PACIFIC FISHERIES INC., Petitioner-Appellant, v. UNITED STATES of America, Respondent-Appellee. Konstantin Vladimirovich Voloshenko, Petitioner-Appellant, v. United States of America, Respondent-Appellee., United States Court of Appeals, Ninth Circuit., 484 F.3d 1103, Nos. 04-35897, 04-35899., Filed April 17, 2007

PACIFIC FISHERIES INC., Petitioner-Appellant, v. UNITED STATES of America, Respondent-Appellee. Konstantin Vladimirovich Voloshenko, Petitioner-Appellant, v. United States of America, Respondent-Appellee.

United States Court of Appeals, Ninth Circuit.

484 F.3d 1103

Nos. 04-35897, 04-35899.

Filed April 17, 2007.

Argued and Submitted Dec. 5, 2006.

Filed April 17, 2007.

Robert J. Chicoine and Cori Flanders-Palmer, Chicoine & Hallett, P.S., Seattle, WA, for appellants Pacific Fisheries and Konstantin Vladimirovich Voloshenko.

Gretchen Wolfinger, Eileen J. O'Connor, and Jonathan Cohen, Department of Jus╜tice, Washington, DC, and John McKay, United States Attorney, Seattle, WA, for appellee United States.

Appeal from the United States District Court for the Western District of Wash╜ington; Marsha J. Pechman, District Judge, Presiding. D.C. Nos. CV-04-01147-MJP, CV-04-01149-MJP.

Before: B. FLETCHER and M. MARGARET McKEOWN, Circuit Judges, and WILLIAM W. SCHWARZER,* District Judge.

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* ═ The Honorable William W Schwarzer, Senior United States District Judge for the Northern District of California, sitting by designation.

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McKEOWN, Circuit Judge:

The Internal Revenue Code allows tax╜payers to recover costs and attorneys' fees if they prevail in either civil or administra╜tive proceedings, so long as the position of the United States was not substantially justified. 26 U.S.C. ╖ 7430. Appellants Pacific Fisheries and Konstantin Vladimi╜rovich Voloshenko (collectively the "tax╜payers") seek attorneys' fees associated with pursuing two federal court petitions to quash third-party summonses. The tax╜payers and the United States agree that the summonses were not enforceable. They disagree about whether the govern╜ment should pay the taxpayers' legal fees as a consequence. The government's issu╜ance of the summonses essentially forced the taxpayers into court, but once there, the government's only action during the litigation was to promptly withdraw the summonses. The question is whether the government's prelitigation conduct should be factored into a determination of wheth╜er its position in the judicial proceeding "was substantially justified" as defined in the statute. 26 U.S.C. ╖ 7430(c)(4)(B)(i). Looking to the language and structure of the statute, we conclude that the litigation fees of these particular taxpayers do not fall within the coverage of the statute gov╜erning fees in a "court proceeding." See 26 U.S.C. ╖ 7430(a)(2).

BACKGROUND

On April 23, 2004, the Internal Revenue Service ("IRS") served two administrative third-party summonses on Bank of Amer╜ica. The first summons requested infor╜mation for the years 1995 to 2000 on an account held by Pacific Fisheries. The second summons requested the same infor╜mation for two accounts held by Konstan╜tin Voloshenko, an employee of Pacific Fisheries.

Both summonses were issued pursuant to a request by the Russian government under a tax treaty between the United States and the Russian Federation. See Convention Between the United States of America and the Russian Federation for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, art. 25, U.S.-Russ., June 17, 1992, S. Treaty Doc. No. 102-39 (1993), 1992 WL 608527, avail╜able at http://www.irs.gov/pub/irs╜trty/russia.pdf. The Russian government requested these records as part of its tax investigation of Voloshenko.

The IRS claims that it attempted to serve summons notices on the taxpayers, but the parties dispute whether either Pa╜cific Fisheries or Voloshenko was properly served. In any event, the taxpayers only received actual notice of the summonses on May 10, 2004, a mere three days before the statutory deadline to file petitions to quash their enforcement.

