Briefing Complete and Argument Scheduled in CIC Services

The Supreme Court has scheduled oral argument in the CIC Services case for December 1.  As has been the practice at the Court since March because of the pandemic, the argument will not occur in person, but rather will be conducted by telephone.  And the questioning therefore will be more structured instead of the traditional free-for-all.  After the advocate is allowed to give a brief, two-minute introduction without interruption, each Justice then will have a turn to ask questions — approximately three minutes for each Justice beginning with the Chief Justice and moving on in descending order of seniority from Justice Thomas down to new Justice Amy Coney Barrett — with the advocate allowed a minute or so at the end to sum up.

The taxpayer’s reply brief (linked below) reemphasizes the textual arguments made in its opening brief.  It contends that the government’s efforts to distinguish unfavorable precedent essentially amount to trying to revive the old principle of “tax exceptionalism,” which the Supreme Court explicitly rejected in 2011 in the Mayo Foundation case.  By contrast, the taxpayer asserts, the government makes no “serious attempt to interpret the words of the statutory text” — even though textual analysis is the correct way to resolve the case.

In addition to the textual analysis, the reply brief argues that the taxpayer’s position is supported by examining the purposes of the Anti-Injunction Act and argues at length that a ruling for the government would create constitutional problems because it would require a taxpayer to run the risk of criminal prosecution in order to raise a pre-enforcement challenge to a reporting requirement.

CIC Services – Taxpayer Reply Brief

Government Brief Filed in CIC Services

The government has now filed its answering brief in CIC Services, defending the divided Sixth Circuit’s decision to dismiss an APA challenge to a reporting requirement on the ground that the lawsuit violated the Anti-Injunction Act.  See our previous reports here.

Like the taxpayer’s brief, the government focuses most of its attention on analyzing the statutory text.  Like the court of appeals, it argues that the terms of the statute literally apply because the penalties for noncompliance with the reporting requirements are defined in the Code as “taxes” and the lawsuit, if successful, would have the effect of preventing collection of those penalties if a taxpayer did not comply with the requirements.  The government distinguishes Direct Marketing Ass’n v. Brohl, 575 U.S. 1 (2015), on which the taxpayer relies, on the ground that that case did not involve requirements that were “enforced by taxes.”  The government rejects the argument that its position undermines the broad purposes of the APA, contending that the taxpayer does not need a pre-payment remedy because it would have an adequate post-payment remedy if it incurred the penalty and then filed a refund suit.  Contrary to the taxpayer’s argument, the government maintains that pursuing the post-payment remedy would not expose the taxpayer to criminal liability for “willfully” disregarding the reporting requirements.

The taxpayer’s reply brief is due October 8.  Oral argument has not yet been scheduled in the case and therefore will occur no earlier than November 30.

CIC Services – Government Answering Brief

Briefing Underway in CIC Services

The opening briefs have now been filed in CIC Services, which involves the applicability of the Anti-Injunction Act, 26 U.S.C. § 7421(a), to an Administrative Procedure Act challenge to a reporting requirement that carries with it a “tax” penalty for noncompliance. See our prior report here. Showing a restraint that is fairly unusual today in Supreme Court litigation, the taxpayer’s brief (linked below) comes in well under the maximum length permitted by the Court’s rules. Showing somewhat less restraint, a variety of organizations and individuals filed a total of ten different amicus briefs in support of the taxpayer’s position.

The taxpayer’s brief argues that this is a simple case, controlled by the statutory text. In particular, the taxpayer argues that use of the terms “assessment” and “collection” in the statute refute the notion that it could apply to a challenge to a reporting requirement. According to the taxpayer, the prohibition against suits that “restrain” those activities means that the statute applies to “suits that actually stop the assessment or collection of a tax–not suits that merely inhibit future assessment or collection.” The brief relies for support on both the opinion of the Sixth Circuit judges dissenting from denial of en banc review and on Direct Marketing Ass’n v. Brohl, 575 U.S. 1 (2015), a Supreme Court decision involving the Tax Injunction Act, 28 U.S.C. § 1341, which the taxpayer describes as “a similarly worded state tax analog.”

The taxpayer makes two additional points apart from its focus on the statutory text. It argues that the Sixth Circuit’s decision frustrates the policy of the APA to facilitate pre-enforcement review while doing nothing to advance the purposes of the Anti-Injunction Act. And the taxpayer argues that the Sixth Circuit’s decision creates an unconstitutional system by allowing a taxpayer to challenge the reporting requirement only by first violating the requirement and thus exposing itself to criminal liability.

The government’s answering brief is due September 8.

CIC Services – Opening Brief for Taxpayer

Supreme Court to Hear Tax Anti-Injunction Act Dispute in the Fall

The Supreme Court granted certiorari in CIC Services, LLC v. IRS, No. 19-930, to address the scope of the Tax Anti-Injunction Act, 26 U.S.C. § 7421(a). The briefing in the case will occur over the summer, with oral argument to occur sometime in the fall.

The basic issue in the case is how narrowly to read the Act’s prohibition on actions seeking to enjoin “the assessment or collection of any tax.” That prohibition means taxpayers who dispute a tax assessment must pay their taxes first before they can litigate the dispute in a refund suit. The CIC case, however, did not involve a tax assessment or, really, tax liability at all (except in a very tangential way). Rather, the dispute was over the validity of an IRS notice imposing reporting and recordkeeping obligations on taxpayers entering into certain “micro-captive” insurance transactions. The plaintiffs sought to halt enforcement of the notice on the ground that it did not comport with APA notice-and-comment requirements. The district court, however, agreed with the IRS that the suit was barred by the Anti-Injunction Act because taxpayers who failed to report their transactions were subject to penalties that are classified by the Code as “taxes,” and the suit would have the effect of restraining the imposition of those penalties. The court reasoned that the lawsuit “necessarily operate[d] as a challenge to both the reporting requirement and the penalty or tax imposed for failure to comply with the reporting requirement.”

A sharply divided Sixth Circuit affirmed, denying the plaintiffs’ petition for a rehearing en banc by a narrow 8-7 vote. On top of that, Judge Sutton, who provided the swing vote for denial, wrote separately to explain that he thought the dissenters had the better reading of the Act but that the issue ultimately turned on the meaning of Supreme Court precedent and should be resolved by that Court without an unnecessary detour into en banc review.

Building off the dissents in the Sixth Circuit, and supported by several amicus briefs, the taxpayer argued in its cert petition that the decision below meant that “even patently unlawful IRS regulations can be insulated from review unless an individual is willing to risk the imposition of enormous fines and—in this case—prison time.” The government devoted most of its response to defending the Sixth Circuit’s construction of the statute on the merits, without saying much about the policy implications. The Supreme Court was persuaded that it needs to step in and resolve the issue, which may bode well for the taxpayer’s position.

The taxpayer’s opening brief is due July 15, and the government’s response is due September 8. The Court has not yet scheduled an argument date, but a November or early December date is likely.

Linked below is the cert petition (with an attached appendix that includes the decisions of the courts below), the government’s brief in opposition, and the taxpayer’s reply brief.

CIC Petition for Certiorari

Government Brief in Opposition in CIC

CIC Reply in Support of Certiorari Petition

Supreme Court Poised to Rule on SIH Partners Cert Petition

We noted in our prior coverage of this case that SIH Partners was likely to seek Supreme Court review of the adverse decision it received in the Third Circuit regarding loan guarantees issued by a CFC, even if a grant of certiorari was a longshot.  The Court is now scheduled to consider the taxpayer’s cert petition at its January 10 conference and will likely announce its determination on January 13.

In an effort to interest the Court in the case, the taxpayer chose to focus entirely on the administrative law issues presented by the case, not on the substantive tax issues.  The only questions presented in the cert petition are: “1. Whether the Third Circuit erred in deferring to the IRS regulation under Chevron” and “2. Whether the Third Circuit erred in holding that the IRS is not bound by its own published Revenue Rulings.”

