U.S. v. Pittsburgh Trade Exchange Inc.

• Citation: 644 F.2d 302
• Decision Date: 06 April 1981
• Docket Number: No. 80-2484,80-2484
• Parties: 81-1 USTC P 9283 UNITED STATES of America and Gerald R. Potocnak, Revenue Agent, Internal Revenue Service v. PITTSBURGH TRADE EXCHANGE INC. and Vincent E. Manella, Appellants.
• Court: U.S. Court of Appeals — Third Circuit

Page 302

644 F.2d 302

81-1 USTC P 9283

UNITED STATES of America and Gerald R. Potocnak, Revenue Agent, Internal Revenue Service v. PITTSBURGH TRADE EXCHANGE INC. and Vincent E. Manella, Appellants.

No. 80-2484.

United States Court of Appeals Third Circuit.

Argued Jan. 23, 1981.

Decided March 27, 1981.

As Amended April 6, 1981.

M. Carr Ferguson, Asst. Atty. Gen., Michael L. Paup, Charles E. Brookhart (argued), William A. Whitledge, Attys., Tax Division, Dept. of Justice, Washington, D. C., for appellees; Robert J. Cindrich, U. S. Atty., Pittsburgh, Pa., of counsel.

John M. Bray, David J. Curtin (argued), Attys., Schwalb, Donnenfeld, Bray & Silbert, A Professional Corp., Washington, D. C., for appellants; William Greenberg, Pittsburgh, Pa., of counsel.

Before GIBBONS and VAN DUSEN, Circuit Judges, and ACKERMAN, ^* District Judge.

OPINION OF THE COURT

GIBBONS, Circuit Judge.

Pittsburgh Trade Exchange, Inc. and Vincent E. Manella, its sole stockholder (collectively hereafter The Exchange) appeal from an order of the district court enforcing a "John Doe" summons served by the Internal Revenue Service. The appeal requires that we consider for the first time the appropriate standards for enforcement of "John Doe" summonses issued on the authority of section 1205(a) of the Tax Reform Act of 1976, Pub.L.94-455, 90 Stat. 1520, 26 U.S.C. § 7609(f). The Exchange contends that the court erred in several respects when it enforced the summons. We affirm.

I

The Exchange is what is commonly known as a "barter exchange" which operates as a clearing house for the exchange of goods and services between its members other than for cash. A member of a barter exchange wishing to purchase particular goods or services can obtain from it a referral to another member which supplies the goods or services desired. The selling member is provided with trade credits equal to the selling price, which can be used, then or in the future, to acquire goods or services from other members. The purchasing member's account, accumulated from sales it has previously made, is debited for the purchase price. For facilitating such barter exchanges The Exchange charges a fee equal to ten percent of the value of each transaction, which compensates it for its referral and record keeping services. Those transactions result, obviously in tax consequences for members engaging in them. The Exchange has been in business since April 1977. All but one of its members are located in Pennsylvania.

In March of 1980 the Internal Revenue Service filed in the district court a petition requesting an order permitting it to serve a John Doe summons on The Exchange. The petition was supported by the affidavit of revenue agent Gerald R. Potocnak. That petition was not served on anyone, and the court, acting ex parte, on March 27, 1980 entered an order granting the requested authority. The court acted pursuant to a subsection of the provision in the Internal Revenue Code dealing with special procedures for third-party summonses:

Any summons described in subsection (c) which does not identify the person with respect to whose liability the summons is issued may be served only after a court proceeding in which the Secretary establishes that

(1) the summons relates to the investigation of a particular person or ascertainable class of persons,

(2) there is a reasonable basis for believing that such person or group of persons may fail or may have failed to comply with the provisions of any internal revenue law, and

(3) the information sought to be obtained from the examination of the records (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.

26 U.S.C. § 7609(f). The subsection is a qualification to the general rules of 26 U.S.C. § 7609(a) & (b) that when a third-party subpoena is served in connection with the investigation of a taxpayer's liability, the taxpayer must be notified and afforded an opportunity to resist compliance and enforcement. Obviously such notice is not possible if the identity of the taxpayer is unknown; hence the special treatment of John Doe summonses.

The summons authorized by the March 27 order was served on The Exchange on April 2, 1980, demanding the production of records reflecting the names and addresses of Exchange members for the calendar years 1978 and 1979, together with

"(c)orporate books of account, ledger, or other records of (The Exchange) which identify for each member every bartering transaction, the date, the participants, and the amount during (those) years ...."

