Earlier this year, we wrote about a document that directed staff at the Department of Taxation to use the negligence penalty, a penalty of 25 percent of the tax due, against taxpayers who receive requests for documents from a tax auditor and for whatever reason are not able to comply with the request within the time frame dictated by the auditor.
The document says that negligence can be found when “[a] taxpayer fails to respond to auditor/examiner’s audit requests, in a timely manner. A failure to respond to a second request within ten business day[s] will be deemed negligent. If taxpayer later responds and can show that the non-filed return was not due to negligence or intentional disregard of rules, the penalty may be removed.”
We had a problem with that statement because the negligence penalty statute says that the negligence has to cause the tax underpayment for which the taxpayer is being penalized, but any failure to produce documents happens later. (That, by the way, is different from the department imposing the penalty for having no documentation to back up the numbers on the tax return, meaning that the numbers on the return were made up. That would be a legitimate imposition of the penalty.)
To prove our point, we filed a lawsuit in Circuit Court asking for the court to declare that part of the department’s internal directive void. We relied on two chapters in the law: chapter 632 on declaratory judgments, where we ask the court to review a document or situation and render a judgment on what the legal consequences are, and chapter 91 on administrative procedure, where we ask the court for a judgment on the validity of a “rule,” which can include any policy pronouncement made by an agency.
The department responded by saying that chapter 632 does not allow for declaratory judgments in tax matters. Which is true, to an extent: the law says that a declaratory judgment is not allowed in a “controversy with respect to taxes.”
But the law goes on to say, “Controversies involving the interpretation of deeds, wills, other instruments of writing, statutes, municipal ordinances, and other governmental regulations may be so determined.” That appears to say that declaratory judgments are allowed in the tax arena if they are used to interpret written documents or governmental regulations. The Administrative Directive in question probably qualifies as both.
What about chapter 91? There is no prohibition on tax controversies and there is no exemption for the Department of Taxation. The department argued that it didn’t matter, because where there is a law covering a specific situation (no declaratory judgments in tax controversies) it overrides a law covering more general situations (declaratory judgments allowed over the validity of “rules”).
The Circuit Court, after considering the arguments, ruled that this was a tax controversy and tossed out the case. The judge didn’t think that the foundation’s case was meritless (“He has a point,” the judge said) but ruled that the court didn’t have the power to do anything about it. Final judgment in the case was filed on Dec. 31, 2024.
At least that now gives us at the foundation something to include on our list of New Year’s resolutions.
The foundation filed its notice of appeal on Jan. 1. Happy New Year.
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Tom Yamachika is president of the Tax Foundation of Hawai‘i.