The taxpayer states that these are questions of broad importance in administrative law and argues that the courts of appeals are in conflict in addressing them.  As to the first question, the taxpayer asserts that “the Third Circuit stretched Chevron deference past the point any other court has gone.”  As to the second, the taxpayer quotes the Third Circuit’s statement that a Revenue Ruling “does not bind the IRS” and asserts that other courts have held that the IRS is bound by its own Revenue Rulings.

The government in response asserts that the case does not present any issue warranting the Supreme Court’s attention.  Its brief in opposition shifts the focus away from the broad administrative law questions set forth by the taxpayer and devotes more attention to the substantive tax issues, suggesting that the outcome would have been the same even if the court had agreed with the taxpayer’s Chevron position.  It notes that the court of appeals “devoted only a single paragraph of its opinion” to a recitation of Chevron principles and simply held that Treasury did not act arbitrarily in failing to adopt the regulatory exception sought by the taxpayer.  In any event, the government disputes the assertion of a circuit conflict regarding Chevron, stating that the cases cited by the taxpayer simply reflect different results attributable to different facts.  As to the Revenue Ruling, the government does not take issue with the principle that Revenue Rulings are generally binding on the IRS, arguing that the Third Circuit’s decision should be understood as stating that the Revenue Ruling cited by the taxpayer was “inapposite” in the circumstances of this case because the regulation leaves no room for the facts and circumstances inquiry sought by the taxpayer.  Finally, to the extent the Third Circuit’s view on Revenue Rulings is in tension with other courts of appeals, the government contends that this case “is a poor vehicle” for the Supreme Court to consider that question.

The taxpayer’s reply brief seeks to cut through the complexity of the government’s response, stating that “the IRS tries to defeat certiorari by ignoring what the other circuits have actually said and rewriting both the agency’s explanation for the Regulation and the Third Circuit’s opinion.”

The three Supreme Court filings are linked below.

SIH Petition for Certiorari

Government Brief in Opposition

SIH Reply Brief in Support of Petition

Rehearing Denied in SIH Partners

The Third Circuit today denied a petition for rehearing en banc in SIH Partners.  See our prior reports here.  The taxpayer now has 90 days to file a petition for certiorari.

The petition for rehearing focused more on general administrative law principles than on the substantive section 956(d) issue in the case.  In particular, the petition criticized the panel for applying Chevron deference to a regulation that did little more than parrot the statutory language.  It also argued that the panel erred in stating that the IRS was not bound by a previously published Revenue Ruling.  Given the Supreme Court’s recent interest in regulatory deference issues (and the lack of any reason to believe that it has any particular interest in the taxation of controlled foreign corporations), one can expect that a cert petition, if one is filed, would have a similar focus.  The Court, however, will have many other opportunities to explore Chevron deference further if it so desires, so it is hard to say that the outlook for Supreme Court review in this case is very promising.

SIH Partners – Taxpayer Petition for Rehearing

 

Third Circuit Affirms Subpart F Income Inclusion Ruling in SIH Partners

A unanimous Third Circuit this morning affirmed the Tax Court in SIH Partners in an opinion that will please government lawyers who are increasingly dealing with APA challenges to Treasury regulations.  As explained in our previous posts here, the issue in SIH Partners was whether loan guarantees by two CFCs resulted in income exclusions, even though the guarantees were not equivalent to an actual repatriation because, among other things, there were many other guarantors.  Because the regulations on their face set forth a bright-line rule that takes no account of the individual circumstances of particular loan guarantees, the taxpayer argued that the regulations were invalid under the APA as arbitrary and capricious.

The Third Circuit noted “the Tax Court’s masterful analysis rejecting” the taxpayer’s challenge to the validity of the regulations, but it then stated that it did not need to rely on that analysis because the taxpayer’s argument failed for another reason.  The court said that the taxpayer, in arguing that a bright-line rule treating all loan guarantees the same was unreasonable, had pointed to IRS administrative guidance issued over the years that relaxed the rule depending on the circumstances.  The taxpayer, therefore, was asking the court to use “hindsight” in violation of the established rule that the validity of an agency action must be assessed based on the administrative record that was before the agency at the time.  The court did not dispute that experience under the regulation might have demonstrated that “the regulations do not always address economic reality,” but it found that fact immaterial.  The court declared:  “We cannot and will not find half-century old regulations arbitrary and capricious, based on insights gained in the decades after their promulgation, when the challenger . . . has not made a showing that those insights were known or, perhaps, at least should have been known to the agency at the time of the regulations’ promulgation.”  Indeed, the court said that the taxpayer’s argument would be better characterized as complaining about the IRS’s failure to amend the regulations to meet the “later observed economic realities,” instead of a complaint that the regulations were arbitrary when first promulgated.  Since no one requested that the IRS amend the regulations, the court said, this argument could go nowhere.

The court’s “hindsight” criticism seems unfair, as the essence of the taxpayer’s argument was not that the administrative guidance was itself a later event that called for amending the regulations, but rather evidence of an obvious flaw in the bright-line regulation as promulgated that Treasury should have recognized from the start.  The court acknowledged that the taxpayer had made this point in oral argument, but simply responded that regulations do not have to be “the most perfect solution possible.”  In the court’s view, the regulation set forth a “straight-forward” rule that comported with the statutory language and hence was not arbitrary.  The court added that no commenter at the time raised “the possibility of multiple-counting of loan guarantors being an issue with the regulations.”  That suggested that this practice was “exceedingly rare” at the time, which meant that it was hardly unreasonable for the regulation not to address it at the time.

The court then went on to make a couple more observations that may well find their way into  briefs in future cases raising APA challenges to regulations.  The taxpayer had argued that the bright-line rule of the regulation was inconsistent with the policy of the statute, which was to address loan guarantees that were effectively repatriations.  The court did not take issue with the taxpayer’s description of the statutory policy.  Instead, it remarked that “we are satisfied that the regulations are not arbitrary or capricious merely because they may not adhere to the policies embodied in the statutes in every case.”  The court also gave short shrift to the taxpayer’s contention that the regulations lacked enough explanation to satisfy the State Farm requirement of “reasoned decisionmaking.”  The court stated:  “Because the challenged regulations barely rocked the statutory boat [that is, they closely tracked the statutory language], and because of the lack of public commentary and the straight-forward nature of the regulations, little explanation was needed.”

As to the second issue in the case, the court held that the taxpayer was not entitled to the lower tax rate applicable to dividends.  Like the Fifth Circuit in Rodriguez v. Commissioner, 722 F.3d 306 (5th Cir. 2013) (see our reports here), the court held that the fact that the payment could be analogized to a dividend did not actually make it a dividend.

A petition for rehearing is due in 45 days, and, if rehearing is not sought, a petition for certiorari is due in 90 days.  The prospects for the taxpayer to get a favorable result from either of those avenues of further review are probably pretty slim.

Third Circuit Decision in SIH Partners

Briefing Complete in Kisor

The petitioner has now filed his reply brief in Kisor, and the case is fully briefed in preparation for the oral argument later this week on March 27.  Given the government’s partial retreat from defending Auer deference (see our prior post here), which the petitioner describes as a “sharp retreat,” the reply brief responds to two different briefs.  First, it responds directly to an amicus brief by a group of law professors (linked in our prior post) that put forth a full-throated defense of Auer deference.  Second, it acknowledges that the government’s “Auer-light” position is “preferable to existing Auer deference,” but it still rejects that position and argues that complete overruling of Auer is the correct approach.  The reply brief concludes that the existing principles of Skidmore deference satisfactorily address the policy goals described in the government’s brief without improperly permitting “an agency to exert its expertise in binding fashion without any participation by the regulated public.”

