Thursday, January 10, 2013

Supreme Court Decision on Burden of Proof for Affirmative Defense of Withdrawal from Conspiracy (1/10/13)

Conspiracy charges are common in the federal crimes universe and in federal tax crimes universe, specifically.  This blog has dealt frequently with the principal conspiracy charge, the Klein conspiracy which is the tax iteration of the defraud conspiracy in 18 USC 371, here.

The Supreme Court yesterday delivered a major conspiracy decision in a non-tax case, holding that the defendant must prove the defense of withdrawal from the conspiracy.  Smith v. United States, ___ U.S. ___, 2013 U.S. LEXIS 601 (2013), here.  The decision is unanimous and is authored by Justice Scalia.  Although not couched in this language, the Court held that, on the affirmative defense of withdrawal, the defendant bears the burden on persuasion (stated in risk terms, the risk of nonpersuasion).  It is a very short opinion, so I encourage readers interested in the subject of withdrawal from a conspiracy or burdens imposed upon the parties in a criminal case with respect to affirmative defenses to read the opinion.  I will introduce the opinion by the key excerpts from the Syllabus (page and case citations omitted):
Held: A defendant bears the burden of proving a defense of withdrawal.
(a) Allocating to the defendant the burden of proving withdrawal does not violate the Due Process Clause. Unless an affirmative defense negates  an element of the crime, the Government has no constitutional duty to overcome the defense beyond a reasonable doubt. Withdrawal does not negate an element of the conspiracy crimes charged here, but instead presupposes that the defendant committed the offense. Withdrawal terminates a defendant’s liability for his co-conspirators’ post-withdrawal acts, but he remains guilty of conspiracy.
Withdrawal that occurs beyond the statute-of-limitations period provides a complete defense to prosecution, but does not render the underlying conduct noncriminal. Thus, while union of withdrawal with a statute-of-limitations defense can free a defendant of criminal liability, it does not place upon the prosecution a constitutional responsibility to prove that he did not withdraw. As with other affirmative defenses, the burden is on him. Pp. 3-6.
(b) Although Congress may assign the Government the burden of proving the nonexistence of withdrawal, it did not do so here. Because Congress did not address the burden of proof for withdrawal in 21 U. S. C. §846 or 18 U. S. C. §1962(d), it is presumed that Congress intended to preserve the common-law rule that affirmative defenses are for the defendant to prove. The analysis does not change when withdrawal is the basis for a statute-of-limitations defense. In that circumstance, the Government need only prove that the conspiracy continued past the statute-of-limitations period. A conspiracy continues until it is terminated or, as to a particular defendant, until that defendant withdraws. And the burden of establishing withdrawal rests upon the defendant.
As I said, the decision is a short one.  As a short decision, however, it assumes the readers' familiarity with some of its assumptions.  Indeed, I suspect that a good teacher could use the case as a starting point to root around many of the concepts of conspiracy law for several class periods.  I don't propose to do that here, because (i) I don't have time to produce a product that my readers should take the time to read and (ii) perhaps not even the skill set.

I make the following comments.

