Aloe Vera of Am. Inc. v. United States
| Decision Date | 10 February 2015 |
| Docket Number | No. CV-99-01794-PHX-JAT,CV-99-01794-PHX-JAT |
| Parties | Aloe Vera of America Incorporated, et al., Plaintiffs, v. United States of America, Defendant. |
| Court | U.S. District Court — District of Arizona |
The United States and Japan are parties to a tax treaty that permits the Internal Revenue Service ("IRS") to disclose to Japan, for purposes of preventing international tax evasion, the tax return information of an American taxpayer.1 The treaty does not authorize, however, the disclosure of tax return information known to be false, and the United States has waived sovereign immunity from liability for its unauthorized disclosure of tax return information. The issue presented is whether and to what extent the United States is liable for allegedly making knowingly false statements to Japanese tax authorities during a joint investigation of Plaintiffs' tax returns.
The first alleged false statement of the United States is an assertion that Plaintiffs had unreported income properly taxable by the United States. The second alleged false statement is that transfer prices between Plaintiffs' Japanese and American entities did not correlate over time with certain commissions paid by one Plaintiff to two otherPlaintiffs. For the reasons that follow, the Court concludes the United States made the first statement while knowing it to be false, but did not know the second statement to be false at the time of its utterance. Because Plaintiffs cannot show the false statement caused actual damages, the Court awards statutory damages of $1,000 to each of three Plaintiffs.
I. Procedural History
Plaintiffs Aloe Vera of America, Incorporated; Rex G. Maughan; Ruth G. Maughan; Maughan Holdings, Incorporated; Gene Yamagata; and Yamagata Holdings, Incorporated (collectively, "Plaintiffs") sued the United States for unauthorized disclosure of tax return information under 26 U.S.C. § 7431(a)(1) after the Japanese media reported that a company owned by Plaintiffs, Forever Living Products Japan, Ltd., had committed tax evasion.
The operative complaint is Plaintiffs' Third Amended Complaint (Doc. 405), in which Plaintiffs alleged two counts against the United States: In Count I, Plaintiffs alleged the United States disclosed false tax return information concerning Plaintiffs to the Japanese tax authorities and the United States knew or should have known that this information was false. (Doc. 405 at 14). In Count II, Plaintiffs alleged the United States knew or should have known at the time of disclosing Plaintiffs' tax return information to the Japanese tax authorities that those authorities routinely did not keep such information confidential within the terms of the tax treaty. (Id. at 16-17).
Although the United States was unsuccessful in having this case dismissed on the issue of subject-matter jurisdiction, see (Doc. 65), the Court ultimately granted summary judgment in the United States' favor, concluding that Plaintiffs had failed to establish the existence of a genuine issue of material fact on either Count I or Count II of the Third Amended Complaint. Aloe Vera of Am., Inc. v. United States, 2007 WL 329111, at *5, 8 (D. Ariz. Feb. 2, 2007). On appeal, the Ninth Circuit Court of Appeals ("Court of Appeals") remanded for a determination of subject-matter jurisdiction based upon the statute of limitations. Aloe Vera of Am., Inc. v. United States, 580 F.3d 867, 873 (9th Cir.2009). The Court found it had jurisdiction over some claims, but reaffirmed its judgment in favor of the United States for the reasons stated in its previous summary judgment ruling. Aloe Vera of Am., Inc. v. United States, 730 F. Supp. 2d 1020, 1035-36 (D. Ariz. Aug. 3, 2010).
On a second appeal, this time concerning the merits of the summary judgment ruling, the Court of Appeals affirmed in part and reversed in part, holding that genuine issues of material fact existed on Count I of Plaintiff's Third Amended Complaint. Aloe Vera of Am., Inc. v. United States, 699 F.3d 1153, 1166 (9th Cir. 2012). Following remand, the United States moved for partial summary judgment, which the Court denied. Aloe Vera of Am., Inc. v. United States, 2013 WL 6836603 (D. Ariz. Dec. 17, 2013). The Court held a bench trial and the parties submitted post-trial briefs on all issues. (Docs. 695, 696, 700, 701).