Kisor – Petitioner Reply Brief

 

Treasury and IRS Issue Joint Policy Statement on the Tax Regulatory Process

Earlier this week, the Treasury Department issued a policy statement on the tax regulatory process.  A significant section of the statement describes the approach that will be taken in Tax Court litigation to arguments based on judicial deference to regulations.  Treasury states that it will not claim Auer deference in such litigation to interpretations set forth in subregulatory guidance, such as revenue rulings, nor will it claim Chevron deference to such interpretations.  That apparent abandonment of Auer deference arguments goes beyond the position the Justice Department has taken in the Supreme Court in the Kisor case, where the government has argued for a significant narrowing of Auer but stops short of stating that it should be overruled.  See our reports on Kisor here.  Note that the Treasury Department statement by its terms applies only to Tax Court litigation, which is handled by the IRS, not to refund suits where the Justice Department handles the litigation.

The Treasury Department statement also addresses topics other than judicial deference, including: when to issue subregulatory guidance; legislative vs. interpretative regulations; and temporary regulations.  For a fuller analysis of the Treasury Department statement, please read this Miller & Chevalier Tax Alert.

Government Brief Filed in Kisor

The government was faced with something of a dilemma in filing its response brief in the Kisor case addressing the level of deference owed to an agency’s interpretation of its own regulation. See our prior reports here. On the one hand, the government was defending the agency action in this case and the decision below, which rested on paying Auer deference to the agency’s interpretation. On the other hand, conservative legal theorists have long been critical of Auer deference, following Justice Scalia’s lead, and the views of the political appointees in this administration about Auer likely range from unenthused to hostile. But on the third hand, the government’s institutional interests would generally be better served by a strong principle of Auer deference, since that would make challenges to agency action more difficult.

The government’s brief attempts to juggle these conflicting imperatives, and the result is a bit schizophrenic. The bottom line is that the government argues that Auer should not be overruled, but that its applicability should be substantially narrowed. In the end, the government does not rely on Auer to defend the agency action in this case, but instead argues that the regulation is clear on its face without the need to consider the agency interpretation at all.  (Although outgunned by the cascade of amicus briefs filed in support of the petitioner, two amicus briefs were filed on the government’s side, including one by a group of administrative law professors (linked below) who argue that Auer “is sound and should be maintained.”)

The first, and longest, section of the government’s brief is a full-fledged assault on the doctrine of Auer deference. The government contends that the doctrine: (1) is not well grounded historically; (2) is not supported by any consistent rationale; (3) is in tension with the APA’s distinction between interpretive and legislative rules; and (4) can have harmful practical consequences by discouraging agency resort to notice-and-comment rulemaking. Notably, the government states that the reasons that support Chevron deference do not apply to Auer, and thus the brief does not signal that the current administration will argue against Chevron deference in a future case.

The government argues, however, that Auer should not be overruled because of stare decisis considerations, including that doing so “would upset significant private reliance interests” because it allegedly “could call into question” earlier decisions that rested on Auer deference. In contrast to the opening part of its brief, this section praises Auer deference where it is limited to “its core applications,” such as “when the agency announces its interpretation in advance in a widely available guidance document.” The government states that the task of choosing among reasonable interpretations is more appropriately performed by administrators than by judges, that Auer deference would promote national uniformity, that it recognizes the technical expertise of agencies, and that it fosters regulatory certainty and predictability—in contrast to a system “in which the meaning of a regulation must be determined de novo in every judicial proceeding.” In addition, the government disagrees with the petitioner’s argument that Auer deference poses a separation-of-powers problem, stating that an agency’s actions in making rules and conducting adjudications are both exercises of “executive power.”

Accordingly, the government proposes “significant limits” on the doctrine that will thread the needle, neither overruling Auer nor further entrenching it. First, the government states that deference should not be paid to an agency interpretation that is “unreasonable,” describing this seemingly benign limitation as a “rigorous predicate.” If the agency interpretation is judged to be within the range of reasonable readings of the regulation, then the government argues that deference is appropriate “only if the interpretation was issued with fair notice to regulated parties; is not inconsistent with the agency’s prior views; rests on the agency’s expertise; and represents the agency’s considered view, as distinct from the views of mere field officials or other low-level employees.”

It is hard to say at this point what the Court will do with the various permutations that have been presented to it for moving forward, but it appears that Auer deference in its current form stands on very shaky ground.

Oral argument is scheduled for March 27.

Kisor – Government Response Brief

Kisor – Amicus Brief by Administrative Law Scholars in Support of Auer

Briefing Underway in Kisor

The opening salvo has been filed in the Supreme Court challenge to the continuing vitality of what is usually called either Seminole Rock or Auer deference – the rule that a court owes deference to an agency’s interpretation of its own regulations. See our prior report here. The petitioner, a Vietnam veteran seeking disability benefits, has filed his opening brief, supported by 25 different amicus briefs.

The petitioner argues that Auer deference is unjustified for three principal reasons. First, petitioner contends that it is incompatible with the Administrative Procedure Act (APA) because it allows an agency to exercise lawmaking authority through administrative interpretation without adhering to the APA’s procedural safeguards of public participation and agency accountability through notice-and-comment rulemaking.

Second, petitioner argues that Auer is a judge-made rule that destabilizes administrative law because it allows an agency to receive deference to what may not be the best interpretation of a regulation, even if it is “reasonable.” That can unfairly confound an individual who can only try to conform his or her conduct to what appears to be the best interpretation of the regulation. Petitioner adds that Auer deference is “especially suspect . . . where the agency has an economic interest in the outcome,” such as when the interpretive issue relates to a monetary claim against the government.

Third, petitioner contends that Auer is incompatible with separation-of-powers principles because it “renders an agency simultaneously a law’s maker and its expositor.” That is in contrast to Chevron deference, which respects Congress’s power because it “rests on agency compliance with the APA.”

The petitioner adds that principles of stare decisis should not deter the Court from overruling Auer. He notes that this is a purely judge-made rule and that the seminal 1945 decision in Seminole Rock provided no reasoning for the doctrine. The petitioner also argues that “no private reliance interests rest on Auer’s continuing vitality” and that reexamination is warranted because of the substantial expansion of the role of administrative agencies in our government since Seminole Rock was decided.

Linked below is the petitioner’s brief and the amicus brief of Professor Thomas Merrill, a leading academic expert on administrative law, who argues that Auer should be overruled and that instead agency interpretations of regulations should be afforded the much more modest recognition of so-called Skidmore deference, which gives weight to an agency interpretation to the extent it has the “power to persuade.” Professor Merrill argues that “the persuasiveness standard would require reviewing courts to engage with and give respectful consideration to the agency’s experience in implementing the statutory regime and familiarity with its own regulations, respect that de novo review would not require.” Like the petitioner, Professor Merrill states that Chevron deference is consistent with the APA, and he does not suggest that the Court should retreat from Chevron. The other 24 amicus briefs can be found on the Supreme Court’s website.

The government’s response brief is due February 25. Oral argument has been scheduled for March 27.

Kisor – Petitioner’s Opening Brief

Kisor – Amicus Brief of Professor Merrill

Briefing Completed in SIH Partners

The final briefs have now been filed in the SIH Partners case.  The government’s response to the taxpayer’s opening brief is long, but hammers extensively on one point — namely, that the regulation is “categorical” in establishing that a loan guarantee issued by a CFC will be treated as taxable.  (The word “categorical” appears 29 times in the government’s brief.).  And the government maintains that this “bright-line” rule flows directly from the statutory text.  Given that premise, the government is able to give most of the taxpayer’s arguments short shrift.

In particular, the government says that the settled legal landscape made it easy for tax planners.  If the taxpayer chose to use its CFC to guarantee the loan, then it should accept the predictable tax consequences of that choice, rather than allegedly seeking a “sea change” in the governing rules that would replace a bright-line rule with a facts and circumstances inquiry.  Whether or not the loan guarantee reflects something like an “actual repatriation,” or was actually necessary for credit purposes, or is affected by other guarantors are all “wholly irrelevant” in the government’s view.  

