Taxpayer Successfully Shows NonPossession and Control to Avoid Summons and Successfully in Most Part Asserted Fifth Amendment (8/5/17; 8/20/17)

In United States v. Lui, 2017 U.S. Dist. LEXIS 119953 (N.D. Cal. 2017), here, the court granted in part and denied in part the IRS petition to enforce the summons to the taxpayer.  The time line of events pieced together from the opinion and the parties' key submissions (Liu's amended memo here, the Gov't's response here,and Lui's Sur-reply here) is:

• 9/??/13 IRS starts audit for 2010 year
• 1/29/14 IRS issues IDR 001 requesting "copies of all delinquent FBARs"
• 2/11/4 "Lui submitted FBAR filings for years 2008, 2009, 2010, 2011 and 2012." [There is some commotion as to whether the 2012 FBAR had been timely filed]
• 7/8/14 first summons issue for testimony
• 8/4/14 Lui responds to summons and invokes Fifth Amendment in Q&A.
• 8/??/14 IRS expands audit to include 2005-2009 and 2011-2012
• 7/29/15 IRS issues second summons for documents related to offshore activity, related to foreign entities.
• 8/10/15 IRS issued IDR 13 and an Foreign Document Request ("FDR" pursuant to 26 U.S.C. § 982. The FDR, with IDR 13, sought records from foreign companies. Id.  [JAT Note, the opinion mentions the FDR but says almost nothing about why that is an issue, since it was not part of the summons enforcement proceeding except as background.]
• 10/14/16 Lui produces some documents but not others.  In his submission, the allegation is made that "Lui fully and timely responded to the IDRs, the FDR, and the both summonses, except that Lui could not provide all documents related to Netfinity and WG. " As to the FDR, "Lui provided certain documents pursuant to the FDR that were not in his possession or control, specifically the limited documents his family in Hong Kong chose to provide him in response to his requests."
• 2/26/16 IRS petitions to enforce summons (I think it may be both summonses)
• 3/16/16 Court approves summons on prima facie basis and issues Lui show cause order
• At some point apparently in 2016, Lui served on Government request for admissions and for documents.
• 12/15/16 Hearing on show cause order
• 7/31/17 Order Issued

Decisions as to Document Production

Lui's defense to the petition to enforce was that he had produced the documents he could but that he did not have possession or control or ability to obtain the documents.  The Court hold that the summonsed party asserting this defense must make a credible showing of lack of possession and control as of the date the summons was issued.  As to what the summonsed party must show, the Court adopted the sliding scale test of United States v. Malhas, 2015 U.S. Dist. LEXIS 151990, 2015 WL 6955496, at *4, which it describes as "the more the Government's evidence suggests the defendant possesses the documents at issue, the heavier the defendant's burden to successfully demonstrate that he does not."  Based on that Court's application of the Malhas test, the Court holds that (one footnote omitted):

The Court adopts the sliding scale test from Malhas, but reaches a different result, because the facts here are markedly different than in Malhas. For one thing, Lui presents far more than his own affidavit to support his argument of non-possession. ECF No. 82 at 21-24. Lui argues he does not have possession of the requested documents  because the non-produced records were either beyond his control or no longer existed as of July 29, 2015, the date of the IRS document summons. ECF No. 82 at 14-17, 21-24. On July 26, 2014, Lui resigned as a director of Netfinity and any related records were transferred out of his possession, custody, care and control to the custody of his siblings. ECF No. 82 at 15, citing ECF No. 24-2 at 154; ECF No. 24-6 at 63-71. Lui argues that "[c]oncurrently," the 2002 Trust assets were distributed among Lui's siblings, and "all shares in Netfinity and WG were transferred to Lui's" siblings." Id. Lui contends that "[u]pon distribution of the assets, the 2002 Trust dissolved because it no longer held any assets." ECF No. 82 at 15 (citing ECF No. 23 at 7). Lui presents numerous exhibits that show Lui had limited power over the trust that held Netfinity shares, ECF No. 24-2 at 17-18, 12, 73, 77, 75, 79; ECF No. 22-2 at 3-7; that the interests in Netfinity and WG were transferred to Lui's siblings at their request, ECF No. 24-2 at 38-41, 19, 35, 105,107-112; that the documents sought are now in the possession of Lui's siblings, ECF No. 24-2 at 63-71, 154; ECF No. 22-2 at 3-7; and that Lui was never a beneficial owner, [*11]  ECF No. 24-2 at 14-16. Moreover, Lui has attached advisory letters from law firms within the foreign jurisdictions, explaining that non-beneficial owners have no legal right to compel production of the documents. ECF No. 21-5 at 3-7. Therefore, Lui argues, he has no enforceable legal right to obtain the records. ECF No. 82 at 15. Lastly, Lui presents evidence that he did not receive a dividend from Galaxy during the audit period, ECF No. 24-2 at 81-82, and asserts he is not the beneficial owner of the Netfinity shares, ECF No. 88 at 4. 

