Third Circuit Court of Appeals Issues Landmark Decision in Virgin Islands Economic Development Program Case

Apr 17, 2013   

Disclosure: Joseph A. DiRuzzo, III of Fuerst Ittleman David & Joseph was part of the trial team that representedthe taxpayers in the June 2010 bench trial in the District Court of the Virgin Islands.

On April 17, 2013, the United States Court of Appeals for the Third Circuit overturned, in part, the ruling of the District Court of the Virgin Islands that the taxpayers were not bona fide U.S. Virgin Islands residents under I.R.C. section 932. The case is V.I. Derviates ex. rel. Vento v. Director of Virgin Islands Bureau of Internal Revenue, et al., case nos. 11-2318, 11-2319, 11-2320, 11-2321, 11-2322,11-2603, 11-2618, 11-2619, 11-2620, 11-2621, 11-2622, 11-2623,11-2624, 11-2625, 12-1416 and 12-1417. The Third Circuit’s precedential decision is available here.

The Vento case is a major win for taxpayers fighting the IRS over Virgin Islands residency and has major implications for those taxpayers who took tax credits for participating in the Virgin Islands Economic Development Program (EDP).

The facts of the case are as follows:

Richard and Lana Vento are married and filed a joint 2001 tax return with the VIBIR. In May 2001, the Ventos (through a limited liability company they controlled) contracted to buy Estate Frydendahl, a residential property on St. Thomas, for $7.2 million. Estate Frydendahl””which included a five-bedroom main house and several outlying buildings, including three two-bedroom cottages with kitchens””was sold furnished, and the transaction closed on August 1, 2001. At the time of purchase, the sellers were living in some of the outlying buildings, but the main house was vacant.

The Ventos hoped that renovations to Estate Frydendahl could be completed in time for them to move in by Christmas 2001. Progress was slow, however, and the Ventos grew frustrated. Consequently, in the late fall of 2001, Lana Vento brought in Dave Thomas, a construction manager whom she had previously hired to work in Hawaii, to supervise the project. In December 2001, Thomas travelled to the Virgin Islands and concluded that the main house at Estate Frydendahl was 50 percent livable, but the normal amenities, including water and electricity, did not work properly or consistently.

The Vento family (including Richard and Lana, as well as their daughters Nicole Mollison, Gail Vento, and Renee Vento) was on St. Thomas for the holiday season in December 2001. Nicole Mollison returned to Nevada with her husband and children on December 26, 2001, while the other Vento family members and guests stayed on St. Thomas through New Year’s Eve. Afterwards, the Ventos began to split their time between the Virgin Islands and the mainland. Lana visited the Virgin Islands most frequently because she was overseeing the construction efforts at Estate Frydendahl. She would spend between one and six weeks at a time there, then leave for another six weeks. During the first five months of 2002, Richard spent 35 days in St. Thomas, 23 days in San Francisco, and 41 days in Nevada. Richard also spent considerable time in Hawaii in 2002.

In addition to purchasing Estate Frydendahl, Richard became interested in participating in the Virgin Islands’ Economic Development Program (EDP), which offers very favorable tax treatment to certain approved Virgin Islands companies. Based on legal advice Richard received regarding the EDP between May 2001 and August 2001, he founded three companies in the Virgin Islands: (1) Virgin Islands Microsystems, which was to perform nanotechnology research; (2) Edge Access, which was to build internet access devices; and (3) VI Derivatives, LLC, which the VIBIR and IRS later deemed a sham partnership. Ultimately, only Virgin Islands Microsystems was approved to receive EDP benefits, and that approval did not occur until 2002.

In 2005, the Virgin Islands Bureau of Internal Revenue (VIBIR) issued Notices of Deficiency and Final Partnership Administrative Adjustments (FPAAs) to Richard Vento, Lana Vento, Nicole Mollison, Gail Vento, and Renee Vento and partnerships they controlled, assessing a deficiency and penalties of over $31 million against the Ventos and approximately $6.3 million against each of their three daughters (Nicole, Gail, and Renee). The VIBIR also concluded that two Vento-owned partnerships, VI Derivatives, LLC and VIFX, LLC were shams and disregarded them for tax purposes.

