Opinion
12101-19
07-17-2023
NORTH BY NORTHWEST VII, LLC, NORTHWEST VII INVESTMENTS, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Elizabeth Crewson Paris Judge
This case is one of six related but not consolidated cases. It, like the other five cases, has previously been calendared for trial. To date, the parties in each of the six cases have filed a stipulation of facts and have been engaged in active discovery and motion practice, including filing several motions for partial summary judgment. All six cases also have a similar but not identical motion pending.
The six cases are North by Northwest VII, LLC v. Commissioner, Docket No. 12101-19, North by Northwest VI, LLC v. Commissioner, Docket No. 12102-19, North by Northwest V, LLC v. Commissioner, Docket No. 12103-19, North by Northwest IV, LLC v. Commissioner, Docket No. 12104-19, North by Northwest III, LLC v. Commissioner, Docket No. 12105-19, and North By Northwest II, LLC v. Commissioner, Docket No. 12106-19.
On June 10, 2022, respondent filed a Motion for Leave to File Amendment to Answer to Petition, docket entry 86, and lodged an Amendment to Answer, docket entry 87. The Amendment to Answer, as lodged, asserts an additional penalty. Both respondent's counsel and respondent's counsel's immediate supervisor signed the Amendment to Answer.
On August 30, 2022, at docket entry 94, petitioner filed a Response in Opposition to respondent's Motion, along with a supporting Memorandum of Law at docket entry 95. On October 31, 2022, at docket entry 103, respondent filed a Reply to petitioner's Response in Opposition. And on December 16, 2022, at docket entry 108, petitioner filed a Sur-Reply to respondent's Motion. Rule 41(a) provides that leave to amend a pleading "will be given freely when justice so requires." Whether leave will be granted is a question falling within the sound discretion of the Court. Young, 926 F.2d at 1087; Estate of Quick v. Commissioner, 110 T.C. 172, 178 (1998), supplemented by 110 T.C. 440 (1998).
Unless otherwise indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, and Rule references are to the Tax Court Rules of Practice and Procedure.
Rule 41(a) is similar to Rule 15(a) of the Federal Rules of Civil Procedure in that both rules state that leave to amend is to be freely given when justice so requires. See Kramer v. Commissioner, 89 T.C. 1081, 1084-85 (1987). In interpreting this language, the Supreme Court has held that "[i]n the absence of any apparent or declared reason-such as undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, futility of amendment, etc.- the leave sought should, as the rules require, be 'freely given.'" Foman v. Davis, 371 U.S. 178, 182 (1962); see also Young v. Commissioner, 926 F.2d 1083, 1087 (11th Cir. 1991), aff'g T.C. Memo. 1988-440, and Cohen v. Commissioner, T.C. Memo. 1988-525.
The parties have stipulated that petitioner is a Georgia limited liability company whose principal place of business is in Georgia. Because this case appears to be appealable to the U.S. Court of Appeals for the Eleventh Circuit, we will follow that court's precedent. See Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971); see also § 7482(b)(1)(E).
An important factor in deciding whether leave to amend will be granted is prejudice to the opposing party. Estate of Quick, 110 T.C. at 178-80. Prejudice can occur if the opposing party was required to engage in substantial new preparation at a late stage in the proceedings, necessitating added time and expense. TBL Licensing LLC v. Commissioner, T.C. Memo. 2022-71, at *11. It is not simply whether an amended pleading that includes the proposed new issues would make the case harder or more expensive for the other party, because that is likely to occur in any amendment to the pleadings, but whether it would create an unfair advantage to the other party. Ax v. Commissioner, 146 T.C. 153, 168-69 (2016).
Respondent's Amendment to Answer, as lodged, asserts the determination that petitioner's underpayment of federal income tax for 2015 was due to fraud within the meaning of section 6663(b). Respondent's position would increase the section 6662 accuracy-related penalty from 20% to 75% of the underpayment. See § 6663(a). Respondent asserts that the additional allegation should be allowed because respondent became aware of additional facts only after filing his Answer on August 23, 2019. The additional facts alleged by respondent include email correspondence suggesting the North by Northwest (NXNW) managers may have ignored advice from a reviewing appraiser and other professionals highlighting problems with the valuations claimed for the NXNW easements and a draft opinion letter from a law firm stating that one of the NXNW transactions, as originally structured but not as implemented, lacked economic substance. Respondent bears the burden of proving the alleged fraud "by clear and convincing evidence." Rule 142(b); see also § 7454(a); Henson v. Commissioner, 887 F.2d 1520, 1525 (11th Cir. 1989), aff'g T.C. Memo. 1988-275.