Immediately after discovering that the summonses had been issued, the taxpayers called IRS Revenue Agent Douglas Sand╜erson to dispute the enforceability of the summonses on statute of limitations grounds. Sanderson replied that he be╜lieved the summonses were enforceable. Three days later, on May 13, 2004, the taxpayers filed two separate petitions to quash the summonses in the United States District Court for the Western District of Washington. The principal reason they advanced for quashing the summonses was that the time period covered by the sum╜monses (1995-2000) was beyond the stat╜ute of limitations on any tax liability in╜curred by the taxpayers. See 26 U.S.C. ╖ 6501(a) (providing for a three-year stat╜ute of limitations in most civil enforcement cases under the Internal Revenue Code); 26 U.S.C. ╖ 6531 (providing for a three-year statute of limitations in most criminal cases under the Internal Revenue Code).

On June 23, 2004, the taxpayers sent a letter to the IRS reiterating their position that the summonses were unenforceable. The letter also requested specific docu╜ments relating to the underlying investiga╜tion.

On June 25, 2004, the IRS sent a notice to Bank of America, with a copy to taxpay╜ers' counsel, that it was withdrawing the summonses. Four days later, IRS counsel wrote to taxpayers' counsel informing him that the summonses had been withdrawn. The IRS requested the taxpayers to volun╜tarily dismiss the petition under Federal Rule of Civil Procedure 41 "[b]ecause the controversy at issue in both matters is now moot and the United States has not made an appearance in either matter."

The taxpayers refused to file voluntary dismissals but offered to stipulate to dis╜missal so long as the IRS provided certain information and assurances. The govern╜ment then moved to dismiss the petitions to quash, arguing that the petitions were moot since the IRS had withdrawn the summonses. See Spencer v. Kemna , 523 U.S. 1, 7, 118 S.Ct. 978, 140 L.Ed.2d 43 (1998) (holding that the jurisdiction of the federal courts is limited to those actions that provide a live case or controversy); Dame v. United States , 643 F.Supp. 533, 534 (S.D.N.Y.1986) (holding that a petition to quash is moot when a summons has been withdrawn). Shortly thereafter, Pa╜cific Fisheries served a set of interrogatories and a request for production of docu╜ments on the government. The taxpayers filed a joint response to the motions to dismiss. They did not oppose the motions to dismiss per se; rather, they requested dismissal of the petitions subject to certain conditions. Specifically, they wanted as╜surances that the IRS would not reissue the summons, requested administrative costs and attorneys' fees, and requested that the court order the government to respond to the discovery requests. ¹

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^1. ═ Although the taxpayers requested adminis╜trative costs in the district court, they have not pursued that argument on appeal.

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In substantially identical orders, the district court granted the government's motions to dismiss in both cases, holding that taxpayers' petitions to quash became moot when the IRS withdrew the sum╜monses. The district court declined to impose conditions on the dismissal or to award attorneys' fees. In declining to award attorneys' fees, the court held that the taxpayers had not convinced the court that they were prevailing parties for the purposes of the fee-shifting statute, 26 U.S.C. ╖ 7430, and that the taxpayers had not established that the United States' po╜sition was not substantially justified.

ANALYSIS

The taxpayers decry what they view as abusive tactics by the IRS and contend that the district court erred in declining to award them attorneys' fees under 26 U.S.C. ╖ 7430. ² Although we are not unsympathetic to the taxpayers' claimed plight, we affirm the district court's order.

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^2. ═ We review the denial of attorneys' fees un╜der 26 U.S.C. ╖ 7430 for an abuse of discretion. United States v. Ayres , 166 F.3d 991, 997 (9th Cir.1999).

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I. STATUTORY FRAMEWORK

The fee-shifting statute provides that:

(a) In general.-In any administrative or court proceeding which is brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under this title, the prevailing party may be awarded a judgment or a settlement for-

(1) reasonable administrative costs in╜curred in connection with such adminis╜trative proceeding within the Internal Revenue Service, and

(2) reasonable litigation costs incurred in connection with such court proceed╜ing.

