Opinion
T.C. Memo. 2020-38 Docket No. 9261-17.
03-26-2020
ACQIS TECHNOLOGY, INC. AND CONSOLIDATED SUBSIDIARY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Jean Ann Pawlow, Eric J. Konopka, and Jason B. Grover, for petitioner. Kathleen K. Raup, for respondent.
Jean Ann Pawlow, Eric J. Konopka, and Jason B. Grover, for petitioner. Kathleen K. Raup, for respondent. MEMORANDUM OPINION
RUWE, Judge: This case is before the Court on the parties' cross-motions for summary judgment pursuant to Rule 121. Petitioner filed a motion for summary judgment asserting that respondent issued it a notice of deficiency for 2010, 2011, and 2012 after the expiration of the three-year limitation period provided in section 6501(a) for each year. Respondent opposes petitioner's motion and has filed a cross-motion for partial summary judgment asserting that the six-year limitation period under section 6501(e)(1) applies because there was a substantial omission of gross income from petitioner's tax returns. The issue before us is whether the returns petitioner filed adequately disclosed the nature and amount of gross income that may have been omitted from petitioner's returns.
Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect at all relevant times.
Petitioner contends that it did not omit any gross income from its tax returns; but even if there was a substantial omission of gross income from petitioner's returns, the three-year limitation period applies because petitioner adequately disclosed the nature and amount of the omitted income.
For the reasons discussed below, we will deny both parties' motions.
Background
Petitioner's principal place of business was in California when it filed its petition.
ACQIS Technology, Inc., was incorporated in California in 1998 and reincorporated in Delaware in 2012. ACQIS Technology, Inc., was in the business of designing, manufacturing, and marketing a modular computer called the iMod. In 2004 ACQIS Technology, Inc., sold its hardware business to a computer manufacturer and refocused its business on expanding its patent portfolio. In 2009 ACQIS Technology, Inc., formed a wholly owned subsidiary, ACQIS LLC, that holds certain patents.
Patent Infringement Litigation
In 2009 petitioner filed patent infringement suits against 11 companies that had purportedly been infringing upon its patents. Eight of the defendants entered into settlement agreements for (1) a release of claims and (2) a license of the patents at issue. The amounts petitioner received in connection with the settlement agreements with these eight parties were reported as income and are not in dispute in this case.
The other three defendants in the patent infringement litigation, Hewlett Packard Co. (HP), Sun Microsystems, Inc., which was acquired by Oracle America, Inc. (Oracle), in 2010, and International Business Machines Corp. (IBM), also settled with petitioner but structured their settlements differently.
Following the acquisition, Oracle became the defendant.
HP Settlement
Petitioner entered into a settlement and patent license agreement with HP on November 3, 2010. Under the terms of this agreement HP acquired a license to certain patents and agreed to purchase class B common stock from petitioner pursuant to the terms of a stock purchase agreement dated November 19, 2010. Under the terms of the stock purchase agreement, HP purchased 1,000,000 shares of class B common stock for $30 million.
Oracle Settlement
Petitioner entered into a settlement and patent license agreement with Oracle on December 30, 2010. Under the terms of this agreement Oracle acquired a license to certain patents and agreed to purchase class B common stock of petitioner pursuant to the terms of a stock purchase agreement dated December 30, 2010. Under the terms of the stock purchase agreement Oracle purchased 266,666 shares of class B common stock for $8 million. After receiving the shares, Oracle assigned all of its shares to a breast cancer charity, Susan G. Komen for the Cure.
IBM Settlement
Petitioner entered into a stock purchase agreement with IBM on December 23, 2011. Under the terms of the stock purchase agreement, IBM purchased 933,333 shares of class B common stock for $28 million. After receiving the shares, IBM also assigned all of its shares to Susan G. Komen for the Cure.
Class B Common Stock
At the time of the purported stock sales the class B common stock did not have any voting rights other than the limited voting rights set forth in Cal. Corp. Code sec. 903 (West 2009). Further, the class B common stock did not share in distributions of dividends related to the receipt of settlement funds in connection with the patent infringement litigation.
Tax Return Disclosure
Petitioner's Form 1120, U.S. Corporation Income Tax Return, for the tax year ending November 30, 2010 (2010 tax year), was deemed filed on February 15, 2011, its Form 1120 for the tax year ending November 30, 2011 (2011 tax year), was deemed filed on February 15, 2012, and its Form 1120 for the tax year ending November 30, 2012 (2012 tax year), appears to have been deemed filed on August 14, 2013.
