Tuesday, September 16, 2014
Ninth Circuit Orders New Hearing in Tax Dispute Involving Electronic Arts Co-Founder Hawkins
By KENNETH OFGANG, Staff Writer
Evidence of video game pioneer William “Trip” Hawkins’ lavish spending is not enough to prove that he willfully avoided paying more than $20 million in state and federal taxes, the Ninth U.S. Circuit Court of Appeals ruled yesterday.
The panel overruled lower court rulings that Hawkins’ tax debts cannot be discharged in his Chapter 11 bankruptcy proceedings, and ordered the bankruptcy court to reconsider its ruling. Judge Sidney Thomas, writing for the Ninth Circuit, said the bankruptcy judge—as well as the district judge who affirmed the bankruptcy judge’s ruling—erred in failing to apply a specific intent standard.
Hawkins co-founded gaming giant Electronic Arts Inc., and was estimated to have a net worth of $100 million 18 years ago. But he incurred massive losses trying to make a go of 3DO, originally an EA subsidiary and the developer of a line of consoles and games in the 1990s
The company failed in the face of popular, much cheaper alternatives to its products. Hawkins also founded Digital Chocolate, a maker of games for handheld devices, which he headed from 2003 to 2012.
As of 1996 Hawkins’ net worth was around $100 million. Thomas said his “saga reads like a Fitzgerald novel, telling the story of acquisition and loss of the American dream, and the consequences that follow.”
Hawkins acquired a $3.5 million home, a private jet and a condominium in high-priced La Jolla, Thomas noted, but 3DO’s financial problems coincided with IRS questioning of a pair of tax shelters that Hawkins entered into on the advice of the accounting firm KPMG.
KPMG dubbed the strategies the “financial leverage investment portfolio,” or FLIP, and the “offshore portfolio investment strategy,” or OPIS.
The strategies were marketed as utilizing “100% leverage offshore” to allow investors “to avoid U.S. regulatory rules that limit the amount of financing permissible in securities transactions.”
The strategy involved the use of shell corporations in the Cayman Islands, which would generate what courts later found to be artificial losses by buying stock in foreign banks with funds borrowed from the same banks, permitting the investors to claim losses on stock they purported to purchase in the banks.
The names of OPIS investors became public in 2002 as a result of an IRS lawsuit against KPMG and others. The investors included members of the Simon family, including onetime U.S. Secretary of the Treasurer William E. Simon Sr. and 2002 California gubernatorial candidate William E. Simon Jr.; race car driver Dale Earnhart Jr., who had been killed the year before his involvement in OPIS became known; New York Jets owner Robert Wood Johnson IV; and John Paul Reddam, founder of the DiTech mortgage companies and owner of 2012 Kentucky Derby and Preakness winner I’ll Have Another.
More than 90 percent of the investors settled with the IRS. An exception was Reddam, who was assessed an $8 million deficiency, fought the government in court, and lost before a different Ninth Circuit panel two months ago.
In 2005, the IRS sought more than $20 million in unpaid taxes, penalties and interest from Hawkins for the years 1997-2000.
Hawkins and his wife filed a personal Chapter 11 bankruptcy petition after the IRS rejected their $8 million settlement offer.
The bankruptcy court eventually confirmed a liquidation plan that discharged most of Hawkins’ debts. But it held that by continuing to spend large amounts of money after 2003—as much as $2.35 million in excess of his earning during the period—he had engaged in a willful attempt to evade taxes, rendering those obligations to both state and federal authorities non-dischargeable.
U.S. District Judge Jeffrey White of the Northern District of California affirmed the bankruptcy court ruling, and Hawkins took the issue to the Ninth Circuit.
Siding with Hawkins, Thomas wrote for a divided panel:
“Given the structure of the statute as a whole, including its object and policy, legislative history, case precedent, and analogous statutes, we conclude that declaring a tax debt nondischargeable under 11 U.S.C. § 523(a)(1)(C) on the basis that the debtor ‘willfully attempted in any manner to evade or defeat such tax’ requires a showing of specific intent to evade the tax. Therefore, a mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took the actions with the specific intent of evading taxes.”
If excessive spending were enough to satisfy the statute, the judge wrote, “there would be few personal bankruptcies in which taxes would be dischargeable,” creating “a large ripple effect throughout the bankruptcy system.”
Senior Judge Andrew Kleinfeld concurred, but Judge Johnnie Rawlinson argued in dissent that the ruling could give the very rich “an unfettered ability to dodge taxes with impunity.”
“There is little doubt, if any, that William Hawkins deliberately decided to spend money extravagantly rather than pay his duly assessed state and federal taxes.”
She pointed out that even after admitting in a 2004 petition to reduce child support payments that he owed $25 million in taxes, Hawkins “maintained a home worth well over $3.5 million, and an ocean-view condominium worth well over $2.6 million,” and bought a $70,000 car despite the fact that he and his wife already owned three vehicles and were the only drivers in the family.
Consistent with the opinions of other circuits, Rawlinson said, the evidence should be viewed as indicating “a willful intent to avoid the payment of taxes by hook or by crook.”
The case is Hawkins v. Franchise Tax Board, 11-16276.
Copyright 2014, Metropolitan News Company