- No Comment: Temporary Anti-Inversion Regulation Rejected Under Administrative Procedure Act
- October 10, 2017 | Authors: Robert S. Chase; Carol P. Tello; Thomas A. Cullinan
- Law Firms: Eversheds Sutherland (US) LLP - Washington Office; Eversheds Sutherland (US) LLP - Atlanta Office ; Eversheds Sutherland (US) LLP - Washington Office
On Friday, September 29, 2017, the Federal court for the Western District of Texas struck down the temporary anti-inversion regulation issued under Sec. 7874, which has been charged with preventing the planned $160 billion merger between Pfizer, Inc., and Allergan PLC, as well as potentially other cross-border merger transactions involving US corporations. The court held that the temporary regulation was unlawfully implemented as it violated the notice-and-comment procedures under the Administrative Procedures Act (APA).
Eversheds Sutherland Observation: It is significant that the court did not afford the temporary regulation any special administrative treatment, rejecting arguments that the regulation was an interpretive rule that should not be subject to the notice and comment requirements. The court analyzed whether the temporary regulation violated the APA under the general principles of administrative law. The decision is another example of courts declining to apply “tax exceptionalism” in the procedural review of tax regulations.
The contested regulation was issued by the Internal Revenue Service (IRS) and the Treasury Department (Treasury) in April 2016 in respect of the anti-inversion rules under Sec. 7874. Those rules operate to cause certain foreign corporations that acquire US corporations to be subject to special rules and, in some cases, to be treated as US corporations. The rules generally apply when the shareholders of the US corporation continue to own a 60 percent or greater interest in the acquiring foreign corporation. The contested regulation that was rejected by the court on procedural grounds involved the treatment of acquisitions of multiple US corporations by a foreign corporation as a single acquisition for purposes of applying the ownership thresholds.
The IRS and Treasury simultaneously issued the regulation relating to the combination of multiple acquisitions as a temporary regulation effective immediately, and as a proposed regulation subject to notice and comment. The plaintiffs in the case, which included the United States Chamber of Commerce, argued that: (1) the regulation exceeded the IRS’s and Treasury’s statutory jurisdictions; (2) the promulgation of the regulation was arbitrary and capricious; and (3) the regulation was promulgated without notice and opportunity for comment in violation of the APA. The court held in favor of the IRS and Treasury on the first two arguments, essentially holding that the IRS and Treasury were allowed to disregard certain foreign parent stock attributable to prior inversions and that the IRS and Treasury had offered a sufficient explanation for the regulation. The court, however, held in favor of the plaintiffs on the third argument, specifically that the rule as embodied in the temporary regulation was promulgated without notice and opportunity for comment in violation of the APA.
Under the APA, after an agency issues a notice of proposed rulemaking, the agency must allow interested persons to submit comments and arguments with respect to the proposed rule for a period of not less than 30 days before the rule can be published. Generally, this 30-day notice and comment requirement applies only to substantive rules. Interpretative rules are exempt from this requirement. The main distinction between substantive rules and interpretative rules is that substantive rules are rules that affect individual rights and obligations and have the force and effect of law, whereas interpretative rules are statements as to what the agency thinks the statute or regulations means.
The IRS and Treasury argued that the rule did not violate the APA because temporary regulations may be issued without subjecting them to notice and comment if they are also simultaneously issued as proposed regulations subject to the requirement, citing to the legislative history of Sec. 7805, which showed Congress’s intent to permit temporary rules that are immediately effective. The IRS and Treasury also argued that the rule was not subject to the notice and comment procedures because it was an interpretative regulation. The court disagreed with the IRS and Treasury on both of these arguments. The court held that legislative history cannot override the text of the APA, which does not provide an exception to the notice and comment requirement for temporary regulations. The court also held that the regulation was not an “interpretive regulation” because it was authorized by and made “substantive modifications to the application of the statute,” and had the force and effect of law.
Eversheds Sutherland Observation: The impact of this decision on the transactions targeted by the regulations is unclear. The court did not strike down the underlying merits of the regulation and only held that the promulgation of the regulation procedurally violated the APA. The proposed final regulations promulgated under Sec. 7874 have the same effective date. If those regulations are finalized, they presumably would comply with the APA and, as a result, would not be affected by this decision. Retroactive applicability dates are authorized by Sec. 7805(b)(1)(B). As a result, there may be little practical import for these specific temporary regulations if and when the proposed regulations are finalized.
Moving forward, this decision may have significant procedural implications. It is not uncommon for the IRS and Treasury to promulgate “temporary and proposed” regulations without first subjecting them to notice and comment procedures, and this decision calls the validity of such regulations into question.
Although the decision was rendered by a district court, and thus is not binding precedent in other courts, it is another example of courts no longer accepting the concept of “tax exceptionalism,” where tax agencies received different treatment from other administrative agencies with respect to the application of certain principles of administrative law. Tax exceptionalism was previously rejected by the Supreme Court in Mayo Found. for Med. Educ. & Research v. United States, 562 US 44 (2011), where the Supreme Court held that general administrative law standards govern the judicial review of Treasury regulations and it was not inclined to “carve out an approach to administrative review good for tax law only.” For a more detailed discussion of tax exceptionalism and the APA, see Starkey & Cullinan, Is The IRS Always Right? J. Tax Prac. & Proc. (2012) and our legal alerts on Mayo and Dominion Resources.Moving forward, it can be expected that future Treasury regulations may not receive special administrative treatment, which may impact the manner in which the IRS and Treasury approach the administrative process. Following the wake of this case and prior cases rejecting the concept of tax exceptionalism, future Treasury regulations will likely be reviewed under the same general administrative standards that apply to the review of regulations promulgated by any other administrative agency, placing an increased administrative burden on Treasury and the IRS. The potential implications are unclear, but it could result in fewer regulatory projects and more limited, non-binding guidance in the form of administrative pronouncements and Revenue Rulings that provide less certainty to taxpayers.