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Big U.S. companies planning complex tax deals should closely monitor a sweeping case in which a Texas judge threw out IRS rules to crack down on corporate inversions, tax attorneys told Bloomberg BNA.
The court ruling puts the brakes on the Internal Revenue Service’s ability to issue swift guidance, possibly creating some leeway for corporations, they said in interviews Oct. 1-2. The decision also might lay the groundwork for lawsuits against other regulations intended to quickly stop perceived abuses.
The U.S. District Court for the Western District of Texas agreed Sept. 29 with the U.S. Chamber of Commerce that the inversions rules—which derailed a $160 billion merger between pharmaceutical giants Allergan Plc and Pfizer Inc.—are “legislative” rather than interpretive. That means the government didn’t give taxpayers enough time to comment on the rules ( Chamber of Commerce of U.S. v. IRS , W.D. Tex., No. 1:16-cv-00944, 9/29/17 ).
The court left open the IRS’s ability to attack corporate inversions, but practitioners said procedurally, the decision could create a very bumpy path for tax regulations going forward.
The Treasury Department issued the anti-inversion rules (T.D. 9761, REG-135734-14) in April 2016.
“The significance of the case may lie less in its impact on inversions and more in its view of legislative regulations versus interpretive regulations,” said Phil West, chairman of Steptoe & Johnson LLP and a former Treasury international tax counsel.
“If upheld, the opinion could have broad ramifications for other regulations as well as these, with many regulations having been issued under similar authority but viewed by the government as interpretive regulations,” West told Bloomberg BNA in emailed comments.
By requiring a 30-day window for comments on legislative regulations, the decision means the IRS has to essentially give companies 30 days’ notice of what it is planning for many of its guidance projects. The ruling might sink other regulations issued with an immediate effective date during the Obama administration, if taxpayers decide to sue.
However, if a company tries to take advantage of that 30-day window, it could be a gamble, John Harrington, a partner with Dentons US LLP and chair of Bloomberg BNA's U.S. International Advisory Board, told Bloomberg BNA. At the end of the 30-day period, the IRS could decide not to change the rules designed to scuttle the deal, leaving companies up the creek.
“If someone rushes a transaction because they think the rule is going to change, there’s a risk there, too,” said Harrington, chair of Bloomberg BNA's U.S. International Advisory Board.
Companies should keep in mind that it is only a Texas district court decision, said Thomas V. Linguanti, a partner with Morgan, Lewis & Bockius LLP. Right now, “I wouldn’t feel I could advise a client one way or the other,” he said. “No one is going to start acting as if this is the law.”
At the same time, “any client that has an inverted transaction or is considering an inverted transaction should watch this case closely,” Linguanti said.
He and other attorneys said they think Treasury has little choice but to appeal the decision, which radically changes the way taxpayers can sue the government over tax regulations—what Linguanti called “a big deal.”
Treasury didn’t respond to a request for comment.
Jeffrey Paravano, managing partner at Baker & Hostetler LLP, disagreed, saying the government may not need to appeal because the court left the substance of the anti-inversions rules alone.
The court ruled that the lawsuit was allowed under the Anti-Injunction Act, traditionally used by Treasury and the Justice Department to create high hurdles in cases where taxpayers haven’t yet paid any tax.
Previously, taxpayers could sue only after they had filed their returns, paid the tax, been through an audit, and still disagreed with the outcome—a process that could take years.
In yet another loss for the IRS, the court ruling “places additional constraints on the IRS on a going-forward basis on whether it would issue temporary regulations,” said Gary Wilcox, a partner at Mayer Brown LLP who previously was IRS deputy chief counsel.
Critics have denounced the IRS’s strategy of issuing proposed and temporary regulations at the same time, with an immediate effective date, to combat perceived abuse. Wilcox said this ruling is the first to address that practice under tax code Section 7805(e).
It wasn’t clear Oct. 2 whether taxpayers would use the court’s decision to take such regulations to court in other areas.
“This case is going to be another piece of evidence that taxpayers would consider when making that decision,” said Brian Kittle, also a Mayer Brown partner.
Joe Calianno, a partner with BDO USA LLP, didn’t go as far as saying more regulations would wind up in court, but told Bloomberg BNA that the Obama administration had issued a number of “rifleshot” guidance projects, effective immediately, with no warning.
The court’s decision could make big inroads on that practice, which Linguanti said is welcome. “This idea of racing to shut down transactions one by one is not good policy,” he said.
Practitioners said that despite the Chamber’s win on procedure, the IRS had good luck on the question of inversions.
The court held the regulation wasn’t “arbitrary and capricious,” nor was it beyond the IRS’s authority. Several attorneys said that if the agency wanted to, it could reissue the regulations as long as it followed the procedural rules.
“The takeaway is that if IRS does this right and follows the rules under the Administrative Procedure Act, they can still write regulations on inversions,” Calianno said.
Robert J. Kovacev, a partner at Steptoe & Johnson who previously was a senior litigation counsel in the Department of Justice Tax Division, said taxpayers should still beware.
“Obviously this is a win for the Chamber, but it is not necessarily a win for taxpayers regarding anti-inversion rules in the long run,” he said.
The Chamber’s lawsuit is aimed specifically at one provision in the regulations known as the “serial acquisition rule.” It yanks the benefits of an inversion if a series of recent prior acquisitions has increased the size of the acquirer, enabling it to circumvent the anti-inversion rules on increasingly larger transactions.
(Corrects spelling of Thomas V. Linguanti's name)
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Text of the court's final judgment is at http://src.bna.com/s2V.
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