SAFE HAVEN FOR LONG-STANDING RECOGNIZED INDUSTRY PRACTICE

GENERAL INVESTMENT CORPORATION v. UNITED STATES
United States Court of Appeals for the Ninth Circuit
823 F.2d 337 (9th Cir. 1987)
July 29, 1987

In this case, a small mining company, General Investment Corporation (GIC), appealed a determination by the Internal Revenue service that workers treated as independent contractors were actually employees for federal employment tax purposes. The facts of the case were as follows:

The taxpayer, General investment Corporation (GIC), is an Arizona corporation engaged in gold and silver mining in Gila County, Arizona. GIC took over operations at the Sunflower Mine site in 1973, following twenty-five years' operation by GIC's predecessor. GIC hired laborers to mine, transport ore, and to maintain the mine, the ore milling site, and mining equipment.

GIC provided the majority of tools, equipment, and supplies required for blasting, transporting, and milling of ore. Blasting and mining was done by a daily three-person crew, treated as independent contractors for tax purposes, but they earned a daily flat-rate wage, which did not fluctuate according to productivity. GIC's president and principal officer, James Duncan, visited the mine daily to assure that mining practices complied with the federal Mine Safety and Health Act (MSHA).

Most of the workers were undocumented Mexican nationals, for whom GIC provided living quarters in its mining camp. While certain rules applied to conduct in the camp, it appears that GIC did not exercise detailed supervision over the daily work. Evidently, the miners themselves organized the taskwork required to extract and transport ore from the mine-tunnel rock face.

After a tax examination, the Internal Revenue Service (IRS) determined that the miners were employees. The IRS assessed a total of $ 82,950.67 for unpaid withholding, Federal Insurance Contribution Act (FICA), and Federal Unemployment Tax Act (FUTA) taxes for 1976-79, together with penalties for failure to file employment tax returns and failure to withhold. GIC paid $ 100 in taxes and sought a refund in the district court. The government counterclaimed for $ 108,975.98 in unpaid FICA, FUTA, and income taxes along with penalties and interest.

At trial GIC's president testified that local miners did not wish to have their taxes withheld. Evidence supported the inference that, because laborers were hired as independent contractors by other small mines in Gila County, the miners would be unwilling to work as regular employees for the Sunflower Mine.

The district court concluded that GIC had a reasonable basis for treating its
workers as independent contractors within the meaning of the safe haven
provisions of § 530, as well as under traditional common law standards. The
court therefore entered judgment for GIC and ordered refund of GIC's payments.
The government appealed. Specifically, the IRS contended that "the district court committed legal error in applying § 530's 'industry practice' provision."

The specific issue on appeal was, therefore, "whether such treatment was justified under § 530(a)(2)(C) of the Revenue Act of 1978, 26 U.S.C. § 3401 note (1979), as undertaken in reliance on a 'long-standing recognized practice of a significant segment of the industry'." As described by the federal appeals court, "section 530(a)(1), Congress granted interim relief from withholding and other forms of employer tax liability for certain taxpayers before 1980. 26 U.S.C. § 3401 note." Further, the appeals court noted that this statute "was designed to relieve employers of the burden of surprise or uncertain imposition of retroactive tax liability resulting from an increase in IRS employment-status audits."

Congress provided that an individual whom the employer did not treat as an employee would be "deemed not to be an employee" for tax purposes "unless the employer had no reasonable basis" for that treatment of the individual. § 530(a)(1)(A) & (B). Section 530(a)(2) provides that an employer's reasonable reliance on any of three supporting elements constitutes a reasonable basis for not treating an individual as an employee. The third provision, in dispute here, creates a conclusive presumption that an employer had a reasonable basis for not treating an individual as an employee, if the employer did so in reasonable reliance on "long-standing recognized practice of a significant segment of the industry in which such individual was engaged." § 530(a)(2) (C), 26 U.S.C. § 3401 note.

In pertinent part, Section 530(a) provides "termination of certain employment tax liability" under the following circumstances:

In general, - if - (A) for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period ending before January 1, 1980, and (B) in the case of periods after December 31, 1978, all Federal tax returns (including information returns) required to be filed by the taxpayer with respect to such individual for such period are filed on a basis consistent with the taxpayer's treatment of such individual as not being an employee, then for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee....

[A] taxpayer shall in any case be treated as having a reasonable basis for not treating an individual as an employee for a period if the taxpayer's treatment of such individual for such period was in reasonable reliance on any of the following:

(A) judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;

(B) a past Internal Revenue Service audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding positions substantially similar to the position held by this individual; or

(C) long-standing recognized practice of a significant segment of the industry in which such individual was engaged.

In challenging the federal district court's application of § 530, the IRS contended on appeal that "the court's definition of the relevant industry was overly narrow." As described by the appeals court, the IRS maintained that "the court should have required GIC to have relied on practices of a significant segment of the nationwide industry of mining." Further, the IRS argued on appeal that "even if the court was correct to regard small Gila County mining concerns as a discrete industry for purposes of § 530, the court clearly erred by finding that plaintiff met its evidentiary burden."

To escape tax liability through § 530(a)(2)(C), GIC must show that a "significant segment of the industry" treated miners as independent contractors. The government argues that the industry in which the workers were engaged should be defined to include all mining businesses nationwide. At a minimum, however, the government suggests that the standard should include all small mining concerns in the nation that process and extract ore. We disagree with both of these positions.

In addressing this issue, the federal appeals court acknowledged that "Section 530 of the Revenue Act of 1978 does not define "industry," [n]or does the Act's extensive legislative history shed light directly on how Congress intended the term to be construed." However, in the opinion of the court, "Congress' overall purpose in passing the legislation does offer some guidance".

