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No Ostrich Here: Qui Tam Victory for Taxpayer from the Illinois Appellate Court

The Illinois Appellate Court has, once again, determined that there was no "reckless disregard," by a taxpayer under the Illinois False Claims Act ("IFCA"), by failing to pay Illinois use tax on internet and catalog sales made into Illinois. The decision issued by the appellate court on October 17, 2016 in State of Illinois, ex rel, Beeler, Schad and Diamond, P.C. v. Relax the Back Corporation, mirrors another recent decision from the same appellate court in State of Illinois, ex rel., Schad, Diamond and Shedden, P.C. v. National Business Furniture, LLC. In both decisions, the appellate court looked to whether the taxpayer acted as someone who, like an ostrich, "buries his head in the sand, ignoring obvious warning signs or refusing to discover information," when it failed to pay Illinois use tax alleged to have been due. In both decisions, the appellate court found no reckless disregard.

No Physical Presence in Illinois

In Relax the Back, an Illinois serial "whistleblower," the Relator, alleged that the taxpayer, Relax the Back Corp.("RTB"), a seller of back and neck care products, knowingly ignored its duty to collect and remit Illinois use tax on its catalog and internet sales to Illinois customers. RTB argued that it did not have sufficient physical presence in Illinois, thus no nexus and no obligation to collect sales or use tax. RTB's only office was in California, with no building, inventory or employees in Illinois. RTB had five retail stores in Illinois, all owned and operated by franchisees and subject to a franchise agreement that expressly disclaimed any agency relationship. Customers could make purchases from RTB through its website or catalog and merchandise was sent to Illinois customers directly from the manufacturer or from a warehouse in California and delivered by common carrier. RTB did not collect use tax on internet or catalog sales into Illinois until 2013, when one of RTB's employees relocated to reside in Illinois.

Steps Taken to Investigate Tax Obligations and Reliance on Those Findings

At trial, RTB's CFO testified that he took numerous steps to investigate its tax obligations on this issue, including the following:

  1. consulted with their outside tax lawyer
  2. consulted with an outside sales tax specialist
  3. followed results of annual financial audits by outside CPA's
  4. confirmed his personal knowledge regarding the current law on nexus

RTB's CFO testified that he relied on all of the outside advice and his own personal familiarity with the current law on nexus, to conclude that RTB did not have sufficient physical presence in Illinois to obligate a use tax collection. At trial, RTB also called an opinion witness, the former manager of the audit bureau at the Illinois Department of Revenue, who testified that RTB's investigation as to its use tax obligations was reasonable in his opinion.

But Relator argued that the RTB franchises in Illinois created sufficient nexus to require RTB to collect and remit use tax on those internet and catalog sales into Illinois and that RTB acted with reckless disregard in failing to collect and remit those taxes. The trial court accepted the RTB testimony that it made an honest effort to determine whether it had tax obligations as to its internet sales, however the trial court determined that the one fact of RTB's requiring its franchises to distribute thousands of catalogs annually to Illinois customers, beginning in 2013, did establish substantial nexus under Quill,because the catalogs invited customers to place orders by fax or phone and thus created a "sufficient nexus" for use tax liability.

The trial court entered judgment against RTB, on the catalog sales only, finding liability of $5,181 in tax owed, which it then trebled and supplemented with statutory penalties of $5,500 for a total liability of $21,043. The trial court subsequently granted Relator's petition for attorney's fees and costs in the amount of $109,061.22. RTB appealed the finding of damages for the catalog sales and fees, and Relator cross-appealed the decision of no liability for the internet sales.

Appellate Court Says No Ostrich, Thus No "Reckless Disregard"

The Illinois Appellate Court determined that:

  1. RTB made honest efforts to determine its obligations by consulting withqualified professionals.
  2. The state of the law on nexus was open to interpretation and dependent onfacts of each case,
  3. Its own recent decision in National Business Furniture  properly addressed"reckless disregard" under the IFCA, Sec. 3(b)(1)(A), and applies in this case,in that it does not result from "innocent mistakes or negligence," but rathercan be described as "the ostrich type situation where an individual has buriedhis head in the sand and failed to make simple inquiries which would alert himthat false claims are being submitted.
  4. RTB did not act with reckless disregard by relying on outside professionals to analyze its tax obligations, for both the internet and  the catalog sales.

Thus, the judgments against RTB for the catalog sales and the Relator's attorney's fees were reversed and the Relator's cross-appeal was rejected.

Don't Be An Ostrich! 

The Illinois Appellate Court has now established and confirmed its position on proving "reckless disregard" under the IFCA. For taxpayers, this is very helpful. Take simple steps today to investigate any potential tax obligations or other issues at your company, including doing an inquiry of appropriate independent professionals, and follow the reasonable advice you receive as you deem appropriate. But whatever you do, don't be an ostrich.           

© Horwood Marcus & Berk Chartered 2022. All Rights Reserved.National Law Review, Volume VI, Number 293

About this Author

 David Ruskin, LItigation Attorney, Horwood Marcus Berk Law Firm

David works with companies and individuals to resolve their complex business disputes, helping them reach their desired goals in the most efficient manner. He represents clients in State and Federal courts nationwide and uses negotiation, mediation and/or litigation as necessary to ensure the goals are met. David is a partner in both the firm's Litigation and State & Local Tax Groups.

David focuses his practice on business litigation including:

  • Whistleblower (qui tam) and False Claims Act (FCA) defense
  • ...