Tax Lawyer's Blog

In Canal Corp. v. Commissioner, 135 T.C. No. 9 (Aug. 5, 2010), the Tax Court found a corporation liable for a $37 million accuracy-related penalty under §6662(a) even though it had obtained a tax opinion from Price Waterhouse Coopers (PWC).

Judge Diane Kroupa issued a scathing rebuke of PWC which should be viewed as a shot across the bow of all tax advisory firms who think their legal conclusions can be bought (the sub-headings and emphases are mine):

Reliance on Advice as Defense to Penalty Assessment

A taxpayer may rely on the advice of any tax adviser, lawyer or accountant. … The advice must not be based on unreasonable factual or legal assumptions and must not unreasonably rely on representations, statements, findings, or agreements of the taxpayer or any other person. Reg. § 1.6664- 4(c)(1)(ii). Courts have repeatedly held that it is unreasonable for a taxpayer to rely on a tax adviser actively involved in planning the transaction and tainted by an inherent conflict of interest. …

Chesapeake claims it reasonably relied in good faith on PWC’s tax advice and “should” opinion and therefore no penalty should be imposed. Respondent contends that Chesapeake unreasonably relied on an opinion riddled with improper assumptions written by a tax adviser with a conflict of interest. …

The PWC Tax Opinion

Chesapeake paid PWC an $800,000 flat fee for the opinion, not based on time devoted to preparing the opinion. [PWC's David] Miller testified that he and his team spent hours on the opinion. We find this testimony inconsistent with the opinion that was admitted into evidence.

The Court questions how much time could have been devoted to the draft opinion because it is littered with typographical errors, disorganized and incomplete. Moreover, Mr. Miller failed to recognize several parts of the opinion. The Court doubts that any firm would have had such a cavalier approach if the firm was being compensated solely for time devoted to rendering the opinion.

In addition, the opinion was riddled with questionable conclusions and unreasonable assumptions. Mr. Miller based his opinion on WISCO maintaining 20% of the LLC debt. Mr. Miller had no case law or Code authority to support this percentage, however. He instead relied on an irrelevant revenue procedure as the basis for issuing the “should” opinion. A “should” opinion is the highest level of comfort PWC offers to a client regarding whether the position taken by the client will succeed on the merits. We find it unreasonable that anyone, let alone an attorney, would issue the highest level opinion a firm offers on such dubious legal reasoning.

We are also nonplused by Mr. Miller’s failure to give an understandable response when asked at trial how PWC could issue a “should” opinion if no authority on point existed. He demurred that it was what Chesapeake requested. The only explanation that makes sense to the Court is that no lesser level of comfort would have commanded the $800,000 fixed fee that Chesapeake paid for the opinion. … 

Taxpayer’s Reliance on Opinion Unjustified

We find that Chesapeake’s tax position did not warrant a “should” opinion because of the numerous assumptions and dubious legal conclusions in the haphazard draft opinion that has been admitted into the record. Further, we find it inherently unreasonable for Chesapeake to have relied on an analysis based on the specious legal assumptions. …

Moreover, Chesapeake did not act with reasonable cause or in good faith as it relied on Mr. Miller’s advice. Chesapeake argues that it had every reason to trust PWC’s judgment because of its long-term relationship with the firm. PWC crossed over the line from trusted adviser for prior accounting purposes to advocate for a position with no authority that was based on an opinion with a high price tag-–$800,000.

Any advice Chesapeake received was tainted by an inherent conflict of interest. We would be hard pressed to identify which of his hats Mr. Miller was wearing in rendering that tax opinion. There were too many. …

Tax Opinion Was Purchased

We also find suspect the exorbitant price tag associated with the sole condition of closing. Chesapeake essentially bought an insurance policy as to the taxability of the transaction. PWC received an $800,000 fixed fee for its tax opinion. PWC did not base its fee on an hourly rate plus expenses. The fee was payable and contingent on the closing of the joint venture transaction. PWC would receive payment only if it issued Chesapeake a “should” opinion on the joint venture transaction. PWC therefore had a large stake in making sure the closing occurred.

Considering all the facts and circumstances, PWC’s opinion looks more like a quid pro quo arrangement than a true tax advisory opinion. If we were to bless the closeness of the relationship, we would be providing carte blanche to promoters to provide a tax opinion as part and parcel of a promotion.

Independence of advisers is sacrosanct to good faith reliance.

We find that PWC lacked the independence necessary for Chesapeake to establish good faith reliance. We further find that Chesapeake did not act with reasonable cause or in good faith in relying on PWC’s opinion. We sustain respondent’s determination that Chesapeake is liable for the accuracy-related penalty.

An $800,000 tax opinion? Yuh, right!

I usually side with taxpayers in penalty abatement cases, especially where they have relied on the written advice of a qualified tax advisor, but in this case it’s hard to justify any conclusion other than that PWC issued whatever opinion was necessary to ensure that the deal would close and it would get paid it’s exhorbitant fee.¹

If Judge Kroupa’s allegations are accurate, the IRS Office of Professional Responsibility should sanction both Mr. Miller and PWC. The intentional issuance of a dubious tax opinion merely to ensure the payment of an excessive fee is much more egregious than what sole practitioner Tim Kaskey got disbarred for.

Let’s see if OPR has a different standard for big firm CPAs.

Footnotes:

¹  Chesapeake (now Canal Corp.) probably has a malpractice claim against PWC, especially in light of the Court’s discrediting of David Miller’s and PWC’s tax opinion letter.

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