Petitioner contends that respondent's Motion would cause it to suffer substantial delay and prejudice. Petitioner asserts that respondent has had ample opportunity to put forth the fraud allegation and that if respondent is allowed to make yet another allegation late after filing his Answer, petitioner would be placed at an unfair disadvantage. Specifically, petitioner claims that its decisions as to "(1) whether to agree to a continuance of trial, (2) whether to go to IRS Appeals, and (3) whether to agree to Respondent's requests for extensions of time to respond to discovery" were made on the assumption that respondent had "asserted all potential penalties." Pet'r's Resp. in Opp'n 16.
Further, petitioner asserts that the additional facts respondent relies on are not newly discovered, evidenced by the fact that the examining agent "confirmed that she received 2 boxes of emails from the NXNW Taxpayers . . . [and] spent 51 hours reviewing these emails and collected them in a spreadsheet." Pet'r's Mem. in Supp. of Opp'n 5. Respondent meanwhile claims that "the excel spreadsheet received by respondent's counsel as part of the administrative file did not include the language quoted" concerning a reviewing appraiser's comments on the appraiser's valuation. Resp't's Reply to Resp. in Opp'n 5 n.3 (emphasis in original).
Petitioner also contends that respondent had improper motive for bringing the fraud allegation. In support of this contention petitioner suggests "that the counsel who decided to assert the fraud penalty deviated from the position taken by multiple IRS attorneys who had . . . more familiarity with the facts of the case" and that "[i]t was only after the NXNW Taxpayers secured . . . two victories that Respondent proceeded to try and assert more heavy-handed penalties." Pet'r's Mem. in Supp. of Opp'n 11, 14. Respondent disagrees, asserting that:
The referenced "victories" are in regard to earlier Motions for Partial Summary Judgment.
Although respondent's Amendment to Answer relies on some facts known to respondent prior to June 2022, it was not until respondent's counsel had conducted a thorough review and compiled enough relevant facts and circumstantial evidence, including information of which respondent's counsel became aware from Webb Creek documents and the third and fifth informal discovery requests from March 2021 through February 2022, that respondent's counsel determined that it was appropriate to assert a penalty for fraud based on the conclusion that there were sufficient facts to satisfy its burden to prove by clear and convincing evidence that petitioner had underpaid tax due to fraud.Resp't's Reply to Resp. in Opp'n 10-11.
Finally, petitioner contends that respondent's Amendment to Answer "is futile because Respondent cannot demonstrate compliance with I.R.C. § 6751(b) when asserting the fraud penalty." Pet'r's Mem. in Supp. of Opp'n 34. Respondent in his Reply states that respondent's counsel's immediate supervisor personally approved, in writing, the section 6663 fraud penalty by signing the Amendment to Answer, which raises the penalty in the first instance. By securing written supervisory approval before asserting the fraud penalty, respondent has satisfied the requirements of section 6751(b). See Roth v. Commissioner, T.C. Memo. 2017-248, at *8-12 (finding associate area counsel's signature on answer sufficient to satisfy supervisory approval requirement of section 6751(b)), aff'd, 922 F.3d 1126 (10th Cir. 2019); see also Kroner v. Commissioner, 48 F.4th 1272, 1276 (11th Cir. 2022), rev'g in part T.C. Memo. 2020-73.
After thorough review of the record and the parties' filings, the Court concludes there is nothing in the record to support a finding that petitioner would suffer undue delay, prejudice, or other substantial harm as a result of respondent's amendment. This case is not currently set for trial and petitioner will have ample time to prepare for respondent's additional allegation. Although the Court will allow respondent to amend his Answer, it is not suggesting any view on the merits of such a penalty in this case.
Considering the burden of proof and production with respect to this additional allegation will fall squarely on respondent at trial, see Rule 142(b); see also § 7454(a); Henson, 887 F.2d at 1525, and given the liberality of the above-described standard, the circumstances here do not meet the requisite prejudice or delay to justify denial of respondent's Motion, see Young, 926 F.2d at 1087; Estate of Quick, 110 T.C. at 180.
To reflect the foregoing, it is hereby
ORDERED that respondent's Motion for Leave to File Amendment to Answer to Petition, filed June 10, 2022, docket entry 86, is granted, and the Clerk of the Court shall file respondent's Amendment to Answer, lodged June 10, 2022, docket entry 87, as of the date of this Order.