of taxpayers, and, without foundation, seek[ing] to publicly taint the entire captive industry as one filled with crooked operatives and tax scammers.” Compl. ¶ 56. Because plaintiffs’ customers – not the plaintiffs themselves – would incur these purported injuries, they do not constitute injuries that permit the plaintiffs to obtain standing in this litigation. To obtain standing, “[a] plaintiff may assert his ‘own legal rights and interests,’ but generally, a litigant may not sue to protect the constitutional rights of a third party.” Moody v. Michigan Gaming Control Board, 847 F.3d 399, 402 (6th Cir. 2017) (quoting Lynch v. Leis, 382 Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 20 of 31 PageID #: 476 16 F.3d 642, 647 (6th Cir. 2004)). However, courts do allow for third-party standing when plaintiffs can show that (1) they suffered an injury-in-fact; (2) there is a close relationship between the plaintiffs and the third party whose rights those plaintiffs assert; and (3) the third party suffers a hindrance that prevents it from bringing the claim itself. Id.; Kowalski v. Tesmer, 543 U.S. 125, 129-30 (2004); Smith v. Jefferson Cty. Bd. Of Sch. Comm’rs, 641 F.3d 197, 208 (6th Cir. 2011). Setting aside the absence of any injury-in-fact (as discussed above), plaintiffs fail to plead sufficient facts that other participants in these captive insurance transactions cannot file suit and assert their own legal rights. This is not surprising, because taxpayers who engage in captive insurance transactions are free to bring the same type of suit brought by plaintiffs here.8 For this reason, as well as those above, plaintiffs’ complaint does not sufficiently plead standing, and thus the Court does not have subject matter jurisdiction over this suit. 4. There Are No Judicially-Manageable Standards to Review the IRS’s Decision to Designate a Subset of Captive Insurance as a “Transactions of Interest” The Court lacks jurisdiction over Count II because the APA’s waiver of sovereign immunity is unavailable where a plaintiff challenges “agency action . . . committed to agency discretion by law.” See 5 U.S.C. § 701(a)(2). Here, Congress committed to the IRS’s discretion the decision to designate a potentially tax avoidant transaction as a type of Reportable Transaction, and the Court lacks judicially manageable standards to review this decision. Because plaintiffs cannot meet their burden of establishing subject-matter jurisdiction over Count II, the Court should dismiss that claim. 8 Such suit would, however, be similarly barred by the Anti-Injunction Act. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 21 of 31 PageID #: 477 17 To determine whether judicial review is available over the designations articulated in the Notices, the court must look to “both the nature of the administrative action at issue and the language and structure of the statute that supplies the applicable legal standards for reviewing that action.” Sierra Club v. U.S. Fish & Wildlife Serv., 930 F. Supp. 2d 198, 204 (D.D.C. 2013); see also Webster v. Doe, 486 U.S. 592, 600 (1988). The burden falls on the plaintiffs to identify provisions in either statute or implementing regulations that could be used to determine whether the challenged agency action is arbitrary or capricious. See Stew Farm, Ltd. v. Nat. Res. Conservation Serv., 767 F.3d 554, 559 (6th Cir. 2014); Madison-Hughes, 80 F.3d at 1127. Before turning to the statutory and regulatory language at issue, it is important to acknowledge the broad latitude given to the IRS to collect information. See e.g., 26 U.S.C. §§ 7601, 7602. In a non-tax context, the Sixth Circuit has held that data collection constitutes a form of “enforcement discretion” where, as here, the agency is required to “select what types of data to collect, how often, and from whom to collect.” Madison-Hughes v. Shalala, 80 F.3d 1121, 1126 (6th Cir. 1996) (court lacked jurisdiction to review HHS’s decision not to collect certain data).9 Because enforcement decisions are presumptively unreviewable under the APA, see Heckler v. Chaney, 470 U.S. 821, 831 (1985), plaintiffs must identify statutory or regulatory language that would permit judicial review. Here, plaintiffs cannot identify any standards in 26 U.S.C. §§ 6011, 6111, 6112, 6707, 6707A, or 26 C.F.R. § 1.6011-4(b)(6) with which the Court might evaluate the IRS’s decision to designate certain captive insurance transactions as a Transaction of Interest. This is not 9 Although Madison-Hughes involved a challenge to the agency’s decision not to collect data, there is no reason to believe that the Court would have reached a different result if the challenge had been to the specific types of data that the agency decided to collect. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 22 of 31 PageID #: 478 18 surprising, because the applicable statutes and regulations were written in sweeping terms. For example, 26 U.S.C. § 6011(a) states, in pertinent part: When required by regulations prescribed by the Secretary any person made liable for any tax imposed by this title, or with respect to the collection thereof, shall make a return or statement according to the forms and regulations prescribed by the Secretary. Every person required to make a return or statement shall include therein the information required by such forms or regulations. 26 U.S.C. § 6011(a) (emphasis added). The relevant regulation, 26 C.F.R. § 1.6011-4(b)(6), provides similarly little guidance for what types of transactions should be designated as Transaction of Interest. Instead, the regulation merely states that such a transaction is “the same as or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest.” 26 C.F.R. § 1.6011- 4(b)(6). In sum, plaintiffs cannot identify a manageable standard that the Court could use to evaluate the propriety of the IRS’s decision to designate a subset of captive insurance transactions as Transactions of Interest. Because the applicable law provides the agency with “virtually limitless discretion,” Tennessee Valley Auth. v. Jones, No. 1:14-CV-356(TRM), 2016 WL 7799315, at *5 (E.D. Tenn. Mar. 22, 2016), the Court lacks jurisdiction. 5. The Congressional Review Act is Neither a Jurisdictional Grant nor a Waiver of Sovereign Immunity Count III of the complaint asserts that the Court should set aside the Notices because the IRS allegedly failed to submit them to Congress and the Comptroller General in accordance with the CRA. Compl. ¶ 62. Even assuming Congress and the Comptroller General did not timely receive the Notices, which the government does not concede, the CRA explicitly bars any claim or relief premised on a “determination, finding, action, or omission” of any CRA requirement, and flatly bars any “judicial review” of such issues. 5 U.S.C. § 805. The claim is thus non- Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 23 of 31 PageID #: 479 19 cognizable and must be dismissed for both lack of jurisdiction and for failure to state a claim upon which relief can be granted. See Montanans for Multiple Use v. Barbouletos, 568 F.3d 225, 229 (D.C. Cir. 2009) (“§ 805 is unequivocal and precludes review of this claim.”). B. Counts I and II Should Be Dismissed for Failure to State a Claim for Relief Under the APA Even if the Court were to exercise jurisdiction, plaintiffs have failed to state a claim for relief under the APA because (1) the governing statutory and regulatory framework did not obligate the IRS to release the Notices through notice-and-comment rulemaking; and (2) it is undisputed that captive insurance transactions have the potential for tax avoidance or evasion. 1. Count I and IV Fail to State a Claim for Relief Under the APA and DJA Because the IRS Complied with the Governing Statutory and Regulatory Framework when Releasing the Notices Counts I and IV are based on the faulty premise that the IRS was obligated to engage in notice-and-comment rulemaking prior to designating a subset of captive insurance transactions as Transactions of Interest. A review of the legislative history demonstrates that Congress purposefully granted the IRS flexibility to designate Reportable Transactions using procedures— including identifying specific subtypes of Reportable Transactions by notice—that would allow the agency to keep pace with the ever-changing landscape of tax shelters. 