26 U.S.C. ╖ 7430. Section 7430 defines several of the above terms, including the following:

(4) Prevailing party.-

(A) In general.-The term "prevailing party" means any party in any proceeding to which subsection (a) applies (other than the United States or any creditor of the taxpayer involved)-

(i) which-

(I) has substantially prevailed with respect to the amount in controver╜sy, or

(II) has substantially prevailed with respect to the most significant issue or set of issues presented . . .

(B) Exception if United States estab╜lishes that its position was substantial╜ly justified.-

(i) General rule. -A party shall not be treated as the prevailing party in a proceeding to which subsection (a) applies if the United States estab╜lishes that the position of the Unit╜ed States in the proceeding was substantially justified . . . .

(7) Position of United States.-The term "position of the United States" means-

(A) the position taken by the United States in a judicial proceeding to which subsection (a) applies, and

(B) the position taken in an adminis╜trative proceeding to which subsection (a) applies . . . .

Id . ╖ 7430(c)(4); ╖ 7430(c)(7).

To prevail on a claim for attorneys' fees, a taxpayer must demonstrate that he has substantially prevailed with respect to the amount in controversy or the most signifi╜cant issue or set of issues presented. Id . ╖ 7430(c)(4). A taxpayer is then entitled to attorneys' fees unless the United States can demonstrate that its position was sub╜stantially justified. Id.

II. THE TAXPAYERS SUBSTANTIALLY PREVAILED WITH RESPECT TO THE MOST SIGNIFICANT ISSUE PRESENTED

As a preliminary matter, we note that the government does not dispute that the taxpayers prevailed with respect to the most significant issue in the proceedings below. The taxpayers filed two petitions to quash IRS summonses in district court. Although the government's motions to dis╜miss were granted, the taxpayers pre╜vailed on the most significant issue be╜cause they received the relief they sought all along-the IRS withdrew the sum╜monses. Cf. Donlon I Dev. Corp. v. United States , 830 F.Supp. 1315, 1317 n. 1 (C.D.Cal.1993) (noting that when the IRS withdrew a summons before moving to dismiss a petition to quash, the govern╜ment conceded that the petitioner pre╜vailed with respect to the most significant issue).

III. THE UNITED STATES' POSITION WAS SUBSTANTIALLY JUSTIFIED

The taxpayers' central contention on ap╜peal is that the district court erred when it placed the burden of demonstrating that the United States' position was not sub╜stantially justified on them. They further contend that had the district court not committed this error, the taxpayers would be entitled to attorneys' fees under the fee-shifting statute. We agree that the district court erred in placing the burden to prove lack of substantial justification on the taxpayers, but we hold that as a mat╜ter of law, the government met its burden to prove its position was substantially justified.

A. BURDEN OF PROOF

The fee-shifting statute provides that a party may not be treated as the prevailing party if "the United States establishes that the position of the United States in the proceeding was substantially justified." 26 U.S.C. ╖ 7430(b)(4)(B)(i) (emphasis added). The language of the statute places the burden squarely on the United States, not on the taxpayer, to demonstrate that the government's posi╜tion was substantially justified. Id.; see also Kenney v. United States , 458 F.3d 1025, 1032 (9th Cir.2006) (allocating the burden to prove that the government's po╜sition was substantially justified to the government). The statute was amended in 1996, in part to specifically shift the bur╜den of proving substantial justification from the taxpayer to the IRS. Compare 26 U.S.C. ╖ 7430(c)(4)(A) (1996) ("The term ▒prevailing party' means any party in any proceeding to which subsection (a) applies (other than the United States or any credi╜tor of the taxpayer involved)-(i) which es╜tablishes that the position of the United States in the proceeding was not substan╜tially justified . . . .") with 26 U.S.C. ╖ 7430(c)(4)(B)(i) (2006) (stating that a party may not be treated as the prevailing party if "the United States establishes that the position of the United States in the proceeding was substantially justified."); see also H.R. Rep. 104-506, at 22, 36 (1996), U.S.Code Cong. & Admin.News 1996, pp. 1143, 1145, 1159 (explaining that the bill's drafters believed it appropriate for the IRS to demonstrate that it was substantially justified in maintaining its position when the taxpayer prevails). Thus, the district court inverted the statu╜tory burden when it held that the taxpay╜ers "ha[d] not convinced the Court that the [government's] position . . . was not sub╜stantially justified."

