Pierson v. United States

• Decision Date: 09 February 1977
• Docket Number: Civ. A. No. 75-218.
• Citation: 428 F. Supp. 384
• Parties: John L. PIERSON, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Delaware

428 F. Supp. 384

John L. PIERSON, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 75-218.

United States District Court, D. Delaware.

February 9, 1977.

COPYRIGHT MATERIAL OMITTED

Charles S. Crompton, Jr., of Potter, Anderson & Corroon, Wilmington, Del., for plaintiff; Stephen D. Gardner, James S. Eustice, Max Folkenflik, of Kronish, Lieb, Shainswit, Weiner & Hellman, New York City, of counsel.

W. Laird Stabler, Jr., U. S. Atty., Dept. of Justice, Wilmington, Del., John J. McCarthy, and D. Patrick Mullarkey, Dept. of Justice, Washington, D.C., for defendant.

MURRAY M. SCHWARTZ, District Judge.

This case arises out of the retroactive revocation by the Commissioner of Internal Revenue ("Commissioner") of two private letter rulings issued previously to Hartford Fire Insurance Company ("Hartford") in connection with a corporate acquisition of Hartford by International Telephone and Telegraph Corporation ("ITT").¹ Plaintiff has filed a Motion to Compel seeking the production of 287 documents currently in the defendant's possession, as well as an order requiring answers or more complete answers to 36 interrogatories propounded by plaintiff to defendant. The defendant has objected to this discovery on the basis of relevance and various interpersonal and government privileges.

Factual Background

No attempt will be made here to describe in detail the events leading up to the initiation of this litigation. For purposes of the instant motion, a brief summary of those events will suffice.

Prior to April of 1969, ITT had acquired approximately eight percent of the Hartford stock outstanding for cash. After negotiations between Hartford and ITT, it was agreed that ITT would acquire control of Hartford through an exchange of stock by Hartford shareholders for ITT stock. A crucial condition of this acquisition was that it qualify as a tax-free reorganization under 26 U.S.C. § 368(a)(1)(B).² In response to a ruling request by Hartford, the Internal Revenue Service ("Service") issued a ruling letter on October 13, 1969, stating that the proposed reorganization between ITT and Hartford would qualify under Section 368(a)(1)(B) provided that prior to the Hartford shareholder vote on the proposed merger, ITT had unconditionally disposed of the Hartford shares it had purchased to third parties.

On October 14, 1969, ITT submitted an application for a supplemental ruling that a proposed transaction between it and Mediobanca S.p.A. ("Mediobanca") would constitute an unconditional disposition of the Hartford stock as required by the earlier Service letter ruling. A draft copy of the proposed contract with Mediobanca accompanied the supplemental ruling request. On October 21, 1969, the Service issued a supplemental ruling letter which stated that the proposed sale by ITT of its Hartford shares to Mediobanca, as described in the contract, would constitute an unconditional disposition of stock as required by the earlier letter ruling. The contract between ITT and Mediobanca was executed on November 3, 1969.

Because of difficulties in obtaining the Connecticut Insurance Commissioner's approval of the merger, ITT eventually obtained control of Hartford through a direct tender offer to the Hartford shareholders.³ In May, 1970, ITT offered to exchange ITT voting stock for Hartford shares. Over 90 percent of the outstanding Hartford shares were tendered, including those held by Mediobanca. The plaintiff in this case also tendered his shares to ITT and did not recognize any gain on the transaction on his 1970 Federal income tax return.

In March, 1974, after an investigation into the facts and circumstances surrounding the request for and issuance of the October, 1969 rulings, the Service revoked retroactively the 1969 letter rulings and ruled that the plaintiff and other Hartford shareholders had participated in a taxable exchange when the Hartford shares were tendered for ITT shares. Plaintiff then filed an amended federal income tax return for the year ending December 30, 1970 and paid additional taxes in the amount of $3,682. This amount reflects the taxes owed when his exchange of Hartford shares for ITT shares is treated as a taxable transaction.

Plaintiff on June 25, 1974, filed a timely claim for refund with the Service. After the Service failed to give notice of disallowance of the refund claim, plaintiff filed suit in this Court pursuant to 28 U.S.C. § 1346(a)(1).

