Tuesday, October 27, 2015

Zorzit v. Comptroller of Md. (Ct. of Special Appeals)

Filed:  October 1, 2015

Opinion byJudge Douglas R. M. Nazarian

Holdings:  (1) Maryland Court of Special Appeals upheld Tax Court’s finding of fraud, holding that appellant taxpayer’s (“Taxpayer”) intent to defraud Maryland Comptroller of Admissions and Amusement tax revenues could be inferred from  circumstantial evidence of understatement of income, failure to maintain records, and concealment of assets.  (2) In the absence of Taxpayer’s relevant records of sales or income, the Comptroller’s tax liability assessment was supported by substantial evidence of reasonableness, making the Tax Court’s affirmance of the assessment not in error.  (3)  No actionable claim of spoliation occurred where duty to preserve and evidentiary advantage were not present.

Facts:  From 1993 until 2009, Taxpayer owned and operated a business providing video poker machines and other coin-operated entertainment to establishments.  Under Md. Code §17-405, 408, and 414 of the Business Regulation Article, it is lawful to operate video poker machines without making cash payouts, provided that the machines are properly licensed and taxes paid on all revenues generated.  However, Taxpayer ran afoul of the Code in several ways.  First, with Taxpayer’s knowledge and approval, proprietors of the establishments made cash payments to video poker winners, deducting the payouts from the profit split between Taxpayer and proprietors.  Second, Taxpayer kept no records of the cash payments, nor any records of individual revenues on a per-machine basis.  Third, Taxpayer calculated its tax liability net of the cash payments.

A wide-scale undercover police investigation conducted from 2006 to 2009 led to the seizure of 83 video poker machines owned by Taxpayer.  Forensic analysis of the motherboards allowed police to determine the in- and out-credits from each machine and compile the data into a report later issued to the Comptroller’s Office.  Although the investigating officers conceded that (1) proprietors likely did not pay out every credit won and (2) in- and out-credits from prior ownership of the machines could not be distinguished, the Comptroller calculated its assessment assuming that every out-credit was paid.  Applying its hypothesis that 55% of in-credits would be paid out, the Comptroller assessed a tax deficiency of $2,159,724.97 for the 2000-2009 period, added interest and imposed a 100% fraud penalty.

Taxpayer appealed the assessment to the Tax Court in 2013, arguing that the payoff percentage was more likely between 20 and 25% due to (1) proprietors often declining to pay out-credits and (2) the unreliability of the in- and out-credits data where significant number of video poker machines had been purchased used.  Accounting for these differences, Taxpayer’s expert testimony provided by a statistician placed the tax deficiency at $466,016.10.  Taxpayer further disputed the fraud penalty on the theory that neither his employed CPAs, his retained attorney, nor his staff were aware the payouts were taxable, thus Taxpayer lacked requisite intent to defraud.  The Tax Court was only partially persuaded, finding the record insufficient to change the Comptroller’s tax liability assessment, but using its discretion to adjust the fraud penalty to 50% by balancing the facts that the accounting was not perfectly accurate but Taxpayer’s fraud warranted a penalty.

Taxpayer filed petition for judicial review in the Circuit Court for Baltimore County which affirmed the Tax Court’s decision on June 5, 2014.  Taxpayer thereafter filed a timely notice of appeal.

Analysis:  Taxpayer presented the court with two questions for review:  first, whether the Tax Court erred in imposing its fraud penalty without a finding of intent to evade payment.  And second, whether the Tax Court erred in affirming an assessment based on admittedly erroneous assumptions and evidence the Comptroller failed to preserve.

The court began by pointing to a case both fully on-point and decided by the same court in 1993: Rossville Vending.  In that case, Rossville’s video poker units had been placed in establishments whose proprietors paid cash payments directly to winners, but Rossville paid no taxes on the cash payments.  Finding no ambiguity in the amusement tax statute’s operative phrase ‘gross receipts,’ the Rossville court found no room for reasonable argument for adjustments or deductions before calculation of the tax due.

Taxpayer pled ignorance: arguing that although he had personal relationships with Rossville Vending’s owners and knowledge of their business, he lacked actual knowledge of the Rossville court’s decision until after the Comptroller’s assessment, and so lacked any intent to withhold taxes.

The court next referenced Genie & Co., which held that direct evidence of fraud is unnecessary, but often inferred by circumstantial evidence.  The Genie court imported the federal “badges of fraud” doctrine to Maryland jurisprudence, highlighting seven factors to guide courts in identifying circumstantial evidence of fraud: 

  1. Consistent and substantial understatements of income (or sales, in the sales tax arena);
  2. Failure to maintain adequate records;
  3. Implausible or inconsistent explanations of behavior, including lack of credible testimony before a tribunal;
  4. Concealment of assets;
  5. Failure to cooperate fully with tax authorities;
  6. Awareness of the obligations to file returns, report income or sales, and pay taxes, and;
  7. Failure to file returns.
Finding substantial evidence of badges one, two, and four in the failure to keep records of gross revenues, concealment to avoid criminal liability, and faulty accounting methods recording net income by location rather than per-machine basis, the court agreed with the Tax Court that the badges of fraud analysis indicated an intent to conceal revenue.  Even were the Taxpayer’s claimed ignorance legitimate, the court further found the failure to research its tax liability to be willful blindness, and tantamount to fraud.  Accordingly, the court affirmed the Tax Court’s penalty.

