Failure to Allow Notice and Comment Period Invalidates Reg on Inversion Transactions

(Parker Tax Publishing October 2017)

A district court held that the issuance of Reg. Sec. 1.7874-8T violated the Administrative Procedures Act (APA) because the IRS and the Treasury Department did not follow the notice-and-comment procedure required by the APA when they issued the regulation. Because the regulation was unlawfully issued, the court set aside the regulation. Chamber of Commerce v. I.R.S., 2017 PTC 456, 2017 PTC 455 (W.D. Tex. 2017).

In April 2016, the IRS issued Reg. Sec. 1.7874-8T, which is aimed at addressing certain inversion transactions. The regulation provides a rule identifying stock of foreign acquiring corporations that is to be disregarded in determining an ownership fraction relevant to categorizing the stock. Reg. Sec. 1.7874-8T was issued as a temporary regulation that was immediately effective and as a proposed regulation subject to notice and comment.

The Chamber of Commerce of the United States of America (Chamber of Commerce) and the Texas Association of Business (TAB) filed a lawsuit asserting that the IRS, the Treasury Department, and John A. Koskinen (IRS Commissioner), and Jacob J. Lew (former Secretary of Treasury), violated the Administrative Procedures Act (APA) by issuing Reg. Sec. 1.7874-8T.

According to the Chamber of Commerce and TAB, the regulation exceeded the IRS's and Treasury Department's (i.e., the Agencies) statutory jurisdiction and the issuance of the regulation was arbitrary and capricious and done without notice and opportunity for comment in violation of the APA. They moved for summary judgment on their claims while the Agencies moved to dismiss the case, arguing that the Chamber of Commerce and TAB lacked standing to challenge the regulation, and that the lawsuit was barred by the Anti-Injunction Act. According to the Agencies, the Chamber of Commerce and TAB lacked standing because they had not alleged an injury in fact that justified prospective relief.

The district court held that Reg. Sec. 1.7874-8T was unlawfully issued without adherence to the APA's notice-and-comment requirements and, as a result, the court set aside the regulation.

With respect to the claim that the Agencies' issuance of Reg. Sec. 1.7874-8T exceeded their statutory jurisdiction, the court concluded that, based on the broad authority granted by Congress in Code Sec. 7874, the issuance of the regulation did not exceed the statutory jurisdiction of the Agencies. The court noted that the regulation directs that certain stock be disregarded in calculations made under the statute, which falls into the statute's allowance that regulations may "treat stock as not stock." Further, the court said, regulation aims to "prevent the avoidance of the purposes" of the statute, which is specifically named as an authorized function of regulations issued pursuant to the statute.

With respect to the claim that the Agencies issuance of the regulation was arbitrary and capricious, the district court reviewed the full analysis by which the Agencies determined the regulation was necessary to achieve the goals of the Internal Revenue Code. The court concluded that the Agencies did not rely on factors that Congress did not intend for them to consider and that the Agencies did not fail to consider an important aspect of the issue before them. The court found that the Agencies offered a plausible explanation for the regulation that did not run counter to the evidence before them. Accordingly, the district court concluded that the Agencies did not engage in an arbitrary and capricious rulemaking in issuing Reg. Sec. 1.7874-8T.

Finally, with respect to the claim that the Agencies violated the APA in issuing the regulation because the Agencies failed to provide affected parties with notice and an opportunity to comment on the regulations, the court agreed with the Chamber of Commerce and TAB. The court found that the temporary nature of the regulation did not excuse the Agencies from the notice-and-comment procedure required by the APA. The court noted that the APA permits agencies to issue interpretative rules without subjecting them to notice and comment and that a rule is interpretative if it is "issued by an agency to advise the public of the agency's construction of the statutes and rules which it administers." The court concluded, however, that Reg. Sec. 1.7874-8T was a substantive or legislative regulation, not an interpretive regulation, and the Agencies were therefore not excused from the notice-and-comment procedure required by the APA.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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