Having considered the bench trial, closing arguments, and post-trial briefing, the Court finds and concludes as follows:
II. Findings of Fact
Plaintiffs are involved in the international supply of aloe vera-based health and beauty products. Plaintiff Rex G. Maughan is the founder of Forever Living Products, a company that sells aloe vera products through multi-level marketing. Rex Maughan owns and operates a number of related entities, including entities that are Plaintiffs in this case, (collectively, the "FLP Group") that manufacture, process, market, and sell these aloe vera-based products. The FLP Group is vertically integrated from the growing of aloe vera plants through the marketing and sales of the finished health and beauty products. FLP Group products are ultimately distributed worldwide through several million independent distributors.
Plaintiff Aloe Vera of America, Incorporated ("AVA") is an S corporationincorporated in Texas and is wholly owned by Plaintiff Rex G. Maughan.2 AVA is a manufacturing company that processes raw aloe vera gel to create a stabilized product with a shelf life that is then sold to other FLP Group entities for multi-level marketing.
Forever Living Products Japan ("FLPJ") was founded in 1980 and is the FLP Group entity responsible for the distribution and marketing of aloe vera products in Japan. During the years relevant to this litigation, 1991 to 2005, Plaintiff Maughan Holdings, Inc. ("MHI") owned 50% of FLPJ and Plaintiff Yamagata Holdings, Inc. ("YHI") owned 50% of FLPJ. MHI is an S corporation incorporated in Arizona and is wholly owned by Plaintiff Rex G. Maughan. YHI is an S corporation incorporated in Nevada and is wholly owned by Plaintiff Gene Yamagata. MHI and YHI are both holding companies for their respective owners.
FLPJ sells its products in Japan through multi-level marketing. Multi-level marketing involves the use of distributors, who are independent contractors that purchase product from FLPJ and sell it to consumers. Distributors earn income in two ways: First, distributors directly sell FLPJ products to consumers at a price that is higher than the distributors' wholesale cost of purchase. Second, each distributor earns a percentage of the sales of other distributors whom that distributor has recruited into the FLPJ marketing program.
Rex Maughan and Gene Yamagata were the original distributors for FLPJ as well as company officers and directors. Thus, they earned income from FLPJ in three ways: as distributors (earning a percentage of the sales of "down line" distributors), as compensation for services rendered as directors and officers, and in the form of dividends through their ownership interests.
AVA generally sells processed aloe vera products to the FLP Group entity responsible for marketing and sales in each country. However, Japan requires that a portion of the manufacturing process occur within its borders. Thus, AVA sells bulk raw aloe vera gel, rather than processed product, to FLPJ. A third party in Japan performs AVA's proprietary stabilization and bottling processes, and FLPJ then distributes the processed products in Japan. FLPJ has been selling AVA's product since the beginning of FLPJ's sales in 1983.3
AVA has been the exclusive supplier of FLPJ's aloe vera products since 1990 when the parties entered into a sales agreement. In the 1990 agreement, FLPJ agreed to purchase its raw aloe vera product exclusively from AVA. FLPJ also agreed to pay a royalty of 3.5% of its sales to AVA in exchange for the use of AVA's technology to process the raw aloe vera gel. During 1991-2005, about 40% of AVA's total sales were to FLPJ under this agreement.
The price for raw aloe vera gel between AVA and FLPJ varied over the years. From 1988 through February 1992, the price was $18 per gallon. From March 1992 through the end of 1995, the price was $20.90 per gallon. During the period from 1988 through 1995, AVA's accounting included in its cost of goods sold to FLPJ a commission/royalty per gallon of aloe vera gel sold. The commission rate was $8.10 per gallon from 1988 through February 1992, and $11 per gallon from March 1992 through the end of 1995. AVA did not retain this commission but paid it directly or indirectly to Maughan and Yamagata in equal shares. AVA deducted this commission from its gross income as an ordinary and necessary business expense.
Plaintiffs were the subject of at least two prior audits before the audits and examinations at issue in this case. First, in 1985, the National Tax Administration of Japan ("NTA"), the agency responsible for the enforcement of Japan's tax laws, audited FLPJ with respect to the deductibility of compensation paid to FLPJ directors. Second, the IRS audited AVA and the Maughans for the 1987-90 tax years. In the process of examining the Maughans' tax returns for the 1988-90 tax years, the IRS determined that FLPJ had been paying royalties for the benefit of Maughan and Yamagata to an entity named "Batrax" for the purpose of deferring tax liability.4 Additionally, an International Examiner's Report prepared for the 1988-90 tax years recommended disallowing deductions taken by AVA for commissions paid by FLPJ to AVA and passed through to Maughan and Yamagata.
In May 1995, the IRS assigned Rick Smith, an international...
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