What lessons should practitioners draw from the Supreme Court’s June 22, 2020, decision denying certiorari in Altera Corp. v. Comm’r of Internal Revenue? Though the regulations at issue in the litigation were ultimately upheld as a result of the Supreme Court’s decision, Altera marks but one of a growing number of instances where taxpayers seek to challenge IRS actions on procedural grounds. While this is happening in more than the regulatory arena (e.g., challenges to assessments of penalties based on failures to obtain appropriate and timely approvals), this note will concentrate on the cases challenging regulations on the grounds of procedural deficiency, i.e., that the IRS failed to follow the Administrative Procedure Act when promulgating the regulations. These cases show that this is a brand new world. Practitioners in the tax controversy field should not assume that IRS regulations are immune from procedural attack and should continue to raise the fundamental questions of whether the IRS complied with the APA.
Altera challenged a set of regulations issued by the IRS in 2003 requiring related parties that entered into cost-sharing agreements to share stock-based compensation. Altera—along with a host of other major corporations as amici—argued that unrelated parties who enter similar agreements do not share the cost of stock-based compensation. After the IRS issued notices of deficiencies to Altera and its U.S. subsidiaries adjusting the group’s income for the 2004-2007 tax years, Altera filed a petition with the Tax Court. In a rather rare 15-0 en banc decision, the Tax Court ruled in Altera’s favor, finding that the IRS’ decision-making process was fundamentally flawed because it rested on speculation rather than data and failed to respond to significant public comments. Altera Corp. & Subsidiaries v. Comm’r, 145 T.C. 91 (2015).
Altera’s victory would be short-lived, however. On appeal, the Ninth Circuit Court of Appeals reversed the Tax Court and held that the regulations at issue had been promulgated properly under the APA. Altera Corp. & Subsidiaries v. Comm’r, 926 F.3d 1061 (9th Cir. 2019). The Ninth Circuit swept aside Altera’s four procedural arguments, finding that the comments to which the IRS failed to respond were not “significant”; the Treasury’s litigation position was not inconsistent with statements made in the rulemaking process; it adequately supported its position that stock compensation is a “cost” that can be shared; and a more thorough review is not warranted because Treasury did not alter its position. Id. at 1080-85. After a bit more litigation, Altera requested cert. which was denied. Though Altera suffered a setback in its bid to have Treasury regulations invalidated, other litigants have been more successful in their attempts. In 2017, the Chamber of Commerce prevailed in its suit challenging the Multiple Acquisition Rule under the APA. Chamber of Commerce v. Internal Revenue Service, No. 1:16-CV-944 (W.D. Tex. 2017). Even though the rule was determined not to be arbitrary and capricious, it was nonetheless subject to scrutiny on other procedural grounds. The court found Treasury’s argument that notice-and-comment was not required because the rule was a temporary regulation unavailing and struck the regulation down pursuant to 5 U.S.C. § 706 because Treasury failed to provide affected parties with notice and an opportunity to comment on the rule. Id.
As with any lawsuit, plaintiffs have to demonstrate that they have standing to bring suit. While proving standing is basically a formality with most lawsuits, it is anything but for litigants challenging Treasury regulations. Specifically, litigants must contend with the Anti-Injunction Act (26 U.S.C. § 7421), legislation that prohibits courts from hearing suits that “restrain the assessment or collection of any tax…” Attempts to clear this hurdle have met with mixed results. In 2014, the Florida Bankers Association filed suit in D.C. federal court challenging regulations finalized in 2012 that require financial institutions to report interest paid to certain nonresident aliens. The plaintiffs alleged the regulations violated the APA and Regulatory Flexibility Act (RFA). In its cross-motion for summary judgment, the Government asserted the plaintiffs either lacked standing to bring the suit or, in the alternative, the suit was barred by the AIA.
The District Court rejected the Government’s arguments, finding that the plaintiffs had standing because its member banks were being directly regulated by the regulations being challenged. As to the AIA, the suit was not barred because it was brought for the purpose of enjoining a regulatory command. Fla. Bankers Ass’n v. United States Dep’t of Treasury, 19 F. Supp. 3d 111, 120 (D.D.C. 2014), vacated sub nom. Fla. Bankers Ass’n v. U.S. Dep’t of the Treasury, 799 F.3d 1065 (D.C. Cir. 2015).
