Aloe Vera of America, Inc. v. U.S.

• Decision Date: 21 September 2000
• Docket Number: No. 99-1794-PHX-ROS.,99-1794-PHX-ROS.
• Parties: ALOE VERA OF AMERICA, INC., et al., Plaintiffs v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Arizona

128 F.Supp.2d 1235

ALOE VERA OF AMERICA, INC., et al., Plaintiffs v. UNITED STATES of America, Defendant.

No. 99-1794-PHX-ROS.

United States District Court, D. Arizona.

September 21, 2000.

Edwin B Wainscott, Quarles & Brady Streich Lang LLP, Phoenix, AZ, Terence Dale Woolston, Woolston & Tarter PC, Phoenix, AZ, for Aloe Vera of America, Inc., Rex G. Maughan, Ruth G. Maughan, Maughan Holdings, Inc.

Merwin D Grant, Grant Williams Lake & Dangerfield PC, Phoenix, AZ, for Gene Yamagata, Yamagata Holdings, Inc.

Melissa A Holton, David M Katinsky, Isaac D Paxman, U.S. Dept of Justice, Washington, DC, for U.S.

David Jeremy Bodney, Peter Shawn Kozinets, Steptoe & Johnson LLP, Phoenix, AZ, Michael Kovaka, Dow Lohnes & Albertson PLLC, Washington, DC, for Bureau of National Affairs, Inc., Tax Management, Inc.

ORDER

SILVER, District Judge.

Introduction

On October 6, 1999, Plaintiffs: Aloe Vera of America, Inc., ("AVA"), a Texas corporation, Rex G. Maughan ("Maughan") and Ruth Maughan, husband and wife, Maughan Holdings, Inc., an Arizona corporation, Gene Yamagata ("Yamagata"), an individual, and Yamagata Holdings, Inc., a Nevada corporation, ("Plaintiffs"), filed a Complaint against the United States of America ("Defendant" or the "Government"), under the Internal Revenue Code (the "IRC"), 26 U.S.C. § 7431(a)(1). Plaintiffs seek to recover civil damages from Defendant for the alleged unauthorized disclosure of tax returns and attendant information by officers and employees of Defendant, through the Internal Revenue Service (the "IRS"), in violation of 26 U.S.C. § 6103. In the Complaint, Plaintiffs allege that the Government has waived sovereign immunity in this action, pursuant to 26 U.S.C. §§ 6103 and 7431.

On December 30, 1999, Defendant filed a Motion to Dismiss for lack of subject matter jurisdiction, pursuant to Fed.R.Civ.P. 12(b)(1), and for failure to state a claim under Fed.R.Civ.P. 12(b)(6). Plaintiffs filed a Response on January 24, 2000, and Defendant filed a Reply on February 10, 2000.¹ The Court heard oral argument on July 10, 2000. At the conclusion of oral argument, Plaintiffs' counsel moved for leave to amend the Complaint in the event the Court finds it deficient.

Facts

The Complaint makes the following factual allegations. Maugham owns or has a substantial ownership interest in a group of associated entities, the Forever Living Products companies ("FLP Group" or the "Group"), some of which are domestic and some foreign. The FLP Group is one of the largest world suppliers of health and beauty products based on the aloe vera plant. The FLP Group is vertically integrated from plantations that grow aloe, through shipping, processing, manufacturing, marketing and sales. Several million distributors worldwide are involved in the distribution of the Group's products. The distributing entity in Japan, FLP Japan, Ltd., ("FLPJ") is owned indirectly by Maugham and Yamagata, in equal parts.² AVA is one of the entities within the FLP Group and "is among a handful of U.S. owned entities which have been extremely successful in Japan and which pay significant tax liabilities to the Japanese Government." (Compl. ¶ 16.) In tax year 1995, FLPJ paid an equivalent of $26,512,085 in national, prefecture, i.e., district, and local income taxes in Japan. Id.

In the summer of 1996, the IRS proposed to the Japanese National Tax Administration (the "NTA") a Simultaneous Examination involving United States tax-payers AVA, Maughan, and Yamagata and the Japanese taxpayer, FLPJ. (Compl. ¶ 17.) On August 5 and 6, 1996, nine representatives of the IRS met with the six NTA officials in Phoenix, Arizona. During that time, the IRS "disclosed vast amounts of information and voluminous documents to the NTA," which, in the most part, "upon information and belief, constituted tax returns and return information of Plaintiffs, within the meaning of [26] § 6103(b)." (Compl. ¶ 19.) Approximately on August 15, 1996, the IRS notified Maughan and AVA that a Simultaneous Examination with the NTA was being conducted for the years 1991 through 1995. (Compl. ¶ 20.) At least one more meeting was held between the IRS and the NTA officials, in Tokyo, Japan, on November 13-15, 1996, during which additional information was disclosed by the IRS to the NTA, which "upon information and belief constituted tax returns and return information of plaintiffs, within the meaning of 26 U.S.C. § 6103(b)." (Compl.21.) Thereafter, a Simultaneous Examination Audit plan (the "Audit Plan") proposed by the IRS to NTA was accepted by the latter and executed by both agencies. (Compl. ¶ 22.) In late 1996, Mr. Kobyashi of the NTA, Tokyo Regional Taxation Bureau ("TRTB"), "threatened representatives of Plaintiffs and FLPJ with a press leak when attempting to coerce FLPJ and Plaintiffs into accepting the audit proposal made by the TRTB." (Compl. ¶ 23.) The FLPJ did not accept the proposal and, on January 20, 1997, the NTA issued Correction notices to FLPJ in the amount of approximately 8 billion yen, i.e., approximately 73 million U.S. dollars. (Compl. ¶ 24.) On February 5, 1997, the IRS issued a thirty-day notice for 1991 and 1992 to Maughan and AVA. (Compl. ¶ 25.) On December 22, 1997, the NTA issued Correction Notices to FLPJ for 1996 in the amount of approximately 2 billion yen, i.e., approximately 20 million U.S. dollars. (Compl. ¶ 26.)

