I will bold-face certain items, without further explanation in this blog, that I hope you will think about as you read the instructions. I will probably discuss most of the bold-faced instructions in later blogs. Keep in mind that the text headings are bold-face simply to show that they are headings. The bold-face to which I particularly draw attention will be in the body of the text. That bold-facing is mine and not Judge Pauley's.
I start with the discussion of the second object of the conspiracy, tax evasion. The court gave this instruction before instructing as to what tax evasion was. I think the court did that simply because the order of presentation in the indictment was with conspiracy as the first count.
Also, readers should be aware of that two types of tax evasion were charged. First, there was tax evasion with respect to unindicted taxpayers, the notion being that the defendants allegedly conspired to commit and themselves did commit, under various derivative liability theories (that I will discuss in a later blog). Second, there was Daugerdas' personal tax evasion with respect to his own returns. In the following discussion, I omit the instructions relevant to this second type of evasion, since it is garden-variety (although he used exotic aggressive tax shelters of his own crafting). I am much more interested in the first type of evasion -- evasion on the returns of unindicted and perhaps even nonculpable -- at least not criminally culpable -- taxpayers. So, in order to make the instructions more readable as to the first type of tax evasion, I am omitting all references to Daugerdas' person alleged evasion. I show those omissions with ellipses -- * * *.
Second Object: Tax Evasion
The second object of the alleged conspiracy is the attempted evasion of income taxes of Jenkens & Gilchrist clients who participated in the Short Sale, SOS, Swaps, and HOMER tax shelters. To prove the second object of the conspiracy, the Government must prove beyond a reasonable doubt that the defendant you are considering and one or more co-conspirators unlawfully, willfully and knowingly agreed to commit the crime of tax evasion with respect to the clients who participated in the tax shelters. The elements of tax evasion are:
First, that a substantial tax was due and owing to the United States by the relevant taxpayer client;
Second, that the defendant you are considering committed, or caused to be committed, one or more affirmative acts of evasion described in the Indictment; and
Third, that the defendant you are considering acted willfully and knowingly in attempting to evade the taxes owed by the taxpayer client.
I will discuss the elements of tax evasion in more detail later in my charge, when I discuss Counts 2 through 11 * * * of the Indictment, which charge substantive counts of tax evasion. The law that I am going to explain in connection with those substantive counts should be applied by you when you are considering whether either of the defendants conspired to commit the tax evasion object of the conspiracy.I now offer the relevant instructions on the substantive crime of evasion:
Counts 2 through 11 are substantive counts of tax evasion. It is a crime to willfully attempt, in any manner, to evade or defeat any income tax imposed by law. Each of the tax evasion counts charges one or both of the defendants with evading or attempting to evade taxes allegedly due and owing by certain clients of Jenkens & Gilchrist and BDO Seidman. Each count relates to a particular tax return by a particular client in a particular year.
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As I discuss the elements of the tax evasion charges, you should consider them not just in relation to Counts 2 through 11 * * * of the Indictment, but also in relation to Count 1 of the Indictment. That is because, as I mentioned earlier, Count 1 charges a conspiracy to accomplish three objects — one of which is to attempt to evade the income taxes of the tax shelter clients. Thus, you should consider my instructions on the elements of the crime of tax evasion when you are considering that object of the conspiracy.
Elements of the Offense
In order for the crime of tax evasion to be proved, the Government must establish beyond a reasonable doubt each of the following three elements:
First, that a substantial tax was due and owing to the United States by the individual at issue, namely, the tax shelter clients in Counts 2 through 11 * * * *.
Second, that the defendant you are considering committed, or caused to be committed, one or more affirmative acts of evasion described in the Indictment; and
Third, that the defendant you are considering acted knowingly and willfully in attempting to evade the taxes owed by the taxpayer client.
Before I instruct you on these specific elements, I want you to keep in mind that the Government must prove these three elements beyond a reasonable doubt for each of the tax evasion counts.
Pages 43 through 45 of the Indictment list the taxpayers, tax returns, tax years, and the defendants involved in each of the tax evasion counts related to the tax shelter clients. * * * * You must consider each count separately, and your verdict on one count should not affect your verdict on any other count.
