Taxpayers get victories over administrative procedure law | Morrison & Foerster LLP

Two recent federal district court decisions assessed whether the process historically used by the Treasury Department and the Internal Revenue Service (“IRS”) to issue guidelines met the requirements of the Administrative Procedure Act (“APA”) . The decisions, CIC services and world freedom, examined the validity of a Notice of Interest Transaction and Interim Settlements, respectively. The ratepayers argued that the guidelines required notice and comment prior to enactment. District judges accepted and invalidated the guidelines.

CIC services[1]

Last year, the U.S. Supreme Court allowed CIC Services to continue its APA litigation against the IRS’ micro-captive notice (Notice 2016-66).[2] On remand, the district court determined that the notice was a rule of law subject to the APA’s notice and comment procedures and other requirements. Because the IRS failed to meet these APA requirements when issuing the notice, the court ruled that the notice was not valid under the APA.[3]

Further, the court found that the notice should be rescinded under the APA as an arbitrary and capricious agency action. The Court’s analysis on this point is consistent with that of the Tax Court in Altera where the court found that the Treasury was not supported belief that something is true is not enough to support a rule (in Altera“The Treasury’s belief that unrelated parties entering into [qualified cost-sharing agreements] would generally share the cost of stock-based compensation” and, in CICthe IRS “denial”[f] this operation (“micro-captive operation”) has the potential for tax evasion or evasion”).[4] We note that the Tax Court of Altera also discussed the deficient manner in which the Treasury responded to comments it received regarding the proposed cost-sharing rule as additional grounds for concluding that the Treasury rule was arbitrary and capricious. These two critical facts, namely the unsubstantiated nature of the Treasury’s conviction and its procedural mishandling of the relevant comments, led it to conclude that the cost-sharing rule violated the PPA.

In CIC, the administrative record for the notice contained no comments or other evidence of the IRS’ engagement with the public. The court therefore looked solely at the quality of the IRS creed support to assess whether it was acceptable under the APA:

The notice simply states that the IRS is aware of the micro-captive transactions and “believes” that these transactions have potential for evasion or tax evasion. While the Opinion goes on to describe these transactions, it does not identify any facts or data to support its belief. The IRS summary of the notice also fails to provide underlying facts and data.[.][5]

Thus, the court determined that the agency’s mere belief without any factual support was sufficient to expose the opinion as proceeding from arbitrary and capricious conduct and thus imposed an independent obligation on the IRS to collect relevant data. and to articulate a factual basis for its rule.

world freedom[6]

Remember Chamber of Commerce v IRS?[7] There, a district court ruled that certain temporary regulations issued under the anti-inversion rules of Section 7874 of the Internal Revenue Code (“IRC”) were invalid under the APA on the grounds that the Treasury did not authorize not public comments before publication.[8] The enactment of these temporary regulations did not include any statement of cause, which under the APA would at least ostensibly have satisfied an exception to the notice and comment requirement.

Record the provisional settlement in question in world freedom. Here, treasure did state “good cause” grounds (four reasons stated over several pages in the official publication of the preamble) for satisfying the exception to notice and comment under the APA. The district court, however, determined that the reasons given did not satisfy the good cause requirement.

At issue were temporary regulations under IRC Section 245A. Congress enacted IRC Section 245A as part of the Tax Cuts and Jobs Act (“TCJA”) in 2017, which grants a domestic corporation a deduction in respect of dividends received from specified foreign corporations in which the national company is a US shareholder. As part of the TCJA, Congress also enacted IRC Section 951A, the Global Intangible Low-Tax Income (“GILTI”) Rules, which subjects a portion of the income of such specified foreign corporations to current US federal income tax. The Treasury argued that Congress intended the 245A exemption for dividends received from specified foreign corporations to apply only when those foreign corporations are subject to the GILTI regime. The TCJA, however, allows the 245A exemption to apply to dividends paid after December 31, 2017, while the GILTI regime applies to a foreign corporation’s first tax year beginning after December 31, 2017. In calendar year taxation, the date shift in the law allowed a foreign company to pay exempt dividends to its shareholders before its profits became subject to the GILTI rules. The temporary regulations created additional criteria beyond the statutory framework to prevent taxpayers from taking advantage of this mismatch, criteria which the Treasury admitted to be “inconsistent with the literal application” of the law.[9]

The district court found the Treasury’s four reasons insufficient. The first ground, that the agency needed to take imminent and urgent action to prevent irreversible harm, is central to its assertion of the just cause exception. The Treasury said in the preamble that in the absence of rules with immediate effect, taxpayers would benefit from IRC Section 245A to the tune of billions of dollars. The district court accepted the claim at face value. Nonetheless, the court found that the Treasury had sufficient time to seek and consider the comments, particularly given the retroactive nature that could attach to any temporary post-comment regulations. As for the Treasury’s other grounds, the district court also rejected the suggestion that the Treasury did not have sufficient time to allow comment.