B. POSITION OF THE UNITED STATES

We next consider whether the United States demonstrated that its posi╜tion was substantially justified. The posi╜tion of the United States is substantially justified if it is "justified to a degree that satisfies a reasonable person." Pierce v. Underwood, 487 U.S. 552, 565, 108 S.Ct. 2541, 101 L.Ed.2d 490 (1988). That is, it must have a reasonable basis in both law and fact. Id . at 565, 108 S.Ct. 2541. The taxpayers argue that the United States acted unreasonably when it failed to with╜draw the summonses before the taxpayers filed the petitions in federal court. Al╜though we acknowledge that there is a serious question whether this prelitigation conduct was arguably unreasonable, the applicable statutory subsection pertains to "a judicial proceeding," not to the govern╜ment's prelitigation conduct. 26 U.S.C. ╖ 7430(c)(7)(A) ("position of the United States" means the position taken. "in a judicial proceeding").

1. STATUTORY HISTORY

The plain language of the statute distin╜guishes administrative from judicial pro╜ceedings and does not provide a bridge for conduct or events that span those proceed╜ings. The statutory evolution of the fees provision underscores this conclusion.

From 1986 to 1988, ╖ 7430 defined the "position of the United States" as "the position taken by the United States in the civil proceeding, and . . . any administra╜tive action or inaction by the District Counsel of the Internal Revenue Service (and all subsequent administrative action or inaction) upon which such proceeding is based." See Pub.L. 99-514 ╖ 1551(a), 100 Stat. 2085 (1986) (enacting this definition). If the current version of ╖ 7430 included this language, we would have no problem adopting the taxpayers' position. Unfortu╜nately for the taxpayers, the statute has been amended and later amendments did not merge civil proceedings and "adminis╜trative actions," nor did later amendments permit benchmarking of the IRS's conduct against "administrative action or inaction [ ] upon which such[civil] proceeding is based." Id .

In 1988, the statute was amended, and the amended version of ╖ 7430 separated administrative and litigation costs. It read:

In any administrative or court proceed╜ing which is brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under this title, the prevailing party may be award╜ed a judgment or a settlement for-

(1) reasonable administrative costs in╜curred in connection with such adminis╜trative proceeding within the Internal Revenue Service, and

(2) reasonable litigation costs incurred in connection with such court proceed╜ing.

Pub.L. No. 100-647 ╖ 6239(a), 102 Stat. 3342 (1988). The statute defined a prevail╜ing party as:

"any party in any proceeding to which subsection (a) applies (other than the United States or any creditor of the taxpayer involved)-(i) which establishes that the position of the United States in the proceeding was not substantially jus╜tified, and (ii) which-(I) has substantial╜ly prevailed with respect to the amount in controversy, or (II) has substantially prevailed with respect to the most sig╜nificant issue or set of issues presented . . . ."

Id . The statute also distinguished between judicial and administrative proceedings. The term "position of the United States" meant "(A) the position taken by the Unit╜ed States in a judicial proceeding to which subsection (a) applies, and (B) the position taken in an administrative proceeding to which subsection (a) applies." Id.

