December 27, 2012
Union Carbide has filed a petition for certiorari, docketed as No. 12-684, asking the Supreme Court to review the Second Circuit’s rejection of its research credit claim. See our prior reports describing the issue and reporting on the decision.
The petition articulates two questions presented: 1) the basic substantive tax question whether, in the context of a production process experiment, the research credit is limited to the costs of supplies that would not have been incurred but for the experiment; and 2) whether the court erred in deferring to the IRS’s proffered interpretation of its own research credit regulations. These two questions are related, of course, as the taxpayer argues that the court’s error in deferring to the IRS’s interpretation led it to misapply those regulations and deny the credit.
With respect to the first question, the petition emphasizes the importance of the decision. It states that production process experiments must be done in the production plant itself and create the risk that the output will be “off-grade scrap” if the experiment does not go well. Therefore, the costs of the supplies that would not be incurred but for the experiment are “trivial in comparison to the supplies that must be placed at risk of loss when conducting this type of research.” The result of the Second Circuit’s decision, the petition continues, “is that the credit is rendered trivial for the type of plant-scale production process research that is so important to manufacturing industries generally, and the chemical industry in particular.” Absent this deference, the petition argues, the regulation is most reasonably construed in accordance with the taxpayer’s broader reading of the term “indirect” expenses.
With respect to the second question, the petition argues that the Second Circuit stretched the concept of “Auer deference” (that is, deference to an agency’s interpretation of its own regulations) too far. The petition asserts that the court mistakenly applied Supreme Court precedent “as requiring a seemingly extraordinary deference to the government’s interpretation of a regulation in a case in which the government itself is a financially interested party, [which] amounts to affording a naked preference to a government litigant over its non-governmental adversaries — permitting the government to place its thumb on the scales of justice.”
As noted in our prior post, the Second Circuit’s opinion did extend the concept of Auer deference beyond the specific situations in which it has thus far been applied by the Supreme Court. In Auer v. Robbins, 519 U.S. 452 (1997), the Court had deferred to an agency’s interpretation when it was set forth in an amicus brief filed by a non-party; here, the court deferred to the IRS’s interpretation presented in a brief in which the IRS was a litigant. Justice Scalia has suggested that he would be open to reconsidering even Auer itself in an appropriate case (even though he authored the Auer opinion). Union Carbide is hoping that other Justices share that view or that they will be troubled by the apparent expansion of the doctrine here, and that enough of them will believe that this is an appropriate case to revisit the question of agency deference to its own regulations. Whether or not that turns out to be the case, the petition’s focus on the broadly applicable deference issue certainly gives the Court something to think about beyond whether it wants to hear the substantive tax issue. Ordinarily, taxpayers have a hard time persuading the Court to hear a technical tax question on which there is no circuit conflict.
The government’s brief in response to the petition is currently due January 3. The government often obtains at least a 30-day extension to file such responses.