Of lenity, Chevron, and KPMG.

I. INTRODUCTION

Despite a mixed track record in challenging tax shelters in civil enforcement actions, the federal government has started prosecuting tax shelter cases criminally. (1) One of the top accounting firms, KPMG, and several of its partners and managers have come under scrutiny for developing and promoting certain tax shelters known colloquially as BLIPS, FLIP, OPIS, and SOS. (2) Under threat of criminal indictment, KPMG decided to save itself. KPMG admitted criminal culpability, paid a fine, and agreed to implement a compliance and ethics program and submit to several years of government monitoring in exchange for deferred prosecution. (3) Meanwhile, the government's criminal prosecution of several former KPMG tax professionals continues to work its way through the federal district courts. (4) Yet some believe that the tax shelters promoted by KPMG were not clearly abusive, or at least not criminally so. (5) One federal district court has decided that a key statutory element of the BLIPS structure was consistent with then-existing interpretations of the Internal Revenue Code (Code). (6) Many who are more skeptical of the KPMG shelters nevertheless are concerned about distinguishing the actions of the defendant tax professionals from those of ordinary tax planners under the specter of criminal enforcement. (7)

Tax shelters have a bad reputation, for good and obvious reasons. Among other things, abusive tax shelters illegitimately deprive the government of much-needed revenue and generally breed disrespect for the tax system. Note that in that last sentence I added the word "abusive." Not all tax shelters fall into that category, at least in the eyes of the law. (8) While most tax experts agree that abusive tax shelters are a big problem, (9) they disagree over precisely how to distinguish ordinary non-shelter tax planning from tax shelters, and legitimate from abusive tax shelters. (10) The federal tax laws are enormously complex. Reasonable people disagree all the time over their meaning. The Internal Revenue Service's (Service's) win/loss record in recent civil tax shelter cases is not great. (11) Drawing the line between the use of shelters in legitimate tax planning and abusive tax shelters is just plain hard.

A significant contributor to the problem of tax shelters, of course, is a tax code rife with ambiguity. Tax shelters in general are designed to take advantage of a lack of clarity in the law. There is always a possibility in litigating a tax shelter case that a court will find the Code to be clear on the issue in question. In many if not most such cases, however, it seems safe to assume that a reviewing court would find the Code susceptible of more than one reasonable interpretation. (12)

In the civil context, depending upon the format of the Service's interpretation, a finding of statutory ambiguity typically means that the reviewing court should apply one or another doctrine of judicial deference in evaluating the government's interpretation: either the strong, mandatory Chevron deference, (13) the slightly less deferential Skidmore deference standard, (14) or perhaps the tax-specific National Muffler deference. (15) Whichever of these review standards applies, the resulting judicial deference gives the government a distinct advantage over the taxpayer in persuading the courts to adopt the government's interpretations of the Code. (16) Consequently, these deference doctrines are useful tools in the Service's effort to maintain the integrity of the tax laws.

In criminal cases, by contrast, the rule of lenity applies to resolve disputes over interpreting ambiguous statutes. (17) This canon of construction generally requires courts reviewing ambiguous statutes in the context of criminal cases to construe those statutes in the defendant's favor. (18) Yet, the Supreme Court has applied the rule of lenity to resolve not only criminal cases but also civil cases where the statute in question could be used as a basis for criminal prosecution. (19)

Several scholars have recognized tension between doctrines of judicial deference and the rule of lenity. (20) Some of the Supreme Court's opinions hint that lenity may well "trump" deference principles in civil cases involving regulatory statutes, like the Code, that provide for both criminal and civil enforcement mechanisms. Other opinions of the Court hint the opposite. By pursuing tax lawyers and accountants criminally for planning and promoting tax shelters, the executive branch is plunging headlong into this bramble bush and may actually push the courts to decide between lenity and deference. The question that arises, therefore, is whether the courts could really choose the taxpayer-friendly rule of lenity over the pro-government deference doctrines for Code interpretation in civil as well as criminal enforcement actions. Such a choice could substantially undermine the government's efforts to protect the integrity of the Code far beyond the narrow scope of abusive tax shelters.

My purpose here is not to defend KPMG, the tax shelters it promoted, or indeed the merits of any particular transaction. Rather, my intent is to sound a note of caution: criminalizing tax shelter activities may have unforeseen consequences for more mundane tax enforcement efforts. To elaborate my concern, this essay proceeds in three parts. Part II presents the tension between the rule of lenity and deference to agency interpretations of statutes in greater depth, surveying the relevant judicial doctrines and their intersection and implications. Space limitations preclude a thorough exploration of how the Supreme Court should address the concerns raised herein. Nevertheless, Part III considers briefly various ways the Court might resolve a direct clash between lenity and deference. Finally, Part IV raises the possibility that the greater exercise of prosecutorial discretion might either avoid forcing the Court's hand or potentially influence the Court toward an outcome favorable to the government and the integrity of the Code.

II. THE PROBLEM

The Code includes many delegations of authority to the Treasury Department more or less to make regulatory law out of whole cloth. Section 1502 represents a classic example, giving the Secretary of the Treasury the authority to develop whatever regulations he deems necessary to reflect clearly the income tax liability of a group of affiliated corporations filing a single return, whether or not such regulations differ from those that apply to corporations filing separately. (21) There can be no clash between the rule of lenity and judicial deference doctrines under such circumstances. Rather, the courts must defer to Treasury's regulations, because Congress has given Treasury and the courts nothing to interpret, and the only law to apply is that promulgated by Treasury.

On the other hand, occasionally Congress enacts a criminal statute with "terms so vague that men of common intelligence must necessarily guess at its meaning and differ as to its application." (22) The Supreme Court holds such statutes unconstitutional and void for vagueness on due process grounds. (23) Of course, distinguishing between unconstitutional vagueness and ordinary ambiguity is often difficult. (24) Nevertheless, whatever the Code's limitations, unconstitutional vagueness is not likely to be among them.

To be clear, the variety of statutory ambiguity that implicates the tension between lenity and deference should not be mistaken either for radical statutory indeterminacy or the utter lack of statutory clarity that raises vagueness doctrine concerns. Instead, the problem at hand arises when a provision in the Code, or any other regulatory statute with both criminal and civil enforcement mechanisms, is susceptible of two or more identifiable and equally defensible alternative interpretations. The question in such cases is whether the courts will automatically choose the more lenient or taxpayer-friendly of those options or defer to the government's preference for a different choice. This Part II explores this problem.

A. Competing Doctrines: Lenity Versus Deference

To understand the dilemma fully, one first must appreciate the competing legal doctrines governing statutory interpretation and judicial review. In the criminal context, the doctrine at issue is the rule of lenity, one of the classic canons of statutory construction. The civil context is more complicated, particularly in the tax area.

The doctrine or rule of lenity provides generally that criminal statutes should be strictly construed in favor of the defendant. (25) Hence, the courts commonly mention two rationales as supporting lenity as a canon of statutory construction. The first is that people deserve fair warning that particular activities will subject them to criminal penalties. (26) The second is that legislatures, rather than courts, should be responsible for defining precisely which actions are crimes. (27)