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State and Local Tax Blog

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Taxes in New York (TiNY) is a blog by the Hodgson Russ LLP State and Local Tax Practice Group members Chris Doyle, Peter Calleri, and Zoe Peppas. The weekly reports are intended to go out every Tuesday after the New York State Division of Tax Appeals (DTA) publishes new ALJ Determinations and Tribunal Decisions. In addition to the weekly reports, TiNY may provide analysis of and commentary on other developments in the world of New York tax law.

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TiNY EXTRA for April 3, 2019

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The Tribunal posted its March 22nd decision in Matter of Moody’s Corp. and Subsidiaries (Division’s Rep: Jennifer Baldwin; Taxpayer’s Rep: Marc Simonetti and Evan Hamme; Article 9-A),  after last Thursday’s TiNY was published.  The decision is important enough to cover in a supplementary edition.

The issue is whether the Division may be compelled by DTA-issued subpoena to produce certain information the Division claims is protected under the “public purpose” exception.  We kind of figured this might turn into a bit of a poop-storm, so our analysis of the ALJ’s November 16, 2017 Order was a little more thorough than our regular quick-hitters.  By way of background, the same day Judge Galliher issued his order in Moody’s he also issued a determination in Matter of S&P Global which described in detail the pre-filing, discretionary adjustment deal the Division gave to S&P to allow it to use customer-based sourcing for its debt-rating business.  In its case, Moody’s was looking to invalidate a closing agreement it alleged was entered into based in part on the Division’s alleged assurances that it never allowed taxpayers to use customer-based sourcing for debt-rating services.  Here is what we wrote about Judge Galliher’s Order:

Matter of Moody’s Corporation & Subsidiaries; Judge: Galliher; Division’s Rep: Jennifer Baldwin; Taxpayer’s Rep: Marc Simonetti and Andrew Appleby; Article 9-A.  The concept of wine “pairings” is foreign to me.  I like different kinds of wine, and I like different kinds of food.  I prefer the wine I like with the food I like. I don’t care whether the wine I like is supposed to “go” with the food I’ve ordered.  But certain things ought to go together;  and Forrest Gump would say this Order and the Determination in Matter of S&P Global, Inc. “go together like peas and carrots.” That Judge Galliher issued the Order and the Determination on the same day probably isn’t coincidence. 

The Order granted the Division’s motion to withdraw certain aspects of Petitioner’s subpoena seeking information regarding how the Division sources receipts from…(wait for it)…debt rating services.  It may be the most significant and thought-provoking order issued by the DTA, ever.

Petitioner was a credit-rating business.  Part of its business was rating debt.  Petitioner was audited for the 2004 – 2010 tax years and that audit was resolved when the parties executed a closing agreement.  During the audit, Petitioner requested an advisory opinion that it was equitable to source receipts from credit rating services using a market-based approach.  Petitioner alleged that the Division refused to issue that advisory opinion.  Following its failure to obtain the requested advisory opinion, the parties negotiated the closing agreement resolving the audit.  During negotiations Petitioner asked whether any other credit rating agency (like McGraw-Hill, for instance) was permitted to use market-based sourcing.  Petitioner alleged that the Division responded that it did not allow market-based sourcing.  (Later in the conversation did the auditors say “We’re from the Government and we’re here to help you”?)  A little less than three years later, Petitioner filed for refunds of the taxes paid.  Which the Division denied.  The denials were challenged in a timely-filed DTA petition.  Petitioner’s argument was that it was entitled to overturn the Closing Agreement.  Although the Judge did not quote from the Petition, I expect that the Petitioner’s premise was that the Division’s alleged denial of the use of market-based sourcing for other credit-rating businesses was an act of “fraud, malfeasance or misrepresentation of a material fact” that would allow it to invalidate the agreement.

Anyway, Petitioner filed a Freedom of Information Law (“FOIL”) request seeking documents relating to how the Division sourced credit-rating receipts.  The Division refused to disclose 807 pages of responsive materials as being exempt from FOIL.  According to the Division, 391 of those pages were exempt as non-final agency communication and the remainder because disclosure would violate taxpayer-secrecy provisions.  A FOIL appeal led to the disclosure of more pages, but 711 remained withheld.  Petitioner sued for the remaining pages in Albany County Supreme Court, and the Division provided the withheld documents for an in camera review.  The Supreme Court (“SC”) judge ordered the disclosure of 17 more documents (some with redactions).  But the SC judge also marked up the Division-supplied privilege log to show where the Judge disagreed with the defenses to disclosure claimed by the Division.  Both parties appealed to the Appellate Division, which pared back the 17 additional documents slated by the SC judge for disclosure to 10, but did not otherwise disturb the SC judge’s decision.

Not yet satisfied, Petitioner requested a judicial subpoena be issued by commencing a special proceeding in Albany County Supreme Court with another SC judge asking for the same documents that were denied under FOIL.  That SC judge denied Petitioner’s request, finding that Petitioner needed to subpoena the information through the DTA.  But the SC Judge also found that the Division failed to show that the requested documents were protected by taxpayer secrecy.