1.  Procedurally, the manner in which the defense was raised to the jury is odd.  The jury raised the defense.  The defendant did not raise it at trial or request instructions; hence the jury was not instructed.  From the opinion:
After it began deliberations, the jury asked the court what to do in the event that a defendant withdrew from the conspiracies outside the relevant limitations period. n2 Smith had not yet raised an affirmative defense of withdrawal, so the court for the first time instructed the jury on the defense. The court explained that “[t]he relevant date for purposes of determining the statute of limitations is the date, if any, on which a conspiracy concludes or a date on which that defendant withdrew from that conspiracy.” Id., at 328a. It defined  withdrawal as “affirmative acts inconsistent with the goals of the conspiracy” that “were communicated to the defendant’s coconspirators in a manner reasonably calculated to reach those conspirators.” “Withdrawal,” the court instructed, “must be unequivocal.” Ibid. Over the defense’s objection, the court told the jury that “[o]nce the government has proven that a defendant was a member of a conspiracy, the burden is on the defendant to prove withdrawal from a conspiracy by a preponderance of the evidence.” Ibid. The jury then convicted Smith of the conspiracy crimes.
   n2 The note to the judge inquired: “‘If we find that the Narcotics or RICO conspiracies continued after the relevant date under the statute of limitations, but that a particular defendant left the conspiracy before the relevant date under the statute of limitations, must we find that defendant not guilty?’” App. 174a.
2.  The critical holding is that, unless Congress assigns the burden to the Government, the Constitution requires that the Government bear the burden of persuasion beyond a reasonable doubt to negate the affirmative defense only where the affirmative defense goes to an element of the crime.  In this case, concept of withdrawal is not an element of the crime; hence, the burden can and is imposed upon the defendant.  The concept of which affirmative defenses go to the elements of the crime and which do not is apparent in most cases.  And, something which appears to be an affirmative defense may not be one at all, when care is paid to the elements of the crime.  For example, in tax cases, a not-uncommon defense is reliance on a professional adviser.  As courts have noted, that is really not a defense at all in tax cases but rather goes to the element of the crime that the defendant act willfully -- if he or she relied upon a professional, he or she did not act willfully.  So, that is not really an affirmative defense.  Consider the following from the current draft of my Federal Tax Crimes book (footnotes omitted, and the cut and paste is not indented because it is my work and the rest of this blog entry is cut and paste anyway):

(4) Corporate Diversions.

A common fact pattern with closely held C Corporations is for the shareholder(s) to take money out of the corporation in a way that underreports the corporation’s tax liability and underreports the shareholder(s)’ tax liability.   There are many ways of implementing this type of double underreporting, but a common pattern is for the shareholder of a corporation that has a lot of cash coming through its business (e.g., a restaurant business) to pocket some of the cash each evening, thus preventing it from being shown on the books from which the corporation and the shareholder calculate their tax liabilities.  As to the shareholder(s), the income that results from such a diversion is dividend income.  Dividends are taxable to the shareholder receiving the dividends, but in the tax law the concept of dividend is a term of art.  It is not just a distribution from the corporation to the shareholder but is a distribution from the earnings and profits of the corporation.  The Code does not define earnings and profits, and the calculation earnings and profits may be dicey indeed.

There’s the rub.  The conventional wisdom is that, to convict of a crime, the Government must prove each element of its case beyond a reasonable doubt.  For tax evasion, the Government must prove a tax due and owing; nobody doubts that proposition as stated.  Although the Government need not prove the precise amount, still its proof must show that a tax was due and owing and that the amount was substantial.   Does the Government have to prove the earnings and profits calculations to support the dividend treatment that in turn supports the element of the crime – a material tax due and owing?

Let’s develop our analysis of this issue with an example that will illustrate some of the complications.  Assume Corporation X wholly owned by individual A is entitled to receive $100 from one of its customers. That customer pays Corporation X in cash.  Instead of putting the cash on the corporate books, A puts it in his pocket.  The cash gets reported by neither the corporation nor the shareholder.  The proper tax treatment of that item is that it is income of the corporation and is a corporate distribution to the shareholder.  Sections 301 and 316 of the Code provide that the distribution to the shareholder is taxed to the shareholder as a dividend to the shareholder to the extent of the corporation's cumulative or current earnings (“E&P”); the balance of the distribution, if any, is taxed either a nontaxable return of capital or a capital gain.

Let's trace the tax consequences.  The corporation which earned the $100 must include the amount in its income.  Let's assume that its effective tax rate on the $100 is 34%.  Logically, whether or not the corporation paid the tax, it owes the tax and thus has only a $66 dividend paying capacity with respect to that $100.  Logically, also, its E&P increases by $66.  If that is the only item of income the corporation had and it had no other deductions (set aside the fact that the effective corporate rate would not apply at this level of taxable income, but assume that it does so that we can illustrate the point), the corporation could only pay $66 in dividends.  (The $34 balance of the $100 actually distributed would be subject to return of capital or capital gain; but assume for purposes of this illustration that the shareholder has adequate basis in his stock so that the $34 is treated as return of capital.)  Assuming that the individual is taxed at 28% rate on that marginal dividend income of $66, the tax would be $18.48, and the individual would have $47.52 left over from his income (setting aside the $34 return of capital).  The total tax loss in this example is thus $52.48 ($34 corporate tax and $18.48 individual tax).  But, without getting into the details now, it may well be that the corporation has insufficient E&P to support the shareholder level tax on the dividend.

