State ex rel. Am. Advisory Servs., LLC v. Egon Zehnder Int'l, Inc.

• Citation: 592 F.Supp.3d 183
• Decision Date: 22 March 2022
• Docket Number: 21-cv-6883 (LJL)
• Parties: STATE of New York EX REL. AMERICAN ADVISORY SERVICES, LLC, Plaintiff-Relator, v. EGON ZEHNDER INTERNATIONAL, INC. and Egon Zehnder International AG, Defendants.
• Court: U.S. District Court — Southern District of New York

592 F.Supp.3d 183

STATE of New York EX REL. AMERICAN ADVISORY SERVICES, LLC, Plaintiff-Relator,

v.EGON ZEHNDER INTERNATIONAL, INC. and Egon Zehnder International AG, Defendants.

21-cv-6883 (LJL)

United States District Court, S.D. New York.

Signed March 22, 2022

Randall Matthew Fox, Kirby McInerney LLP, New York, NY, for Plaintiff-Relator.

Jeffrey S. Bucholtz, King & Spalding LLP, Washington, DC, Kyle Patrick Sheahen, Andrew Chapman Hruska, King & Spalding LLP, New York, NY, for Defendants.

OPINION AND ORDER

LEWIS J. LIMAN, United States District Judge:

In July 2021, Plaintiff-Relator American Advisory Services LLC ("American Advisory" or "Plaintiff") filed a complaint (the "Complaint") in the Supreme Court of the State of New York, County of New York against Defendants Egon Zehnder International, Inc. ("EZI USA") and Egon Zehnder International AG ("EZI AG" and together with EZI USA, "EZI" or "Defendants") alleging violations of the New York False Claims Act. On August 16, 2021, Defendants removed this action to federal court; shortly thereafter, Plaintiffs moved to remand this case to New York State court pursuant to 28 U.S.C. § 1447. Defendants oppose remand.

For the reasons that follow, the motion to remand is denied.

BACKGROUND

The Court accepts the well-pleaded facts of the complaint, shorn of its legal conclusions, as true for purposes of this motion. See Dkt. No. 1-5 ("Compl."); cf. Qatar v. First Abu Dhabi Bank PJSC , 432 F. Supp. 3d 401, 406 (S.D.N.Y. 2020) ("When considering a motion to remand, the district court accepts as true all relevant allegations contained in the complaint and construes all factual ambiguities in favor of the plaintiff." (quoting Federal Ins. Co. v. Tyco Int'l Ltd. , 422 F. Supp. 2d 357, 391 (S.D.N.Y. 2006) )).

I. Factual Background

A. The Parties

Defendant EZI AG is a Swiss limited liability company with its headquarters in Zurich, Switzerland. Compl. ¶ 22. EZI AG is in the executive search business; it finds candidates to fill high-level executive and corporate board of director positions. Id. ¶ 28. It operates as a global partnership, with sixty-eight offices in forty countries around the world, including in Europe, Asia, Africa, the Middle East, and the Americas. Id. ¶¶ 23, 28. EZI USA is the United States subsidiary of EZI AG, incorporated in Delaware and with its headquarters in New York and offices across the country. Id. ¶¶ 21, 26, 29. The United States is the largest market in which EZI AG and its subsidiaries operate, and New York City is the location of EZI USA's largest office. Id. ¶¶ 26, 29.

EZI USA and EZI AG do not view themselves as separate corporate entities but view themselves and apparently conduct themselves as part of one "elite global executive search firm," id. ¶ 49, with offices and thousands of employees all over the world, id. ¶ 27. Indeed, EZI USA has marketed itself as part of a global executive search firm with a "one firm" philosophy that is expert at working across borders to find suitable executives and board members for its clients. Id. ¶ 48. Various EZI AG offices around the world, including the United States EZI USA offices, enter into contracts with clients to find candidates for specific positions, such as executive jobs or seats on corporate boards. Id. ¶ 20. Clients typically agree to pay a set price, in monthly installments, for these services and to pay EZI's expenses. Id.

Plaintiff-Relator American Advisory Services LLC is a Wyoming limited liability company that brings this case on behalf of the State of New York pursuant to the New York False Claims Act ("NYFCA") to recover monies and interest lost to the State of New York and the City of New York due to what it alleges is Defendants’ knowing misconduct. Id. American Advisory's sole member is a resident of the State of New York. Id.

B. EZI USA's State and City Tax Reporting

The case arises out of EZI USA's New York State and New York City income tax reporting.

Since at least 2003, EZI USA has been subject to New York State corporate franchise taxes, the Metropolitan Commuter Transportation Mobility Tax (the "MTA Surcharge"), and New York City general corporation taxes. Id. ¶ 36. Under federal law, income that EZI USA receives for providing personal services to its clients is counted as gross income and is subject to taxation in the United States. Id. ¶ 41. In turn, federal taxable income is used in calculating New York taxes. Id. (citing 26 U.S.C. § 861(a) ; 26 C.F.R. § 1.861-4 ; N.Y. Tax L. § 208.9(ii)). Correspondingly, in calculating federal taxable income—and thus, the income used to calculate New York taxes—an entity can deduct expenses associated with income earned in the United States and the ratable part of global expenses. Id. (citing 26 U.S.C. § 861(b) ).