Don’t assume a regulation or rule is the last word

While these rulings are subject to appeal, there have also been (and will continue to be) appeal victories invalidating tax and non-tax agency rules based on APAs. For example, in early March of this year, the Sixth Circuit reversed a district court’s decision and ruled that an IRS notice regarding the listed transactions was not valid under the APA.[10] And, in late December last year, the Eleventh Circuit reversed the Tax Court’s decision and found that part of a conservation easement settlement was arbitrary and capricious and violated the procedural requirements of the APA.[11]

A lesson learned from recent years of tax litigation is, when considering the potential impact of a regulation or rule, to assess the genesis of the rule in light of ABS. The judicial trend is to bring much of Treasury and IRS guidance within the bounds of the APA, and any substantive rule issued without notice or comment raises a potential violation of the APA.

The enduring genius of the APA is to require (with rare exceptions) that an agency seek input from regulatees in order to craft a rule based on reason and fact that will best serve regulatees in pursuit of the purpose of the law. Just as taxpayers have to compromise when dealing with the government, the government has to compromise when dealing with them.[12]

[1] CIC Services, LLC v Internal Revenue Service129 AFTR 2d 2022-1119 (D.Tenn 2022).

[2] 141 S.Ct. 1582 (2021).

[3] In reaching its decision, the court held that the Sixth Circuit’s analysis in Mann Construction, Inc. v. United States, 129 AFTR 2d 2022-885 (6th Cir. 2022), which also implied the validity of an IRS opinion, was binding on the court and “equally applied” to the IRS’ arguments in this case. . In particular, the court noted that the Sixth Circuit “expressly rejected” the IRS’ arguments in Mann Building that “the notice was only an interpretative rule, which required no notice or comment and that, although the notice was a statutory rule, Congress exempted it from the requirements of the APA in that regarding its disclosure rules”. CIC Services129 AFTR 2d 2022-1119.

[4] The Ninth Circuit overturned the Tax Court in Altera circumventing this aspect of the Tax Court’s analysis. See Altera Corp. vs. Commissioner, 122 AFTR 2d 2018-5984 (9th Cir. 2018) rev’g 145 TC 91 (2015) (dissenting noting that “[t]The majority also ignores the Tax Court’s criticism that the final rule applied to all QCSAs, but was based solely on the Treasury’s beliefs about the subset of QCSAs involving “intangibles to High Yield” where stock-based compensation is a “significant component” of compensation. The Treasury’s inability to explain this jump and the Commissioner’s inability to defend it provide another reason why the Treasury failed to comply with the APA. (internal quotes omitted)); see also OVERVIEW: Altera v. Commissioner—The law on administrative procedure in a state of siege?

Bloomberg Tax: Daily Tax Report (August 1, 2019). The Tax Court decision remains a viable precedent in all other circuits.

[5] 129 AFTR 2d 2022-1119 (internal citations omitted).

[6] Liberty Global, Inc. v. United States129 AFTR 2d 2022-__, (D. Col.) (04/04/2022).

[7] 120 AFTR 2d 2017-5967 (WD Texas 2017), appeal rejected122 AFTR 2d 2018-5375 (5th Cir. 2018).

[8] The temporary regulations amounted to a drive-by assault effectively invalidating specific pending transactions where the regulatory criteria were perfectly suited to stop those taxpayers.

[9] See Liberty Global, Inc. v. United States 1:2020cv03501 | United States District Court for the District of Colorado | Justia for file.

[10] Mann Building129 AFTR 2d 2022-885.

[11] Hewitt c. Commissioner, 21 F.4th 1336 (11th Cir. 2021). But note that the Sixth Circuit recently came to the opposite conclusion in Oakbrook Land Holdings LLC v. Commissioner28 F.4e 700 (2022).

[12] We note that proposed regulations recently issued by the Treasury would limit review of IRS appeals to exclude taxpayer litigation risk considerations regarding an argument that a tax regulation, notice, or procedure is invalid unless until there is a final court ruling on the matter. See 87 Fed. Reg. 176 at 55942-43 (September 13, 2022).

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