First Element: Tax Due and Owing
In order to establish the first element of tax evasion, the Government must prove beyond a reasonable doubt that the relevant taxpayer * * * owed a substantial federal income tax for the tax year at issue. The Government claims that the reason the taxpayers * * * owed more taxes than they reported is that the losses they claimed on their tax returns as a result of the Short Sale, SOS, Swap, or HOMER tax shelters were not allowable. The Government contends that these losses were not allowable because they stemmed from transactions that lacked “economic substance.”
A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss allegedly sustained in such a transaction is not properly claimed on a tax return.
In order to establish that a transaction lacks economic substance, the Government must prove, beyond a reasonable doubt, two components.
The first component is that the relevant taxpayer had no genuine business purpose for engaging in the transaction in question apart from the creation of the tax deduction.
The second component is that there was no reasonable possibility that the transaction would result in a profit.
Now, let me provide an explanation of the first component—namely, whether the taxpayer had a business purpose, that is, any non-tax reason for entering into the tax shelter. In deciding that question, you may consider any direct evidence of the taxpayer’s motive. But you are not limited to direct evidence in deciding why a taxpayer did the transaction. You may consider circumstantial evidence as well.
For example, you may consider the manner in which the tax shelter was sold to the taxpayer—in other words, whether and to what extent it was sold to the taxpayer as a way to create a tax deduction to offset other taxable income and/or as a way to generate a return, exclusive of tax benefits, on an investment.
You may consider also whether a reasonable taxpayer would have paid the fees necessary to do the transaction in order to gain the chance of whatever profit potential existed if the transaction had not also resulted in tax benefits.
You may also consider the evidence of whether a taxpayer had developed a genuine secondary motive to enter in to the transaction for profit after being told of its associated tax benefits.
Ultimately, if you find that the Government has proved beyond a reasonable doubt that the taxpayer had no genuine business purpose for entering into the tax shelter in any particular count, you will go on to consider the second part of the economic substance test. If you find, however, that the Government has not proved that tax benefits were the sole reason for entering into the tax shelter, you must reject the Government’s economic substance argument and, therefore, reject its contention that there was additional tax due and owing. That would require you to find the defendant you are considering not guilty on the particular tax evasion count that you are considering.
Now, as I mentioned, the second component of the economic substance test that the Government must prove beyond a reasonable doubt is that there was no reasonable possibility that the tax shelter in question would result in a profit. The word “profit” in this context means a return in excess of all of the costs and fees incurred by the taxpayer in connection with entering into the tax shelter, disregarding entirely any tax benefits.
I want to emphasize to you that this component requires you to reach an objective judgment about whether the Government has proved that there was no reasonable possibility that the strategy would result in a profit. In other words, this does not depend upon what the taxpayer believed about the profit potential. It requires you to consider all of the evidence and reach a conclusion about whether the Government has proved beyond a reasonable doubt that there was no reasonable possibility of a profit. In doing this, you will have to consider the evidence concerning the investment aspects of each of the four tax shelters at issue in this case—for example, the digital options trades involved in the SOS tax shelter and the German bonds transactions involved in the HOMER transactions.
In considering whether the Government has met its burden of proof on this second factor, you should take into account whether the taxpayer, considering all of the aspects of the strategy, had any reasonable chance of making a profit, as I defined it a moment ago.
If you unanimously find that the Government has proved beyond a reasonable doubt both components of the economic substance test—in other words, that the taxpayer had no genuine business purpose for entering into the tax shelter and that there was no reasonable possibility of making a profit—you may find that the requirement of additional tax due and owing has been satisfied. At that point, you will go on to consider whether the Government has proven that the additional tax due and owing was substantial. If you do not find that both components of the economic substance test have been proved beyond a reasonable doubt, then the Government will not have proved that additional tax was due and owing and you must find the defendant you are considering not guilty.
If you find beyond a reasonable doubt, based on all the evidence, that the taxpayer owed more tax for the year in question than was declared on the tax return, then you must consider whether there was a substantial additional amount of tax due.
The Government need not prove the exact amount the taxpayer owed, or that all of the tax charged in a particular count was evaded. In the context of this case, it must prove beyond a reasonable doubt only that the relevant taxpayer took a deduction that resulted from a tax shelter that lacked economic substance and that the amount by which the taxpayer thereby understated the tax due and owing on that return was substantial.
