2nd Circuit Holds Foreign Governments Cannot Use RICO to Collect Taxes in US Courts
September 13, 2005. The U.S. Court of Appeals (2ndCir) issued its opinion [12 pages in PDF] in European Community v. RJR Nabisco, holding that foreign governments cannot bring civil suits in US Courts against tobacco companies under the Racketeer Influenced and Corrupt Organizations Act (RICO) to recover lost tax revenues and law enforcement costs due to alleged smuggling. This is a technology related opinion that will benefit international e-commerce.
While this case involves smuggling of cigarettes and the RICO, and the related case of Pasquantino v. United States, which the Supreme Court decided in April, involved alcohol smuggling and the wire fraud statute, both of these cases have ramifications for companies that do business internationally, especially in e-commerce.
Governments may have special policy rationales for regulating, and taxing, alcohol and cigarettes. However, nothing in these opinions limit their reach to alcohol and cigarettes. These opinions affect all tax collection efforts.
Both the present case and Pasquantino arise out of efforts by foreign governments to collect taxes on goods made in the US and sold in their countries. David and Carl Pasquantino bought alcohol legally in the state of Maryland, and paid all US taxes. They had a third person smuggle it into Canada in car trunks, and sell it in Canada, without paying the required excise taxes, in violation of Canadian law. The venture made business sense because Canadian taxes on alcohol are much higher than those in the US.
The US revenue rule prevents US prosecutors from prosecuting for violation of foreign tax laws. Moreover, US prosecutors could not prosecute for violation of US tax laws, because none were violated. The US instead prosecuted the Pasquantinos with violation of wire fraud statute, which is codified at 18 U.S.C. § 1343.
That statute provides that "Whoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises, transmits or causes to be transmitted by means of wire, radio, or television communication in interstate or foreign commerce, any writings, signs, signals, pictures, or sounds for the purpose of executing such scheme or artifice, shall be fined under this title or imprisoned not more than five years, or both. If the violation affects a financial institution, such person shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both."
The Pasquantinos had made phone calls. The US charged that these some of their phone calls were made in furtherance of a scheme to defraud the Canadian government.
A trial jury of the U.S. District Court (DMd) returned verdicts of guilty, and the District Court entered judgment against the defendants. A divided three judge panel of the U.S. Court of Appeals (4thCir) reversed in an opinion reported at 305 F.3d 291. However, an en banc panel of the Court of Appeals then affirmed the convictions in an opinion released on July 18, 2003, and reported at 336 F.3d 321.
The Supreme Court affirmed the convictions in a 5-4 opinion [38 pages in PDF] issued on April 26, 2005. It held that the US may prosecute under the wire fraud statute for communications made in connection with efforts to violate the tax laws of other nations, without running afoul of the revenue rule. It reasoned that the US was not collecting tax revenues. It was prosecuting for violation of the wire fraud statute. The case is Sup. Ct. No. 03-725. The opinion is reported at 125 S. Ct. 1766
In the present case, the European Community, and some individual nations, filed a civil complaint in U.S. District Court against RJR Nabisco and other tobacco companies alleging violation of the RICO statute, which is codified at 18 U.S.C. §§ 1961-1968. (The District Court heard this, and two related cases, together.) That is, this is a RICO suit to collect taxes brought by the foreign nations themselves. The Supreme Court vacated an earlier opinion of the 2nd Circuit, and remanded. However, it wrote in its Pasquantino opinion that it declined to address the RICO issue. It instructed to 2nd Circuit to reconsider in light of the Pasquantino opinion.
In the present opinion, the 2nd Circuit considered the Supreme Court's opinion in Pasquantino, and reaffirmed its earlier decision (reported at 355 F.3d at 128). It held that notwithstanding Pasquantino, foreign governments cannot use the RICO to collect unpaid foreign taxes. It held that the revenue rule prevents it.
The Court reasoned that "the revenue rule is designed to address two concerns: first, that policy complications and embarassment may follow when one nation’s courts analyze the validity of another nation’s tax laws; and second, that the executive branch, not the judicial branch, should decide when our nation will aid others in enforcing their tax laws." It continued that in Pasquantino the Supreme Court "found that concerns about sovereignty and separation of powers were not implicated where the United States government brings a criminal prosecution."