Without question, Congress intended to protect employers who exercised good faith in determining whether their workers were employees or independent contractors. Section 530 is but one way for an employer to prove it had a "reasonable basis" for not treating its workers as employees for tax purposes. The legislative history specifies that "reasonable basis" is to be "construed liberally in favor of taxpayers." (H.R. Rep. No. 1748, 95th Cong., 2d Sess.) The IRS has embraced Congress' liberal construction directive in its procedural guidelines for § 530. (Rev. Proc. 78-35 § 3.01, 1978-2 C.B. 536.)

Applying this legislative purpose to the facts of the case, the appeals court concluded that the district court had properly held that "GIC had a reasonable basis for treating its workers as independent contractors within the meaning of the safe haven provisions of § 530." In so doing, the appeals court rejected the burdensome IRS notion that "practices of a significant segment of the nationwide industry of mining" were required to establish a "long-standing recognized practice of a significant segment of the industry in which such individual was engaged" within the meaning of section 530.

To require the district court to examine nationwide mine employment practices would be cumbersome, and to demand such a showing by a small operator like GIC would thwart congressional intent. Several dozen small mining concerns with operations similar to the Sunflower Mine exit in Gila County, a geographic area covering 4,400 square miles. The government fails to provide any substantial reason why these small Gila County metallic mineral mines should not be viewed as a discrete industry sufficient to stimulate the kind of reliance protected by § 530. In light of the provision's curative, remedial character which responded to peculiar circumstances of past deficiencies in the IRS' enforcement of the employment tax laws, we conclude that the district court appropriately interpreted § 530.

Despite such a construction of section 530, the IRS argued on appeal that "the district court erred by finding that the hiring of miners as independent contractors was a recognized practice among a significant segment of the Gila County small mining industry." However, in establishing evidence of an industry practice, the appeals court noted that the taxpayer GIC "need not prove the practice was uniformly followed by the industry, Rev. Proc. 78-35 § 3.01(C), 1978-2 C.B. 536." In this particular instance, the appeals court found that the following evidence on the record "supported GIC's assertion that the use of contract laborers was a routine practice among small gold and silver mines in Gila County.

At trial, both Duncan and Thorne, another local mine operator, testified that they always hired laborers as independent contractors. Duncan testified that GIC's practice of contracting for labors followed the routine practice of the Sunflower Mine's previous owner. Duncan and Thorne also had extensive familiarity with the operations of a number of other small Gila County mines through their roles as officers of a county-wide mining trade association. Their impression, based on meetings with mine owners and numerous visits to other mines, was that all hired laborers on as independent contractors. Duncan also testified that workers who had experience working for other mines were unwilling to work for GIC unless they were treated as contract laborers, because their wages would be lower as employees.

As a result, the appeals court found that "the district court did not clearly err in concluding that the treatment of laborers as independent contractors was a long-standing, recognized practice of a significant segment of the industry." The appeals court, therefore, concluded that "GIC had a reasonable basis for treating its miners as independent contractors and is relieved of liability for the years 1976-78" pursuant to the safe haven provisions of section 530 (§ 530(a)(2)(c), 26 U.S.C. § 3401 note).

As noted by the appeals court, for tax periods after December 31, 1978, "relief under § 530 is available only if GIC filed required tax or information returns" (§ 530(a)(1), 26 U.S.C. § 3401 note). Since GIC conceded that "it failed to file information returns for its 1979 workers and is not entitled to § 530 relief for that year," the appeals court acknowledged that "GIC cannot avail itself of § 530 relief to avoid employment tax liability for 1979." The issue was "whether the workers in fact qualify as independent contractors under the common law" for 1979, "a later tax year to which § 530 cannot be applied."

In determining the GIC workers' federal tax status for the year in question, the district court had found that the applicable common law standards dictated that "GIC also escaped employment tax liability for 1979." The appeals court described these common law factors for determining employee vs. independent contractor status as follows:

Although a variety of factors may be used to analyze employment status for tax purposes, employer control over the manner in which the work is performed, either actual or the right to it, is the basic test. The Treasury Regulations include the following subsidiary factors to define common law employment status: (1) whether the business has the right to discharge the worker; (2) whether the business furnishes tools to the person rendering the service; (3) whether the business provides the worker with a place to work; and (4) whether the work is performed in the course of the individual's business rather than in some ancillary capacity. See Treasury Regulations on Employment Tax & Collection of Income Tax at Source, 26 C.F.R. §§ 31.3121(d)-1(c)(2), 31.3306(i)-1(b), 31.3401(c)(1)(b)(1987).

Applying this control test to the facts of the case, the appeals court found that "the district court clearly erred by finding that GIC demonstrated that its miners were independent contractors."

Trial testimony established that Duncan, as president of GIC, hired and discharged the workers. There was no indication that the laborers had their own independent businesses, although some also worked for neighboring mines. The jobs did not require sophisticated skills, and GIC provided most of the tools and all heavy equipment. Duncan selected daily crew members, provided safety training, and established strict rules governing conduct in the mining camp. The miners were unable to earn more than the daily flat-rate wage through their skill, management abilities, or efficiency.

GIC did not exercise control over every detail of the work, and GIC contends that payment was on a piecework basis. On the record before us, however, we cannot conclude that Duncan lacked the right to control his laborers. The mere fact that the workers set their own hours and determined when to take breaks did not make them independent contractors...

Having found GIC's workers were employees for 1979 pursuant to the applicable common law employment standards, the appeals court held that "GIC is liable for taxes, penalties, and interests in accordance with the IRS assessment for that year."