Plaintiffs allege that

The IRS Audit Plan was incorrect, erroneous, and flawed as a matter of U.S. domestic tax law, international tax law, the U.S.-Japan Tax Treaty, and the Organization for Economic Cooperation and Development ("OECD") guidelines for transfer pricing. The IRS Audit Plan intentionally ignored appropriate transfer pricing analysis; the effects of the U.S. and Japanese adjustments proposed as a result of the Simultaneous Examination was to impose double taxation of income in contravention of the U.S.-Japan Income Tax Treaty.

(Compl. ¶¶ 27-28.) According to the Complaint, the primary issue was the NTA's characterization of "certain contract amounts paid by AVA to Maughan and Yamagata on the sale of AVA products to FLPJ," which the NTA characterized as income in the form of a director's bonus, coming directly from FLPJ, while the same amounts had been reported by AVA in the United States as taxable income. (Compl. ¶ 30.) The IRS did not consider these contract payments made by AVA to Maughan and Yamagata as ordinary and necessary business expenses and, consequently, disallowed deduction of these amounts under 26 U.S.C. § 162(a). Id. As a result of such treatment of these payments, over $100 million in additional income was shifted from the United States to Japan, increasing FLPJ's profit margin and tax liability in Japan for the audit years 1991-1995. Id.

Plaintiffs further allege, that Defendant, in violation of standard IRS procedure, did not consult the U.S. Competent Authority, located in Washington, D.C., which is responsible for preventing double taxation under several U.S. Income Tax Treaties, and that the Audit Plan was not approved by the U.S. Competent Authority. (Compl. ¶ 32.) On March 24, 1997, the FLP Group requested Competent Authority Assistance, which request was granted. (Compl. ¶ 33.) The U.S. taxpayers contested the tax audit adjustments. (Compl.¶ 34.) At the end of August 1997, the IRS Appeals Officer in Phoenix, Arizona, conceded the primary Simultaneous Examination issue and the proposed $32 million income increase to AVA for 1991 and 1992. The concession was issued in writing, on or about October 24, 1997. (Compl. ¶ 35.)

To date, despite the efforts of the U.S. Competent Authority, the Japanese Competent Authority refuses to accept that this matter involves the U.S.-Japan Tax Treaty and "continues to erroneously insist that the matter is wholly one of internal Japanese Taxation and that transfer pricing is not relevant to the resolution of the issue." (Compl. ¶ 36-37.) Plaintiffs allege that the NTA's position is a result of the improper actions by the IRS described in the Complaint. Id. Specifically, Plaintiffs allege that

The IRS ... disclosed false information to the NTA in an attempt to improperly and irrevocably prejudice the NTA against plaintiffs and FLPJ, (including but not limited to the following), to wit:

(a) That the United States and Japanese taxpayers committed fraud;

(b) That commission payments by AVA to Rex Maughan and Gene Yamagata on AVA sales to FLPJ remained unchanged over the years although cost of product to FLPJ changed;

(c) That Rex Maughan made a decision to move income and assets from and out of FLP, Inc. so that a tax deficiency due to the IRS could not be collected;

(d) That Rex Maughan set up the "Batrax System"³ tax shelter designed to bring income into the United States from other countries without paying tax; and

(e) That the FLP Group has built much wealth by not paying taxes and that FLP was not in compliance with the U.S. tax laws.

(Compl. ¶ 39.) Plaintiffs further allege that all of these statements were presented to the NTA as facts, though they were "unverified, unsubstantiated, inaccurate, and [the] false position of the IRS calculated to produce the desirable Simultaneous Audit result, which was double taxation." (Compl. ¶ 40.) Plaintiffs allege that the IRS either knew or should have known that the statements were false, and that, as a result of the IRS's actions, on October 9 and 10, 1997, Japanese media published numerous stories about the FLPJ tax deficiencies. These stories appeared on Japanese national radio and television and in all five of the major Japanese newspapers with national circulation. The stories were also picked up by the International Press and reported in the United States. (Compl. ¶ 43.) "The stories contained extensive return information as well as numerous false and inflammatory statements and were ascribed `to those involved in the audit.'" (Compl. ¶ 44.)

The IRS has denied any leaks to the Japanese press. (Compl....