The government similarly disposes of the taxpayer’s administrative law argument.  It states that the statutory text established a categorical rule and the commenters did not argue that Treasury should adopt a non-categorical rule; therefore, the relatively sparse explanation for the regulation was not problematic.  In the government’s words, “that an explanation is brief does not mean that it is inadequate.”  Interestingly, the government goes on to make a fallback argument that it acknowledges was not presented to the Tax Court.  It argues that, even if the regulation is invalid for failure to comply with the APA, the outcome of the case would not change because the statute is “self-executing,” and therefore the statute itself would make the loan guarantee a taxable event.

Finally, the government states that the taxpayer has provided no sound reason for the court not to follow Rodriguez and other lower court decisions that reach the same result, and therefore the taxpayer is not entitled to be taxed at the lower qualified dividend rate.

The taxpayer begins its reply brief by citing to a notice of proposed rulemaking issued 11 days before the government’s brief was filed.  The proposed regulations would “reduce the amount determined under section 956” in certain instances in light of the Tax Cuts and Jobs Act.  The taxpayer argues that the reasoning in the notice contradicts the government’s position because the notice describes the IRS’s “longstanding practice” as trying to “conform the application of section 956 to its purpose,” and thus to try to achieve symmetry between section 956 taxation and actual repatriations of earnings.

Apart from the new proposed regulations, the taxpayer argues that the statutory language governing guarantees did not establish a categorical rule, but rather left the proper tax treatment to be determined by regulation.  Therefore, Treasury had to make a choice and was required to explain the bright-line choice that it made.  And similarly, regulation was required, and the statute cannot be treated as self-executing.  

With respect to the dividend rate issue, the taxpayer urges the court not to follow Rodriguez.  In that connection, it states that the Rodriguez court mistakenly believed that Congress specifically designates when section 951 inclusions are to be treated as dividends, when in fact there are Treasury regulations that treat inclusions as dividends without specific statutory authorization.

Supreme Court to Reconsider Important Administrative Law Precedent

The Supreme Court granted certiorari this morning in a non-tax case that should be of considerable interest to tax litigators because of the important administrative law principle that will be decided.  In Kisor v. Shulkin, the Federal Circuit applied the government’s interpretation of the governing regulation in ruling against a veteran’s claim for disability benefits.  The court found that the regulation was ambiguous, and therefore it ruled that it should defer to the government’s interpretation under the longstanding Supreme Court precedents of Bowles v. Seminole Rock & Sand Co., 325 U.S. 410 (1945), and Auer v. Robbins, 519 U.S. 452 (1997).  The court denied rehearing en banc, although three judges joined an opinion dissenting from that denial.  The Supreme Court has now granted certiorari specifically to address the question “[w]hether the Court should overrule Auer and Seminole Rock.”

Auer deference has played an increasingly prominent role in tax cases since the Supreme Court’s decision in Mayo Foundation made tax cases subject to general administrative law principles.  Revenue Rulings and other lower level administrative interpretations of Treasury regulations are pervasive in the tax area and are subject to being relied upon by courts under Auer deference principles.  And the government has even argued for Auer deference to interpretations stated in its briefs, with the Second Circuit agreeing with that argument.  See, e.g., our prior coverage of the MassMutual and Union Carbide cases here and here.  If Auer is overruled, taxpayers will likely benefit in future litigation involving conflicting views of the meaning of a Treasury regulation.

In recent years, several individual Justices have expressed concern about the wisdom of Auer or Seminole Rock deference, pointing out that it potentially allows an end run around the notice-and-comment procedure for issuing regulations and arguably violates separation-of-powers principles.  Instead of noticing clear regulations that can reasonably be commented upon, Auer enables agencies to promulgate ambiguous regulations and then later to provide administrative interpretations of those regulations (outside the notice-and-comment framework) that create a rule to which courts must defer.  Justice Scalia (who ironically was the author of Auer) was the first to suggest publicly back in 2011 that the Court should reconsider the Auer deference doctrine.  See Talk Am., Inc. v. Michigan Bell Tel. Co., 564 U.S. 50 (2011) (Scalia, J., concurring). In Decker v. Northwest Envtl. Def. Center, 568 U.S. 597, 615 (2013), Chief Justice Roberts and Justice Alito remarked that Justice Scalia had raised “serious questions” about the doctrine.  More recently, in Perez v. Mortgage Bankers, 135 S. Ct. 1199 (2015), Justice Scalia stated flatly that Auer should be “abandoned,” and Justice Thomas wrote a long concurring opinion explaining his view that Auer deference was “constitutionally suspect.”  Justice Alito added that those two Justices had “offered substantial reasons why the Seminole Rock doctrine may be incorrect.”  And just this past March, Justice Gorsuch joined an opinion of Justice Thomas dissenting from the Court’s denial of certiorari in which the latter again described Auer as “constitutionally suspect.”  Garco Construction, Inc. v. Speer, No. 17-225 (Mar. 19, 2018).  Thus, even with Justice Scalia no longer on the Court, four sitting Justices have indicated great skepticism, to put it mildly, about the continuing vitality of Auer deference.  In addition, in a keynote address at a 2016 conference at the Antonin Scalia (George Mason) Law School, Justice Kavanaugh spoke approvingly of Justice Scalia’s criticism of Auer deference and predicted that Justice Scalia’s view would become the law.  Things can change when cases are fully briefed and argued in the Supreme Court, but for now the future of Auer/Seminole Rock deference looks bleak.

The petitioner’s opening brief is due January 31, and the case should be argued in the spring and decided by June 2019. 

Kisor – Petition for Certiorari

Third Circuit to Consider Validity of Subpart F Regulations Governing Loan Guarantees

In SIH Partners v. Commissioner, the Tax Court upheld the IRS’s determination that loan guarantees by two controlled foreign corporations (CFCs) resulted in income inclusions subject to taxation in the U.S. as ordinary income under subpart F. The CFC earnings were actually distributed to the U.S. shareholder in 2010 and 2011 and reported then as qualified dividends taxable at 15 percent. But the IRS determined that, under the section 956 regulations, those earnings should have been taxed at the 35 percent ordinary income rate in 2007 and 2008 when the CFCs served as co-guarantors of loans.

The taxpayer raised three basic objections to the Commissioner’s determination. First, it argued that the regulations implementing Code section 956(d)—the regulations under which the IRS treated the loan guarantees as investments in U.S. property to be included in U.S. income—were invalid under the Administrative Procedure Act. Second, it argued that even if the regulations were valid, there should be no income inclusion under the particular facts and circumstances of the guarantees. Third, it argued that, in any event, the Subpart F income should be taxed at the lower qualified dividend rate because the underlying theory of the section 951 income inclusion is that the guarantee is deemed to be a dividend.

The Tax Court rejected all three arguments. It discussed at length the taxpayer’s argument that Treasury failed “the reasoned decisionmaking and reasoned explanation requirements” of Motor Vehicle Mfrs. Assn. v. State Farm Mut. Automobile Ins. Co., 463 U.S. 29 (1983), because it did not explain the regulatory treatment of guarantees when it issued the regulations back in 1963-64. (Compliance with State Farm has increasingly become an issue in tax cases in recent years. The Tax Court identified a State Farm problem with the cost-sharing regulations in Altera because of Treasury’s failure to address particular comments in the rulemaking (see our report on the Tax Court’s Altera decision here), and the Federal Circuit struck down on State Farm grounds a section 263A capitalization regulation in the Dominion Resources case (see our report here)).

The Tax Court found that the regulatory process for the section 956 regulations complied with State Farm’s reasoned decisionmaking requirement, describing this case as distinguishable from State Farm for several reasons, including that: (1) it “did not reverse previously settled agency policy”; (2) the regulations “were not promulgated contrary to facts or analysis that supported a different outcome”; (3) “Treasury’s decision did not (and could not) purport to rely on findings of fact”; and (4) “no substantive alternatives to the final rules were presented for Treasury’s consideration during the rulemaking process.” The Tax Court was untroubled by the lack of explanation for the regulatory determinations, rejecting the notion that “an on-the-record consideration of any particular factors is required for rulemaking under section 956(d).”