Petitioner classified the funds received from HP, Oracle, and IBM in connection with the sale of class B common stock on its tax returns as capital contributions and did not include these funds in its gross income. Petitioner included the funds received in connection with the patent infringement litigation settlements from the eight other companies in its gross income.
2010 Tax Return
On petitioner's 2010 tax return it reported a total of $2,342,973 as gross receipts. Petitioner listed $12,075,431 in "Other costs" under Schedule A, Cost of Goods Sold, of the return and in an attached Statement 5 to Schedule A described the $12,075,431 as "Legal Settlement Fees". On Schedule K, Other Information, of the return, petitioner listed its business activity as "Sales & Development" and listed its product or service as "Computer."
On Schedule L, Balance Sheet per Books, of the return, petitioner showed an increase in common stock from $656,855 at the beginning of the year to $30,674,097 at the end of the year, an increase of $30,017,242. No other information was disclosed on the return regarding the increase in common stock. A copy of the relevant portion of Schedule L is provided below.
Image materials not available for display.
2011 Tax Return
On petitioner's 2011 tax return it reported a total of $13,410,300 as gross receipts. Petitioner listed $10,433,698 in "Other costs" under Schedule A of the return and in an attached Statement 5 to Schedule A described the $10,433,698 as "Legal Settlement Fees." On Schedule K of the return petitioner listed its business activity as "Patent" and listed its product or service as "Royalties."
On Schedule L of the return petitioner showed an increase in common stock from $30,674,097 at the beginning of the year to $38,674,097 at the end of the year, an increase of $8 million. No other information was disclosed on the return regarding the increase in common stock. A copy of the relevant portion of Schedule L is provided below.
Image materials not available for display.
2012 Tax Return
On petitioner's 2012 tax return it did not report any gross receipts but reported $307,043 of gross royalties, which was included in gross income. On Statement 12 of the return petitioner listed $12,693,786 as "Legal Settlement Fees". On Schedule K of the return petitioner listed its business activity as "Patent" and listed its product or service as "Royalties."
On Schedule L of the return petitioner showed an increase in common stock from $38,674,097 at the beginning of the year to $72,435,983 at the end of the year, an increase of $33,761,886. No other information was disclosed on the return regarding the increase in common stock. A copy of the relevant portion of Schedule L is provided below.
Image materials not available for display.
Notice of Deficiency
Respondent issued petitioner a notice of deficiency on February 1, 2017, which was more than three years after the deemed filing dates of petitioner's 2010, 2011, and 2012 tax returns. Respondent determined deficiencies of $5,003,457, $2,960,097, and $4,777,425 for the 2010, 2011, and 2012 tax years, respectively, along with accuracy-related penalties under section 6662(a) of $1,000,691, $592,019, and $955,485, based on proposed increases in petitioner's income of $30 million for the 2010 tax year, $8 million for the 2011 tax year, and $28 million for the 2012 tax year.
Respondent also determined a $235,301 deficiency for the 2015 tax year, along with an accuracy-related penalty under sec. 6662 of $47,060. This increase was based on the disallowance of losses from previous tax years.
Discussion
I. Summary Judgment Standard
The purpose of summary judgment is to expedite litigation and avoid unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). This Court may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). The burden is on the moving party to demonstrate that there is no genuine dispute as to any material fact and that he or she is entitled to judgment as a matter of law. FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74-75 (2001). Where both parties move for summary judgment, each motion must be examined to determine whether it has been established that there is no genuine dispute as to any material fact and that a decision may be rendered as a matter of law. Take v. Commissioner, 82 T.C. 630, 633 (1984), aff'd, 804 F.2d 553 (9th Cir. 1986). For the reasons discussed below, a decision may not be rendered as a matter of law at this time. Accordingly, we will deny both parties' motions.
II. Limitation Period Standard
The issue before us is whether a three-year or six-year limitation period applies to petitioner's returns for tax years 2010, 2011, and 2012. As a general rule a notice of deficiency for a tax year must be mailed within three years of the date a return is filed for that year. Secs. 6213(a), 6501(a), 6503(a). Section 6501(e)(1)(A) provides an exception to the general rule and gives the Commissioner six years to mail the notice if the gross income omitted from the return exceeds 25% of the amount of gross income reported on the return. However, under section 6501(e)(1)(B)(iii) gross income for purposes of this calculation does not include the amount of any omitted income insofar as the taxpayer discloses the omitted amount "in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature and amount of such item." (Emphasis added.)
