STATE OF ALASKA

IN THE MATTER OF:  Case No. 12-OTA-97

WOODBINE ALASKA FISH CO.

DECISION

The taxpayer, Woodbine Alaska Fish Company (WAFCO), appeals from two informal conference decisions of the Department of Revenue (DOR) which upheld penalties and interest assessed in connection with WAFCO’s late payment of the Alaska Corporation Net Income Tax (AS.43.20), Fisheries Business Tax (AS.43.75), and Seafood Marketing Assessment (AS 16.51.120) for 1990. WAFCO is an Alaska corporation. In the relevant time period, 1990 through 1991, WAFCO operated a shore-based processing facility in Egegik, Alaska and a floating processor, the M/V Woodbine.

The issues on appeal are (1) Whether WAFCO’s failure to pay the various taxes on time was due to reasonable cause and not to willful neglect; and (2) Whether a late filing penalty is appropriate when a taxpayer files a photocopy, instead of an original, of a return by the return due date.

This appeal was transferred to the Office of Tax Appeals from DOR by agreement of the parties on April 3, 1997. ¹ Prior to transfer this appeal had been submitted to a DOR hearing examiner for decision based on the written record. After the appeal was transferred, the Administrative Law Judge (ALJ) scheduled a telephonic conference for the purpose of clarifying some aspects of the record. That conference was held on May 15, 1997. The appeal was submitted for decision by the ALJ at that time.

FACTS

The findings of fact set forth below are based on a preponderance of the evidence in the written record. The evidentiary record consists of DOR exhibits A through R; taxpayer’s unmarked exhibits which were submitted as supplemental evidence by letter dated November 1, 1994 to Donna Page, Senior Revenue Hearing Examiner; and a letter from the DOR Appeals Officer dated November 25, 1994 stating that DOR had verified certain facts. The parties provided verbal explanation and clarification of certain documents during the recorded conference held on May 15, 1997.

The Corporate Income Tax Penalty

1. WAFCO’s Alaska Corporation Net Income Tax ( "income tax") return and payment of income taxes for the year ending December 31, 1990, were due on March 15, 1991. WAFCO received an extension until October 16, 1991, for filing its income tax return. This filing extension, however, did not extend the time for payment of taxes.

2. WAFCO mailed its income tax return and tax payment to DOR by the extended filing deadline. DOR received the return and the tax payment on October 21, 1991.

3. On July 10, 1992, DOR assessed a 25% failure to timely pay penalty ($2,802) and interest ($876.80) for late payment of income taxes. WAFCO appealed this assessment on August 10, 1992. At the same time WAFCO paid the assessed penalty and interest in full.

4. On March 31, 1994, DOR issued an Informal Conference Decision affirming the assessment. On April 24, 1994 , WAFCO requested a formal hearing and refund of the penalty and interest.

The Fisheries Business Tax and Seafood Marketing Tax Penalties

5. WAFCO requested and received two extensions to file its 1990 Alaska Fisheries Business Return . The final extended filing date was June 15, 1991. The filing extension did not relieve WAFCO of the responsibility to make an estimated payment of at least 90 percent of its tax liability before April 1, 1991.

6. On April 1, 1991, WAFCO wire transferred $10,000 in payment of the fisheries business tax.

7. On May 1, 1991, DOR received a 1990 Seafood Marketing Assessment Return from WAFCO. Included with the return was a payment in the amount of $18,758.68, representing $17,697.14 in tax, $884.57 in late payment penalty, and $176.97 in interest.

8. On or before June 15, 1991, WAFCO filed by mail a photocopy of its fisheries business return for 1990. No payment was included.

9. On July 19, 1991, DOR received an original fisheries business return from WAFCO for 1990. Included with the return was a payment in the amount of $226,453.65 representing $205,683.69 in tax, $17,345.80 in self-assessed late payment penalty and $3,469.16 in interest.

10. On March 19, 1992, DOR assessed WAFCO additional tax ($893.83) attributable to undervaluation of part of its herring catch; an additional penalty for late payment ($23,960.70); and additional interest ($4,718.30) for 1990 fisheries business and seafood marketing taxes. The additional penalty and interest represented a recalculation of the late payment penalty and interest due and credited WAFCO with the amount already paid in self-assessed penalty and interest.