We interpreted the 1988 version of the statute in Huffman v. Commissioner of Internal Revenue , 978 F.2d 1139 (9th Cir.1992). We acknowledged that "diver╜gent judicial opinions exist to whether the phrase ▒position of the United States' re╜fer[s] to the government's position both in prelitigation administrative proceedings and after commencement of litigation." Id . at 1144. We held that because the provision defining "position of the United States" refers to an "administrative pro╜ceeding" as distinct from a "judicial pro╜ceeding," "it follows that the prevailing party in both administrative proceedings and judicial proceedings who seeks admin╜istrative and litigation costs must separate╜ly establish that the United States' posi╜tion in each of the proceedings was not substantially justified." Id. at 1146. We continued, "[t]hus the position taken in the administrative proceeding does not auto╜matically apply to the judicial proceed╜ing . . . . According to the plain language of ╖ 7430 and under normal rules of statuto╜ry construction, a bifurcated analysis of ▒substantially justified' should be made in each proceeding." Id .

Huffman drew additional support from the statute's definition of "position of the United States." Under the 1988 version of the statute, "position of the United States" meant "the position taken by the United States in a judicial proceeding to which subsection (a) applies, and the position tak╜en in an administrative proceeding to which subsection (a) applies." Pub.L. No. 100-647 at ╖ 6239(a). Huffman held that this meant the United States could have different positions in administrative and judicial proceedings. See Huffman , 978 F.2d at 1146; Pub.L. No. 100-647 ╖ 6239(a), 102 Stat. 3342 (1988) (enacting the provision containing this definition).

The 1996 amendments were significant in shifting the burden of proving substan╜tial justification from the taxpayer to the government. See Pub.L. No. 104-168 ╖ 701, 110 Stat. 1452 (1996). ³ The current statute now states that "a party shall not be treated as the prevailing party in a proceeding to which subsection (a) applies if the United States establishes that the position of the United States in the pro╜ceeding was substantially justified." See id.; see also 26 U.S.C. ╖ 7430(c)(4)(B)(i) (2006). However, the 1996 amendments did not change the dividing line between administrative and judicial proceedings: the statute retains the language defining the position of the United States as "(A) the position taken by the United States in a judicial proceeding to which subsection (a) applies, and (B) the position taken in an administrative proceeding to which subsec╜tion (a) applies . . . ." See 26 U.S.C. ╖ 7430(c)(7).

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^3. ═ Although the statute has been amended at other times in other respects, none of those changes is relevant to our discussion here.

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Because the statutory language continues to treat administrative proceedings separately from judicial proceedings, Huffman's bifurcated inquiry applies with equal force to the present statute. Cf. Kenney v. United States , 458 F.3d 1025, 1032-33 (9th Cir.2006) (applying Huffman's bifurcated inquiry in a case under the new version of the statute). We disagree with the taxpayers' argument that the 1996 amendments somehow render Huffman's reasoning inapplicable.

Finally, we note that in another adminis╜trative law context, the Equal Access to Justice Act ("EAJA") provides for attor╜neys' fees awards when a government agency takes a position either before or during litigation that is not substantially justified. 28 U.S.C. ╖ 2412. See, e.g., Thangaraja v. Gonzales , 428 F.3d 870, 873-74 (9th Cir.2005) (examining the Im╜migration and Naturalization's position in agency proceedings as well as the immi╜gration judge's and Board of Immigration Appeals' decisions in determining that at╜torneys' fees were warranted under the EAJA); Lewis v. Barnhart , 281 F.3d 1081, 1083-84 (9th Cir.2002) (considering the finding of an administrative law judge be╜fore civil litigation commenced in deter╜mining whether the United States was substantially justified).

The EAJA, first enacted in 1948, pro╜vides that "[u]nless expressly prohibited by statute, a court may award reasonable fees and expenses of attorneys . . . to the prevailing party in any civil action brought by or against the United States or any agency or any official of the United States acting in his or her official capacity in any court having jurisdiction of such action." 28 U.S.C. ╖ 2412(b). To recover, a party must demonstrate that the position of the United States is not substantially justified. Id. ╖ 2 412(d)(1)(A); ╖ 2412(d)(1)(B).