Former sec. 6501(e)(1)(B)(ii), redesignated from former sec. 6501(e)(1)(A)(ii), see Hiring Incentives to Restore Employment Act, Pub. L. No. 111-147, sec. 513(a)(1), 124 Stat. at 111 (2010), was redesignated sec. 6501(e)(1)(B)(iii) and amended by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Surface Act), Pub L. No. 114-41, sec. 2005(a), 129 Stat. at 456, to insert the parenthetical text below into clause (iii) (as so redesignated):
(iii) In determining the amount omitted from gross income (other than in the case of an overstatement of unrecovered cost or other basis), there shall not be taken into account any amount which is omitted from gross income stated in the return if such amount is disclosed in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature and amount of such item.
Sec. 6501(e)(1)(B)(iii) was made effective for returns filed after July 31, 2015, as well as for returns filed on or before that date if (on that date) the period for assessment under sec. 6501 (determined without regard to amendments made by Surface Act sec. 2005) remained open. Surface Act sec. 2005(b), 129 Stat. at 457. Consequently, sec. 6501(e)(1)(B)(iii) could be interpreted to apply to one or more of the years at issue. However, the newly added parenthetical--concerning overstatements of basis--has no bearing on the issues in this case. Further, we are unable to decide at this time whether current sec. 6501(e)(1)(B)(iii), rather than former sec. 6501(e)(1)(B)(ii), applies for one or more of the years at issue. For convenience, we will refer to sec. 6501(e)(1)(B)(iii) as the applicable provision for all years at issue.
The parties agree that the notice of deficiency for 2010, 2011, and 2012 was not mailed within three years of the returns' filing dates but was mailed within six years of the returns' filing dates. The narrow issue before us is whether petitioner adequately disclosed certain purportedly omitted income for each year within the meaning of section 6501(e)(1)(B)(iii). Petitioner bears the burden of showing that its disclosure was adequate. See Univ. Country Club, Inc. v. Commissioner, 64 T.C. 460, 468 (1975).
III. Section 6501(e)(1)(B)(iii) and Adequate Disclosure
Whether disclosure is adequate for purposes of section 6501(e)(1)(B)(iii) is a factual question. Whitesell v. Commissioner, 90 T.C. 702, 707-708 (1988). In order for disclosure to be adequate, it must appear on the face of the return or a statement attached to the return and "be apparent * * * to the elusive 'reasonable man'". Univ. Country Club, Inc. v. Commissioner, 64 T.C. at 471; see also Manashi v. Commissioner, T.C. Memo. 2018-106, at *6. In addition it "must be sufficiently detailed to alert the Commissioner and his agents as to the nature of the transaction so that the decision as to whether to select the return for audit may be a reasonably informed one." Estate of Fry v. Commissioner, 88 T.C. 1020, 1023 (1987) (emphasis added); see also Heckman v. Commissioner, T.C. Memo. 2014-131, at *12, aff'd, 788 F.3d 845 (8th Cir. 2015). Disclosure is not adequate if the Commissioner must thoroughly scrutinize the return to ascertain whether gross income was omitted. See CNT Inv'rs v. Commissioner, 144 T.C. 161, 214 (2015); Highwood Partners v. Commissioner, 133 T.C. 1, 22 (2009).
In order to determine whether disclosure was adequate to apprise the Commissioner of the nature and amount of omitted income, the Court examines whether the return offered a "clue" regarding the existence, nature, and amount of the omitted income. Quick Tr. v. Commissioner, 54 T.C. 1336, 1347 (1970), aff'd, 444 F.2d 90 (8th Cir. 1971). The disclosure need not detail every underlying fact but must be "more substantial than simply providing a clue that would intrigue the likes of Sherlock Holmes." Thiessen v. Commissioner, 146 T.C. 100, 114 (2016) (citing Quick Tr. v. Commissioner, 54 T.C. at 1347). Although a misleading statement may provide a "clue" to omitted gross income, it does not adequately apprise the Commissioner of the nature and amount of an item. Phinney v. Chambers, 392 F.2d 680, 685 (5th Cir. 1968); Benson v. Commissioner, T.C. Memo. 2006-55, slip op. at 9, supplementing T.C. Memo. 2004-272, aff'd, 560 F.3d 1133 (9th Cir. 2009).
A. The Nature of the Underlying Transaction
Petitioner's motion argues that whether it adequately disclosed the disputed transactions should be judged based upon petitioner's characterization of the underlying transactions as stock sales and that respondent's view of the true nature of the purported stock sales is irrelevant for deciding the limitation period question. We disagree.