That same year, the IRS issued FPAAs that were nearly identical to those issued by the VIBIR. Significantly, however, the IRS also issued FPAAs to two other Vento-controlled partnerships. The Taxpayers challenged the VIBIR’s and IRS’s Notices of Deficiency and FPAAs in several separate proceedings in the District Court of the Virgin Islands.

The United States, on behalf of the IRS, intervened in the cases between the Taxpayers and the VIBIR, arguing that the Taxpayers should have filed and paid their 2001 taxes to the IRS instead of the VIBIR because they were not bona fide residents of the Virgin Islands.

In June 2010, the District Court in the Virgin Islands conducted a bench trial. The sole issue at trial was whether the Taxpayers were bona fide residents of the Virgin Islands as of December 31, 2001. The District Court held that they were not, and the Taxpayers, joined by the VIBIR, appealed.

The Virgin Islands taxation statutory scheme is known as the “Mirror Code,” under which the Internal Revenue Code is applied to the Virgin Islands merely by substituting “Virgin Islands” for “United Sates” throughout the Internal Revenue Code. However, Virgin Islands residents are subject to different tax filing requirements than other United States citizens. Under the version of 26 U.S.C. § 932(c) applicable in these appeals, taxpayers who are “bona fide resident[s] of the Virgin Islands at the close of the taxable year are required to” file an income tax return for the taxable year with the Virgin Islands. 26 U.S.C. § 932(c) (1986).

Thus, bona fide Virgin Islands residents who fully report their income and satisfy their obligations to the VIBIR do not pay taxes to the IRS. See Abramson Enters., Inc. v. Gov’t of Virgin Islands, 994 F.2d 140, 144 (3d Cir. 1993), available here. This is true even if the bona fide Virgin Islands resident is also a resident of the mainland United States. Slip op. at 19 (emphasis added).

As outlined by the Third Circuit, the meaning of “residency” may vary according to context. Martinez v. Bynum, 461 U.S. 321, 330 (1983). In the tax context, residency requires far less than domicile. Sochurek v. Comm’r, 300 F.2d 34, 38 (7th Cir. 1962); see also Croyle v. Comm’r, 41 T.C.M. (CCH) 339 (1980) (“[T]he citizen need not be domiciled in a foreign country”¦in order to be classed as a resident for Federal income tax purposes.”) Furthermore, while a person can have only one domicile, he can be a resident of multiple places at the same time.

As the Third Circuit explained, the intent to become a resident is not necessarily the intent to make a fixed and permanent home. Rather, it is the intent to remain indefinitely or at least for a substantial period in the new location. According to the Third Circuit, both Richard and Lana Vento intended to become Virgin Islands residents as of December 31, 2001. That intent was evidenced by their purchase of Estate Frydendahl and their ongoing business interests in the Virgin Islands. “And while the Ventos undoubtedly were motivated to live in the Virgin Islands because of its relatively favorable tax system, there is nothing unlawful or deceitful about choosing to reside in a state or territory because of its low taxes. Therefore, the District Court erred when it held that those motivations counseled against the Ventos bona fide residency claims.” Slip op. at 31-32 (emphasis added).

The Ventos’ purchase and renovation of Estate Frydendahl showed that, by the end of 2001, they planned to remain in St. Thomas at least for a substantial period. Months before the end of 2001, the Ventos purchased Estate Frydendahl for $6.75 million, and began a renovation process that would eventually cost them another $20 million. This substantial outlay, approximately three times the size of the tax controversy in this case, was deemed by the Third Circuit to be strong evidence that the Ventos were not purchasing a sham property to avoid paying taxes, but rather that they had a bona fide intent to remain indefinitely or at least for a substantial period in the Virgin Islands. Richard Vento’s establishment of business interests in the Virgin Islands further supported his claim of bona fide residency.