The Tax Court also ruled that the regulations were not “arbitrary and capricious” in imposing a blanket rule that treats any CFC guarantor as holding U.S. property equal to the principal value of the obligation guaranteed. The court stated that the legislative history indicated that “Congress itself thought extensively about which transactions should be treated the same as repatriations of CFCs’ earnings,” and there was nothing to suggest that “Congress expected Treasury to craft ad hoc exceptions based on some sort of facts-and-circumstances test.” Thus, even though the court acknowledged that the blanket rule led to illogical results in some cases where the full amount of the guarantee cannot reasonably be viewed as a repatriation, the court concluded that it “is not manifestly contrary to the statute or unreasonable that the agency would choose a broad baseline rule for pledges and guarantees as opposed to a less administrable case-by-case approach.” Finally, the court observed that it was “relevant,” albeit not dispositive, that the regulations in question had been on the books for nearly 50 years before the guarantee transactions.

Having upheld the validity of the regulations, the Tax Court gave short shrift to the taxpayer’s other contentions. The taxpayer argued convincingly that the circumstances of the guarantees, including the existence of other guarantors, were such that there clearly was no equivalent to an actual repatriation in the full amount of the guarantees. The court declared this evidence “irrelevant” because the regulations were categorical and made “no provision for reducing the section 956 inclusion by reference to the guarantor’s financial strength or its relative creditworthiness.” With respect to denying the lower qualified dividend rate, the court relied on its prior decision in Rodriguez v. Commissioner, 137 T.C. 174 (2011), aff’d, 722 F.3d 306 (5th Cir. 2013), which held that treating a CFC’s investment in U.S. property “as if it were a dividend” under section 956 does not mean that the tax rate for actual dividends should apply. See our prior coverage of Rodriguez here.

The taxpayer has appealed to the Third Circuit, raising the same basic three arguments. In challenging the validity of the regulations, the taxpayer argues primarily that the regulations are arbitrary and “ignore both congressional intent and economic reality” by creating “broad-brush rules” that treat “every CFC guarantor of a U.S. person’s loan as though it has made the full amount of the guaranteed loan.” The taxpayer maintains that even the IRS in its past administrative guidance had recognized that it is arbitrary to ignore particular facts and circumstances showing that a guarantee is not equivalent to a repatriation; hence, the government is staking out new ground with its current position requiring strict adherence to the letter of the regulation. Secondarily, the taxpayer argues that Treasury’s failure to provide a sufficient reasoned explanation for the regulatory rule violated State Farm principles.

Assuming that the regulations are valid, the taxpayer argues that the court of appeals should follow prior IRS guidance and remand the case to the Tax Court to examine the particular facts and circumstances “to determine whether, in substance, there was a repatriation of CFC earnings.” Finally, the taxpayer argues that the Rodriguez case was wrongly decided and therefore the included income should be taxed at no higher than the qualified dividend rate. The taxpayer points out that the government’s theory for accelerating the recognition of income from the actual repatriation date to the earlier guarantee date is that the guarantees were “an investment in U.S. property that is substantially equivalent to a dividend.” If so, the taxpayer argues, the government cannot “simultaneously argu[e] that they are not substantially equivalent to a dividend for purposes of the applicable rate.”

The government’s answering brief is due November 16.

SIH – Tax Court opinion

SIH – Taxpayer Opening Brief

Altera Case Submitted for Decision

The reargument of the Altera case was held on October 16. Chief Judge Thomas, who penned the original majority decision, was quiet during the argument, asking only one question. But both Judge O’Malley, who wrote the original dissent, and Judge Graber, who is the new judge on the panel and who might reasonably be expected to cast the deciding vote, were very active questioners. A video tape of the argument can be viewed at this link.

The oral argument was not quite the last gasp in the parties’ presentations to the panel. At the end of the week, counsel for Altera filed a post-argument letter further addressing some of the points that were raised at the argument. The letter stated that some of the statements made by government counsel at the argument were contrary to the provisions of Treas. Reg. § 1.482-4(f)(2)(ii), and that these departures from the existing regulations underscored why adminstrative law principles “do not permit an abandonment of arm’s-length evidence and the parity principle, even if the statute permitted it, without complying with the rules governing administrative procedure.” The government filed its own letter in response, asserting that its counsel’s statements did “not contradict any Treasury regulations” and did not implicate the administrative law principles referenced by Altera.

These letters are attached below.

The case is now submitted for decision. Ordinarily, one would expect several months to elapse after argument before a decision from the Ninth Circuit would issue in a complex case. (The original opinion in this case was issued more than nine months after the oral argument.) Given that Judges Thomas and O’Malley have already written opinions in the case, however, it is very possible that a decision could come much sooner.

Altera – Altera post-argument letter

Altera – Government post-argument letter

 

Supplemental Briefing Completed in Altera

Attached are the four supplemental briefs filed by the parties in the Altera case.  First, in anticipation of the reargument of the case, with Judge Graber now sitting on the panel in place of the deceased Judge Reinhardt, the court invited the parties to file supplemental briefs limited to half of the length of a normal court of appeals brief.  This briefing opportunity was designed to give the parties the chance to restate or add to their arguments on the issues previously addressed in the case, having now had the opportunity to read the competing opinions of Judges Reinhardt and O’Malley that had been vacated.  Although the court’s order took pains to tell the parties that they were “permitted, but not obligated,” to file “optional” supplemental briefs, it will surprise no one that both parties took advantage of the option and filed supplemental briefs on September 28 that pressed right up against the 6500 word limit.  In addition to the parties’ briefs, four supplemental amicus briefs were filed by:  1) the Chamber of Commerce; 2) a group of trade associations; 3) Cisco; and 4) a group of law school professors, with that last one being in support of the government.

This deluge of paper, however, was not enough for the panel.  On the same day that the supplemental briefs were due, the court issued the following order inviting another set of supplemental briefs on the question whether Altera’s suit was barred by the statute of limitations:

“The parties should be prepared to discuss at oral argument the question as to whether the six-year statute of limitations applicable to procedural challenges under the Administrative Procedure Act, 28 U.S.C. 2401(a), applies to this case and, if it does, what the implications are for this appeal. Perez-Guzman v. Lynch, 835 F.3d 1066, 1077-79 (9th Cir. 2016), cert. denied, 138 S. Ct. 737 (2018). Additionally, the parties are permitted, but not obligated, to file optional simultaneous supplemental briefs on this question on or before October 9, 2018. The briefs should be no longer than 6,500 words [that is, half the length of an ordinary appellate brief].”

The court’s injection of this new issue into the case was potentially a very significant development.  If the court were to conclude that Altera’s APA challenge was barred by the statute of limitations, the Ninth Circuit decision in Altera would not shed any light on any of the important issues thought to be presented involving the APA or the substance of the cost-sharing regulations.

In the end, however, it appears that the court’s latest order will not amount to anything.  Altera filed a full-fledged supplemental brief in response to the court’s order in which it raised several objections to the court’s suggestion, including an argument that the government had waived any possible statute of limitations claim.

More significantly, the government did not embrace the court’s suggestion either.  The government simply filed a short letter brief in which it stated that any prepayment suit filed by Altera within the six-year limitations period would have been barred by the Tax Anti-Injunction Act.  (In this connection, the government cited to its brief in the Chamber of Commerce case; see our coverage of that appeal here.)  Hence, the government acknowledged that it would be “unfair” to Altera if that six-year period were held to bar its later suit because that would have the effect of depriving Altera of any ability to sue in the Tax Court.   Moreover, the government noted that the limitations period is not “jurisdictional” and therefore, even if it would otherwise be applicable, the government had waived its right to invoke a limitations defense just as Altera argued in its brief.  The government concluded by stating its position that the six-year statute of limitations that is generally applicable to  APA challenges “does not apply to this case.”  Thus, there is no realistic possibility that the Ninth Circuit will toss the case on statute of limitations grounds, and it can be expected to address the important issues presented by the Tax Court’s opinion.