Since Petitioner still wanted to see the documents, it had Judge Galliher issue a subpoena seeking disclosure of only those documents claimed as exempt from FOIL as non-final agency communication and documents claimed to be taxpayer secrets.  The Division responded with a motion to withdraw the subpoena.  In deciding the motion, the Judge reviewed all of the issues previously decided through the courts.  Many of the defenses argued by the Division (e.g. taxpayer secrecy and attorney-client privilege) had been stripped away by the courts in their prior decisions.  But in the end, the Judge withdrew the subpoena by applying the “public interest privilege.”  I don’t recall learning about the public interest privilege in my law school Evidence course, but it appears to be a real deal.  According to the Judge:  “Determining whether the public interest privilege applies requires a balancing of the competing interests of the parties (see Matter of World Trade Ctr.). A showing that disclosure of the information sought would be helpful, or useful, is not sufficient to override a demonstrated or manifest potential harm to the public good by disclosure (see Cirale at 118). Balancing the competing interests can include weighing ‘”the encouragement of candor in the development of policy against the degree to which the public interest may be served by disclosing information which elucidates the governmental action taken,”’ and can also take into account ‘the extent to which pertinent information is available to a party from other public sources’ (World Trade Ctr. at 10).”

The Judge found that the public interest foundation for the public interest privilege was similar to that of the FOIL exclusion for non-final agency communications.  And thus determined that there was a bona fide public interest in the Division’s non-disclosure.  The Judge also acknowledged the Petitioner’s legitimate interest in obtaining the information sought by the subpoena, but found that Petitioner’s interest was undercut by the fact that the Division’s allowance of market-based sourcing to McGraw-Hill was now a matter of public record (see above).  And the Judge also expressed a concern that sustaining Petitioner’ subpoena would create a road map through which taxpayers with “settler’s remorse” would flood the courts with attempts to reopen settlements.

Here is the Judge’s parting shot:

Internal candor is especially relevant in tax matters, given that taxpayers have (and here had) the right to pursue requests such as destination sourcing and alternative apportionment via the audit process, and subsequent protest and litigation, as opposed to choosing to accept resolution by closing agreement. Simply put, petitioner could have exercised its right to proceed with the audit, and thereafter pursued any subsequent challenge procedures to the extent it was dissatisfied with the outcome thereof. Given all of these factors, any public interest in mandating disclosure of the documents sought herein, involving the deliberative process within the context of the Division’s audit and policy making functions, is outweighed by the policy considerations supporting the public interest privilege, to wit, ensuring full, frank, and candid discussions between agency personnel, including weighing the relative merits of a variety of circumstances that arise in the process of an audit. Disclosure here might, arguably, serve petitioner to some degree. Such disclosure, however, would not serve the public interest, but would instead work to its detriment by chilling or inhibiting internal candor in the Division’s audit functions, its negotiation processes, and its policy formulation activities. Accordingly, and on balance, the materials sought by the subpoena duces tecum, dated April 12, 2017, are properly protected by the public interest privilege, and the subpoena requiring disclosure of the same is hereby withdrawn.

I get it.  Really, I do.  I want the Division to engage in “full, frank and candid discussions between agency personnel,” and the Judge’s Order encourages that.  But I have real concerns about letting the Division operate without any public scrutiny other than through the privacy-fence knotholes that the Division permits and controls. And this is particularly troubling when issues of the propriety of discretionary actions are involved.  How does one prove an action is “arbitrary and capricious” if you can’t get the proof of how the action came to be?  And it’s not like we’re talking about national security or public safety interests here;  it’s taxes.  Also, I don’t see anything in the order that would limit the privilege identified to documents.  So, I am a little worried that every time I ask a question of an auditor at a hearing the Division’s counsel is going to jump up and assert the public interest privilege, and then we’ll all sit around arguing about the weight of the competing interests of the public and my client.

The slope upon which this Order is poised is among the slipperiest I’ve seen.  So, I hope that the ALJs will understand that the key element in allowing the privilege to apply in this case is that most of the information sought was already publicly-available as a result of the Determination in Matter of S&P Global, and will apply the privilege stingily.

Both parties took an exception to the Judge’s Order.  The Tribunal’s 26-page decision is thorough and logical: First, the Tribunal agreed with the ALJ that the only protection from disclosure of the particular documents in question would be the public interest privilege.  And the Tribunal agreed that whether said privilege applies ought to be determined by weighing Petitioner’s need for the documents to properly litigate its case against the Division’s desire to exclude the documents from disclosure to encourage candor in intra-agency discussions and negotiations with taxpayers.  But here is where the Tribunal diverged from the ALJ: the Tribunal found that a proper balancing analysis could be done only when the documents in question had been subject to an in camera review by the ALJ.  Judge Galliher had made his decision without ever having seen the documents.  The Tribunal remanded the matter back to Judge Galliher to do an in camera review as part of applying the balancing test.  

So Judge Galliher will see the documents in question.   But whether the documents will be seen by Petitioner or get into the hearing record is still uncertain.

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