Paul Hastings Secures Victory on behalf of the United Arab Emirates Embassy in Tax Litigation Case

October 18, 2010

Washington, DC (October 18, 2010) Paul, Hastings, Janofsky & Walker LLP, a leading global law firm, announced today that the firm secured a victory on behalf of the Embassy of the United Arab Emirates over IRS attempts to tax the income of its non-diplomatic employees.

Litigation partner Hamilton Loeb brought the suit on behalf of the Embassy of the United Arab Emirates and one of its security guards, Shoukri Abdel Fattah. Loeb serves as outside general counsel to the UAE Embassy, and has been lead counsel in more than two dozen cases in which the IRS has sought to tax income of Embassy staff that does not have formal diplomatic status.

The Abdel Fattah case was the test case designed to challenge the IRS' interpretation of Section 893 of the tax code, in which the IRS contended that embassy staff would be exempt from tax only if the State Department provided a formal certification prior to the payment of the wages.

"This decision will have a broad impact within the embassy community and multilateral institutions in Washington," said Loeb. "It was widely understood for decades that these employees were not subject to US income tax. The IRS unilaterally attempted to reverse that understanding in 2007. Some embassies elected not to get into a quarrel, but the tax code was clear that the IRS was simply wrong on this. This is what courts are for to set things right when an agency overreaches."

The Paul Hastings litigation victory came in two steps. In a 35-page opinion in late April, the Tax Court sided with the firms argument that the Embassy's non-diplomatic employees are exempt from US income tax under Section 893. The embassy community watched closely as the 90-day appeal clock ticked on the ruling and as the IRS and Justice Department determined whether they would challenge the Abdel-Fattah ruling, attempting to limit its applicability. The appeal clock ran out last week with no IRS appeal, and the IRS issued an official determination (called an Action on Decision) that it would adopt the Abdel-Fattah rule and withdraw its tax deficiency notices to employees at embassies of countries that provide reciprocal tax-free treatment to US embassy staffers.

The controversy grew out of an IRS initiative in 2007 to subject embassy and multilateral agency staff to tax unless the employing country obtained a certification from the State Department that it does not tax incomes of similarly-situated employees of US embassies. The applicable Tax Code provision, section 893, was enacted in the 1930s to exempt income of non-US staff in order to encourage reciprocal tax-free treatment for staff in American embassies overseas. It included a certification authority by which the State Department can inform the IRS of countries that provide the tax-free reciprocity.

"The IRS has now backed off that position entirely, in response to the Tax Court's ruling," said Loeb. "That will mean peace of mind for hundreds, if not thousands, of employees who are facing ruinous tax claims. Many of the affected embassy staff work as security guards, drivers, bookkeepers, and administrative staff, and thus are not in a position to fund a back-tax liability in the tens of thousands of dollars."

Paul, Hastings, Janofsky & Walker LLP is a leading global law firm with offices in Asia, Europe, and the United States. We provide innovative legal solutions to financial institutions and Fortune 500 companies. Please visit www.paulhastings.com for more information.