Scope of Review — Applicability of the APA

Since the touchstone of any discovery motion is relevance, the primary issue for decision is whether the documents and information sought relate to any of the legal or factual issues in dispute.⁴ The plaintiff asserts two theories to substantiate his claim for a tax refund. First, he alleges that as a matter of law the exchange of Hartford shares for ITT shares constituted a tax-free reorganization under Section 368(a)(1)(B). Second, he contends that the Commissioner abused his discretion under Section 7805(b) by applying retroactively the revocation of the 1969 letter rulings. Accordingly, even if the transaction did not qualify as a tax-free exchange, the ruling revocation can be given only prospective effect.

Although both theories concern a single tax refund claim, it is important to distinguish the two theories for there is a different standard of review applicable to each. Moreover, because of the different standards, materials relevant to the Court's consideration of one theory may not be, and indeed probably will not be, relevant to consideration of the other theory. Therefore, attention will be given first to the appropriate standard to be applied and to the proper focus of the Court's review under each theory. See A. O. Smith v. F.T.C., 403 F.Supp. 1000, 1003 (D.Del.1975).

As to the first theory of recovery, there is little dispute about the proper standard of review. The parties agree that the Commissioner's determination to revoke the 1969 letter rulings and to treat the exchange as taxable is subject to de novo review by the Court. See Lewis v. Reynolds, 284 U.S. 281, 283, 52 S.Ct. 145, 76 L.Ed. 293 (1932). That is to say, the Court must place itself in the shoes of the Commissioner and decide whether the transaction qualifies under Section 368(a)(1)(B). The kinds of materials on which the Court's review should focus are discussed in more detail infra in the section concerning relevance. Suffice it to say at this point that the focus of the Court's review on plaintiff's first theory is not the reasons for the revocation. For the purpose of the review is to determine whether the Commissioner was correct in concluding that the transaction was taxable and, consequently, was correct in assessing a tax deficiency.

As to the plaintiff's second theory of recovery, involving the retroactive effect given to the revocation of the 1969 letter rulings, the parties have suggested quite different approaches for the Court to take. The plaintiff argues that administrative action taken pursuant to Section 7805(b) is subject to review under the Administrative Procedure Act (APA) for abuse of discretion. See 5 U.S.C. § 701 et seq. Under this approach, the focus of judicial review is on the factors considered by the Commissioner in making his decision.

The defendant, by contrast, contends that the APA does not apply and that the test to be applied is whether the result of the retroactive application constituted an abuse of discretion. See Lesavoy Foundation v. Commissioner, 238 F.2d 589 (3d Cir. 1956).⁵ Under this approach, the Court is asked to consider any evidence relevant to determining whether the result constituted an abuse of discretion, including evidence not considered by or available to the Commissioner.⁶ Defendant argues the focus of review is on evidence tending to show or not show that the result of the decision was an abuse of discretion. The Court agrees with the parties that the proper standard of review is abuse of discretion,⁷ but cannot subscribe fully to the approach of either side.

The defendant's theory is novel, but unconvincing. The cases cited to support its adoption neither discuss the approach suggested here nor mention that material presented to the Court had not been considered by the Commissioner. See, e. g., Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633 (8th Cir. 1963); Lesavoy Foundation v. Commissioner, 238 F.2d 589 (3d Cir. 1956). Further, the defendant has not referred to any authority which approves this confusing hybrid procedure.

At bottom, the defendant seeks to characterize review of a Section 7805(b) decision as equivalent to review of an ordinary assessment of a tax deficiency.⁸ The problem with this procrustean analysis is that the standard of review for the former is far narrower than for the latter. See Revell, Inc. v. Riddell, 273 F.2d 649, 659 (9th Cir. 1960). In an ordinary refund action, the Court is permitted to place itself in the shoes of the Commissioner. See id. But, where as here the basis of the refund action is in part a revocation ruling given retroactive effect, and one focal point of the Court's inquiry is on whether the Commissioner abused his discretion under Section 7805(b), the Court may not substitute its judgment for the Commissioner. See Lesavoy Foundation, Inc. v. Commissioner, supra at 593.⁹ Accordingly, defendant's analysis is incorrect.

The close parallel between review of Section 7805(b) determinations and review of administrative actions by agencies subject to the APA leads the plaintiff to conclude that the APA also regulates review under Section 7805(b). On its face, the APA would arguably appear to apply.¹⁰ There is no statute precluding judicial review¹¹ and retroactive revocations are not within that narrow category of agency action committed to agency discretion. See 5 U.S.C. § 701(a).¹² Further, the Service is not listed among the agencies excluded from Chapter 7 of Title 5. Nevertheless, despite thorough...