Swiss Taxpayer Wins US Tax Treaty Refund Dispute

The United States District Court for the District of Columbia on January 31 ruled in favor of Starr International Company in a case concerning an erroneous refund paid to the taxpayer, which the IRS sought to reclaim.

In 2011, the IRS erroneously issued a USD21m refund to Starr International Company, Inc. for the 2008 tax year.

Under the applicable statute of limitations, the Government had two years to file suit to reclaim that refund, but it failed to do so.

Instead, four years after issuing the refund, the Government filed a counterclaim in this case, which Starr originally brought to recover taxes withheld for the 2007 tax year.

The IRS contended that it is entitled to an extended limitations period – of five years, rather than two – because, it alleged, it was induced to issue the refund by Starr’s misrepresentations of material fact.

In Starr International Company, Inc. v. United States of America (Case No. 14-cv-01593 (CRC)), the Court found that Starr made no such misrepresentations in its refund claim. The Court therefore ruled that the two-year statute of limitations should apply.

Facts of the case

The case concerned the US federal income taxes on dividend income attributable to stock held by Starr, a Swiss-based company, in US corporations. These taxes are typically withheld at a rate of 30 percent and remitted directly to the IRS. A tax treaty between the United States and Switzerland, however, entitles certain Swiss-resident corporations to a significant reduction in the tax rate applied to US-source dividends – from 30 percent to either five or 15 percent. Sometimes the IRS grants a refund claim erroneously. When this happens, the Government generally has two years to realize its error and initiate a lawsuit to recover the refund.

Under US law, the statute of limitations can be extended to five years, “if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.” The Government bears the burden of proving a misrepresentation of material fact in order for the five-year statute of limitations to apply.

In December 2007, Starr filed a request with the United States Competent Authority (USCA) seeking discretionary benefits – specifically, a reduced rate of withholding paid on dividends it received from AIG stock – under the US-Swiss Treaty.

A Swiss corporation automatically benefits from the Treaty if it meets one of a dozen or so enumerated criteria – for example, if it does significant business in Switzerland.

While that request was pending before the USCA, Starr filed a refund claim with the IRS’s Ogden Service Center – a prerequisite for bringing legal action against the IRS to claim a refund before the courts – for the 2007 tax year, seeking a refund in the amount it would be entitled to receive if it were eligible for the treaty benefits.

Starr indicated on the front page of its Form 1120-F that the refund request was a “Protective Refund Claim” and informed the USCA that it was filing this claim. The USCA representative who was reviewing Starr’s treaty benefits eligibility request contacted the Ogden Service Center and instructed it not to issue a refund.

In October 2010, the USCA issued a final determination letter denying Starr its requested treaty benefits for the 2007 tax year.

Starr then filed a refund request with the IRS for USD21m for the 2008 tax year and an amended claim for the 2007 tax year. On the first page of its 2008 Form 1120-F, next to the line indicating the amount to which Starr claimed it was owed, Starr wrote “See Statement 1,” referring to an attached five-page statement with several attachments. In the first paragraph of this statement, Starr disclosed that it had not been granted benefits by the USCA. The statement went on to detail Starr’s legal arguments about why it believed the USCA’s determination was incorrect.

Starr also attached about 90 pages of correspondence between Starr and the USCA, including the determination letter that set forth the USCA’s basis for deciding that Starr did not qualify for the benefits.

In 2011, the IRS granted Starr’s 2008 refund request and issued a refund for USD21,151,745.75. It did not act on Starr’s 2007 amended claim.

In 2014, Starr filed suit in the US District Court for the District of Columbia seeking a refund of taxes paid for the 2007 tax year on the basis that the USCA erroneously denied its request for treaty benefits.

The Court held that Starr’s refund claim was not subject to judicial review because, in order to grant Starr its requested refund, the Court would need to “dictate the outcome” of the Treaty’s mandatory consultation with the Swiss competent authority and would thereby “impinge upon the Executive’s prerogative to engage in that [consultation] process.”

The Court ultimately ruled that the USCA’s determination did not violate the APA, and Starr has appealed that ruling.

Meanwhile, in 2015, the Government amended its answer to Starr’s complaint before the District Court by adding a counterclaim seeking to recover the 2008 refund as erroneously issued.

Citing IRS regulations, the Government contended that the USCA’s denial of benefits was not administratively reviewable by the Ogden Service Center, and so the Ogden Service Center did not have jurisdiction to issue the refund in the first place.

As the Government recognized, because it brought suit to recover the erroneous refund almost four years after it was issued, its counterclaim would be untimely under the default two-year statute of limitations. Thus, for the Government’s counterclaim to succeed, it had to prove before the Court that Starr induced the IRS to issue the refund “by fraud or misrepresentation of a material fact,” for the five-year limitations period to apply. The parties then accordingly filed cross-motions for summary judgment on the issue of whether the Government’s claim is timely.

The IRS said Starr made three misrepresentations of material fact that induced the refund: (1) it indicated on line nine of the Form 1120-F that it was entitled to a USD21m refund; (2) it failed to notify the representative overseeing the matter at the USCA that it was filing the refund request with the IRS; and it failed to notify the Ogden Service Center that it lacked jurisdiction to issue a refund. The Court found that none of these acts or omissions were material misrepresentations for purposes of the statute of limitations.

The Government had sought to argue that they qualify as misrepresentations because Revenue Procedure 2006-54, which sets out procedures for requesting treaty benefits from the USCA, and specifically section 12.04 of that regulation, makes clear that denials of discretionary treaty benefits are final and not subject to administrative review. In the Government’s view, section 12.04 does more than foreclose a formal administrative appeal of the USCA’s determinations; it also prevents a taxpayer from filing a refund claim that does not “take that directive into account.”

The Court said the Government had argued that section 12.04 required Starr to construct its claim in a way that would ensure it would not be granted. Otherwise, Starr would be effectively seeking administrative review of the USCA’s determination in violation of the regulation.

Rejecting this argument, the Court stated: “This theory has a core deficiency that spells trouble for the Government’s case: A refund claim cannot be naturally understood as an attempt to obtain administrative review of a regulatory decision related to the claimed amount. Rather, refund claims are non-adversarial mechanisms for taxpayers to seek money the IRS has withheld. And, as the Government concedes, filing a refund claim is an absolute, jurisdictional prerequisite to seeking judicial review of an IRS refund determination.”

“Specifically, while taxpayers generally have the right to sue the Government in federal court for a refund of taxes ‘erroneously or illegally assessed or collected,’ the taxpayer must submit an administrative refund claim to the IRS before filing such an action. If a taxpayer instead proceeds directly to federal court, the court will lack subject matter jurisdiction and must dismiss the action.”

The Court therefore concluded: “It cannot be that section 12.04 imposes a generalized duty on taxpayers to file refund claims that will not result in refunds.”

It provided examples of where a misrepresentation is made. For instance, where a taxpayer disregards an express instruction on Form 1120-F, ignores a disclosure requirement created by statute or regulation, or “perhaps,” according to the Court, where the taxpayer fails to disclose information it understood was necessary for the IRS to reach an informed decision.

The Court therefore ruled that “Starr properly completed and filed its 2008 Form 1120-F, accurately indicating the amount it believed it was due while repeatedly alerting the IRS to the fact that the USCA had denied it treaty benefits. The Ogden Service Center’s erroneous payment of the refund claim does not mean that Starr misrepresented a material fact. […] The Court will therefore apply the standard two-year statute of limitations to the Government’s counterclaim, rendering it untimely.”