Opinion
No. 3:03-0510.
March 22, 2004
MEMORANDUM and ORDER
I. INTRODUCTION
Currently pending in this civil action is defendant's motion to preclude argument at variance with claim (Docket Entry No. 39). Plaintiff has responded to the motion (Docket Entry No. 41), and defendant has filed a reply to this response (Docket Entry No. 44). Upon consideration of the papers supporting and opposing the motion, as well as the exhibits thereto, and for the reasons stated below, defendant's motion is DENIED.
II. BACKGROUND
This is a lawsuit seeking refund of an excise tax assessed by defendant under 26 U.S.C. § 4975(a) for the calendar year 1992, and paid by plaintiff. This tax was levied as a penalty for certain actions plaintiff took with respect to its captive pension plan. Plaintiff, as sponsor of its employee stock ownership plan (ESOP), guaranteed four loans made by banks to the ESOP for the purpose of purchasing employer securities. Section 4975 imposes an excise tax upon prohibited transactions, including a loan or loan guarantee between a qualified employee benefit plan and the employer that sponsors the plan. However, there is a statutory exception to this prohibition for a loan between a plan sponsor and its ESOP, provided that the loan meets certain conditions.
Here, plaintiff pledged the ESOP's stock as collateral for the bank loans. The loan documents called for the lenders to release the collateral as the loans were repaid, at a rate proportional to both principal and interest payments. During 1988, the collateral was released and allocated to participant accounts in proportion to principal and interest payments, in accordance with the loan agreements.
This formula for the release of collateral securing an exempt loan to a leveraged ESOP is also included in the Treasury Regulations, at section 54.4975(b)(8)(1).
Beginning in 1989 and continuing until 1996, the treatment of the ESOP's stock did not conform to the regime established in the loan documents — that much is agreed. But the parties hold divergent beliefs as to the reason for this nonconformity which caused defendant to identify the loans as prohibited transactions subject to the excise tax. Defendant contends that in 1989, according to the administrative claim which plaintiff submitted as a necessary predicate for filing this lawsuit, the lenders, at plaintiff's behest, began releasing the collateral from encumbrance only in proportion to the amounts of principal paid, retaining their security interest in those stocks pledged to secure the interest on the loans even though the payments made by the ESOP had been applied to both principal and interest. This resulted in an under-allocation of securities to the accounts of the ESOP participants.
On the other hand, plaintiff contends that the wrongdoing lay not with the lenders' failure to treat collateral as released, but in its own erroneous release of the de-collateralized securities on a principal-only basis (rather than on the basis of principal and interest payments) back to the accounts of ESOP participants from a stock suspense account, where the securities resided while pledged as collateral for the loans. Thus, plaintiff contends that this improper release back to the ESOP's participants' accounts was the result of a bookkeeping error on its part. Plaintiff maintains that its administrative claim for refund is properly read as encompassing this factual theory, which it now seeks to litigate. Defendant contends that this theory impermissibly varies from the statement of plaintiff's administrative claim, and that plaintiff should therefore be precluded from arguing in the first instance before this Court its entitlement to a refund on the basis of these facts.
III. CONCLUSIONS
"A taxpayer must first file an administrative claim for refund with the Secretary of Treasury prior to bringing an action against the United States for a tax refund." McDonnell v. United States, 180 F.3d 721, 722 (6th Cir. 1999) (citing 26 U.S.C. § 7422(a)). This administrative claim "must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof." Id. (quoting Treas. Reg. § 301.6402-2(b)(1)).
When a party fails to state with specificity the grounds for the refund, the court is without jurisdiction to entertain the action. See Salyersville Nat'l Bank v. United States, 613 F.2d 650, 651 (6th Cir. 1980). "Federal courts have no jurisdiction to entertain taxpayer allegations that impermissibly vary or augment the grounds originally specified by the taxpayer in the administrative refund claim." Charter Co. v. United States, 971 F.2d 1576, 1579 (11th Cir. 1992). The purpose of the "variance rule" is to prevent surprise, and to give the IRS adequate notice of the claim and its underlying facts so that it can make an administrative investigation and determination regarding the claim. Id.; see also Angle v. United States, 996 F.2d 252, 254 (10th Cir. 1993); Boyd v. United States, 762 F.2d 1369, 1371 (9th Cir. 1985).Id.
However, "in considering a claim for a refund the IRS is required to examine those issues to which its attention necessarily has been directed." Thomas Nelson, Inc. v. United States, 694 F. Supp. 428, 437 (M.D. Tenn. 1988) (Nixon, J.). InThomas Nelson, this Court held that the taxpayer's claim in litigation, though not expressed in so many words in its administrative claim, was properly before the Court inasmuch as it was "inextricably tied to and subsumed within" the administrative claim, and therefore not "factually distinct from and substantially at variance with" that claim. Id. (citing Union Pacific Railroad Co. v. United States, 389 F.2d 437, 442 (Ct.Cl. 1968) (a court may consider the ground for a refund that is "comprised within the general language" of the administrative claim)). In distinguishing Salyersville Nat'l Bank v. United States, this Court noted that the taxpayer in that case had claimed before the agency that certain commissions had been improperly included in its income by the IRS because the taxpayer was not licensed to earn such commissions, and then advanced the position in litigation that the commissions had in fact never been received. Id. In Thomas Nelson, as here, the differences in the claims were not nearly so stark.