Let's add two complications to illustrate a major problem.

First, let's assume that the corporation also had $200 net taxable income from other sources and made no distributions to the shareholder other than the diversion noted above.  In that case, the corporation's E&P is $198 ($300 of net taxable income less $198 of tax), the corporation would still owe the $34 tax on the marginal $100 in question that was diverted to the shareholder but the entire $100 diversion would be taxable as a dividend to the shareholder receiving the diversion.  E&P is more than sufficient to cover the entire distribution.  The tax loss on the $100 diverted would thus be $62 rather than $52.48.  (In effect, the shareholder has been distributed some of the other earnings of the corporation.)

Second, instead of assuming other corporate income, assume the corporation had not only the right to the $100 in question but had $200 of deductions.  This would mean that the corporation had no E&P.  The diversion of the $100 to the shareholder therefore would (i) attract no corporate level tax, (ii) would not be a dividend, and (iii) would be taxed (and then at capital gains rates) only if and to the extent that the amount diverted exceed the shareholder's basis in the stock.  So, if his basis exceeded $100, for example, there would be no corporate or shareholder level tax that could be evaded by the diversion.  In this example, there is no tax loss resulting from the diversion.  (It may well be that the shareholder may not have contemporaneously recognized and claimed the $200 of deductions, so that when he diverted the $100 cash, he intended to avoid tax at both the corporate and shareholder levels; but, if the corporation in fact was entitled to the deductions, the Government will not be able to convict for tax evasion since an actual material amount of tax evaded is an element of the crime.)

There are a myriad of variations on these examples that will produce varying levels of tax based upon the corporation's taxable income and E&P.

Now let’s go back to the question asked – what is the Government’s burden, if any, to prove earnings and profits where it must prove that the taxpayer failed to report shareholder level tax on the diverted income?  As you can see, that issue is heavily dependent upon the existence of E&P so as to support a dividend in an amount sufficient to convict.  Does the Government have to prove E&P, one of the more murky areas of the tax law, before it may convict?

The Supreme Court addressed a variation of this issue in Boulware v. United States, 552 U.S. 421 (2008).  The issue it technically resolved is whether, in order to require the Government to prove sufficient E&P to support the element of tax due and owing, the defendant must at least put in play the issue of whether the defendant or the corporation “intended” the corporate diversion to be a dividend from the corporation.  As the issue was thus framed, the answer was obvious, for the statute requires E&P before there can be a taxable dividend as opposed to a return of capital.  Regardless of such “intent,” there can be no dividend and no tax.  A § 7201 case must fail, and the Court so held in a straight-forward unanimous decision.

In resolving the issue, the Boulware Court referred to a more nettlesome issue.  Is the Government required from the beginning to prove up E&P in such a case as an essential component of its burden to prove a tax due and owing?  Will the Government suffer a directed verdict after its case in chief if there is no proof of E&P?   Recognizing the difficulties and distractions inherent in a requirement that the Government prove E&P from the get go, the courts have  generally required the defendant do meet some minimal production burden to put the issue in play.