Under Sochurek, a taxpayer’s unlawful tax evasion motives can clearly be considered evidence against bona fide residency. However, in this case, the Third Circuit held that the Ventos’ desire to take lawful advantage of more favorable tax treatment in the Virgin Islands did not undermine their claim of bona fide residency. Significantly for all pending Virgin Islands tax cases, the Third Circuit held as follows:

[A] taxpayer’s sincere desire to change his residency in order to take advantage of lawful tax incentives does not undermine his claim of bona fide residency. If anything, such a motivation would support the taxpayer’s intent to establish bona fide residency, which is a prerequisite for taking advantage of the lawful tax incentives.

Slip op. at 33-34; (emphasis added).

In refuting the IRS’ claim of improper motive in establishing a residency in the Virgin Islands, the Court acknowledged the well-settled proposition that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” citing Gregory v. Helvering, 293 U.S. 465, 469 (1935). Furthermore, the Court reiterated that “a taxpayer’s legitimate tax avoidance motives should not be held against him.” Slip op. at 37 citing Lerman v. Comm’r, 939 F.2d 44, 45 (3d Cir. 1991).

The Third Circuit faulted the District Court’s decision that the Ventos only moved to the Virgin Islands so they would be able to file tax returns with the VIBIR and not the IRS. The District Court’s decision was erroneous because that is precisely what Congress intended. The purpose of 26 U.S.C. § 932(c) is to “assist the [Virgin] Islands in becoming self-supporting” by “providing for local imposition upon the inhabitants of the Virgin Islands of a territorial income tax, payable directly into the Virgin Islands treasury. If a taxpayer decides to move to the Virgin Islands because he would prefer to file his taxes with the VIBIR rather than the IRS, that taxpayer is helping the Virgin Islands become self-supporting, so his move does not upon its face lie[] outside the plain intent of [§ 932(c)].”  Slip op. at 37. The Third Circuit concluded: “Using [the Ventos] desire to subject themselves to the mirror code as evidence that they did not intend to comply with it would be both incongruous and contrary to the Congressional scheme.”  Slip op. at 38.

Turning to physical presence, the Court viewed IRC § 932 as merely requiring that a taxpayer be a bona fide resident of the Virgin Islands at the close of the taxable year. Id. § 932(c)(1)(A) (1986). As stated by the Court:

Under the terms of § 932, a taxpayer can take advantage of its provisions even if he became a bona fide resident of the Virgin Islands only on the last day of the taxable year.

Slip op. at 40. Therefore, the Ventos’ presence or lack thereof in the Virgin Islands in the first part of 2001 sheds little light on their eligibility for § 932(c), which requires only that they be bona fide residents of the Virgin Islands at the end of 2001. Slip op. at 40.

In addition to being a huge win for the taxpayer and a huge loss for the IRS, this case is nothing short of a landmark in the longstanding dispute between the IRS and numerous individuals and entities which have attempted to participate in the Virgin Islands Economic Development Program. The IRS intervened in the District Court and essentially fought against the taxpayers and the Virgin Islands. The Third Circuit rebuffed the IRS and in doing so provided clear guidance regarding how participants in the Virgin Islands Economic Development Program are to be treated when faced with the claims of the IRS that they were not bona fide Virgin Islands residents and/or did not properly claim an EDP tax credit. Further, the fact that the taxpayers have multiple residences and moved to the Virgin Islands to participate in the Virgin Islands EDP will not be viewed against them, all of which strongly contradicts the IRS’s position that if a taxpayer has a residence in the 50 States he cannot be a bona fide Virgin Islands resident.

The attorneys at Fuerst Ittleman David & Joseph are actively litigating against the IRS, the United States, and the Virgin Islands Bureau of Internal Revenue in Virgin Islands residency cases in the District Court of the Virgin Islands, the U.S. Tax Court, the Third Circuit Court of Appeals, and the U.S. Court of Federal Claims. Additionally, Joseph A. DiRuzzo, III, is licensed to practice in the Virgin Islands and actually lived on St. Thomas for years before relocating to South Florida. Joseph A. DiRuzzo, III, is actively litigating federal tax cases (both civil and criminal) on St. Thomas and St. Croix.

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