This Court has previously noted that when a "taxpayer arrives at an incorrect computation of tax only by reason of a difference between him and the * * * [Commissioner] as to the legal construction to be applied to a disclosed transaction, the difference between the correct and the incorrect item is not to be considered an omission from gross income." Walker v. Commissioner, 46 T.C. 630, 640 (1966) (citing Davis v. Hightower, 230 F.2d 549 (5th Cir. 1956)). However, the disclosure must still provide an adequate clue as to the nature and amount of omitted income, even if the taxpayer may report the legal construction of a transaction as he sees fit. In this case the Court must know what the nature of the underlying transaction actually is, not just the taxpayer's subjective view of how the underlying transaction should be characterized, in order to determine if an adequate clue was provided by the taxpayer's disclosure. See Thiessen v. Commissioner, 146 T.C. at 116; Rutland v. Commissioner, 89 T.C. 1137, 1152 (1987); Benson v. Commissioner, slip op. at 14, 17.
Even in Univ. Country Club, Inc. v. Commissioner, 64 T.C. 460, 469-471 (1975), which is the cornerstone of petitioner's argument, the Court implicitly analyzed whether there was a sufficient clue showing that the transactions were licenses, not stock sales as the taxpayer had characterized the transactions.
Petitioner cites CNT Inv'rs, LLC v. Commissioner, 144 T.C. 161 (2015), in support of its position that disclosure was adequate because petitioner fully reported the transactions consistently with its desired tax treatment. We disagree with petitioner's characterization of CNT Inv'rs, LLC. In that case the taxpayer did not report the transactions in dispute consistently with its desired tax characterization, unlike the taxpayer in Univ. Country Club, as this Court noted. But the fact that this Court found the taxpayer did not even adequately disclose the transactions based upon its desired tax treatment does not either overrule or conflict with this Court's general rule that the Court must know what the nature of a transaction is before it can determine whether the nature of a transaction is adequately disclosed.
In Thiessen v. Commissioner, 146 T.C. at 116, this Court stated the taxpayers needed "to put * * * [the Commissioner] on notice that * * * [the taxpayers] had engaged in the prohibited transactions" in order for the taxpayers' disclosure to be adequate. In that case the taxpayers had engaged in what this Court determined to be a prohibited transaction when, in addition to rolling over their retirement fund distributions into individual retirement accounts, the taxpayers entered into loan guaranties. The taxpayers disclosed the rollover but did not disclose the loan guaranties. The Court found disclosure was inadequate because it made no mention of the loan guaranties. Disclosure of the loan guaranties would have been relevant only if the transaction was viewed from the perspective of what the nature of the transaction actually was, a prohibited transaction, and not from the taxpayers' subjective view of the transaction.
Similarly in Benson, this Court determined that certain payments were properly characterized as constructive dividends, rather than rental payments as the taxpayer had reported them. The Court judged the adequacy of disclosure based upon whether the disclosure apprised the Commissioner of constructive dividends, not rental payments. Benson v. Commissioner, slip op. at 17.
Respondent implicitly argues in his motion that the adequacy of disclosure should be judged according to his view of the transactions. Respondent's motion is a Trojan horse, and this Court would have to adopt his view of the transactions in order to grant it. Certain material facts remain in dispute regarding the proper characterization of the transactions, and therefore it would be premature for the Court to reach a conclusion as to which party's view of the transactions is correct and accordingly whether disclosure was adequate.
Respondent has moved for partial summary judgment on the issue of whether petitioner's income tax returns for tax years 2010, 2011, and 2012 disclosed the patent infringement litigation settlement transactions "in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature and amount of such item" with the meaning of sec. 6501(e)(1)(B)(iii).
Respondent argues that the purported stock sales should be recharacterized as payments made to settle patent infringement litigation, or in the alternative that the purported stock sales were sham transactions without economic substance. Under either theory the money received from the purported stock sales should have been included in gross income.
B. Disclosure Inadequate To Apprise the Secretary of the Nature of Omitted Income Under Respondent's View of the Transactions
In addition we cannot grant petitioner's motion for summary judgment because if either of respondent's theories about the true nature of the transactions is correct, petitioner's disclosure was inadequate.
Petitioner argues that its disclosure of the purported stock sales is directly analogous to the taxpayer's disclosure in Univ. Country Club and that therefore the disclosure is adequate. We disagree and find the case before us clearly distinguishable.