In 1985, Congress added language to the EAJA clarifying that "position of the Unit╜ed States" means "in addition to the posi╜tion taken by the United States in the civil action, the action or failure to act by the agency upon which the civil action is based." Pub.L. No. 99-80 ╖ 2, 99 Stat. 183 (1985); see also id . ╖ 24 12(d)(2)(D). The EAJA also specifically excludes from its coverage any action that might be brought under 26 U.S.C. ╖ 7430. 28 U.S.C. ╖ 2412(e). Thus it is evident from the statutory language that Congress intended the fee-shifting inquiry under the tax stat╜ute to be different from the fee-shifting inquiry under the EAJA. The tax statute includes no gap filler for including prelitigation agency action as part of the govern╜ment's position in litigation.

2. APPLICATION TO DISTRICT COURT "JUDICIAL PROCEEDING"

With these principles in mind, we hold that the government's position in the "judi╜cial proceeding" was substantially justified. Huffman instructs us to look at a party's conduct at "each stage of the case" in determining whether an award of attor╜neys' fees is appropriate. 978 F.2d at 1148. Here, the taxpayers filed the peti╜tions to quash in district court and then, one month later, the taxpayers sent a let╜ter to the IRS asking for more information and informing the IRS that they believed the summonses were invalid. Two days later, the IRS withdrew the summonses and requested that the taxpayers volun╜tarily dismiss the petitions to quash. Af╜ter the taxpayers refused to dismiss the case, they launched a mini-litigation sur╜rounding their requested fees and condi╜tions. The only position taken by the gov╜ernment was withdrawal of the summonses before its answer was due. ⁴ The government's withdrawal of the summonses, which both parties agree were unenforcea╜ble, was surely reasonable. The govern╜ment also acted reasonably when it asked the taxpayers to voluntarily dismiss the petitions to quash, given that those peti╜tions were moot after the summonses were withdrawn. Accordingly, the government established that its position in litigation was substantially justified and the taxpay╜ers are not entitled to attorneys' fees.

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^4. ═ The government asks us to adopt a categori╜cal rule that in considering attorneys' fees under 26 U.S.C. ╖ 7430, the government does not take a position until it files its answer. We decline to adopt that bright-line rule, even though we hold that the government's con╜duct in this case was reasonable. Such a rule would make no sense as it would potentially exclude conduct or positions taken in a judicial proceeding before the answer was filed. See Huffman , 978 F.2d at 1148 (stating that "[g]enerally, the position of the United States is established initially by the Government's answer to the petition" but stopping short of articulating a bright-line rule to that effect); see also Wade v. United States , 865 F.Supp. 216, 219-20 (D.N.J.1994) (holding that a court may consider the government's pre-an╜swer conduct, such as motions to dismiss, in deciding whether to award attorneys' fees un╜der the statute).

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The taxpayers also argue that the district court should have permitted them discovery to shore up their claim that the IRS was unreasonable, to support their claim for conditions, and to provide a basis for the district court to impose sanctions. This endeavor is premised on the taxpay╜ers' view that the IRS has engaged in improper conduct in this and at least two other Russian tax treaty cases. As the district court pointed out, it was unaware of any case under Rule 41(a)(2) "in which plaintiffs were able to condition their own voluntary dismissal upon payment or per╜formance by defendants." The district court did not abuse its discretion in deny╜ing the taxpayers' requests, since the pur╜pose of discovery is to aid a party in the preparation of its case, not to punish its opponents for past sins. See Fed.R.Civ.P. 26(b) advisory committee's note (1946 amendments). To the extent taxpayers seek sanctions, there is no basis for us to award sanctions in this appeal for preliti╜gation conduct nor did the district court err in declining to exercise its supervisory powers vis-a-vis the alleged conduct of the government. Gomez v. Vernon , 255 F.3d 1118, 1134 (9th Cir.2001) (holding that where a party has not acted in bad faith during the litigation, inherent powers sanc╜tions are not appropriate).

Although the IRS's issuance of the ad╜ministrative summonses forced the taxpay╜ers into litigation, we see no fees remedy for them in the judicial proceeding. We conclude that their case falls into a gap in the statute, but it is not our role to bridge that gap.

AFFIRMED.

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