Zorzit v. Comptroller of Md.

¹⁶¹ NAZARIAN, J. John Zorzit and Nick’s Amusements (collectively, “Nick’s”) were ordered to pay $5,770,353.18 by the Maryland Tax Court—$2,159,724.97 in unpaid admissions and amusement taxes, interest on those taxes, and a fraud penalty of $1,079,862.45. Nick’s does not dispute failing to pay taxes, but contests the amount owed and disagrees with the fraud penalty. It argues that the Comptroller’s assessment that was the basis for the Tax Court’s Order was fatally flawed and that the Comptroller failed to prove the necessary intent to defraud. We disagree with both arguments and affirm.

I. BACKGROUND From 1993 until 2009, Mr. Zorzit owned and operated Nick’s Amusements. Nick’s provided coin-operated entertainment machines to bars and restaurants, including jukeboxes, pool tables and video poker machines. Nick’s retained ownership of the machines, and split the profits with the owner of the venue. With video poker machines, owners and managers of the locations made cash payouts to winning customers, with Nick’s knowledge and approval, and these payouts were deducted from the profit they split.

Nick’s concedes that these payouts were illegal. Moreover, Nick’s kept no records of the payouts—indeed, as counsel for the Comptroller suggested at the Tax Court, keeping records would have been recording a criminal enterprise. 1 Nick’s was charged criminally as a result of the video poker business many times. Mr. Zorzit testified that prior to 2009, Nick’s was a defendant in more than fifteen cases in the Circuit Court for Baltimore County, but none of these ever yielded a conviction. He claimed, in fact, that there was an ¹⁶² understanding between Nick’s and the former State’s Attorney for Baltimore County: MR.

ZORZIT: If [Baltimore County Police saw gambling], they’d come back, [get] a search warrant, come in there with 20 people. Go through the machines, call us up and say we got your machines, can you come over and open them up. We’d come over and open them up so they didn’t bust them. And it was very cordial with everybody.

They had my cell number.... As soon as they would tell us, you know, what location [from which police were seizing machines], the truck would go over there with some more new ones because they were going to take those out. So the truck would be sitting there. They would be wheeling the machines that they have out, and we’d be wheeling the new ones in, and that’s since I was a kid.

THE COURT: Okay. MR. ZORZIT: And then we go to court, and [our attorney] Arnold Zerwitz, I know he testified 12 to 15 times. I think it was a little more than that.

We’d go to work. It’s already worked out before we go in. The prosecutor ... for years said I’m not prosecuting these things. This is ridiculous.

It is, of course, lawful to operate video poker machines without making payouts, at least so long as the machines are properly licensed and taxes are paid. See Md.Code (1992, 2010 Repl.Vol.), §§ 17-405,17-408, and 17-414 of the Business Regulation Article. Video poker machines and other “games of entertainment” are subject to an “admissions and amusement” tax of 10% in Baltimore County. Baltimore County Code § 11-4-601.

Although counties impose these taxes, businesses are required to remit admissions and amusement taxes to the Comptroller. Md.Code (1988 Repl.Vol.2010), §§ 2-109, 4-201, 4-301 of the Tax General Article (“TG”). Nick’s helped its Baltimore County customers obtain licenses for their video poker machines and collected the taxes. 2 ¹⁶³ After the machines were installed and running, Nick’s “route men” visited each location, opened the machines, counted the cash, calculated the admission and amusement taxes to be paid on the revenue at that location, and, then-and-there, split the profits with the location’s owner. But Nick’s did not consider illegal payouts to be taxable, and the route men did not include payouts when calculating Nick’s tax liability.

What’s more, Nick’s route men did not keep records that would allow anyone to calculate the taxes due on payouts. First, the route men kept no records of payouts at all. Second, they did not record revenue on a per-machine basis—they tallied all of the revenue by location, net of payouts, and wrote down only that total before calculating taxes and license fees, and splitting the profits. Thus, when a route man returned to Nick’s office with the day’s receipts, video poker revenue was indistinguishable from revenue from jukeboxes, pool tables, or any other cash revenue.