In Univ. Country Club, Inc. v. Commissioner, 64 T.C. at 463, the taxpayer founded a country club that in its first year of operation sold four types of memberships. Each member was required to pay initiation fees and dues, but "founder" members were required to purchase shares of class B stock. Id. The taxpayer classified the money received from these stock sales as capital contributions. Id. at 465.
The Commissioner determined that the purported stock sales were in substance licenses. This Court found that the Commissioner's assessment was barred by the limitation period, because the description of the transactions on the totality of the return was adequate to apprise the Commissioner of the nature and amount of the transactions. Id. at 469, 471.
The central distinction between Univ. Country Club and the case before us is that the taxpayer in Univ. Country Club attached a schedule to its tax return that provided a sufficient "clue" to the Commissioner that the transactions may have been licenses rather than stock sales. Id. at 470. The taxpayer in Univ. Country Club did disclose the stock sales on Schedule L of its return similar to how petitioner did in this case, but the taxpayer also attached to its return a schedule in reconciliation of the capital surplus account that disclosed crucial, itemized information about the memberships sold. Id. This detailed schedule allowed the Commissioner to surmise that the transactions may have been licenses rather than stock sales. No such corresponding clue exists in the case before us that allowed respondent to surmise that the transactions were anything other than stock sales.
If respondent's characterizations of the transactions are correct, petitioner needed to provide a "clue" that in some way apprised respondent that the funds received from the purported stock sales were actually funds received from the patent infringement litigation settlements. See Thiessen v. Commissioner, 146 T.C. 100, 116 (2016) (finding that the taxpayers failed to provide any "clue" on their returns to the prohibited transaction in question, and therefore disclosure was inadequate); Rutland v. Commissioner, 89 T.C. 1137, 1153 (1987) (disclosing that a transaction, without identifying the parties to the transaction when identification of the parties is necessary to give notice to the Commissioner that a prohibited transaction occurred, is insufficient); Benson v. Commissioner, T.C. Memo. 2006-55, slip op. at 16-17 (finding that the taxpayers did not adequately give the Commissioner a "clue" when the taxpayer did not identify a specific property that generated rental income because absent disclosure of the property that made the purported rental payments there was not a clue that the transactions were in substance something other than rental payments), supplementing T.C. Memo. 2004-272, aff'd, 560 F.3d 1133 (9th Cir. 2009). We will not outline the myriad of ways that petitioner could have met this disclosure requirement without changing its tax position, but its failure to provide any sufficient "clue" linking the purported stock sales to the patent infringement litigation settlement makes the disclosure inadequate.
In addition, if respondent is correct that the funds received from the purported stock sales should have been treated as payments made to settle the patent infringement litigation, then petitioner's disclosure on Schedule L is misleading and therefore inadequate. Misleading disclosure on a return is insufficient to apprise the Commissioner of the nature and amount of omitted income. See Estate of Fry v. Commissioner, 88 T.C. at 1023. In Benson v. Commissioner, slip op. at 14, this Court found that the label "royalties" on certain transactions was misleading and inadequate to apprise the Commissioner that the transactions constituted a tax planning tool lacking in economic substance. In this case if respondent is correct that the funds received for the purported stock sales should have been reported as payments made to settle the patent infringement litigation, then placing the funds received on Schedule L and treating them as capital contributions was misleading.
Petitioner argues that the size of the increase of common stock on its balance sheet, along with the disclosure of legal settlement costs that were large relative to gross receipts, provided sufficient "clues". We disagree. Based on these supposed clues, any connection between the purported stock sales and litigation settlement payments would be, as Sherlock Holmes might say, "founded upon the observation of trifles." Arthur Conan Doyle, The Boscombe Valley Mystery 13 (Soul Care Publishing 2011) (1891). Rather, this case is more akin to Estate of Whitlock, where this Court found "there are just too many missing fact links in the logical chain connecting the items actually disclosed" to the omitted amounts of gross income. Estate of Whitlock v. Commissioner, 59 T.C. 490, 511 (1972), aff'd in part, rev'd in part on other grounds, 494 F.2d 1297 (10th Cir. 1974).
IV. Conclusion
At this time certain material facts are still in dispute regarding the purported stock sales that leave us unable to reach a conclusion as to which party's characterization of the transactions is correct and whether petitioner's disclosure was adequate.
Accordingly, petitioner's motion for summary judgment will be denied, and respondent's motion for partial summary judgment will be denied.
In reaching our decision, we have considered all arguments made by the parties, and to the extent not mentioned or addressed, they are irrelevant or without merit.
To reflect the foregoing,
An appropriate order will be issued.