McHenry v. Comm'r of Internal Revenue, CIV. NO.: 1:10-cv-00021

• Decision Date: 18 July 2011
• Docket Number: CIV. NO.: 1:10-cv-00021
• Parties: EMMIT J. MCHENRY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. District Court — Virgin Islands

EMMIT J. MCHENRY, Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

CIV. NO.: 1:10-cv-00021

DISTRICT COURT OF THE VIRGIN ISLANDS DIVISION OF ST. CROIX

Dated: July 18, 2011

AMENDED MEMORANDUM OPINION

Finch, Senior Judge

THIS MATTER is before the Court on the motion of the United States ("respondent"), to dismiss the complaint for lack of subject matter jurisdiction. Petitioner Emmit McHenry ("petitioner") opposes the motion, maintaining that this Court is the exclusive forum in which to bring this suit.

I. Background

Petitioner is a United States citizen who currently maintains a mailing address in Great Falls, Virginia. On December 30, 2009, petitioner received a tax deficiency notice from the Office of the Internal Revenue Service ("IRS") at Richmond, Virginia. In the deficiency notice, the IRS asserted that in the tax years 2001, 2002, and 2003 petitioner improperly claimed to be a resident of the United States Virgin Islands ("USVI") and improperly recast income from sources within the United States as income from sources within the USVI in order to avoid federal tax liability.¹ The IRS stated that all transactions entered into between petitioner, or any entity owned by him, (including Netcom Solutions International, Inc.,) and the March Group,LLLP and Thurman Holdings, Inc., would be disregarded for federal tax purposes. The IRS seeks to recover the taxes fraudulently withheld by petitioner and to impose civil fraud penalties. In response to the IRS' deficiency notice, petitioner filed this petition for a redetermination of his tax liability.²

Petitioner denies the charges alleged in the deficiency, claiming that he established residency in the Virgin Islands during the relevant time period and that the transactions entered into by Netcom and the March Group were necessary and proper and had economic substance. He also asserts affirmative defenses, including the three-year statute of limitations for the assessment of taxes set forth in 26 U.S.C. § 6501. Petitioner asks the Court to declare that there are no adjustments to his income tax liability for tax years 2000 and 2002, nor any basis for asserting penalties. Alternatively, the petitioner seeks a determination that the notice of deficiency is invalid. Respondent argues that this Court lacks jurisdiction to hear this matter because the United States is immune from suit in district court to redetermine a notice of deficiency pursuant to the Declaratory Judgment Act, 28 U.S.C. § 2201, and the Tax Injunction Act, 26 U.S.C. § 7421(a). Respondent also contends that dismissal is proper because petitioner has failed to allege a jurisdictional basis for this suit.

II. Standard of Review

An assertion of sovereign immunity constitutes a challenge to the Court's subject matter jurisdiction. Cudjoe ex rel. Cudjoe v. Department of Veterans Affairs, 426 F.3d 241, 246 (3d Cir. 2005). Such a challenge is properly considered pursuant to Rule 12(b)(1) of the FederalRules of Civil Procedure. "When subject matter jurisdiction is challenged under Rule 12(b)(1), the plaintiff must bear the burden of persuasion." Hedges v. United States, 404 F.3d 744, 750 (3d Cir. 2005)

"Challenges to subject matter jurisdiction under Rule 12(b)(1) may be "facial" or "factual." Turicentro, S.A. v. American Airlines Inc., 303 F.3d 293, 300 n.4 (3d Cir. 2002). When considering a facial attack, that is, one that contests the sufficiency of the pleadings, the court accepts the complaint's allegations as true. Id. (citing NE Hub Partners, L.P. v. CNG Transmission Corp., 239 F.3d 333, 341 n. 7 (3d Cir. 2001)). In contrast, when considering a factual attack, the court "accords plaintiff's allegations no presumption of truth" but instead "weigh[s] the evidence relating to jurisdiction, with discretion to allow affidavits, documents, and even limited evidentiary hearings." Id. Whether an attack is facial or factual is determined by examining the specific challenge raised by the government. Cestonaro v. United States, 211 F.3d 749, 752 (3d Cir. 2000). In this case, the Court finds that the respondent's attack is facial as it adheres not to facts alleged but to the sufficiency of the pleading on its face.

III. Analysis

A. The doctrine of sovereign immunity applied to a tax redetermination suit

"A waiver of sovereign immunity must be express and unambiguous in order to confer federal courts with subject matter jurisdiction." Cudjoe, 426 F.3d at 246. Thus, in the absence of clear congressional consent, there is no jurisdiction to entertain suits against the United States. United States v. Mitchell, 445 U.S. 535, 538 (1980) (citing United States v. Sherwood, 312 U.S 584, 587-588 (1941)). Moreover, "the Government's consent to be sued must be construed strictly in favor of the sovereign . . . and not enlarged beyond what the language requires." United States v. Nordic Village Inc., 503 U.S. 30, 34 (1992) (internal quotations and citationsomitted). See also Cudjoe, 426 F.3d at 246 (citing Orff v. United States, 545 U.S. 596 (2005) ("With respect to its scope, any waiver of sovereign immunity must be strictly construed in favor of the sovereign").