Substantiality is not measured in terms of any particular percentage of the tax shown to be due or payable. All of the circumstances must be taken into consideration. A few thousand dollars of additional tax due in a given case may or may not be considered substantial, 18 depending on the circumstances of that case.
Second Element: Attempt to Evade or Defeat a Tax
The second element that the Government must prove beyond a reasonable doubt is that each of the defendants committed or caused to be committed an affirmative act of evasion described in the Indictment. For each count, the Government must prove that the defendant you are considering took an affirmative act to attempt to evade or defeat taxes. The phrase “attempt to evade or defeat a tax” involves two elements: first, the formation of an intent to evade or defeat a tax, and second, willfully performing some act to accomplish the intent to evade or defeat that tax. There are many different ways in which a tax may be evaded or an attempt may 4 be made to evade it.
You should also keep in mind that while the Government must prove that the defendant you are considering committed, or caused to be committed, some affirmative act of tax evasion, it need not prove each act of evasion listed in the Indictment. For each count, it is enough if the Government proves one affirmative act by the defendant you are considering.
However, you all must agree on the same affirmative act of evasion that the defendant in question committed in order to satisfy this element. In other words, it is not sufficient for you to agree that the defendant in question committed or caused to be committed some affirmative act of evasion without agreeing on the same affirmative act that he committed or caused to be committed. I have used the word “caused” when describing how a defendant may be found liable under the tax evasion statute. A defendant who willfully causes the doing of an act by another person, which if it were done by the defendant directly, would make the defendant guilty of a crime, may be punished as a principal, even if the act in question was committed by an entirely different person—here, the taxpayer client.
Under this theory, the taxpayer’s intent is irrelevant, and it is thus does not matter whether the taxpayer himself lacked an intent to evade taxes. A defendant “causes” the relevant taxpayer to take some action if you find that the Government has proven beyond a reasonable doubt that the defendant willfully played a substantial part in bringing about or actually causing the action. Further, I instruct you that something may have more than one cause. When multiple causes exist, the defendant is a cause of a particular act by a taxpayer if he was a substantial factor in bringing about that act. Whether something was a cause of something else is a question of fact for your determination.
Third Element: Knowing and Willful Conduct
The third element the Government must prove beyond a reasonable doubt for each 6 count of tax evasion is that the defendant you are considering acted knowingly and willfully.
As I have already instructed you, an act is done knowingly only if it is done purposely and deliberately and not because of carelessness, mistake, accident, negligence or even gross negligence or other innocent reason. To satisfy this element, the Government must prove beyond a reasonable doubt that the defendant you are considering knew that the relevant taxpayer employed or would employ the strategy in question, took or would take a deduction attributable to that strategy on his tax return, and would have reported a substantially higher tax liability if the taxpayer had not done so.
With respect to the crime of tax evasion, a willful act is defined as a voluntary and intentional violation of a known legal duty. In other words, an act is done willfully if it is done voluntarily, intentionally, and with a specific intention to do something the law forbids. In order to establish that the defendant acted willfully, the Government must prove beyond a reasonable doubt that the defendant you are considering was aware that tax deductions based on transactions lacking economic substance were prohibited and was aware that the tax shelters in fact lacked economic substance. This means that the defendant (1) knew that the relevant taxpayer had no genuine business purpose apart from the creation of a tax deduction for entering into the tax shelter, (2) knew that the tax shelter had no reasonable possibility of making a profit, as I previously defined it, and (3) knew that the tax due and owing attributable to the tax shelter in 1 question would have been substantially greater than the tax reported on the taxpayer’s tax return.
In determining whether a defendant acted willfully, you are entitled to consider all the evidence in this case that bears on his state of mind. Science has not yet devised a way for us to enter into a person’s mind and figure out exactly what he is thinking. Intent and knowledge therefore rarely, if ever, are proved by direct evidence, and more often are proved by circumstantial evidence such as a defendant’s words, conduct, acts, and all surrounding circumstances as of the time the acts occurred. You should apply your common sense and draw such reasonable inferences as may be warranted by the facts proved. In determining, for each count, whether each defendant intended to evade or defeat taxes, you may consider any statements he made and acts he committed or omitted, together with all other facts and circumstances that are in evidence, which reasonably relate to the determination of his state of mind.
I instruct you, however, that a defendant does not act willfully if he believes in good faith that his actions comply with the law.