The Government offers little direct evidence to the contrary. It primarily relies on a 2005 SEC filing that lists Lui as the owner of Netfinity. ECF No. 33-1. In addition, the Government also asks the Court to consider the suspicious timing of events by which the shares of Netfinity were distributed out of Lui's control and to his siblings, ECF No. 84 at 10, as well as Lui's lack of documentation surrounding the transfer of the Netfinity stock to his siblings. Id. at 8. 

These circumstances, though suspicious, are insufficient to demonstrate that Lui possesses or has the capacity to obtain the challenged documents. Although Lui may have been on notice of the IRS' investigation into his foreign assets because of the FDR or the testimonial summons in 2014, Lui's duty to retain these documents was not fixed until July 29, 2015, the date of the document summons. n4 The Court finds that the suspicious timing alone is not enough to overcome the plethora of evidence that Lui has offered to show that he did not possess, control, or have custody of the documents at issue which the IRS sought in its July 29, 2015 document summons as of that date. The Court cannot compel Lui to produce documents that he does not have in his possession or control.
   n4 The Government argues the relevant summons date was July 8, 2014 because it placed Lui "on notice that the IRS was examining his foreign interests." ECF No. 84 at 8. The obligation to retain documents does not begin until the actual document summons is issued. See Asay, 614 F.2d at 660. 

Nonetheless, although Lui has succeeded in demonstrating that he does not possess documents directly related to the Netfinity or WG assets, he has not met his burden of showing that he has no documents related to the transfer of those assets. As the Government argues, "[i]t is difficult to believe that such a significant purchase and transfer of stock would be unaccompanied by correspondence or at least emails maintained by the transferor." ECF No. 84 at 8. In the IRS' initial summons, it included "letters of wishes, letters of intent, orders of instructions and other similar documents expressing the founder's or beneficiary's wishes or instructions regarding the entity." ECF No. 1-3 at 7. Lui has not included any emails or other correspondence with regard to the transfer of the Netfinity stock. He has, however, been able to provide declarations from his siblings corroborating the fact that he no longer has access to Netfinity documents. ECF No. 83-1, 83-2, 83-3, 83-4, 83-5, 83-6, 83-7, 83-8, 83-9, 83-10, 83-11. Therefore, Lui is ordered to turn over any additional correspondence or other records in his possession regarding the transfers, or to submit a declaration under penalty of perjury that no such documents exist and that none existed as of July 29, 2015. Such declaration must be filed by August 11, 2017.

Decisions as to Testimonial Summons

The Court sustained Lui's assertion of the Fifth Amendment for most questions (related to FBAR obligations and foreign entity ownership).  The exceptions the Court made were

• Lui had waived his Fifth Amendment privilege to "Who keeps the books and records of Netfinity Asset Corporation?"
• Lui must answer the following questions because he had asserted that he had searched diligently and produced all records:
• (1) Did you possess any summonsed documents as of July 29, 2015 (the service date for the Document Summons)?
• (2) Who possessed the Netfinity documents on July 29, 2015?
• (3) Where do the individuals that possessed the documents on July 29, 2015 reside?
• (4) How did you know that your siblings possessed or controlled the documents on July 29, 2015?
• (5) What documents do you possess that evidence your siblings' possession or control of the Netfinity documents?

The court quashed Liu's requests for admission and production.

The docket entries as of today are here:

JAT Comments:

1.  My gut reaction is that Lui's lawyer did a great job.  See the Lui's submissions linked above.

2.  The general notion is that, once the witness testifies as to anything within the scope of the Fifth Amendment privilege, he has waived the privilege as to all related matters in the proceeding.  As applicable in investigations, once he waives his privilege as to some part of the investigation, he waives it as to all.  As to trials, once he waives the privilege by testifying, he waives it for all questions within the scope of the trial.  (Now there is some nuance behind all of that, but that is the general statement.)  The following arguments were submitted by Liu in the Sur-Reply (footnotes omitted):

First, waiver cannot be lightly inferred. See Smith v. United States, 337 U.S. 137, 150 (1949). For a party to waive the Fifth Amendment, he must have reason to believe that his statements are both “testimonial” and “incriminating.” See Klein v. Harris, 667 F.2d 274, 288 (2d Cir. 1971). “Testimonial” means “voluntarily made under oath in the context of the same judicial proceeding,” which would apply here. Id. “Incriminating,” however, means something more than matters that are “collateral” to the circumstances and must directly inculpate the person in the commission of the (alleged) crime. Id. Here, Lui has merely stated that requested documents are in the control of his siblings as of July 26, 2014, a fact that in no way incriminates him with regard to the actions the IRS may assert are criminal, such as allegedly willfully not filing certain forms.