The United States Court of Appeals for the D.C. Circuit reversed the District Court, holding that the suit was, in fact, barred by the AIA. Writing for the majority, Justice Brett Kavanaugh noted that challenges to a regulatory tax fall within the scope of the AIA, even if the plaintiff claims he is merely challenging the regulatory aspect. Fla. Bankers Ass’n v. U.S. Dep’t of the Treasury, 799 F.3d 1065, 1070–71 (D.C. Cir. 2015). The Court ruled that invalidating the regulation would prevent the collection of tax, which the AIA explicitly prohibits. Id. The plaintiffs appealed to the U.S. Supreme Court, but on June 6, 2016, the petition for certiorari was denied.
The question of whether the AIA insulates the IRS from pre-enforcement review of agency regulations is now pending before the Supreme Court in CIC Services, LLC v. Internal Revenue Service, No. 19-930. CIC filed suit in the Eastern District of Tennessee in March 2017, asking the district court to enjoin enforcement of new rules that created reporting requirements on section 831(b) micro-captive transactions. The new rules were issued as Notice 2016-66, and CIC argued this constituted an illegal attempt by the IRS to circumvent the APA. The district court ruled for the IRS, finding that the suit was barred by the AIA. On appeal, the Sixth Circuit Court of Appeals affirmed the decision, holding that although challenges to reporting requirements are not ordinarily barred by the AIA, allowing CIC’s suit would have the effect of restraining the collection of taxes. CIC Services, LLC v. Internal Revenue Service, 936 F.3d 501 (6th Cir. 2019). The U.S. Supreme Court granted CIC’s petition for certiorari on May 4, 2020. It may be interesting to see if the Court looks solely at the notice at immediate issue or at the underlying statute and regulation which grant the IRS remarkable authority to require disclosure of some transactions.
In addition to CIC, practitioners should also take notice of two cases currently being litigated by the same plaintiff in the U.S. District Court for the District of Columbia: Silver v. Internal Revenue Service, No. 19-247 (“Silver I”) and Silver v. Internal Revenue Service, No. 20-1544 (“Silver II”). Monte Silver, an American expatriate residing in Israel, practices law through his one-person firm, Monte Silver, Ltd. Silver provides legal services to clients worldwide in matters involving U.S. law.
Though Silver’s lawsuits target two different Treasury regulations, the substantive arguments are virtually identical. Silver I challenges Treasury’s Final Regulations interpreting Internal Revenue Code Section 965, the Transition Tax, issued on January 15, 2019. The Transition Tax, part of President Trump’s Tax Cuts and Jobs Act of 2017, subjects U.S. corporations to a one-time tax on the accumulated profits of their controlled foreign corporations (CFCs). Silver alleges that the Section 965 regulations failed to differentiate between small businesses like his and the CFCs owned by massive corporations.
Silver alleges Treasury violated the RFA and Paperwork Reduction Act (PRA). Specifically, the regulations violated the RFA by failing to include a “final regulatory flexibility analysis”, and instead were issued with a conclusory statement that the new regulations would not have a significant impact on small businesses. Concerning the PRA, the suit claims that the required PRA certification is missing, and the only document in the administrative record that even considers the PRA is a one-page checklist. Because of these respective procedural flaws, Silver argues that the regulations violate the APA and should be set aside.
Silver II takes aim at Treasury’s June 21, 2019, Final Regulations interpreting Internal Revenue Code section 951A—the global intangible low-taxed income (GILTI). Silver’s allegations essentially mirror those from his Section 965 lawsuit: that Treasury failed to comply with the RFA and PRA when promulgating GILTI regulations.
Mr. Silver achieved a major victory in Silver I when Judge Amit P. Mehta denied Treasury’s motion for summary judgment, allowing the case to move forward. Silver II is still early in the litigation process. Practitioners should closely follow the developments of Mr. Silver’s two lawsuits and watch for new cases as tax counsel have begun to utilize such arguments routinely.
When challenging Treasury regulations, practitioners can and should take note of whether Treasury adhered to the procedural requirements of the APA. Altera’s defeat in the Ninth Circuit notwithstanding, courts have shown that they are willing to entertain these types of arguments, and litigants should not assume that IRS regulations are immune from attack on procedural grounds. It will be interesting to see what transpires. Practitioners may win in a given case but tax administration may take a step backward depending upon the resolution of CIC and the other cases. The almost universal chant of the need for additional tax guidance may only grow louder to the extent the APA, RFA and other three letter procedural requirements increase the burden on the regulatory process. Nonetheless, it is incumbent upon practitioners to utilize all tools in their representation.