The oral argument is scheduled for October 16.

Altera – Altera Supplemental Brief

Altera – Government Supplemental Brief

Altera – Altera Statute of Limitations Supplemental Brief

Altera – Government Statute of Limitations Letter Brief

Altera Opinion Withdrawn

In a surprising move, the Ninth Circuit announced today that it has withdrawn its opinion in Altera “to allow time for the reconstituted panel to confer on this appeal,” even though no petition for rehearing has been filed yet.  See our prior report on the Altera decision here.  The mention of  the “reconstituted panel” refers to an order issued by the court last week that appointed Judge Graber as a replacement judge for Judge Reinhardt, who passed away in March.

At the time, the order appointing Judge Graber seemed to be an exercise in closing the barn door after the horse is gone.  But it now appears that Judge Graber is being asked to review the case and give her independent judgment regarding the issues, notwithstanding the decision issued in July.  If so, that would place the outcome in doubt again, since the two other living judges, Chief Judge Thomas and Judge O’Malley, differed on their views of the case.

In some courts, the death of a judge while a case is under consideration automatically means that the judge’s vote will not count.  Unless the remaining two judges agree, that death would necessitate appointing a third judge to render a decision.  But the Ninth Circuit does not follow that approach.  The now-withdrawn opinion recited that “Judge Reinhardt fully participated in this case and formally concurred in the majority opinion prior to his death.”  For whatever reason, the court now seems to have decided on its own that it made a mistake in allowing Judge Reinhardt to cast the decisive vote from the grave in such an important case.

Altera – Ninth Circuit order substituting Judge Graber

Altera – Ninth Circuit order withdrawing opinions

 

Chamber of Commerce Appeal Dismissed

We reported earlier that it was likely the government would dismiss its appeal in the Chamber of Commerce case once final regulations were issued addressing inversion transactions.  Those regulations were issued on July 11.  Yesterday, the government moved to dismiss the appeal with prejudice as moot (without specifying the final regulations as the cause), and the court immediately entered an order dismissing it.  Thus, there will be no appellate review of the novel issues raised by the district court’s decision in this case regarding temporary regulations and the Administrative Procedure Act.  See our prior report here.

It is possible that the government will consider asking the district court to vacate its decision because the appeal became moot.  Vacatur might have been appropriate under the old rule of United States v. Munsingwear, Inc., 340 U.S. 36 (1950).  But because the mootness was caused by the government’s own action of issuing final regulations, a motion to vacate likely will not be granted under the current standard set forth in U.S. Bancorp Mortgage Co. v. Bonner Mall Partnership, 513 U.S. 18 (1994).

Chamber of Commerce – Fifth Circuit Order Dismissing Appeal

Chamber of Commerce – Government Motion to Dismiss

Ninth Circuit Reverses Altera and Revives Cost-Sharing Regulations

The Ninth Circuit today by a 2-1 vote reversed the Tax Court’s Altera decision that had invalidated Treasury regulations requiring taxpayers to include employee stock options in the pool of costs shared under a cost-sharing agreement. See our previous reports here. The court’s decision (authored by Chief Judge Thomas) held that the regulations were a permissible interpretation of Code section 482 in imposing that requirement even in the absence of any evidence that taxpayers operating at arm’s length actually share such costs in similar arrangements. The court also held that Treasury’s rulemaking did not violate the Administrative Procedure Act (APA).

The court’s opinion follows the structure of the government’s brief in first analyzing section 482, even though the Tax Court decision rested on the APA. The court began with a detailed history of the development of section 482 and the related regulations. Quoting a law review article, the court stated that Congress and the IRS gradually realized in the years after 1968 that the arm’s-length standard “did not work in a large number of cases” and therefore they made “a deliberate decision to retreat from the standard while still paying lip service to it.” Relying heavily on legislative history, the court stated that the addition of the “commensurate with income” language in the 1986 Act was intended “to displace a comparability analysis where comparable transactions cannot be found.”

Armed with that conclusion, the court found that there was no violation of the APA. The court explained that the commenters had attacked the regulation as inconsistent with the arm’s-length standard, but Treasury in its notice had “made clear that it was relying on the commensurate with income provision”; therefore, the comments in question were just “disagree[ing] with Treasury’s interpretation of the law,” and there was no reason for Treasury to address those comments in any detail. The taxpayer argued that the notice of rulemaking indicated that Treasury would be applying the arm’s-length standard and therefore the Chenery principle of administrative law did not permit the regulations to be defended on the ground that the arm’s-length standard did not apply. See our prior summary of the parties’ arguments here. The court rejected this argument in cursory fashion, stating that it “twists Chenery . . . into excessive proceduralism.” It maintained that the citation of legislative history in the notice was a sufficient indication that Treasury believed that it could dispense with comparability analysis, and therefore the regulations were not being upheld on a different ground from the one set forth by the agency.

Having concluded that there was no APA violation in issuing the regulations, the court then applied the Chevron standard of deferential review to analyze the regulations, and it concluded that they were a reasonable interpretation of the statute. Pointing to the legislative history, the court ruled that the “commensurate with income” language was intended to create a “purely internal standard . . . to ensure that income follows economic activity.” The court added that “the goal of parity is not served by a constant search for comparable transactions.” Rather, by amending section 482 in 1986, Congress had “intended to hone the definition of the arm’s length standard so that it could work to achieve arm’s length results instead of forcing application of arm’s length methods.”

Finally, the court rejected the argument that the new regulations were inconsistent with treaty obligations. It remarked that “there is no evidence that the unworkable empiricism for which Altera argues is also incorporated into our treaty obligations,” describing the arm’s-length standard as “aspirational, not descriptive.”

Judge O’Malley (of the Federal Circuit, sitting by designation) dissented. She approached the case along the lines of the taxpayer’s argument and concluded that the Tax Court had correctly found an APA violation because “[i]n promulgating the rule we consider here, Treasury repeatedly insisted that it was applying the traditional arm’s length standard and that the resulting rule was consistent with that standard.” And “Treasury never said . . . that the nature of stock compensation in the [cost-sharing] context rendered arm’s length analysis irrelevant.” Accordingly, “Treasury did not provide adequate notice of its intent to change its longstanding practice of employing the arm’s length standard.” Finally, Judge O’Malley also noted her disagreement with the majority’s conclusion on the merits that the regulations are consistent with section 482. She explained that the plain language of the commensurate with income provision restricts its application to a “transfer (or license) of intangible property,” which would not encompass a cost-sharing agreement, even if the agreement relates to joint development of intangibles.

It is likely that the taxpayer will seek rehearing of the decision by the full Ninth Circuit, especially since such a rehearing petition was successful a decade ago in Xilinx. A rehearing petition would be due on September 7. If the taxpayer elects not to seek rehearing, a petition for certiorari would be due October 22.

Altera – Ninth Circuit opinion

 

Briefing Delays in Chamber of Commerce Could Portend Dismissal of Appeal

The government’s appeal in the Chamber of Commerce case raises important issues of administrative law (see our previous report here), but it seems increasingly unlikely that the court of appeals will ever reach those issues.

The government’s opening brief was filed in March. That brief (linked below) addresses several issues—including standing, the Anti-Injunction Act, and the authority of temporary regulations issued without notice-and-comment. At the time, the government had sought to avoid having to file its brief at all, filing a motion shortly before the (already extended) due date that asked the court of appeals to stay the briefing schedule indefinitely to await the “imminent” issuance of final regulations addressing inversions. The motion explained that, “having completed notice and comment, Treasury and IRS plan to finalize the proposed regulation,” and stated that the government would then “reevaluate whether it should proceed with this appeal.” As an alternative to a complete stay of the briefing, the government asked for an additional 45-day extension until April 30 to file its brief, and the plaintiffs consented to that extension request.