Beginning in 2006, the Baltimore County Police Department (“County Police”) conducted a wide-scale investigation of Nick’s video poker operations. After significant undercover work and speaking with informants, the County Police seized eighty-three video poker machines owned by Nick’s from twenty-nine locations on January 28, 2009. 3 Police opened the machines and analyzed their motherboards in an effort to determine how much money was paid into the machines and how much had been won (the “in-credits” and “out-credits,” respectively). County Police officers later called to testify conceded that bar and restaurant owners likely did not pay out every credit won, 4 and that if Nick’s had purchased used ¹⁶⁴ machines, the in- and out-credits from previous owners would still be recorded on those machines. But having no way to distinguish between previous out-credits and out-credits during Nick’s ownership of machines, the County Police compiled the raw data from these motherboards into a report, and turned that report over to the Comptroller’s Office.

The Comptroller independently analyzed the report. The Comptroller at no time took possession of or tested the machines. Using the figures from the motherboards, the Comptroller’s Office devised a “payoff percentage,” representing the percentage of out-credits to in-credits. The Comptroller assumed that every out-credit was paid, and ultimately hypothesized that 55% of the money paid into a machine would be paid back to customers. 5 The Comptroller then applied this figure to the gross revenue that Nick’s had recorded for the period of August 2003 to January 2009.

Nick’s had not retained records for January 2000 through July 2003, so the Comptroller devised a monthly average return for the 2003-2009 period, used that number for the months without records, then applied the payoff percentage. 6 After estimating the amount of money bar and restaurant owners had paid out over the years, and applying a 10% admissions and amusement tax rate, the Comptroller ultimately arrived at a tax deficiency of $2,159,724.97 for the 2000-2009 period. The Comptroller then added interest on the outstanding tax bill and imposed a 100% fraud penalty. Mr. Zorzit later testified that after the raid, he sought access to the video poker machines from the County Police, but his request was denied. Sergeant Thomas Hench of the County Police testified, however, that no one at Nick’s asked ¹⁶⁵ for access to the machines to conduct their own testing of the motherboards.

He also testified that the Comptroller never asked for the machines, nor asked the County Police to preserve them, and that after storing the machines for “[a] year or two” they were destroyed. Nick’s appealed the assessment to the Tax Court. It argued that the deficiency assessment was inadequate because the assessment (1) assumed all of Nick’s revenue claimed by Nick’s came from video poker; (2) used out-credits from the life of the video poker machines when a significant number of Nick’s machines had been bought used; and (3) assumed that all out-credits represented payouts even though bar and restaurant management often would not pay and repairmen might accumulate out-credits while testing the machines. At the hearing, Nick’s offered testimony from Ben Cummings, one of Nick’s route men, 7 who estimated that only 65% of Nick’s revenues came from video poker, and that the payoff percentage was between 20 and 25%.

Nick’s also offered expert testimony from a statistician, who applied Mr. Cummings’s numbers to the Comptroller’s methodology and calculated a tax deficiency of only $466,016.10. Finally, Nick’s disputed the fraud penalty, claiming that neither of the two CPAs they employed, nor their retained attorney, nor anyone else on staff were aware that payouts were taxable, and that Mr. Zorzit and the company lacked the requisite intent to defraud. The Comptroller in turn called two police officers who had participated in investigating Nick’s, Corporal Montgomery and Sergeant Hench. They described their investigation and the illegal video poker business in general.

The Comptroller also called one of its auditors, Charles Drasher, who testified that Nick’s did not maintain records or program the machines in a way that allowed auditors to determine which out-credits resulted in payouts and which did not: ¹⁶⁶ COUNSEL: If there were statements to the effect that not all out-credits may have resulted in payments, why did the comptroller base the assessment on all of the out-credits that were made? MR. DRASHER: Again, there was no reliable documentation as to what percentage of out-credits represented payouts. And in speaking with Sergeant Hench, he informed me that he believed [ ] all of the out-credits to be payouts.

COUNSEL: Ben Cummings has provided what he called guesstimates as to the amount of money that came from the non-video poker machines and the number of out-credits that did not result in payouts. Why didn’t the Comptroller take his guesstimates into account? MR. DRASHER: Again, there were no documents, no records to back up any estimates he may have made.

