Government Surrenders on FET; Getting Refunds May not be Automatic (or Easy) for Business Customers

On May 25, 2006, a little over three years after LB3 filed its first case in federal court seeking to overturn the federal excise tax on toll telephone service, and after suffering five straight defeats in the federal courts of appeals, the Government announced that it was giving up the fight. The Treasury Department announced that it “was conceding the legal dispute over the federal excise tax on long-distance telephone service.” The Department of Justice will no longer pursue litigation opposing FET refund claims, and the Government will issue refunds of tax on long-distance service for the past three years.

Although the Government’s press release states that “no immediate action is required by taxpayers,” enterprise customers should note that for companies, refunds are not automatic. Indeed, under the Notice put out by the IRS, companies will have to re-file any previous requests for refunds of taxes paid after March 1, 2003, and will have to make such requests as part of their 2006 federal income tax forms – a requirement that will be both burdensome and disadvantageous to business users.  If true, this is outrageous – we’ll be working on it, and will keep clients posted. For more information on the Government’s surrender and what to do now, please feel free to contact Hank Levine or Steve Rosen.

May 2006 FET Update – LB3 Wins Two More Appeals Against the Government.

LB3 recently scored another pair of victories as part of its effort to obtain refunds of the 3% federal excise tax ("FET") on communications services. On April 27, 2006, the United States Court of Appeals for the Second Circuit affirmed the trial court’s decision granting summary judgment in favor of the taxpayer in Fortis, Inc. v. United States.  Less than two weeks later, the United States Court of Appeals for the Third Circuit affirmed the lower court’s decision in Reese Brothers, Inc. v. United States. As a result, LB3 now has won eight straight cases against the Government, including four victories at the appellate level. The tally in the FET litigation now stands at Taxpayers: 12, IRS: 0.

Even before this recent pair of victories for taxpayers, the growing list of adverse decisions was causing the Government to reconsider its policy of collecting the FET. On April 14, 2004, The Wall Street Journal reported that the Government “is working on a plan to stop collecting the [FET] levy and refund billions of dollars to consumers and businesses.” A Treasury Department spokesman was quoted as saying "Treasury, IRS and [the] Justice Department are working together and considering the matter and you could expect some sort of decision to come in the future."

Meanwhile, another appeal is pending. On April 4, 2006, LB3’s Stephen Rosen argued before the United States Court of Appeals for the Federal Circuit in the Government’s appeal of Honeywell International Inc. v. United States.

During the oral argument in Honeywell, the Government reportedly faced “heated questioning” from the three-judge panel. “The practice used to be if the Government lost a case in three circuits, the Government would drop it,” noted Judge Daniel Friedman. “I take it that is not the case today?” Judge Randall Rader followed up by asking “How many circuits is it going to take?” Counsel for the Government replied, “I don’t know the answer.”

The answer to Judge Rader’s questions may be found in testimony by Secretary of the Treasury John Snow before the House Ways and Means Committee on February 15, 2006. The following colloquy about FET occurred between Rep. Jim Ramstad (R-MN) and Secretary Snow:

Mr. RAMSTAD: Mr. Secretary, I want to ask you about a thorn in the side of many taxpayers, and I am referring to the telephone excise tax. As you know, this tax was first enacted . . . in 1898 as a temporary tax to fund the Spanish‑American War. It is imposed by the Federal Government on long distance phone calls. It seems to me almost an absurdity today that the tax only applies to phone calls for which charges are levied based on the distance and the time of the phone call [when] . . . as we all know, most phone companies today don't base their charges on both distance and duration of the call. Rather, they charge a flat rate per minute regardless of the distance the customer happens to be calling.

Now, in the past few years, a number of taxpayers, business taxpayers, have challenged the IRS's collection of this tax in Federal court. In fact, no fewer than three Federal courts and a host of Federal District Courts have all ruled against the IRS. Can you please tell me why in the world . . . the IRS continues collecting this tax, and can you give us an indication of how long the Government will keep litigating this issue? Mr. Secretary, why not give it up?

[Laughter.]

Secretary SNOW: Well, I think the courts may require us to do that very soon. You know, this is pending in the Sixth Circuit. The Department of Justice took an appeal from the District Court. We are awaiting that judgment. Should the judgment come down in alignment with the prior three Federal Circuit Courts, I think the handwriting is on the wall.

Mr. RAMSTAD: That will be the end of the temporary tax enacted in 1898 to fund the Spanish‑American War?

Secretary SNOW: I would think the time to bring that to an end would be upon us.

Mr. RAMSTAD: That will be good news to taxpayers. Thank you, Mr. Secretary.

The proceeding to which Secretary Snow was referring was actually not a pending appeal (a three-judge panel from the Sixth Circuit had already ruled against the Government in November 2005), but a motion by the Government for rehearing before the full Sixth Circuit. On March 30, 2006, the Sixth Circuit denied the Government’s motion and let the lower court’s ruling stand. Now that five courts of appeal have ruled against the Government, perhaps Secretary Snow will see the handwriting on the wall after all . . . .

LB3 Serves as Co-Counsel in Class Action to Recover FET Paid by Residential Subscribers.