10 Consistent with this 10 Reference to legislative history is appropriate because the Internal Revenue Code does not clearly define how the IRS should identify particular examples of categories of Reportable Transactions. Section § 6707A(c)(1), which defines the term “Reportable Transaction” by reference to § 6011, authorizes the IRS to create regulations through notice-and-comment rulemaking that (1) define categories of Reportable Transactions (e.g., Listed Transactions or Transactions of Interest) and (2) specify procedures (e.g., notices, guidance), which the IRS will later use to identify particular examples of such categories (e.g., certain captive insurance transactions). Plaintiffs’ suggest a very different reading of 26 U.S.C. § 6707A—one that would require the IRS to undergo notice-and-comment rulemaking before designating as a Reportable Transaction any variation of any transaction that the IRS determines has the potential for tax avoidance or evasion. This latter construction would—contrary to Congressional intent—prevent the IRS Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 24 of 31 PageID #: 480 20 statutory framework, the IRS promulgated, via notice-and-comment rulemaking, a regulation (i.e., 26 C.F.R. § 1.6011-4(b)(6)) that created the “Transaction of Interest” category of Reportable Transactions. This regulation also provided that specific Transactions of Interest could be identified through IRS notices. Because it is undisputed that the IRS released the Notices at issue here in accordance with 26 C.F.R. § 1.6011-4(b)(6), plaintiffs cannot state a procedural claim under the APA. During its consideration of the American Jobs Creation Act, Congress endorsed the IRS’s practice of designating Reportable Transactions by notice, rather than rulemaking. Before 2004, the term “Reportable Transaction” was not used anywhere in the Internal Revenue Code. In passing the American Jobs Creation Act, Congress relied heavily on the Treasury Department’s “final regulations regarding the disclosure of reportable transactions.” H.R. Conf. Rep. 108-755 (2004), at 595 & n.452. Those regulations required the disclosure of six categories of Reportable Transactions. Tax Shelter Regulations, 68 Fed. Reg. 10161, 10163-66 (Mar. 4, 2003). One category of Reportable Transaction, “Listed Transactions,” concerned any transactions that were the same as or substantially similar to one of the transaction types determined to be a tax avoidance transaction and “identified by notice, regulation, or other form of published guidance as a listed transaction.” Treas. Reg. § 1.6011-4(b)(2) (2003), 68 Fed. Reg. at 10164 (emphasis added). Rather than deviate from the procedures outlined in the regulations, Congress ultimately incorporated them into the Internal Revenue Code. Like the regulations, Congress recognized each of the six categories of Reportable Transactions. H.R. Conf. Rep. 108-755, at 595-96. Like from timely obtaining critical information about transactions that appear to promote tax avoidance or evasion to keep up with the ever-changing landscape of tax shelters. Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 25 of 31 PageID #: 481 21 the regulations, Congress described Listed Transactions as transactions that are the same as, or substantially similar to, “a transaction that is specified by the Treasury Department as a tax avoidance transaction whose tax benefits are subject to disallowance under present law.” Id. at 595 (citing 26 C.F.R. § 1.6011-4(b)(2) (2003), 68 Fed. Reg. at 10164). Similar to the regulations, Congress defined “Reportable Transactions” in 26 U.S.C. § 6707A as “any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion.” See Pub.L. 108-357, Title VIII, § 811(a), Oct. 22, 2004, 118 Stat. 1418, 1575-76. Congress required “[e]ach material advisor with respect to any reportable transaction” to file a return “in such form as the Secretary may prescribe,” id. § 815(a), 118 Stat. at 1581 (codified at I.R.C. § 6111(a)), and gave this requirement teeth by creating a specific penalty for material advisors who failed to comply. See id. § 816, 118 Stat. at 1583 (codified at 26 U.S.C. § 6707). The statutory scheme enacted by Congress granted the IRS flexibility to establish regulations to designate transactions as Reportable Transactions, as well as to dictate the form in which participants would make disclosures about such transactions to the IRS. See 26 U.S.C. § 6011 (“When required by regulations prescribed by the Secretary any person . . . shall make a return or statement according to the forms and regulations prescribed by the