Writing that the purpose of the Illinois False Claims Act "is not to penalize frank differences of opinion or innocent errors made despite the exercise of reasonable care," an Illinois judge has ruled against a Chicago-based class action law firm serving as the whistleblower in a qui tam action filed against an out-of-state taxpayer.
In the October 23 order, Cook County Circuit Court Judge Thomas Mulroy ruled against Schad, Diamond & Shedden PC, the Chicago law firm that is driving much of the national discussion about potential abuses of state false claims acts that extend to taxes.
Stephen Diamond, the Chicago firm's director and the relator in the case, did not respond to a request for comment.
Schad Diamond and Shedden v. National Business Furniture LLC is one of hundreds of pending cases in which the Chicago firm has alleged that a remote seller committed fraud by failing to collect use tax on the shipping and handling charges associated with its Internet and catalog sales in the state. The firm, which purports to conduct its own investigations into the sales and use tax practices of online retailers by buying items over the Internet, is able to file such whistleblower actions as the consumer in the transactions.
During a two-day bench trial in August, National Business Furniture's financial officers said they had relied on a completed Illinois Department of Revenue audit in determining that the company's practice of not collecting use tax on the charges was consistent with Illinois law and accompanying regulation. The entire audit file maintained by the company was introduced into evidence, as was documentation showing how the company handled tax on shipping and handling. The company argued that it acted in good faith and did not make any false statements to the state.
Mulroy wrote that because the case was brought under the False Claims Act, it wasn't for the court to interpret or apply various Illinois tax laws. Rather, Mulroy said, the whistleblower had the burden of proving that the taxpayer had acted in deliberate ignorance or reckless disregard of Illinois law. "The Court finds Relator has not met its burden," he said.
Peter Brann and David Swetnam-Burland of Brann & Isaacson represented National Business Furniture, a Milwaukee-based retailer of office furniture and supplies.
"We believe the judge's order was a strong vindication that a Department of Revenue audit of sales and use taxes completely resolves tax issues for the time period covered and that a taxpayer is reasonable to rely on the results of an audit in its own tax planning," said Swetnam-Burland. "I think to rule otherwise would risk undermining completely the audit system and leave taxpayers open to this kind of predatory litigation by a plaintiff with a financial interest in the outcome."
DOR spokeswoman Susan Hofer declined to comment on this specific case, but forwarded a statement about qui tam tax litigation generally.
"We don't think it makes sense to include tax disputes in the False Claims Act, and in those situations where [the DOR] has audited the taxpayer and not assessed any tax on the disputed transactions, it is unfair to force the taxpayer to endure an expensive round of civil litigation brought by a private party who has no expertise in state tax law," Hofer said.
Swetnam-Burland said there were two reasons why National Business Furniture decided to stay in court rather than settle.
"One was the size of the demand," he said. "The other was that they were, frankly, outraged by the use of the False Claims Act for this purpose, especially in light of the completed and closed audit."
Diamond alleged that the company knowingly failed to collect and remit $199,076 in tax on shipping charges in Illinois for January 2006 through July 2014. Based on the False Claims Act's triple damages and mandatory penalties, Diamond alleged that National Business Furniture owed the state $731,500.
The Illinois DOR conducted a sales and use tax audit of National Business Furniture for the period from January 1, 2006, through June 30, 2007. The DOR did not ask about or require the company to collect or remit use tax on shipping and handling charges associated with its website or catalog sales to Illinois customers. At the completion of the audit, total tax assessed -- completely unrelated to the company's treatment of shipping and handling charges -- amounted to $2,472, plus penalties and interest.
According to the DOR, there are about 350 qui tam actions pending involving tax on shipping and handling. Swetnam-Burland said Brann & Isaacson represented three different out-of-state retailers in the cases, but that the other two companies settled before trial.
Settlements are common and, according to critics of Diamond and his firm, are likely the main reason the firm files those suits by the hundreds. In 2012 testimony to a state legislative panel, witnesses said the False Claims Act's triple damages and mandatory penalties, which are meant to encourage real whistleblowers to come forward, also provide incentives for financially motivated third parties to file unwarranted fraud suits to force settlements.
Mulroy's Cases Now
For administrative purposes, all of the cases are now before Mulroy, who in June -- in the first of the shipping and handling cases to go to trial -- wondered aloud why the case was even before him.
"It stands logic on its head in my opinion to hold the taxpayer to a higher standard of knowledge on the taxation of delivery charges than the Illinois Department of Revenue," Mulroy said in State of Illinois Ex Rel. Schad Diamond and Shedden v. FansEdge Inc.
However, according to practitioners who have filed motions to dismiss Diamond's complaints based on the fact that the DOR has already audited their clients, Mulroy has denied all such taxpayer motions, saying that each case will come down to the credibility of the witnesses.
Swetnam-Burland said the state also made no effort to defend the DOR's audit or intervene in the case to get it dismissed.
"That was one of our great disappointments," Swetnam-Burland said. "I think that the state could and should have taken stronger action when presented with the facts regarding the audit to short-circuit this case and not let our client litigate for 2-1/2 years to a final judgment on an issue that could have been resolved at the beginning."