Capitol BC Rests., LLC v. Comm'r of Internal Revenue (In re Capitol BC Rests., LLC), Case No. 16–12666–JNF

• Citation: 568 B.R. 574
• Decision Date: 12 June 2017
• Docket Number: Case No. 16–12666–JNF,Adv. P. No. 17–1018
• Parties: IN RE CAPITOL BC RESTAURANTS, LLC, Debtor Capitol BC Restaurants, LLC, Plaintiff v. Commissioner of Internal Revenue, Defendant
• Court: United States Bankruptcy Courts. First Circuit. U.S. Bankruptcy Court — District of Massachusetts

568 B.R. 574

IN RE CAPITOL BC RESTAURANTS, LLC, DebtorCapitol BC Restaurants, LLC, Plaintiff

v.Commissioner of Internal Revenue, Defendant

Case No. 16–12666–JNF

Adv. P. No. 17–1018

United States Bankruptcy Court, D. Massachusetts.

Signed June 12, 2017

Peter J. Haley, Nelson Mullins Riley & Scarborough LLP, Donald Ethan Jeffery, Murphy & King, Professional Corporation, Boston, MA, for Plaintiff.

Lauren Hume, Department of Justice, Tax Division, Washington, DC, for Defendant.

MEMORANDUM

Joan N. Feeney, United States Bankruptcy Judge

I. INTRODUCTION

The matter before the Court is the Motion to Dismiss filed by the United States of America on behalf of the Internal Revenue Service ("IRS"). The IRS seeks dismissal of the Debtor's Complaint pursuant to Fed. R. Civ. P. 12(b)(1) for lack of subject matter jurisdiction and (6) for failure to state a claim upon which relief can be granted. See Fed. R. Bankr. P. 7012(b). The Debtor filed an Opposition to the Motion. The Court heard the Motion and Opposition on May 10, 2017 and took the matter under advisement.

In its Complaint, Capitol BC Restaurants, LLC (the "Plaintiff" or the "Debtor") states the following:

The Debtor and Petitioner Capitol BC Restaurants LLC brings this action to object to the proof of claim of the [IRS], seek a determination of the amount of that claim in accordance with 11 USC [sic] § 505 and to petition for a redetermination of the deficiency (or liability) set forth by the Commissioner of Internal Revenue in the Commissioner's notices of deficiency (or liability) dated November 30, 2016 and December 6, 2016.¹

Although the Debtor is a limited liability company that is wholly owned by Capitol BC, LLC, which, in turn, is owned, according to the Debtor, by "direct and indirect members," including Banyan Mezzanine Fund L.P., the Debtor annually filed Form 1065, U.S. Return of Partnership Income, prior to the commencement of its bankruptcy case. It is undisputed that the Debtor is not liable for any taxes except those relating to Social Security and Medicare withholding taxes ("FICA") and unemployment withholding taxes ("FUTA"), for which the IRS filed and later amended a proof of claim. The Debtor, in its Complaint, did not mention, let alone set forth grounds for objecting to, the FICA and FUTA claims set forth by the IRS in its original and amended proofs of claim. Accordingly, in seeking a determination of the IRS's "claim," as will be set forth in detail below, the Debtor, in actuality, is seeking a redetermination of the amount of deductions available to it for costs of goods sold and inventory and the imposition of penalties that will pass through to, and affect the income taxes owed by the Debtor's "partners."

The dispositive issue is whether this Court has jurisdiction to determine, in the Debtor's bankruptcy case, the income tax liability of its "partners," where the Debtor is treated as a partnership for tax purposes, and is seeking an adjustment of deductions and penalties imposed by the IRS pursuant to 11 U.S.C. § 505(a) where it is not liable for any such income taxes and where its "partners" are solely liable for any income taxes owed.²

II. BACKGROUND

Capitol BC Restaurants, LLC filed a voluntary Chapter 11 petition on July 13, 2016.³ Its case is jointly administered with the case of its parent, Capitol BC, LLC, Case No. 16–12243–JNF. In the Debtor's bankruptcy case, the IRS filed a proof of claim on August 30, 2016 in the amount of $4,286,536.83. Of that amount, it claimed $2,979,348.10 was entitled to priority for FICA and FUTA taxes and the balance was unsecured. On April 5, 2017, after the filing of this Complaint, it filed an amended proof of claim in the amount of $4,213,964.85. Of that amount, $2,894,323.49 was for FICA and FUTA taxes entitled to priority under 11 U.S.C. § 507(a)(8) and $1,319,641.36 was for an unsecured "penalty to date of petition on unsecured priority claims (including interest thereon)."

On February 27, 2017, the Debtor filed a Motion to Retain Special Counsel to Prosecute Tax Matters together with the Affidavit of Peter J. Haley, Esq. Pursuant to its Motion, the Debtor sought authority to retain Attorney Haley and the firm of Nelson, Mullins, Riley & Scarborough, LLP which "acts as counsel to Banyan Mezzanine Fund, L.P. ("Banyan"), a secured creditor in this proceeding and post-petition lender to the Debtor." In its motion, the Debtor also disclosed that certain affiliates of Banyan hold equity interests in the Debtor's parent, Capitol BC, LLC, and that Banyan had agreed to be directly responsible to the firm of Nelson, Mullins, Riley & Scarborough, LLP for all fees and expenses incurred because the Debtor lacked the financial means to fund the litigation. The Court granted the Debtor's Motion on March 14, 2017 in the absence of objections from any parties in interest.