In United States v. Bok, 157 F.3d 157 (2d Cir 1998), the taxpayer was convicted for tax evasion (§ 7201) and tax perjury (§ 7206(1)) with respect to his two tax returns.  In part here relevant, the defendant attempted a defense that the corporate diversions were not dividends and were instead return of capital because the corporation did not have the required earnings and profits.  The jury was not instructed as to the requirement that the corporation have E&P which it must find.  The Court said:\
Although our earlier cases have not stated it with perfect clarity, a defendant does always bear the burden of production – under which the defendant must make an initial showing on each key element of the theory – to receive an instruction on the return of capital theory. That is, there must be some credible evidence that the corporation did not enjoy income or profits for the tax year at issue, and that the amount of the taxpayer's capital contribution exceeded the amount of the distribution from the corporation. The court in Leonard effectively held as much: 
In prosecutions for income tax violations, production of a rather slight amount of evidence by the Government, here the proof of receipt of what are charitably characterized as constructive dividends rather than embezzled funds, may transfer the burden of going forward to the defendant. Although the ultimate burden of persuasion remains with the Government, Leonard did not introduce sufficient evidence of an absence of earnings or profits 
. . . .     
Though Leonard used precatory language in discussing the defendant's burden of production, it did not purport to do away with the general requirement that a proposed jury instruction must have an adequate basis in fact. To the extent that Leonard was at all unclear on the issue, we now clarify that in order to merit a charge on the return of capital theory, a defendant must satisfy a burden of production by showing that an adequate basis in fact exists for the charge. As suggested by the cases cited in Leonard, this is not the only circumstance in which a taxpayer faces a burden of production once the government has come forward with evidence of tax evasion. See, e.g., United States v. Vardine, 305 F.2d 60, 63 (2d Cir. 1962) (“It is reasonable to require the defendant, if he wishes to disprove intent and likely source [of a net worth bulge], to bear the burden of going forward when he alleges that he had additional deductions not claimed on his income tax return.”). Of course in cases involving the return of capital theory, the allocation of the burden of going forward to the taxpayer does not affect the ultimate burden of persuasion, which always remains with the government. 
Like the taxpayer in Leonard, Bok failed to satisfy his burden of going forward and therefore did not establish an adequate basis in the record for his proposed instruction. Specifically, neither Bok nor the government produced any admissible evidence to suggest that Abacus lacked earnings or profits for 1988. Although Bok did introduce Abacus's 1988 financial statements, he made clear that they were offered only to show Bok's state of mind when he gave information to his accountant, not for the underlying truth of the figures in the statements. Even if the financial statements had been admitted for their truth, they alone would not have satisfied Bok's burden because they were based entirely on information provided by Bok, purportedly using an entirely different method of accounting than that used on Abacus's corporate return. In addition, Bok had suggested that Abacus did have net earnings for 1988. During the IRS's investigation, Bok accounted for the low figures in the gross receipts portion of Abacus's return by explaining that he had mistakenly entered the corporation's net profits in place of its gross receipts. At trial Bok referred to this explanation for the false statements on Abacus's returns in arguing that he lacked the requisite intent to be convicted. Bok continues to make the same argument on appeal, noting his contention that the numbers on the gross receipts line of Abacus's tax returns “were really net profits.” Brief for Defendant-Appellant David S. Bok at 36. Finally, Bok declined the trial court's invitation to elicit facts to support his proposed charge. Because Bok's accountant had not been qualified as an expert witness, the trial court rejected Bok's attempt to establish through the cross examination of the accountant that, as a matter of law, a return of capital was a nontaxable event. In doing so, however, the trial court expressly suggested that Bok use the witness to develop facts that Bok might later use as the basis for a jury instruction; Bok did not follow up on the trial court's suggestion. 
Thus, despite our generous approach to jury instructions, under which the defendant is entitled to an instruction on his theory when “there is some foundation in the proof, no matter how tenuous,” Bok did not provide sufficient facts to warrant his proposed charge. Given the lack of evidence produced by Bok on the issue of Abacus's earnings or profits, we cannot say the trial judge erred in finding no basis in the record for the return of capital theory. Because Bok failed to satisfy his burden of production, the trial court properly rejected Bok's proposed instruction.
-----------[END OF BOK CASE]-------------
Is it right that the Government can shift to the Defendant any burden with respect to an element of the crime?  The courts pay homage to the requirement that the Government prove the elements beyond a reasonable doubt and that it is not incumbent upon the defendant to do anything.  Yet, as you see, the defendant is required to mount this defense as to an element of the Government's case because of a shifting trial burden.  I will return to this issue from time to time, for the defendant's counsel must be keenly aware when some burden has been shifted to the defendant.