Secretary”); accord H.R. Conf. Rep. 108-755, at *597, n.462 (explaining that the Secretary “may modify . . . the definitions of ‘listed transaction’ and ‘reportable transactions’ as appropriate” (parenthesis omitted)). Using this flexibility, the IRS created the “Transaction of Interest” category when it issued 26 C.F.R. § 1.6011-4(b)(6) on August 3, 2007. See 72 Fed. Reg. at 43146-01, 2007 WL 2212181. That regulation, which was a product of notice-and-comment rulemaking, authorized Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 26 of 31 PageID #: 482 22 the IRS to designate “Transactions of Interest” “by notice, regulation, or other form of published guidance.” 26 C.F.R. § 1.6011-4(b)(6). Although the IRS had considered comments suggesting that designations be made after notice and comment, the IRS explained that defining “Transactions of Interest” in the regulations “would unduly limit the IRS and Treasury Department’s ability to identify transactions that have the potential for tax avoidance or evasion.” See 72 Fed. Reg. 43147. In light of the foregoing legislative and regulatory history, plaintiffs cannot support their contention that the IRS was obligated to undergo additional notice-and-comment rulemaking prior to designating a new Transaction of Interest. Because plaintiffs do not allege that the IRS did not follow 26 C.F.R. § 1.6011-4 when it released the Notices, plaintiffs have not identified a legal wrong, and thus fail to state a claim for relief. 2. Count II Fails to State a Claim for Relief Under the APA because It was Rational for the IRS to Conclude that Captive Insurance Transactions Have the Potential for Tax Avoidance or Evasion Count II alleges that the Notices were irrational and thus violated the APA because (1) the IRS already has access to most of the information “legitimately” needed to assess the validity of captive insurance transactions, Compl. ¶ 49, and (2) the scope of the Notices include both legitimate and non-legitimate captive insurance transactions, Compl. ¶ 56. Yet these allegations fail to state a claim where, as here, plaintiffs have conceded that captive insurance transactions have “a potential for tax avoidance or evasion,”11 26 U.S.C. § 6707A(c)(1) (defining “Reportable Transactions”). 11 The United States does not concede that “potential for tax avoidance or evasion” constitutes a judicially manageable standard. Such a standard would still be “so broadly drawn that the court has no standard or substantive priorities against which to measure [the IRS’s] discretion.” Sheldon v. Vilsack, 538 F. App’x 644, 649 (6th Cir. 2013); cf. Parsons v. United States Dep’t of Justice, No. 14-10071, 2016 WL 5476284, at *6-7 (E.D. Mich. Sept. 29, 2016) (designation of Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 27 of 31 PageID #: 483 23 Under the APA, the court will set aside a final agency action only if it is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. Latin Americans for Soc. & Econ. Dev. v. Adm'r of Fed. Highway Admin., 756 F.3d 447, 464 (6th Cir. 2014). This is a highly deferential standard, id., lest the Court “become a superagency that can supplant the agency’s expert decision maker.” Ethyl Corp. v. Envtl. Prot. Agency, 541 F.2d 1, 36 (D.C. Cir. 1976); see also id. Rather, the Court must focus on whether the agency considered the relevant factors and has provided an explanation that rationally connects the data with the choice made. Latin Americans for Soc. & Econ. Dev., 756 F.2d at 464. Count II fails to state a claim under the APA because it is based on the faulty premise that the IRS does not need the information requested in the Notices. The IRS’s request for information cannot be irrational where, as here, plaintiffs concede that the IRS may not possess all of the information necessary to determine whether some or all captive insurance transactions should be designated as a listed transaction. See Compl. ¶ 49. The decision about what information is helpful is up to the IRS, not the taxpayer or a material advisor. Cf. Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310, 323 (1985) (“The decision of how many, and which, licensees to contact is one for the IRS-not Tiffany-to make.”). Thus, even assuming plaintiffs are correct that “the overwhelming majority” of the information is available to the IRS to analyze captive insurers, this is insufficient, as a matter of law, to establish that the IRS’s designation is arbitrary, capricious, or an abuse of discretion. Cf. Tiffany Fine Arts, 469 U.S. at 323 (“We have never held, however, that the IRS must conduct its investigations in the least intrusive way possible.”); May v. United States, Appeal No. 15-16599, fans and members of musical group as “gang” was not reviewable), appeal docketed (October 17, 2016). Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 28 of 31 PageID #: 484 24 2017 WL 2196755, at *2 (9th Cir. May 16, 2017) (IRS’s access to information concerning Reportable Transaction did not trigger limitations period where taxpayer failed to submit that information on required Form 8886). Similarly, plaintiffs cannot demonstrate that it was arbitrary or capricious for the IRS to have designated captive insurance transactions as having the potential for tax evasion where, as here, they have conceded that “it would seem likely that some § 831(b) captives are used for abusive tax purposes.” See Pls.’ Mot. for Prel. Inj., ECF No. 9 at *4. Given the deferential standard of review applicable in APA cases, Count II does not state a claim for relief. III. CONCLUSION Plaintiffs have failed to carry their burden of establishing subject-matter jurisdiction in this case. First, the AIA and the tax exception to the DJA bar plaintiffs’ request to enjoin the IRS from assessing or collecting Subchapter 68B penalties that are treated as taxes as a matter of statute. Second, plaintiffs have not demonstrated that they have standing because the complaint does not allege that they have or will likely participate in any specific captive insurance transaction(s) that fall within the scope of the Notices, and most of their harms cannot be remedied through this suit. Third, the Court lacks jurisdiction over Count II because Congress committed to the IRS’s discretion the decision to designate potentially tax-avoidant transactions as Transactions of Interest. Fourth, the Court lacks jurisdiction over Count III because, by its terms, the CRA does not grant jurisdiction nor waive the government’s sovereign immunity. Given that these jurisdictional defects cannot be cured through amendment, the Court should dismiss the complaint for lack of jurisdiction with prejudice. Alternatively, the Court should dismiss the complaint for failure to state a claim upon which relief can be granted, because (1) the governing statutory and regulatory framework did not obligate the IRS to release the Notices Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 29 of 31 PageID #: 485 25 through notice-and-comment rulemaking; and (2) it is undisputed that the captive insurance transactions have the potential for tax avoidance or evasion. DATE: May 30, 2017 Respectfully submitted NANCY S. HARR Acting United States Attorney DAVID A. HUBBERT Acting Assistant Attorney General /s/ Richard J. Hagerman RICHARD J. HAGERMAN NY Bar 5113303 KYLE L. BISHOP Trial Attorneys, Tax Division U.S. Department of Justice P.O. Box 227 Washington, D.C. 20044 202-616-9832 (v) 202-514-6866 (f) Richard.J.Hagerman@usdoj.gov Kyle.L.Bishop@usdoj.gov Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 30 of 31 PageID #: 486 CERTIFICATE OF SERVICE I hereby certify that on this 30th day of May, 2017, I electronically filed the foregoing document with the Clerk of Court using the CM/ECF system, which will send notification of such filing to counsel of record: /s Richard J. Hagerman RICHARD J. HAGERMAN Trial Attorney United States Department of Justice, Tax Division Case 3:17-cv-00110-TRM-HBG Document 25-1 Filed 05/30/17 Page 31 of 31 PageID #: 487 1 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TENNESSEE NORTHERN DIVISION CIC SERVICES, LLC, et al., ) ) Plaintiffs, ) ) v. ) ) INTERNAL REVENUE SERVICE, et al., ) ) Defendants. ) _______________________________________) Case No. 3:17-cv-00110-TRM-HBG ORDER The United States’ motion to dismiss the complaint with prejudice for lack of subject- matter jurisdiction is hereby GRANTED. The clerk shall enter judgment accordingly. IT IS SO ORDERED DATE________________ _____________________________ HON. TRAVIS R. MCDONOUGH UNITED STATES DISTRICT JUDGE Case 3:17-cv-00110-TRM-HBG Document 25-2 Filed 05/30/17 Page 1 of 1 PageID #: 488