A good faith belief is one that is honestly and genuinely held. A person who acts on a belief or on an opinion honestly held lacks the required criminal intent and cannot be found guilty of a crime merely because that belief turns out to be incorrect or wrong. This is true regardless of how wrong, unreasonable, or irrational the defendant’s belief was, so long as the belief was held in good faith.
The burden of proving good faith, however, does not rest with the defendants, because the defendants have no obligation to prove anything in this case. Therefore, unless the Government proves beyond a reasonable doubt that a defendant did not actually believe that there was a reasonable basis for the relevant taxpayer to take the tax position reported on the taxpayer’s tax return for a particular count, then he cannot have had the criminal intent necessary to constitute willfulness for purposes of this charge and you must find that defendant not guilty on that count.
Now, I want to say something about the transaction costs that you have heard about in this case and their relationship to the question of whether a defendant knew the tax shelter in question had no reasonable possibility of making a profit. When you are considering this question, you must ask yourselves whether the defendant you are considering had a good faith belief that the fees charged to the clients by Jenkens & Gilchrist and BDO Seidman were not required to be included in evaluating the tax shelter’s profit potential. If you find that the defendant you are considering had such a good faith belief, and you find that, with respect to the first element of tax evasion, the only reason the tax shelter had no reasonable possibility of profit was because of the inclusion of those fees, then you may not find that the defendant you are considering acted willfully. Rather, you must find the defendant you are considering not guilty.As noted above, the court refers back to instructions it had given in the conspiracy instructions as to the definition of knowingly and willfully in the context of whether the defendant "unlawfully, willfully and knowingly" entered into the conspiracy. Although the tax evasion crime (and by reference the conspiracy to commit tax evasion) requires only that the defendant act willfully, Judge Pauley grafted the knowingly requirement onto the tax evasion crime. (I don't think knowingly adds anything to willfully, but apparently Judge Pauley thought so.) Here is the relevant part of the definition of knowingly and willfully as instructed under the conspiracy charge:
“Unlawfully,” “Willfully,” and “Knowingly” Defined
The terms “unlawfully,” “willfully,” and “knowingly” are intended to ensure that if you find that a defendant did join the conspiracy, you may not find the defendant guilty unless you also conclude beyond a reasonable doubt that, in doing so, the defendant knew what he was doing; in other words, that he took the actions in question deliberately and voluntarily.
“Unlawfully” simply means contrary to law. The defendant need not have known that he was breaking any particular law or any particular rule, but he must have been aware of the generally unlawful nature of his acts.
An act is done “knowingly” and “willfully” if it is done deliberately and purposefully; that is, a defendant’s acts must have been the product of his conscious objective, rather than the product of force, mistake, accident, mere negligence, or some other innocent reason.
With respect to the tax evasion object of the conspiracy, the Government must also prove beyond a reasonable doubt that the defendant acted willfully, as I will discuss in more detail when instructing you regarding tax evasion.
With respect to the objects of the conspiracy to defraud the United States and to commit wire fraud and mail fraud, the Government must prove beyond a reasonable doubt that the defendants acted with the specific intent to defraud the United States by fraudulent, deceitful, or dishonest means.
Now, knowledge is a matter of inference from the proven facts. Science has not yet devised a manner of looking into a person’s mind and knowing what that person is thinking. However, you do have before you the evidence of certain acts and conversations alleged to have taken place involving the defendants or in their presence. You may consider this evidence, if you choose to credit it, in determining whether the Government has proven beyond a reasonable doubt each defendant’s knowledge of the unlawful purposes of the conspiracy.
It is not necessary for the Government to show that a defendant was fully informed as to all the details of the conspiracy in order for you to infer knowledge on his part. To have guilty knowledge, a defendant need not have known the full extent of the conspiracy or all of the activities of all its participants. It is not even necessary for the defendant to know every other member of the conspiracy.
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In sum, the defendant, with an understanding of the unlawful nature of the conspiracy, must have intentionally engaged, advised or assisted in the conspiracy for the purpose of furthering an illegal undertaking. The defendant thereby becomes a knowing and willing participant in the unlawful agreement—that is to say, he becomes a conspirator.The full set of Judge Pauley's instructions on retrial in Daugerdas is linked here. I have bookmarked the instructions for easier navigation, but the bookmarks are apparently viewable only if you download the pdf file.