Plaintiff's claim before the IRS is appended to its complaint, at exhibit B. The paragraph of plaintiff's claim which defendant initially focuses on reads as follows:
As a result of an inquiry from the U.S. Department of Labor, it was determined by National Health that collateral held was being released in proportion to the principal paid — and not in proportion to the principal and interest paid, as was provided for under the security agreement securing the loan. Upon this discovery and prior to any action by the Internal Revenue Service, National Health released additional collateral on the basis provided in the loan documentation.
(Docket Entry No. 1, p. 16). Though defendant construes this paragraph as an admission that the lenders did not properly release the collateral, such construction appears to read into the language of the claim an identity between taxpayer and lender that simply is not there. While the taxpayer plaintiff, as sponsor of the ESOP and guarantor of its loan obligation, assumes any liability incurred by the ESOP within the framework of the loan transaction, it does not appear reasonable for the IRS to assume that plaintiff would have any identity of interest with the other party to the transaction, so as to justify the inference that the multiple references in the claim to release of collateral by "National Health" or "taxpayer" in fact should be read to mean release by the lending banks at the direction of the taxpayer.
". . . National Health released additional collateral on the basis provided in the loan documentation." (Docket Entry No. 1, p. 16).
"In reviewing National Health loans and release of collateral . . ." (Id. at 18).
"National Health's minor deviations with respect to the release of collateral would have corrected themselves if they had not been discovered." (Id. at 20).
"In fact, the regulations upon which the Service relies do not necessarily have to be read to preclude collateral from being released in the way that taxpayer had released it." (Id. at 17).
"The taxpayer's failure to release collateral in proportion to total payments was in fact reversed in late 1996." (Id.).
While plaintiff's administrative claim refers to the security agreement and/or loan documents as establishing the proportion in which collateral is to be released from encumbrance, the language of the claim is fairly read as ascribing fault in failing to maintain that proportion solely to the taxpayer, and its failure to release the pledged shares from the ESOP suspense account according to principal and interest payments. As plaintiff controls the reallocation of pledged securities back to the participants' accounts, it appears that these pledged securities are only truly and finally "released" from encumbrance when given their release on the books of both lender and taxpayer. Accordingly, while the term "release" may speak of an action to be taken by the lender as used in the applicable statutes and regulations, the undersigned is persuaded that the same term as used in plaintiff's claim is only reasonably construed as speaking of an action taken by the taxpayer on its books or the books of the ESOP.
This construction is further supported by references in the claim to the failure to release collateral as "a minor technical violation", "National Health's minor deviations", "a small and minor deviation", and "minor self-correcting technical irregularities" (Docket Entry No. 1, pp. 19-20). Such references clearly support plaintiff's argument that the alleged impropriety admitted in the administrative claim was in the nature of a bookkeeping error whereby assets were released by the lender but not yet reallocated to the appropriate accounts, rather than a material breach of the security agreement covering the loans at issue.
Moreover, the administrative investigation into the loan activities at issue here appears to indicate that the IRS considered the improper release to be related to plaintiff's bookkeeping, and not any mistake or complicity on the part of the lending banks. On December 21, 2000, an IRS case manager issued a report of his investigation, which included the following statement of facts:
Both the loan documents and ledgers, relating to the leveraged ESOP loans were inspected. Review of the loan documents revealed the following loans and their terms: . . .
Inspection of Trust's general ledger indicates that the shares were released on a principal only basis. For the 1988 plan year the release was originally performed on a principal and interest basis, but the Employer recalculated the release to include principal only and an adjusting entry was made. For all subsequent years the release was performed on a principal only basis. The taxpayer stated that they were told by their legal council to make this change.
Inspection of Trust's general ledger also indicates that the formula used to release the shares on a principal only basis was not in compliance with the Regs. pertaining to a principal only release.
(Docket Entry No. 38, p. 10; cf. Docket Entry No. 41, p. 53).
In sum, while plaintiff could perhaps have been more specific in its wording of the administrative claim, the undersigned concludes that its statement of the claim was sufficient to apprise the IRS of the exact nature of its claim (if not successful in so apprising the Service, as indicated above), that the language of the claim necessarily directed the IRS' attention to the issue presented in this litigation, which is at worst "comprised within the general language of the claim," and that the argument which plaintiff now makes is therefore not "factually distinct from and substantially at variance with" its administrative claim.
It must be noted that in view of plaintiff's timely filing of an amended administrative claim for refund (see Docket Entry No. 40, n. 1), which is apparently more specific in presenting the argument advanced here, it would appear that even if this Order is successfully appealed, the variance issue would at some point in the near future become academic.
Accordingly, defendant's motion to preclude argument at variance with claim is hereby DENIED.
So ORDERED.