Mr. Drasher echoed the testimony of Corporal Montgomery regarding the relative revenue that came from the video poker machines. He testified that one bar owner in the Nick’s network ascribed roughly $50 and $300-$400 per week respectively to pool table and jukebox revenue, but that video poker devices brought in $7,000-$10,000 per week. Mr. Drasher also referred to this Court’s decision in Genie & Company, Inc. v. Comptroller of the Treasury, 107 Md.App. 551 , 668 A.2d 1013 (1995), and identified the “badges of fraud” that, in the Comptroller’s view, supported the fraud penalty. The Tax Court ultimately found enough evidence of fraud under Genie to uphold the fraud penalty.

And although the court expressed doubt about the accuracy of the assessment, it adjusted the fraud penalty to compensate: What I don’t have is sufficient evidence for me to come up with the accurate percentage of how much of the total receipts come from video [poker] machines and how much come from the other sources. I know it’s not a hundred percent, and I’m pretty sure it was above 65 percent, but I don’t know what it is in between, and I’m not allowed to guess. I need sufficient evidence in the record to come up with a number, and I don’t have it. ¹⁶⁷ The other issue I had to address is the out-credits and how much of them represented payouts. Some testimony was that it was about 25 percent on these, it looks like bartenders playing on the machines after hours, repair people putting credits onto the machines to make sure that they operated correctly.

The other end of the extreme was someone who said the amount is inconsequential. Again, I don’t have any testimony that gives me the ability to specify a number somewhere between 0 and 25 percent. So I will affirm the assessment that I have in front of me since I can’t come up with a different number that I feel [confident] is correct. What I will do, though, is I have discretion in terms of the amount of [the] fraud penalty charge, based on the fact that I don’t believe the accounting is a hundred percent accurate.

As a matter of fact, I’m pretty sure that it’s not. I’m going to reduce the fraud penalty to 50 percent, which should cover any illegal accounting by the comptroller’s office, as well as allow the fact that, you know, if fraud takes place, I think there should be a penalty. The Tax Court’s order affirmed the $2,159,724.97 assessment, charged interest through July 31, 2013 totaling $2,530,765.72, “which interest shall accrue until the assessments are paid off in their entirety,” and assessed a reduced fraud penalty in the amount of $1,079,862.45. Nick’s filed a Petition for Judicial Review on August 13, 2013 in the Circuit Court for Baltimore County.

The court heard argument on April 24, 2014, and on June 5, 2014, filed a Memorandum Opinion affirming the Tax Court’s decision. Nick’s filed a timely Notice of Appeal.

II

DISCUSSION Nick’s presents two questions for our review: 1. Whether the Tax Court erred in imposing a civil fraud penalty without finding intent to evade payment of a tax known to be owed within the meaning of [§] 13-703 of the Tax—General Article; and ¹⁶⁸ 2. Whether the Tax Court erred in affirming the Comptroller’s assessment when the assessment was based upon inarguably and admittedly erroneous assumptions and other evidence that the Comptroller failed to preserve. Nick’s argues that the Tax Court erred in assessing a penalty for civil fraud.

It claims that neither the company nor its employees nor its professionals knew that the company owed tax on payouts, and that the Tax Court found as much. It argues that this ignorance belies any intent to evade payment of the tax, and without that intent, there can be no finding of fraud. Nick’s also argues that the Comptroller has assessed an admittedly erroneous amount against them— exacerbated by his failure to preserve the motherboards—and that the Tax Court must be reversed for affirming the assessment. The Comptroller counters that the Tax Court properly assessed a fraud penalty under the holding of Genie.

He further argues that substantial evidence supports the assessment, and draws our attention to the fact that a fully accurate assessment was impossible because Nick’s failed to maintain adequate records. The Comptroller claims that the statutory scheme empowered him to “estimate the tax owed by Nick’s using the limited documents and data that were available,” and he asserts that he “did [his] best to come up with a reasonable estimate under the circumstances.” The Comptroller argues finally that he cannot be penalized for the destruction of the motherboards because he never possessed or even inspected them. We hold that the assessment was reasonable, that there were sufficient badges of fraud to sustain the Tax Court’s fraud penalty, and that the Comptroller should not have been sanctioned for the destruction of the motherboards. We undertake a “severely limited” review of Tax Court decisions.