LB3 is serving as co-counsel in a class action, Sloan et al. v. United States, which was filed in the Federal District Court for the District of Columbia on April 11, 2006. The suit is being brought to recover FET paid by residential telephone subscribers under a Federal statute known as the Little Tucker Act, which allows suits for illegal takings of private property by the government. The complaint asserts that the collection of FET on non-distance-sensitive long-distance services is an unlawful agency action because it is both an unlawful “taking” deprives residential subscribers of their property without due process of law.

Meanwhile, LB3 continues to file new refund claims on behalf of enterprise customers for wireless and wireline services. As described below, the Government has not given up collecting the FET, which means that it is essential that enterprise customers continue to file for refunds of the tax.

A Short History of the FET Controversy

The FET has bedeviled enterprise customers for decades. Under the Internal Revenue Code, the tax applies to long distance service when the charge for each individual call varies with "distance and elapsed transmission time." But pricing for long distance services is no longer distance sensitive: carriers charge the same price for a call from New York City to Pittsburgh as they do for a call from New York City to Los Angeles. Because the prices of these services are "postalized" (i.e., do not vary with distance), the FET should be inapplicable.

Despite the plain language of the Internal Revenue Code, since 1979 the IRS has asserted that Congress intended to tax all long distance voice service, even if the underlying rates are not distance sensitive. The Court of Federal Claims, five Federal District courts and three Courts of Appeal have now told the Service that it cannot ignore the plain language of the statute; further, the lone District Court judgment in favor of the Government was reversed on appeal.

The stakes are significant: enterprise customers stand to recover as much as 3% of their annual spend on intrastate, interstate, and international voice minutes going back three years, which can add up to millions of dollars. And filing these claims neither upsets the telecom vendor (the carriers, who are merely collection agents for the IRS, would like to see the FET go away as much as customers do) nor creates a shortfall (because taxes do not contribute to a customer's minimum commitment).

Enterprise Customers Take on the FET

Since May 2003, LB3 has filed refund lawsuits on behalf of seven of its clients. After a temporary setback in Florida — where the court decided (on its own) that the word "and" in "distance and elapsed transmission time" really means "or" — courts in nine subsequent cases (five brought by LB3) rejected the Florida court's reasoning and ruled in the taxpayer's favor. Here is the scorecard to date on the cases brought by LB3:


• OfficeMax, Inc. v. United States. The trial court granted summary judgment in favor of the taxpayer, which is claiming $384,000 in refunds. On November 2, 2005, the United States Court of Appeals for the Sixth Circuit affirmed the trial court's ruling. The Government’s motion for rehearing en banc was rejected on March 30, 2006.
• Fortis, Inc. v. United States. The trial court granted summary judgment in favor of the taxpayer, which is claiming $434,000 in refunds. On April 27, 2006, the United States Court of Appeals for the Second Circuit affirmed the trial court’s ruling.
• Reese Bros., Inc. v. United States. The trial court granted summary judgment in favor of the taxpayer, which is claiming $335,000 in refunds. The Government has appealed to the Third Circuit. On May 9, 2006, the United States Court of Appeals for the Third Circuit affirmed  the trial court’s ruling.
• Honeywell International, Inc. v. United States. A trial court granted summary judgment in favor of the taxpayer. The Government has appealed to the Federal Circuit. Oral argument was held on April 4, 2006, and a decision from the Federal Circuit is pending.
• American Bankers Insurance Group v. United States. A panel of the United States Court of Appeals for the Eleventh Circuit reversed the trial court's decision in favor of the Government and ordered entry of summary judgment in favor of the taxpayer, which sought (and has now received) over $360,000 in refunds. The Government decided not to file a petition for a writ of certiorari to the Supreme Court. On March 27, 2006, LB3, on behalf of ABIG, filed a complaint in the United States District Court for the Southern District of Florida seeking refunds for taxable quarters that were not encompassed in the initial ABIG case and, seeking to enjoin the IRS from continuing to collect FET from ABIG.
• Convergys, Inc. v. United States. The taxpayer is claiming over $6 million in refunds in this action, which was held in abeyance pending the Sixth Circuit decision in OfficeMax. Now that the Sixth Circuit has ruled, the case is expected to be re-activated.
• McKesson v. United States. The taxpayer is claiming nearly $1 million in refunds in this action, which was filed in the Court of Federal Claims.

IRS to Carriers: Ignore the Eleventh Circuit, Keep Collecting FET

In an almost unprecedented decision not to recognize that a United States Court of Appeals decision is law in the Circuit in which it was decided, on October 26, 2005, the IRS instructed carriers to continue collecting FET, "including from taxpayers within the jurisdiction of the United States Court of Appeals for the Eleventh Circuit." One publication summed up the Service's decision this way: "IRS Announces That It Will Violate Court of Appeals Ruling Regarding Excise Tax on Phone Service." The bottom line is that FET refunds are not automatic — enterprise customers won't get refunds unless they continue to file for them.

Conclusion

LB3, on behalf of its clients, is committed to litigating these cases through the Circuit Courts of Appeal and, if necessary, to the Supreme Court. We believe that the trial courts' decisions in OfficeMax, Fortis, Reese and Honeywell, along with the appellate courts' decisions, including those in Fortis, ABIG, OfficeMax, and Reese Brothers confirm that the long distance services purchased by most large business users are plainly not subject to the FET.

For further information about the FET litigation or about filing an FET refund claim, please contact Hank Levine or Stephen Rosen.