11. WAFCO requested an informal conference to appeal the March 19, 1992 assessment. The informal conference decision, dated March 31, 1994, affirmed the additional tax assessed for undervaluation of herring, concluded that reasonable cause did not exist to abate the late payment penalty and concluded that a late filing penalty should be assessed for the period before the original fisheries business return was filed. The adjusted penalty and interest amounts under the informal conference decision were $20,692.64 in failure to timely file penalty, $31,730.66 in failure to timely pay penalty and $9,271.67 in interest.

12. WAFCO filed a timely request for a formal hearing to appeal the penalty and interest issues in the informal conference decision. WAFCO agreed to pay the additional tax relating to the valuation of herring.

The Circumstances Surrounding WAFCO’s Late Payment of Taxes for 1990

13. At the start of the first quarter of 1991 the taxpayer had cash assets totaling $168,623. Almost all of this amount, $160,000, was held in an escrow account as collateral for a vessel mortgage held by the National Marine Fisheries Service (NMFS). In February 1991 the taxpayer had to petition NMFS to release funds from the escrow account to enable the taxpayer to pay certain trade debts in order to continue operations. In mid March 1991, $159,011 was disbursed from the escrow account to pay trade debts, leaving an account balance of less than $1,000.

14. At the end of March 1991 WAFCO’s accounts payable totaled $440,401.40, excluding the fisheries business tax liabilities. Total income from sales in the first quarter of 1991 was $302,866. Payroll expenses alone during the first quarter were $136,677. By the end of the first quarter 1991 debts far exceeded liquid assets.

15. The taxpayer’s cash flow problems during the first quarter of 1991 were caused by a combination of circumstances common to the industry . First, financing for the taxpayer’s purchase of a processing plant in late 1989 was delayed until July 1990 and then the loan obtained was far below the actual purchase and renovation costs. Second, the majority of vendors who provided the processing vessel and plant with operating supplies at the start of the fishing season required payment in advance due to the generally weak financial conditions in the industry.

16. On April 6, 1991, during the Spring cod fishery, a fire caused extensive damage to WAFCO’s processing vessel, the M/V WOODBINE. The vessel was unable to continue processing operations for a significant portion of the cod season. The cost of repairing the vessel, approximately $150,000, was under the insurance deductible and had to be paid by WAFCO. During the second quarter when the vessel was disabled for a substantial period of time WAFCO had to pay payroll expenses of $358,146 in addition to the repair expenses.

17. In the summer of 1991 the Governor of Alaska temporarily closed the Bristol Bay Salmon fishery in support of striking fishermen. This resulted in further operating losses for WAFCO.

18. By December 31, 1991 WAFCO had incurred a net operating loss for the year of over 1.6 million dollars. In 1993 WAFCO applied for a refund of 1990 income taxes based on a carryback of net operating losses incurred in 1991. DOR approved the refund.

DISCUSSION

Reasonable Cause for Late Payment

AS 43.05.220(a) imposes a penalty of five percent of the unpaid balance of a tax for each 30-day period or fraction thereof during which a taxpayer fails to file a return or pay taxes due under Title 43 "unless it is shown that the failure is due to a reasonable cause and not to willful neglect." The taxpayer claims that the late payment of its corporate income taxes, fisheries business taxes and seafood marketing taxes for 1990 was due to reasonable cause.

The first issue for decision is whether the taxpayer’s financial problems , described in the findings of fact, constitute "reasonable cause" to excuse the late payment of taxes. This is a mixed question of fact and law to be resolved by exercise of the independent judgment of the administrative law judge (ALJ) under AS 43.05.435.

15 AAC 05.200 describes certain circumstances which may constitute reasonable cause under AS 43.05.220. These include, but are not limited to: (1) disasters which render it impossible to make a timely payment or which make delay unavoidable; (2) acts or omissions of a third party which were beyond the control of the taxpayer and which made delay unavoidable; and (3) the taxpayer acted in good faith and took all steps and precautions reasonably necessary to ensure timely payment.

The Alaska regulations also provide that DOR will apply the administrative and judicial interpretations of Internal Revenue Code 6651 and Treasury Regulations 301.6651-1(c) in determining whether a delinquency is due to reasonable cause. 15 AAC 05.200(b). The cited Treasury Regulation provides, in pertinent part:

... . A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship ...if he paid on the due date. (Emphasis supplied.) ²

26 CFR Ch. 1 (4-l-96 Edition) 301.6651-1 (c)

"Undue hardship" means more than a mere inability to pay taxes on time. To avoid a penalty for late payment based on undue hardship, a taxpayer must demonstrate that he would sustain a substantial financial loss if he paid the taxes on the due date. 26 CFR 1.6161-1(b); Glenwal-Schmidt v. United States, 78-2 USTC 9610 ( D. DC 1978).