According to Internal Revenue Service ("IRS") regulations cited in the Complaint, "[g]ross income from sources within the United States includes compensation for labor or personal services performed in the United States irrespective of the residence of the payer, the place in which the contract for service was made, or the place or time of payment." 26 C.F.R. § 1.861-4(a). "In the case of compensation for labor or personal services performed partly within and partly without the United States by a person other than an individual, the part of that compensation that is attributable to the labor or personal services performed within the United States, and that is therefore included in gross income as income from sources within the United States, is determined on the basis that most correctly reflects the proper source of income under the facts and circumstances of the particular case." Id. § 1.861-4(b).

Between November 1, 2003 and October 31, 2013, EZI USA worked on thousands of client assignments together with at least one foreign EZI AG office in, among other locations, Amsterdam, Berlin, Belgium, Calgary, Copenhagen, Dubai, Dusseldorf, Frankfurt, Geneva, Hamburg, Helsinki, Hong Kong, London, Melbourne, Milan, Montreal, Mumbai, New Delhi, Paris, Sao Paulo, Shanghai, Singapore, Tokyo, Toronto, and Zurich. Compl. ¶¶ 51–52. During this time, the same accounting firm prepared EZI USA's tax records. Id. ¶ 84. Plaintiff alleges that EZI USA did not provide the accounting firm information about all of EZI USA's revenues from its joint assignments and that the firm thus calculated EZI USA's federal taxable income and prepared its records with incomplete information. Id. ¶¶ 84, 87. The tax preparer used the federal taxable income amount (which was incomplete) to prepare EZI USA's New York tax returns and statements and to calculate EZI USA's tax liability to New York. Id. ¶¶ 44, 46, 95–99.¹ Thus, for each tax year from its tax year ending on October 31, 2004 through its tax year ending on October 31, 2013, EZA USA submitted, or caused to be submitted, to the New York State Department of Taxation & Finance or the New York City Department of Finance tax returns and statements concerning the New York taxes, which purported to report income based on a figure for federal taxable income that did not accurately reflect the federal taxable income that EZI AG was required to report. Id. ¶ 42.

C. EZI Bookkeeping

EZI AG and its subsidiaries including EZI USA kept two sets of books. Id. ¶ 3. One set of books was based on the "fax charge" system and was used internally to conduct the company's business and evaluate its actual performance. Id. ¶¶ 3, 58–60. The other set of books was used to prepare EZI USA's tax returns. Id. ¶¶ 3, 112.

The fax charge system worked as follows. When EZI USA worked on an assignment for which a foreign affiliate handled billing the client, EZI USA claimed its share of the performance credit for the joint assignment by sending the billing office what the company called a "fax charge."² Id. ¶ 58. The amount of the fax charge was calculated by multiplying the fee billed to the client by the percentage split agreed to between the offices working on the joint assignment. Id. ¶ 59.

EZI AG's financial manual (the "Financial Manual") stated:

Fax charges are used to calculate the real performance of an office. E.g. local billings plus fax billings net (can be positive or negative) results in performance billings. Or generally: local plus fax results in performance.

A real money transfer is not taking place when doing a fax charge.

Fax charges are intercompany transactions and are being reconciled on a monthly basis (except fax billings backlog).

Id. ¶ 64. Under this system, when two offices worked on a joint assignment, one office—referred to as the billing office—sent invoices to and received payment from the client. Id. ¶ 65. The other office—referred to as the non-billing office—had to send a fax charge on a form required by EZI AG in order to get credit for its work on the joint assignment. Id.

EZI incorporated fax charge intercompany transactions into business reports and, as indicated by the quotation from the Finance Manual above, referred to these reports as their "performance" records. Id. ¶ 75. These reports included "Billing Statistics Reports, Performance Key Figures Reports, and Performance Profits & Losses (P&L) reports." Id. EZI used these reports to make decisions about various offices and personnel, including setting budgets and evaluating office and personnel performance. Id. ¶ 76. Indeed, for some years, EZI AG announced in press releases its worldwide and United States revenues that were calculated using fax charges. Id. ¶ 79. EZI USA's revenues reflected in these press releases were millions of dollars more than the revenues it listed on its tax returns. Id. ¶ 80.

Fax charges were considered to be confidential by EZI AG. Id. ¶¶ 108–110. The Financial Manual called for strict confidentiality about fax charges, stating: "Fax charges are internal EZI procedures and must not be shown or communicated to third parties. " Id. ¶ 105. The Finance Manual itself was also considered to be strictly confidential and was not to be made ...