With my colleague Marilyn Ames we are revising our subchapter on the Anti-Injunction Act in Chapter 1 of Saltzman and Book IRS Practice and Procedure to take into account last month’s CIC Services decision. Embedded in our discussion of the AIA is a discussion of its cousin, the Declaratory Judgment Act. Under the Declaratory Judgment Act, a federal court may issue a declaration resolving the parties’ competing legal rights “[i]n a case of actual controversy within its jurisdiction, except with respect to Federal taxes.”
Gilbert v US is a recent Ninth Circuit opinion that discusses and applies the DJA in the context of a contract dispute between a foreign entity that owned Arizona property and the Gilberts, US citizens that bought the property. In this post I will discuss the case and the somewhat unusual path that led to the court’s finding that the DJA prevented the court from reaching the merits of the dispute.
The Gilberts entered into a contract to buy residential property in Arizona. The contract called for a $1.2 million purchase price to be paid over the course of about five years. A few years into the contract and the Gilberts informed the seller that future payments were subject to withholding under the Foreign Investment in Real Property Tax Act (FIRPTA) and the Fixed, Determinable, Annual, or Periodical income (FDAP) rules. The sellers disagreed, informing the Gilberts that they were exempt nonresidents. The Gilberts sought a declaratory judgment from a federal district court that would establish that withholding money from their agreed purchase price to pay the federal taxes required under FIRPTA and the FDAP rules was not a breach of their real estate contract.
The district court dismissed the case and the Ninth Circuit affirmed. In dismissing the case, the Ninth Circuit summarized US withholding rules. FIRPTA applies to non US sellers of US real estate and triggers a withholding requirement on a purchaser to ensure that funds to pay the required taxes are collected under FDAP rules.
The Gilberts argued that the DJA did not apply because they were seeking an order with respect to their obligations to withhold on behalf of another’s liability. Moreover, according to the Gilberts, since there had yet to be an assessment or collection of taxes, the order would not restrain assessment or collection.
The Ninth Circuit disagreed. In doing so, it noted that while the DJA’s language sweeps more broadly than the AIA (it covers all actions “with respect to taxes” rather than the AIA’s “for the purpose of restraining the assessment or collection of any tax”) courts have applied the statutes coextensively. Looking to AIA cases, the court noted that the cases do not require assessment to apply. Here, as the Ninth Circuit noted and citing the 4th Circuit case International Lotto Fund case, withholding is a method of tax collection, and there is no “justification for treating withholding from a foreign corporation as anything other than the collection of a tax.”
The opinion also acknowledges that the Gilberts were not seeking to stop the government from collecting taxes but instead “seek to comply with their asserted FIRPTA and FDAP obligations but in a way that avoids any adverse contractual consequences.” Despite that intent, the opinion concludes that the action is barred, emphasizing that a prepayment determination on FIRPTA and FDAP would be binding and undermine the standard refund procedures:
The Supreme Court has recognized that the government’s vital interest in securing tax revenues justifies a “pay-first, litigate-later” system of judicial review. See Flora, 362 U.S. at 164 & n.29. The Gilberts’ attempt to litigate the existence, or extent, of their withholding obligation before paying withheld funds to the government departs from this longstanding principle. There can be no dispute that the ultimate issue in this case is the parties’ tax obligations flowing from their real estate transaction. And even though the Gilberts are not seeking to avoid tax liability, Congress has made clear that the court lacks jurisdiction over their request for declaratory relief. 28 U.S.C. § 2201(a).
CIC Services came out a few days before Gilbert but the Ninth Circuit does not cite it or address its impact. While withholding and information reporting are closely connected tools to address the tax gap, actions like this that have a direct impact on tax collection differ from challenges to reporting regimes. While CIC Services suggests a focus away from the downstream circumstances withholding is a method of tax collection rather than a regulatory mandate. The DJA and AIA are still formidable hurdles to consideration of disputes that relate, even indirectly, to tax liability.