The Supreme Court in Boulware recognized the issue and ducked it as follows:
Boulware does not dispute that he bears the burden of producing some evidence to support his return-of-capital theory, including evidence that the corporation lacked earnings and profits and that he had sufficient basis in his stock to cover the distribution. See Tr. of Oral Arg. 53. He instead argues that, as to the “with respect to . . . stock” requirement, it suffices to show “[t]hat he is a stockholder, and that he did not receive this money in any non-stockholder capacity.” Id., at 57.  The Government, for its part, on the authority of Holland v. United States, 348 U.S. 121 (1954) and Bok, 156 F.3d at 163-164, argues that Boulware must offer more evidence than that.  We express no view on that issue here, just as we decline to consider the more general question whether the Second Circuit's rule in Bok, which places on the criminal defendant the burden to produce evidence in support of a return-of-capital theory, is authorized by Holland and consistent with Sandstrom v. Montana, 442 U.S. 510, 99 S. Ct. 2450, 61 L. Ed. 2d 39 (1979), and related cases.
On remand in Boulware case, however, the Ninth Circuit actually read the opinion consistent with Bok as requiring the defendant to meet a production burden.  Applying that perceived requirement, the Ninth Circuit zapped Boulware by finding that that the defendant’s offer of proof to meet that production burden was not sufficient to put the return of capital defense in play.  The Ninth Circuit’s opinion can be criticized as results oriented in the way it resolved the particular case before it, but does give a clear roadmap for what the careful lawyer must do to tee up the defense in the future.

But, let’s go back to the Supreme Court’s cryptic reference to Holland in the context of determining whether imposing a production burden on a defendant was consistent with the normal criminal requirement that the Government prove its case beyond a reasonable doubt.  The cryptic reference to Holland is apparently to the part of Holland that says, in effect, once the Government proves the elements of the crime, the defendant stands quiet at his peril.  I don’t think the Supreme Court’s comment in Holland meant that a formal production burden had shifted to the defendant; rather, I think the court was dealing with practical trial dynamics where, with the Government having produced some evidence, the risk to the defendant is that the jury will find it persuasive.  If that is correct, as to the E&P issue, that simply begs the question unless the Government in its case in chief has proved up E&P.  But, the reference to Sandstrom v. Montana, which dealt with the effect of presumptions in criminal cases, suggests that the Court may have been thinking of some type of presumption that the corporation has E&P that carries the day for the Government in the absence of some evidence from the defendant that there is no E&P to support the dividend.  This may well be the practical effect of Bok, by placing a burden of production on the defendant.  As noted, however, the Supreme Court expressed no view on whether that type of shift of burden to the defendant on the element of the crime is appropriate, and thus leaves resolution of the issue to another day.

Many contexts other than corporate diversions or E&P uncertainties present the same issue as to when, despite the concept that the Government must prove each element beyond a reasonable doubt, a legal or practical burden shifts to the defendant.  Does the Government make a tax evasion case simply by showing that a taxpayer omitted an item of income from his return?  What if the taxpayer failed to report deductions, so that there either was not a tax due and owing or, if there was, the amount was not material?  Must the Government prove not only the omitted income but also the negative -- i.e., that the taxpayer's other tax attributes did not wipe out the tax effect of the omitted income?  Is the burden shifted to the taxpayer to prove that he or she did not have a tax due and owing?  I don't know that this issue has ever been that sharply defined for a court decision. The Government will certainly attempt to correctly determine the taxpayer's liability in its investigation and not even bring the case if there are offsetting deductions.  But how does the Government prove that there were no offsetting deductions?  And, if the case gets to trial, can a taxpayer rest on the Government's failure to prove beyond a reasonable doubt that there were no offsetting deductions?  More practically, of course, if there are offsetting deductions, the taxpayer will want to try to prove them in his or her defense.  Once the taxpayer puts them in play, presumably, the Government would then have to prove beyond a reasonable doubt that the deductions were not available, otherwise it will have not shown a tax due and owing beyond a reasonable doubt.  (But, as I note in discussing proof issues related to the net worth method, for such items as this, as a practical matter, the burden of proof has really been shifted to the defendant.)

As I discuss later, with respect to corporate diversions, certain conventions have arisen in the sentencing phase of the case which may permit a sentencing court to determine the sentencing tax loss without getting hung up on these technicalities.  The question I present here -- and do not answer -- is whether these conventions, in effect, apply to the case in chief where the Government is required to prove the elements of the offense beyond a reasonable doubt?

No comments:

Post a Comment

Please make sure that your comment is relevant to the blog entry. For those regular commenters on the blog who otherwise do not want to identify by name, readers would find it helpful if you would choose a unique anonymous indentifier other than just Anonymous. This will help readers identify other comments from a trusted source, so to speak.

Post a Comment