In the Informal Conference Decisions from which WAFCO appeals, DOR concluded that reasonable cause did not exist to excuse the late tax payments because the taxpayer’s financial statements indicated that at the end of 1990 the taxpayer had sufficient liquid assets to make timely payment of income and fish taxes due in the Spring of 1991 if the taxpayer had exercised ordinary business care and prudence. ³ I disagree and conclude that reasonable cause does exist to excuse the late payment of taxes in this case.

The first quarter of 1991 is the critical time period for determining whether reasonable cause existed to excuse WAFCO’s late payment of taxes. Reasonable cause for failure to pay a tax must exist on the date that a tax is due, not only after the tax due date, in order to avoid assessment of a penalty according to the IRS interpretation of 26 USC 6651 (a) (2). Industrial Indemnity v. Snyder, 84 -1 USTC 9507 (E.D. Wash. 1984 ). Here, the taxpayer’s corporate income taxes of approximately $11,206 were due on March 15, 1991. The fisheries business taxes and seafood marketing taxes, totaling approximately $234,387, were due on March 31, 1991.

Events during the remainder of 1991 must also be considered in determining whether there was reasonable cause for the delay in payment because WAFCO did not pay the taxes until July (fish taxes) and October (income taxes). The events constituting reasonable cause must continue throughout the delinquency period. Stevens Bros. Foundation Inc. v. Commissioner, 39 T.C. 93 (1962), aff’d in part, 324 F. 2d 633 (8th Cir. 1963).

The evidence submitted on appeal demonstrates that the taxpayer started 1991 with insufficient liquid assets to pay its total tax liabilities and that by March, 1991 when various taxes were due, the taxpayer’s debts far exceeded liquid assets. In order to pay trade debts necessary to continue operations the taxpayer had to petition the NMFS during the first quarter of 1991 to release the funds held in escrow as security for a vessel mortgage. Clearly the taxpayer was unable to make timely payment of the total state taxes of approximately $244,500 that were due between March 15 and March 31, 1991.

The taxpayer explained that the cash flow problems that rendered it unable to pay its taxes in March were caused by a combination of factors including the delay and difficulty in financing purchase of a plant for expanded operations and the demand of most suppliers for payment in advance of the spring fishing season. DOR did not dispute this explanation of the causes for the taxpayer’s financial problems during early 1991. There is no evidence that mismanagement was involved. The taxpayer’s financial problems in the first quarter of 1991 were due to circumstances common to the industry over which the taxpayer had little control.

In the second quarter of 1991 additional circumstances beyond the control of the taxpayer caused a continuation of the cash flow problems that prevented the taxpayer from paying its taxes in full. Those events were the damaging fire aboard the processing vessel in early April and the temporary closure of the Bristol Bay Salmon fishery in early summer.

It is significant that this taxpayer apparently made a good faith effort to make tax payments as soon as it was able to do so. The taxpayer wire transferred $1,000 on April 1 as partial payment of the fisheries business tax ; paid $17,697 in Seafood Marketing taxes on May 1; and paid $205,683, the balance of the fisheries business taxes, plus a substantial self-assessed penalty, on July 19 after income from sales had increased substantially.

For the foregoing reasons, I conclude that reasonable cause exists to excuse the late payment of the various taxes in this case because the taxpayer was unable to pay the taxes when due despite having exercised ordinary business care and prudence in providing for payment of its tax liabilities. In this case the record demonstrates that the taxpayer could not have paid state taxes when due without incurring a severe hardship, the termination of its fishing and processing operations and sale of non-liquid assets. See, Glenwal-Schmidt v. United States, 78-2 USTC 9610 ( D. DC 1978) ⁴

The Late Filing Penalty

The second issue concerns the validity of the late filing penalty that was assessed because the taxpayer filed a photocopy, instead of an original, fisheries business return by the due date. This is a question of law to be decided in the independent judgment of the ALJ.

The taxpayer contends that it cannot find any provision in the applicable statutes or regulations which requires filing an original instead of a photocopy of a return. I cannot find any such requirement either.