Relying on two federal statutes, the Declaratory Judgment Act, 28 USC § 2201(a) ("DJA"), and The Tax Anti-Injunction Act, 26 U.S.C. § 7421(a) ("TAIA"), respondent argues that petitioner is barred from bringing his tax suit in this Court. Section 2201(a) of the DJA provides in pertinent part that

In a case of actual controversy within its jurisdiction, except with respect to Federal taxes other than actions brought under section 7428 of the Internal Revenue Code of 1986 . . . any court of the United States, upon the filing of an appropriate pleading, may declare the rights and other legal relations of any interested party seeking such declaration, whether or not further relief is or could be sought. Any such declaration shall have the force and effect of a final judgment or decree and shall be reviewable as such.

28 U.S.C. § 2201 (emphasis added.)

In other words, the DJA provides a statutory basis for seeking a declaratory judgment in a United States court that does not, with a narrow exception, involve federal taxes.³

Section 7421(a) of the TAIA provides that

Except as provided in sections 6015(e), 6212(a) and (c), 6213(a), 6225(b), 6246(b), 6330(e)(1), 6331(i), 6672(c), 6694(c), 7426(a) and (b)(1), 7429(b), and 7436, no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.

26 U.S.C. § 7421(a) (emphasis added.)

Respondent argues that petitioner, by asserting affirmative defenses to the notice of deficiency and asking the Court to prevent the proposed assessment from having effect, seeks torestrain the assessment of collection of taxes, relief that is barred under § 7421(a) of the TAIA. A taxpayer wishing to challenge a proposed tax assessment must do so in the United States Tax Court, which has exclusive jurisdiction over such claims pursuant to 26 U.S.C. § 6213.

Petitioner attempts to surmount the jurisdictional barriers erected by the DJA and TAIA by arguing that because the tax laws of the Virgin Islands are implicated in the IRS' notice of deficiency, this Court has jurisdiction over his claims pursuant to 48 U.S.C. § 1612. It is petitioner's contention that § 1612, which provides this Court with "exclusive jurisdiction over all criminal and civil proceedings in the Virgin Islands with respect to the income tax laws applicable to the Virgin Islands," operates as a waiver of sovereign immunity and provides this Court with exclusive jurisdiction, as to any other federal court, including the Tax Court, over his claims. Alternatively, petitioner relies on judicially crafted exceptions to the DJA and TAIA.

1. The mirror system of taxation in the Virgin Islands

In order to provide context for petitioner's arguments, the Court will first briefly describe the tax system of the Virgin Islands as it pertains to petitioner's claims and then address the jurisdictional argument stated above.

Virgin Islands income tax law generally tracks U.S. federal income tax law pursuant to 48 U.S.C. § 1397. Chase Manhattan Bank, N.A. v. Government of Virgin Islands, Bureau of Internal Revenue, 300 F.3d 320, 322 (3d Cir. 2002). Section 1397 provides that

The income-tax laws in force in the United States of America and those which may hereafter be enacted shall be held to be likewise in force in the Virgin Islands of the United States, except that the proceeds of such taxes shall be paid into the treasuries of said islands.

48 U.S.C. § 1397.

The effect of § 1397 is to create a "mirror system," whereby the income tax law of the Virgin Islands duplicates the language of the Internal Revenue Service Code ("IRC"),⁴ substituting the words "Virgin Islands" for the words "United States" where necessary. Johnson v. Quinn, 821 F.2d 212, 214 (3d Cir. 1987) (citing Rev. Rul. 73-315, 1973-2 C.B. 226). The provisions of the IRC are applicable to the Virgin Islands unless they are "manifestly inapplicable or incompatible with a separate territorial income tax." Abramson Enterprises, Inc. v. Government of Virgin Islands of U.S., 994 F.2d 140, 142 (3d Cir. 1993) (citations omitted). The effect of the mirror statute is to "establish[] the Virgin Islands as a separate tax jurisdiction with authority parallel to that of the U.S. Treasury Department." WIT Equipment Company, Inc. v. Director, Virgin Islands Bureau of Internal Revenue, 185 F. Supp. 2d 500, 502 (D.V.I. 2001). However, as this Court has previously noted "[t]he mirror system not only creates two separate taxation authorities, but also implicitly recognizes Virgin Islands residents' liability to both. The federal tax liability is discharged only to the extent that the resident properly reports all income and pays his or her Virgin Islands tax obligation." Id. (citing 26 U.S.C. § 932(c)(4) (...