The court of appeals, however, did not act on the extension request before the due date, and the government accordingly filed its brief on March 16. It thus appeared for a time that the court of appeals might move forward towards deciding the case without waiting for the issuance of final regulations. That is no longer the case.

The court first granted the plaintiffs a fairly routine 45-day extension until May 31. But today the court granted the plaintiffs an additional 60-day extension until July 30. This extension, to which the government consented, is expressly linked to the issuance of the final regulations. Treasury has announced that those regulations will be issued in June, and the plaintiffs state in their motion that the extension is necessary to “facilitate the parties’ efforts to determine whether the final rule will cause the Government to dismiss its appeal or will otherwise affect the presentation of the issues.”

Although the government’s original motion back in March did not commit it to dismissing the appeal, it strongly signaled that the government is inclined towards that course of action once the final regulations are in place. Under Federal Rule of Appellate Procedure 42, an appellant can voluntarily dismiss its appeal as long as it pays certain costs to the appellee. Thus, even if the plaintiffs would want the appeal to continue in order to obtain an appellate decision on the broad administrative law issues, they cannot prevent the government from dismissing the appeal if it chooses to do so.

Chamber of Commerce – Appellees Request for Extension

Chamber of Commerce – Opening Brief for US

Chamber of Commerce – US motion for stay

Fifth Circuit Poised to Consider Validity of Temporary Regulations Aimed at Curbing Inversions

We present here a guest post by our colleague Katherine Zhang.

In Chamber of Commerce v. Internal Revenue Service, the Fifth Circuit will consider whether “tax exceptionalism” exists in the context of temporary regulations. At issue in the case are Treasury regulations that provide special rules for calculating the “ownership fraction” for entities engaged in inversion transactions. The district court set aside the regulations as promulgated in violation of the Administrative Procedure Act (APA), and the government has appealed.

Since the Supreme Court consigned the broad notion of “tax exceptionalism” to the scrap heap in Mayo Foundation, 562 U.S. 44 (2011) (see our prior reports here and here), by applying Chevron deference principles to Treasury regulations, the courts have increasingly grappled with the extent to which the APA constrains the promulgation of Treasury regulations. The Altera case pending in the Ninth Circuit presents another important facet of the general interplay between the APA and Treasury regulations (see our reports on Altera here). In this case, the focus is on APA constraints on the issuance of temporary regulations.

Generally, an “inversion transaction” occurs where a foreign corporation replaces the U.S. parent of a multinational group. If the transaction meets certain criteria, then Code section 7874 applies to impose adverse U.S. tax consequences on the parties involved. One key criterion is that, after the transaction, former shareholders of the U.S. parent hold at least 60 percent of the stock of the new foreign parent. This percentage is commonly referred to as the “ownership fraction,” and it may be measured by either vote or value. If the ownership fraction is at least 60 percent and less than 80 percent, then in the ten-year period after the transaction, U.S. tax is imposed on income or gain recognized in this period from transfers or licenses that are part of the transaction or that are made to foreign related persons after the transaction. The resulting liability cannot be reduced by tax attributes such as net operating losses or foreign tax credits. If the ownership fraction is at least 80 percent, then the new foreign parent is treated as a domestic corporation.

In April 2016, the Treasury Department invoked its broad regulatory authority under section 7874 to adopt special rules for calculating the ownership fraction. Under one of these rules, the denominator of the ownership fraction (by value) disregards stock of the foreign corporation attributable to certain prior domestic entity acquisitions. As a result, the ownership fraction increases, and the 60 percent threshold brings more transactions within the ambit of section 7874. The rule is designed to prevent companies from using a series of transactions to safely achieve an inversion that would fall within section 7874 if done all at once or as part of a single plan. The rule was issued both as a temporary regulation that was effective immediately and as a proposed regulation.

This rule is the central focus of Chamber of Commerce. In August 2016, the U.S. Chamber of Commerce and the Texas Association of Business filed suit in the Western District of Texas, arguing that the rule was invalid for failure to meet the requirements of the APA. The government contested both the plaintiffs’ power to bring suit and the merits of the APA objections.

The district court first rejected the government’s jurisdictional challenges that were raised in a motion to dismiss. A plaintiff generally must establish standing by demonstrating that it suffered an “injury in fact” that was caused by the defendant’s conduct and that likely would be redressed by a favorable decision. But an association has standing to bring suit on behalf of its members if, among other elements, the members would have standing to sue in their own right. The court agreed that both plaintiffs had standing because Allergan plc was a member of each trade association.

Shortly after Treasury and the IRS issued the rule in April 2016, Allergan announced the cancellation of a previously announced merger with Pfizer Inc. According to the plaintiffs, the rule eliminated the tax benefits of the merger—because Allergan’s “corporate composition” included several prior acquisitions of domestic corporations, the rule would have applied to cause the entity resulting from the merger to be treated as a domestic corporation subject to U.S. federal income tax. On this basis, the court found that Allergan would have standing to sue in its own right. Although Allergan did not have a specific transaction pending, there was no need for it to “engage in futile negotiations” for a transaction that the rule has “altogether foreclosed or made economically impracticable.” Instead, it was sufficient that Allergan “identified a specific transaction that was thwarted by the Rule and asserted that it would actively pursue other inversions if this court were to set aside the challenged Rule.” The court went on to conclude that the plaintiffs demonstrated “injury in fact” by showing that Allergan was the “targeted object” of the rule. Therefore, the plaintiffs “have alleged an actual, concrete injury, that is fairly traceable to implementation of the Rule, and that would be redressed by a decision setting aside that Rule.”

The court also determined that the suit was not barred by the Anti-Injunction Act, which prohibits suits “restraining the assessment or collection of any tax.” According to the court, the plaintiffs’ suit did not seek to restrain the assessment or collection of tax. Citing Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2015), which analyzed the analogous Tax Injunction Act applicable to state taxes, the court reasoned that “[a]ssessment and collection of taxes does not include all the activities that may improve the government’s ability to assess and collect taxes.” Here, rather than trying to restrain the assessment or collection of tax, the plaintiffs merely challenged the validity of a rule “so that a reasoned decision can be made about whether to engage in a potential future transaction that would subject them to taxation under the Rule.” The rule itself did not constitute the assessment or collection of tax, but only determined who was subject to tax and facilitated the assessment or collection of tax.

The court then turned to the plaintiffs’ motion for summary judgment, which raised the substantive claims of an APA violation. Broadly speaking, the APA governs agency actions and judicial review of such actions. Provisions of the APA governing agency rulemaking require agencies to publish a notice of proposed rulemaking in the Federal Register and to provide “interested persons” with an opportunity to comment. The proposed rule must be published no less than 30 days before its effective date, to allow for adequate opportunity to comment. The APA also directs a reviewing court to “hold unlawful and set aside” certain types of agency action, including actions that exceed statutory jurisdiction, actions that are arbitrary and capricious, and actions taken without procedure required by law. The plaintiffs challenged the rule on all three of these grounds.

The district court rejected the plaintiffs’ first two arguments, finding that the rule did not exceed Treasury and the IRS’s statutory jurisdiction and did not constitute arbitrary and capricious rulemaking. The court reached a different result, however, with respect to the plaintiffs’ third argument, ruling that issuance of the rule as an immediately effective temporary regulation violated the APA’s notice-and-comment requirements.