When The Exchange declined to comply, the Internal Revenue Service brought this action to enforce the summons. An order issued directing The Exchange to show cause why it should not comply. It filed an answer and an opposing affidavit. Over the objection of the Internal Revenue Service a two-day evidentiary hearing was held in July, 1980, and on September 12, 1980 the Court filed a memorandum holding that the summons was proper and an order directing compliance. ¹ This appeal followed.

II

The government contends that the enforcement order should be affirmed for a reason which it advanced but the district court rejected. It contends that once the district court in an ex parte proceeding decides to authorize a John Doe summons no further inquiry into its propriety can be made. That contention is based upon the Internal Revenue Service construction of 26 U.S.C. § 7609(h). Enacted at the same time as section 7609(f), subsection (h) provides:

The United States district court for the district within which the person to be summoned resides or is found shall have jurisdiction to hear and determine proceedings brought under subsections (f) and (g). The determinations required to be made under subsections (f) and (g) shall be made ex parte and shall be made solely upon the petition and supporting affidavits. An order denying the petition shall be deemed a final order which may be appealed.

The Internal Revenue Service reads the quoted language as providing the exclusive method of review of the propriety of any John Doe summons. We disagree.

Prior to the enactment of the Tax Reform Act of 1976 there was no express authorization or prohibition of John Doe summonses, and the control of their use was subject only to those provisions of the Internal Revenue Code dealing with enforcement. 26 U.S.C. § 7604(a). In United States v. Bisceglia, 420 U.S. 141, 95 S.Ct. 915, 43 L.Ed.2d 88 (1974), an enforcement proceeding directed at a bank which resisted a John Doe summons, the Supreme Court held that 26 U.S.C. § 7602 authorized such summonses, subject to those limitations on use of any summons which the Court laid down in Reisman v. Caplin, 375 U.S. 440, 84 S.Ct. 508, 11 L.Ed.2d 459 (1964) and United States v. Powell, 379 U.S. 48, 85 S.Ct. 248, 13 L.Ed.2d 112 (1964). The Bisceglia holding produced some concern in Congress that the use of John Doe summonses could become widespread and uncontrolled. This concern was part of a larger one, having to do with Internal Revenue Service examinations of third-party records when the taxpayer might be left unaware. Therefore, the thrust of section 7609, taken as a whole, was to require that the target taxpayer be given notice, so that he would be able to assert appropriate defenses. 26 U.S.C. § 7609(a)-(d).

Appreciation of that context is basic to an understanding of subsections (f) and (h) John Doe summonses necessarily required separate treatment because the target taxpayer was unknown and thus could not be notified in advance. S.Rep.No.94-938, 94th Cong., 2d Sess., reprinted in (1976) U.S.Code Cong. & Ad.News at 2897, 3798. Such summonses were thus subjected to an additional control, besides that already in 26 U.S.C. § 7604(b) requiring resort to the court for enforcement: for the first time, Congress imposed judicial review of the decision to issue a summons prior to its issuance. It required that a detached and impartial judge in the district of the person to be summoned be satisfied that the three criteria of subsection (f) have been met. Since John Doe process for the production of records may not be issued until authorized by the judge, subsection (f) permits an ex parte determination and authorizes an appeal by the Internal Revenue Service from orders denying its petition. Obviously in such an appeal nothing can come before an appellate court except the propriety of issuing a summons, not the propriety of enforcing it after it issues. The "determinations required to be made under subsection(s) f" is only that: a determination that a summons may issue, not that it should be enforced. Nothing in the 1976 Act or its legislative history suggests that Congress intended to reduce or contract the scope of the district court's authority in subsequent enforcement proceedings. Indeed, the contrary appears to be the case. At 306. Procedural protections, additional to those which the Supreme Court recognized in the Bisceglia case, were intended, but the substantive holdings in that case were approved, or at least not overruled.

Thus we reject the Internal Revenue Service contention that subsection 7609(h) deprived the district court of authority to conduct an evidentiary hearing in its subpoena enforcement proceeding brought under 26 U.S.C. § 7604(a). Subsection (h) simply does not speak to enforcement questions.

III

The next question is what standards are appropriate in a section 7604(a) proceeding for the enforcement, against a third party, of a John Doe summons. The Exchange, relying chiefly on the language "reasonable basis for believing that such person or group or class of persons may fail or have failed to comply with any provision of any internal revenue law" in 26 U.S.C. § 7609(f)(2), urges that stricter judicial scrutiny is required in John Doe cases than under the familiar rules of United States v. Powell, 379 U.S. 48, 85 S.Ct. 248, 13 L.Ed.2d...