Comptroller of the Treasury, Income Tax Division v. Diebold, Inc., 279 Md. 401, 407 , 369 A.2d 77 ¹⁶⁹ (1977). 8 We give great deference to the Tax Court’s fact-finding, and “great weight to the Tax Court’s interpretation of the tax laws, but review its application of the case law without special deference.” State Dep’t of Ass’t & Taxation v. Andrecs, 444 Md. 585, 604 , 120 A.3d 734 (2015) (citations omitted). For its part, Nick’s appears to take no issue with the Tax Court’s fact-finding as such, but instead challenges the adequacy of the record to support the Tax Court’s findings and its legal authority to assess taxes and impose penalties in the face of evidentiary gaps. A. Rossville Vending Is Controlling. It is rare that a claim of “tax confusion” can be refuted so thoroughly, let alone by a reported decision of an appellate court old enough to drink alcohol or gamble in a casino.

This is just such a case. In 1993—three years before Nick’s was incorporated—we decided Rossville Vending Machine Corp. v. Comptroller of the Treasury, 97 Md.App. 305 , 629 A.2d 1283 (1993), a case that involved the admissions and amusement tax liability of a nearly identical Baltimore County-based video poker business: Rossville owned a number of video poker machines that it placed in bars, restaurants, and other establishments frequented by the general public (collectively referred to hereafter as “establishments” or singularly as “establishment”). The machines were activated by patrons placing quarters in them. A player accumulated “points” or “credits” as he or she played and got winning poker hands.

When the player accumulated sufficient “credits” or “points,” he or she would be paid winnings in cash directly by the owner, or owner’s employee, of the establishment (not Rossville), based on the player’s number of accumulated “credits” or “points.” It ¹⁷⁰ was conceded that such payouts constituted violations of Maryland’s anti-gambling laws. Rossville’s financial arrangements with each owner of an establishment included a fifty-fifty split of the revenues received from the play of the machines in that establishment, after reimbursement for the owner’s winnings payouts and deduction of expenses such as fees and taxes. Id. at 307 , 629 A.2d 1283 . Unlike Nick’s, however, Rossville Vending received documentation of payouts from the bar and restaurant owners, and reflected the payouts in its internal accounting.

Id. at 307-08 , 629 A.2d 1283 . Ultimately, the County Police investigated Rossville and raided its offices and various establishments where Rossville had installed, video poker machines. Id. at 308 , 629 A.2d 1283 . The County Police seized Rossville’s accounting records, and turned them over to the Comptroller’s office.

Id. And although Rossville had paid taxes on profits from the machines, the Comptroller took the position that payouts to customers were also taxable, and levied a deficiency assessment against Rossville. Id. at 308-09 , 629 A.2d 1283 . Rossville appealed to the Maryland Tax Court, and the Tax Court affirmed the assessment.

Rossville, 97 Md.App. at 310 , 629 A.2d 1283 . Ultimately, so did we. We explained that the admissions and amusement tax statute has “contained the operative phrase ‘gross receipts’ as the basis for computation of the tax” since it was enacted in 1936, id. at 316 , 629 A.2d 1283 , and that the plain meaning of the statute imputed tax liability for payouts: [W]e conclude that the natural and ordinary significance of “gross receipts” as used in the context of the Maryland admissions and amusement tax statute, both in 1936 when it was enacted originally and today, provides no room for reasonable argument that it contemplates deductions or adjustments for expenses, partner/co-venturer reimbursements, or trade discounts before calculation of the tax due. We conclude further that there is no need for further investigation of appellant’s references to foreign authority ¹⁷¹ or its arguments by analogy to other taxing situations.

Where “there is no ambiguity or obscurity in the language of a statute, there is usually no need to look elsewhere to ascertain the intent of the General Assembly.” Id. at 318 , 629 A.2d 1283 (quoting City of Baltimore v. Hackley, 300 Md. 277, 283 , 477 A.2d 1174 (1984)). Nick’s concedes that illegal payouts were made on its video poker machines and that it did not pay taxes on those payouts. Nick’s also does not dispute that Rossville is binding here, and by implication, it does not appear to dispute that it owes some amount of taxes. Instead, Nick’s pleads ignorance: it claims that despite Mr. Zorzit’s personal relationship with the owners of Rossville Vending and knowledge of that business, no one at Nick’s, nor its experienced attorney, nor its experienced accountant knew that Rossville was on the books until the Comptroller levied this assessment.

As a result, it claims, neither Nick’s nor Mr. Zorzit had or could have formed the intention to withhold taxes. Second, Nick’s takes issue with the Comptroller’s computation of tax