However, even assuming that an original return is required, timely filing of a photocopy of a complete return⁵ constitutes an immaterial variance that does not justify imposition of a failure to file penalty. Review of recent cases addressing the issue of what constitutes a tax return demonstrates that the courts have upheld failure to file penalties in circumstances indicating willful failure to comply; i.e. the taxpayer filed a form that that was substantially incomplete and insufficient to calculate tax liability or the taxpayer intentionally obliterated the phrase "under penalties of perjury". See, e.g. United States v. Hoopes, 545 F.2d 721 (10th Cir. 1976); Vaira v. Commissioner, 444 F.2d 770 (3rd Cir. 1971). Here, by contrast, the taxpayer apparently filed a photocopy of a complete return in good faith. There are no grounds to sustain the failure to file penalty under these circumstances.

Conclusion

I conclude that reasonable cause exists under AS 43.05.220 (a) to excuse WAFCO’s late payment of state taxes due in March 1991. Therefore, DOR must abate in full the penalties for failure to pay . WAFCO is entitled to a refund, with interest, of the late payment penalties that it has paid, including the penalties paid in connection with its appeal of the corporate income tax assessment and the penalties that it self-assessed and paid with its fisheries business taxes and seafood marketing assessment. ⁶ DOR must also fully abate the failure to file penalty for the reasons discussed above.

This is the decision of the administrative law judge under AS 43.05.465(a). This decision will become a final decision under AS 43.05.465(f), and the record will become a public record under AS 43.05.470, 60 days from the date of service of this decision unless reconsideration is ordered pursant to a motion for reconsideration filed within 30 days. A request for a protective order to maintain the confidentiality of taxpayer information in the decision or in the record must be filed within 30 days.

Dated: October 16, 1997

Shelley Higgins, Administrative Law Judge

Footnotes

¹ A transitional provision in the legislation that established the Office of Tax Appeals authorized transfer to the Office of Tax Appeals of an appeal pending at the formal hearing level in the Department of Revenue on the effective date of the legislation provided that the parties to the appeal agree in writing to the transfer. Section 18 (a), ch. 108, SLA 1996. (return to text)

² In a case challenging a penalty for late filing, the United States Supreme Court held that the correlation of "reasonable cause" with "ordinary business care and prudence" under the regulations is consistent with Congressional intent. United States v. Boyle, 469 U.S. 241, 246 (1985) ("Congress obviously intended to make absence of fault a prerequisite to avoidance of the late-filing penalty... A taxpayer seeking a refund [of penalties] must therefore prove that his failure to file on time was the result neither of carelessness, reckless indifference, or intentional failure." 469 U.S. at 246 ( n.4 ) (return to text)

³ However, at the time that the informal conference decisions were issued DOR did not have all of the relevant documentation relating to the taxpayer’s financial condition and did not have any evidence relating to the losses caused by the fire on the processing vessel in early April 1991. The taxpayer submitted additional evidence in support of its appeal from the informal conference decisions. If the taxpayer had submitted all of the documentation relating to its financial condition and the vessel fire during the informal conference this appeal might have been unnecessary. It is reasonable to assume that DOR might have reached a different conclusion regarding reasonable cause if DOR had been able to consider all of the evidence now before the administrative law judge. (return to text)

⁴ In that case a federal district court found "undue hardship" excusing late payment of employment withholding taxes where the taxpayer, who had a construction contract with the Navy, was prevented from paying taxes on time because of cash flow problems caused by the Navy withholding substantial contract payments and delaying adjudication of the contract disputes. The court ordered a complete refund of the late payment penalties that had been assessed and paid by the taxpayer after the release of disputed contract payments. (return to text)

⁵ The record does not contain a copy of the return filed by the taxpayer on or before June 15, 1991. I am assuming, based on discussion of this issue with the parties during the May 15, 1997, conference that the document filed by the due date was a photocopy of a complete return. In this regard, it is significant that the original assessment issued on March 19, 1992, for the fisheries business tax included a late payment penalty but did not include a late filing penalty. (return to text)

⁶ The taxpayer’s request for appeal of the income tax assessment expressly requested a refund of the penalties paid. While the request for appeal relating to the fisheries business tax and seafood marketing assessment does not expressly request a refund of penalties already paid, it appeals the findings in the informal conference decision and is reasonably construed as including applying to those penalties already paid. Furthermore, the November 1, 1994, letter of Virginia Ferrari to Hearing Examiner Page does specifically request "reduction" of the penalties paid in connection for the fish taxes. (return to text)