The government argued for a form of “tax exceptionalism” based on Code section 7805(e), which states that Treasury can issue temporary regulations (subject to automatic expiration after three years), as long as those temporary regulations are accompanied by proposed regulations that are subject to notice and comment. Although that provision contains no language restricting temporary regulations from becoming effective immediately, the court was not persuaded. The APA specifically contemplates that subsequent statutes might override its notice-and-comment requirements, but it requires that statutes make this change “expressly.” 5 U.S.C. § 559. According to the court, section 7805 did not make any such change “expressly”—it refers to effective dates of regulations in connection with limitations on retroactivity in section 7805(b), but “neither explicitly states nor suggests congressional intent to allow a regulation to become effective earlier in relation to publication than provided for in the APA.” The court also declined to look for any such intent in the legislative history, saying that it “will not disregard explicit directives of the APA in favor of legislative history.”

The court also held that the rule did not qualify for the APA’s exception for “interpretative” rules, which exempts such rules from notice-and-comment requirements. 5 U.S.C § 553(b)(A). As described by the court, an interpretative rule advises the public as to the “agency’s construction of the statutes and rules which it administers,” while a substantive rule “affects individual rights and obligations” and “is issued by an agency pursuant to statutory authority.” The court determined that the rule at issue was a substantive rule—it was promulgated pursuant to subsections of section 7874 that authorized Treasury to issue regulations to provide for “adjustments to the application of this section” and to “treat stock as not stock.” These types of rules are “modifications to the application of the statute,” not mere interpretations.

The impact of the Fifth Circuit’s decision in Chamber of Commerce could extend well beyond its effect on the particular inversion rule that is directly at issue. If the court of appeals agrees with the district court’s approach, its decision could well cast doubt on the validity of all temporary Treasury regulations. Conversely, the court of appeals may decide that, under section 7805, tax still is exceptional in at least one important respect.

The government’s opening brief is due March 16.

Chamber of Commerce – District Court opinion

 

Ninth Circuit Briefing Completed in Altera

The parties have now completed briefing in the Ninth Circuit in the Altera case, in which the Tax Court struck down Treasury regulations that require taxpayers to include employee stock options in the pool of costs shared under a cost-sharing agreement.  As described in our previous reports, the Tax Court’s decision implicated both the specific issue of whether the cost-sharing regulations are a lawful implementation of Code section 482 and the more general administrative law issue of the constraints placed on Treasury by the Administrative Procedure Act (APA) in issuing rules that involve empirical conclusions.

The government’s opening brief focuses only on the specific section 482 issue, maintaining that the Tax Court erred in believing that the challenged regulations involved empirical conclusions. Specifically, the government relies heavily on what it terms the “coordinating amendments” to the regulations promulgated in 2003.  Those amendments, which purport to apply the “commensurate with income” language added to section 482 in 1986 for intangible property, state in part that a “qualified cost sharing arrangement produces results that are consistent with an arm’s length result . . . if, and only if, each controlled participant’s share of the costs . . . of intangible development . . . equals its share of reasonably anticipated benefits attributable to such development.”  Treas. Reg. § 1.482-7(a)(3).  By its terms, this regulation states that determining whether a cost-sharing agreement meets the longstanding section 482 “arm’s length” standard has nothing whatsoever to do with how parties actually deal at “arm’s length” in the real world.  On that basis, the government argues that the APA rules are not implicated because the regulations did not rest on any empirical conclusions.  And for the same reason, the government argues that the Ninth Circuit’s earlier decision under the prior cost-sharing regulations, Xilinx v. Commissioner, 598 F.3d 1191 (9th Cir. 2010), is irrelevant since that decision was premised on the understanding (now allegedly changed by the amended regulations) that how parties actually deal at “arm’s length” was relevant to whether the section 482 “arm’s length” standard was met under those prior regulations, which did not explicitly provide a rule for stock-based compensation.  Finally, the government defends the validity of the regulation’s approach to “arm’s length” in the cost-sharing context as being in line with statements made in the House and Conference Reports on the 1986 amendments to section 482, which noted the general difficulty in finding comparable arm’s-length transfers of licenses of intangible property.

In its response brief, the taxpayer takes the government to task for relying on a “new argument” rather than directly addressing the reasoning of the Tax Court. The taxpayer first observes that Treasury never took the position in the rulemaking that the traditional “arm’s-length” standard in section 482 can be completely divorced from how parties actually operate at arm’s length—a position that assertedly “would have set off a political firestorm.”  Accordingly, the taxpayer argues that the government’s position on appeal violates the bedrock administrative law principle of SEC v. Chenery Corp., 318 U.S. 80 (1943), that courts must evaluate regulations on the basis of the reasoning contemporaneously given by the agency, not justifications later advanced in litigation.  And in any event, the taxpayer argues, this position cannot be sustained because it is an unexplained departure from Treasury’s longstanding position that the 1986 amendments to section 482 “did not change the arm’s-length standard, but rather supplied only a new tool to be used consistently with arm’s-length analysis rooted in evidence.”

The taxpayer describes the government’s reliance on the “coordinating amendments” in the regulations as “circular reasoning” that simply purports to define “arm’s length” to mean something other than “arm’s length.”  Even if that is what the regulations say, the taxpayer continues, the regulations could not be sustained because they depart “from the recognized purpose of Section 482 to place controlled taxpayers at parity with uncontrolled taxpayers” and conflict with “the arm’s-length analysis implicit in the statute’s first sentence.”

The government’s reply brief criticizes the taxpayer for not even arguing that its cost-sharing agreement clearly reflects income, and it therefore characterizes the taxpayer as arguing that “the arm’s-length standard gives related taxpayers carte blanche to mismatch their income and expenses.”  With respect to the correct interpretation of section 482, the government repeats its position from the opening brief, maintaining that the term “arm’s length” does not necessarily connote equivalence with real-world transactions.  Instead, the government argues that it is the taxpayer that departs from the statute by failing to give proper effect to the “commensurate with the income attributable to the intangible” language added in 1986.

The government responds to the Chenery argument by denying that it is arguing a different ground for the regulation than that advanced by Treasury.  Rather, the government states that its brief simply further develops the basis advanced by Treasury because it was clear in the regulations that emerged from the rulemaking that Treasury was rejecting the position that an “arms-length” standard can be applied only by looking at empirical evidence of transactions between uncontrolled taxpayers.

Although the briefs are quite long, the basic dispute can be stated fairly succinctly. The parties purport to agree that an “arm’s-length” standard must govern.  The taxpayer says that application of this standard always depends on analyzing actual transactions between uncontrolled parties, where available.  The government says no; in its view, “arm’s length” does not necessarily require reference to such transactions.  Instead, according to the government, in the cost-sharing context “Treasury prescribed a different means of ascertaining the arm’s-length result,” one that “is determined by reference to an economic assumption rather than by reference to allegedly comparable uncontrolled transactions.”

The intense interest in this case is illustrated by the filing of many amicus briefs. The government, which rarely benefits from amicus support in tax cases, is supported by two different amicus briefs filed by groups of law professors—six tax law professors joining in one of the briefs and 19 other tax and administrative law professors joining the second brief.  The taxpayer’s position is supported by seven amicus briefs—including one from the Chamber of Commerce and one from a large group of trade associations.  Four briefs were filed by individual companies—Cisco, Technet, Amazon, and Xilinx.  The seventh brief was filed by three economists—a business school professor (who testified as an expert witness for the taxpayer in Xilinx), a fellow at the American Enterprise Institute, and a managing director at the Berkeley Research Group.  They profess no financial interest in the outcome but argue, based on their experience in dealing with issues relating to stock-based compensation, that, as a matter of economics, the government’s approach is not consistent with how parties acting at arm’s length would proceed.

Notwithstanding the interest in the case, no decision is expected in the near future. The Ninth Circuit has a backlog of cases awaiting the scheduling of oral argument.  In recent years, oral arguments in tax cases typically have not been scheduled until at least a year after the briefing is concluded, and often closer to 18 months.  Thus, oral argument in this case should not be expected before next winter.  And then it will likely be several months after the argument before the court issues its decision.  So at this point, it would be surprising if there were a decision in Altera before mid-2018.

Altera – Taxpayer brief

Altera- Gov’t Opening Brief

Altera – Gov’t Reply Brief