The U.S. trustee has moved to convert the Debtor's Chapter 11 case to a case under Chapter 7. On May 10, 2017, by agreement, the Court continued the hearing on the U.S. trustee's motion to permit finalization of the sale of a liquor license. Upon completion of that transaction, the Debtor has represented through counsel that it will consent to the conversion of its Chapter 11 case to a case under Chapter 7.

III. THE COMPLAINT

The Plaintiff filed a Complaint on February 28, 2017 against the IRS "to object to the proof of claim filed by the IRS" and to seek a determination of the amount of "that claim" in accordance with 11 U.S.C. § 505, as well as "to petition for a redetermination of the deficiency (or liability) set forth in IRS's notices of deficiency (or liability)" under certain notices issued by the IRS. The Plaintiff also represented that the IRS had filed a proof of claim in the amount of $4,286,536.83. As noted above, the IRS amended its proof of claim after the filing of the Complaint.

Specifically, the Plaintiff alleged that the IRS issued Notices of Final Partnership Administrative Adjustment ("FPAA Notices") on November 30, 2016 and December 6, 2016, after the commencement of its case on July 13, 2016. According to the Plaintiff, "[t]he adjustments as determined by the Commissioner are to net earnings (income taxes) for the calendar years ending on 12/31/2013 in the amount of ($11,267,455.00) and 12/31/2014 in the amount of ($11,048,436.00), all of which is in dispute." The adjustments for the tax years ending on December 31, 2013 and December 31, 2014 were to inventory, cost of goods sold, and expenses, and included the imposition of "a 20 percent accuracy-related penalty under IRC Section 6662 for tax attributable to adjustments of partnership items determined," and "a 20 percent accuracy-related penalty due to negligence or disregard of rules and regulations as provided by IRC Section 6662(c)" for both tax years. See 26 U.S.C. § 6662.

The Plaintiff alleged that the imposition of the 20 percent penalties was unwarranted and that the adjustments made by the IRS were based upon numerous errors, including errors in "in issuing defective notices [and] that contained conflicting dates, conflicting grounds for imposition of penalties." In addition, the Plaintiff alleged the IRS failed to give adequate notice to "Petitioner [sic] of his rights and obligations [sic]."

The Plaintiff, presumably by way of background, asserted that "[i]n TEFRA proceedings, the Commissioner determines penalties against partners on a partnership level determination, or stated otherwise, the negligence of the partnership acting through its managers."⁴ The Debtor, in its Complaint, references cases, Treasury Regulations and the Internal Revenue Service Manual pertaining to the definition and determination of negligence, as well as the grounds for imposition of the accuracy-related penalty for failing to attempt to reasonably comply with, or to carelessly, recklessly or intentionally disregard, the Internal Revenue Code.

The Plaintiff further alleged that it, and its parent, Capitol BC, LLC, entered into a management contract (the "Management Contract") with CRM, Inc. ("CRM"), "a purpose of which was to, 'assist the [Petitioner] with respect to the day-to-day activities and Management of the Restaurants....' " Under the Management Contract, CRM was to prepare or cause to be prepared all necessary financial statements and sales and use and personal property tax returns for the Debtor. The Plaintiff alleged that CRM "handled virtually all of the Petitioner's financial affairs."

The Plaintiff complained that the IRS, on November 17, 2015, sent it a notice at an incorrect address in Iselin, New Jersey that its federal tax returns for 2012 and 2013 had been selected for examination, adding that the FPAA also was incorrectly addressed to "RRGK LLC, SOLE MBR" in Massachusetts when in fact its sole member is Capitol BC, LLC. By way of explanation, it averred, among other things, the following: 1) RRGK, LLC was formed in 2011 for the purpose of bidding at an auction to purchase the assets of a group of restaurant-owning entities that had filed Chapter 11 cases in the United States Bankruptcy Court for the District of Delaware, identified as "the Bugaboo Creek Entities;" 2) RRGK LLC offered the highest price at the auction and entered into an asset purchase agreement dated March 8, 2011 pursuant to which it agreed to acquire the assets comprising the businesses of the Bugaboo Creek Entities; 3) the United States Bankruptcy Court for the District of Delaware approved the sale on March 11, 2011; 4) on March 18, 2011, RRGK LLC formed the Debtor as as a single member Delaware limited liability company, filed an IRS Form SS–4 on behalf of the Debtor, and received a letter from the IRS dated March 24, 2011 in which Capitol BC Restaurants, LLC was assigned the employer identification number 45–1019863; 5) prior to the final sale of the Bugaboo Creek Entities, RRGK LLC designated the Debtor as the purchaser of the assets, with certain exceptions and the Debtor and the Bugaboo Creek Entities...