Turning next to Taxpayer’s arguments against the Comptroller’s method of calculation, the court noted that the Tax General Article TG §13-403 anticipated situations where parties neglected to keep accurate records (emphasis added):
(a)  If a person … fails to keep the records required under §4-202 of this article, the Comptroller may
(1)    Compute the admissions and amusement tax by using a factor….
* * *
(b)  The factor utilized by the Comptroller pursuant to this section shall be developed by:
(1)    a survey of the business… including any available records
(2)    a survey of other persons… engaged in the same or similar business
(3)    other means.
The court continued, pointing out that the plain meaning of the statute indicated the legislature had vested broad discretion in the Comptroller to use reasonable methods for calculating assessments against parties like Taxpayer.   Indeed, the court found the Comptroller’s calculation methods to be supported by substantial evidence of reasonableness in light of the lack of relevant financial records.  Using the only records available – those obtained by the police’s forensic investigation – the Comptroller calculated Taxpayer’s tax liability as best he could.  As a result, the court found Taxpayer’s request to substitute his expert’s “guesstimate” for the Comptroller’s assessment notwithstanding Taxpayer’s failure to retain adequate records unconvincing.  Such a finding would lead Maryland companies to keep no records, file no returns, and refer the Comptroller to unverifiable memories of employees; an untenable result.  Thus the court found that the Tax Court did not err by relying on the Comptroller’s calculation.

Dealing finally with Taxpayer’s spoliation claim (which arose after a police agency destroyed the motherboards of the video poker machines), the court found the Comptroller lacked any duty to preserve the video poker machine motherboards because he neither possessed nor had access to them.  Moreover, no evidentiary advantage existed because both the Comptroller and Taxpayer had copies of the police report.  Accordingly, the court found no misbehavior to sanction.

The full opinion is available in PDF.

Thursday, October 22, 2015

Morgan Stanley & Co. Inc. vs. Andrews (Ct. of Special Appeals)

Filed: October 1st, 2015 

Opinion by: J. Berger.


Funds held in a joint account are presumed to be owned by both account holders, but the presumption can be rebutted by clear and convincing evidence to the contrary.


Creditor obtained a judgment against Son in the amount of $196,477.16 in the Circuit Court of Montgomery County. Creditor then sought to obtain a writ in order to garnish funds in a joint account held by Son and his Father. The Circuit Court issued the writ of garnishment for the joint bank account.

Father filed a motion asserting a claim to the funds in the account and requested a hearing on the matter. Son only accessed this account to handle affairs on behalf of his father. He never deposited funds of his own in the account, nor did he withdraw funds for personal usage. The Circuit Court denied his motion.  Father filed motions to vacate, which were denied. All transactions from this account were explained and accounted for through witness testimony and documentation in the trial court.

Father appealed to The Court of Specials Appeals who remanded the case to the trial court. The trial court found in favor of the Father and this appeal followed.


Creditor argued that the funds held in a joint account were “per se” subject to garnishment. Creditor based this argument on the assertion that both holders can deposit and deplete funds at will.

The Court had not dealt with this matter before and drew from its analysis from a similar situation discussed in Wanex v. Provident State Bank of Preston 53 Md. App. 409, 413 (1983). In that case a daughter was a signatory on her father’s business bank account. A creditor sought a writ of garnishment against the bank account. The father argued that the writ would interfere with the daughter’s interest in the account. The daughter never deposited any of her own funds into the jointly held account. The trial court decided that the daughter did not have an ownership interest in the account and the Court of Special Appeals affirmed.  

The Court noted that: “the garnishing creditor can reach funds of the depositer only in cases where the depositer is the true owner thereof” Wanex, 53 Md. App. 413  

The question becomes whether ownership should simply be based on the fact that an account holder has his or her name affixed to the account. The Court applied two factors from Wanex in order to define “true” ownership: 1) the exercise of control over the funds in the account and 2) contribution, or source of funds in the account. Various others factors can be considered as well for example; what parties paid taxes from the account, whose name appears on checks and who had possession of the documents for the account.

The Court stated that an account holder can rebut the presumption of ownership by proving, by clear and convincing evidence, which portion of the account belongs to each owner. The Court determined that “Maryland courts have long held, in a variety of contexts, that titling of a bank account and the right to withdraw from the account does not indicate ownership.”

The trial court considered the evidence in the form of testimony from the PNC branch manager, the Father, the Son and bank records.  Because Son withdrew funds from the account exclusively for the purpose of overseeing renovations for his father’s beach home, the Court decided that the evidence presented in the trial court provided clear and convincing proof that the Father was the sole owner of the funds held the joint account.

The full opinion is available in PDF.