"The present civil lawsuit, on the other hand, is brought by foreign governments, not by the United States. Moreover, the executive branch has given us no signal that it consents to this litigation", the Court of Appeals wrote. "In short, the factors that led the Pasquantino Court to hold the revenue rule inapplicable to § 1343 smuggling prosecutions are missing here."
The Court of Appeals, quoting an earlier opinion, concluded that "Here, the substance of the claim is that the defendants violated foreign tax laws. ``When a foreign nation appears as a plaintiff in our courts seeking enforcement of its revenue laws, the judiciary risks being drawn into issues and disputes of foreign relations policy that are assigned to -- and better handled by -- the political branches of government.´´"
"In Pasquantino, this concern was alleviated by the direct participation of the political branches in the litigation. ... Here we have no such assurance. We therefore see no reason why Pasquantino’s analysis should disturb our conclusion that the revenue rule bars civil RICO suits by foreign governments against smugglers." (Citation and footnote omitted.)
It may also be noteworthy that the European Community was able to bring this action, in part, because the US Congress, in enacting the USA PATRIOT Act in 2001, added certain smuggling or export control violations to the list of RICO predicate acts under 18 U.S.C. § 1956(c)(7).
The present case and Pasquantino are significant because they concern not just alcohol and cigarettes, but the law regarding collection efforts, in the US, by foreign tax collectors, of any kind of tax. These cases affect any businesses that have some connection to other countries, and might be sued in the US. These cases are of particular importance to e-commerce businesses, in part, because such entities may have some connection to countries all over the world.
An e-commerce company may be incorporated in one country, have its headquarters in another, production facilities in many countries, and call centers in still others. It may sell to buyers all over the world. In the case of online sales of software, it may known were all of its buyers are. The servers and communications facilities used in transactions may involve even more countries. Thus, even a small enterprise may find that there are a potential multitude of countries that may claim that taxes are owing to it.
Tax laws tend to be immensely complicated, even when applied only intranationally. Companies have difficulty understanding their own nation's laws. Moreover, tax collectors have political incentives to impose taxes on foreign entities, rather than their own subjects, and sometimes seek to collect abusive taxes from entities with only tenuous connections to the taxing jurisdiction.
Until recently the rule was clear. The US will not collect taxes for foreign governments or enforce foreign tax laws. It is their own responsibility. Pasquantino created a significant exception, and consequential uncertainty. While the US did not technically collect taxes for Canada, the threat of a criminal prosecution, at the behest of a foreign tax collector, if taxes are not paid, has many attributes of a collection action. Although, five members of the Supreme Court opined otherwise.
Pasquantino has a limiting attribute. It concerns prosecutions for violation of the wire fraud statute. Foreign governments cannot bring such actions. Thus, under Pasquantino, foreign tax collectors must win the cooperation of US prosecutors.
In the present case, the foreign governments sought to collect the taxes themselves, without assistance of US prosecutors, by pleading the RICO statute.
Moreover, if foreign governments were allowed to use US RICO suits to collect claimed taxes, the US District Courts could become the court of choice for forum shopping tax collectors from around the world. It should be observed that in one of the three cases heard along with the RJR Nabisco case the lead defendant is Japan Tobacco, Inc. Thus, European nations are attempting to use US courts to collect taxes from a Japanese company.
E-commerce companies, as well as many other business sectors, should take some comfort in the just released opinion.
Justice Thomas wrote the opinion of the Supreme Court in Pasquantino. Justices Rehnquist, O'Connor, Stevens and Kennedy joined. Justices Ginsburg, Breyer, Scalia and Souter dissented. The breakdown may be notable. Should the present case be heard by the Supreme Court, two of the five members of the Pasquantino majority will not be present -- Rehnquist and O'Connor.
The present case is European Community, et al. v. RJR Nabisco, et al.,
and consolidated cases, U.S. Court of Appeals for the 2nd Circuit, App. Ct. Nos.
02-7325 (L), 02-7330 (CON), and 02-7323, appeals from the U.S. District Court.
Judge Sotomayor wrote the opinion of the Court of Appeals, in which Judges Oakes
and Calebresi joined.