Second, offering evidence to challenge an IRS summons on the basis of non-possession or control does not mean forfeiting Fifth Amendment protections. See United States v. Asay, 614 F.2d 655, 660 (9th Cir. 1980) (recipients of summonses bear the burden of offering credible evidence of non-possession); United States v. Bright, 596 F.3d 683, 694 (9th Cir. 2010) (upholding Fifth Amendment privilege in a summons action, after the taxpayer submitted declarations regarding non-possession and attempts to comply with document requests); see also Emspak v. United States, 349 U.S. 190, 196 (1955) (courts should indulge every reasonable presumption against finding a waiver). The government’s position contradicts Bright, and would force a taxpayer to choose between (i) preserving his Fifth Amendment rights or (ii) presenting evidence of non-possession.

The government further asserts that Lui’s Fifth Amendment claims for questions relating to Netfinity “are suspect” because “he now alleges that he was never the beneficial owner.” ECF No. 84, pp. 8:28-9:2. The government reasons that if Lui did not own the stock, then he should have no legitimate fear of prosecution. ECF No. 84, p. 9:2-3.

The government’s position ignores that even though Lui was not the beneficial owner of Netfinity, that fact does not resolve whether the IRS questions could lead to incriminating evidence the IRS might use to prosecute Lui. The IRS has consistently declined to acknowledge that the 2002 Trust existed, and it denied that Lui timely filed a 2012 FBAR. Further, the IRS appears to believe that Lui either had income tax or information reporting obligations because of his record ownership of Netfinity shares. The government has not, for example, said that it will not try to prosecute Lui for alleged failures to file IRS Form 5471 relating to ownership of foreign corporations, Foreign Bank Account Reporting Forms (“FBARs”), or other IRS filing obligations subject to criminal enforcement.

Addendum 8/20/17 7:00pm:

A commenter identified as Eliot made an excellent point:

A taxpayer served with a summons for documents she doesn't possess has to carefully thread a needle-- she has to present evidence of non-possession, but may have a legitimate Fifth Amendment privilege as to the obvious follow-up question of "what happened to them?" There are some older cases, which neither the parties nor the court cited in Liu, which deal with this issue: Curcio v. United States, 354 U.S. 118 (1957); United States v. O'Henry's Film Works, 598 F.2d 733 (2d Cir. 1979).

The following is from O'Henry's Film Works (emphasis supplied):

A plain reading of Curcio and McPhaul [364 U.S. 372] leads to the conclusion that the duty of the putative custodian of an organization's records extends beyond mere production or nonproduction: when the agent fails to produce documents that are the subject of a valid summons or subpoena, if called before a court, he must give sworn testimony that he does not possess them. The agent's statement that he does not possess the records at issue is merely part of his duty to comply with a lawful demand for them. It might be called "testimony auxiliary to his nonproduction," by analogy to Judge Learned Hand's holding that an agent must identify the documents he does produce because "testimony auxiliary to the production is as unprivileged as are the documents themselves." United States v. Austin-Bagley Corp., 31 F.2d 229, 234 (2d Cir. 1929). Just as an agent's identification of documents he has produced "merely makes explicit what is implicit in the production itself," Curcio, supra, 354 U.S. at 125, 77 S.Ct. at 1150, so does an agent's statement that he does not possess documents he has failed to produce make explicit what is implicit in the nonproduction. Because the agent's testimony is unprivileged, it is not a waiver of his privilege against self-incrimination as to other matters. The agent cannot be interrogated further unless, at this point, he voluntarily waives his Fifth Amendment privilege or is granted immunity. The Government is then free to attempt to establish by extrinsic evidence that the documents exist in the agent's custody or control, or that the agent destroyed the documents.

 3. Liu's accountant was involved in a previous write-up.  SeeTaxpayer Right to Be Present at Interview of Federally Authorized Practitioner (4/10/15), here.