Podcast - Chamber Of Commerce v. Internal Revenue Service

In this Ropes & Gray podcast, tax associate Brandon Dunn is joined by tax partners Kat Gregor and David Saltzman to discuss one of the most notable tax decisions from the fourth quarter of 2017 and its implications for taxpayers, particularly multinational corporations. On September 29, 2017, in Chamber of Commerce of the United States of America et al v. Internal Revenue Service et al, the U.S. District Court for the Western District of Texas held that the Internal Revenue Service and the U.S. Treasury Department violated the Administrative Procedures Act by issuing an anti-inversion rule, specifically the "Multiple Domestic Entity Acquisition Rule," saying it was unlawfully implemented without giving the public enough notice or time to comment.

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Brandon Dunn: Hello, and thank you for joining us today on this Ropes & Gray podcast. I'm Brandon Dunn, an associate in the tax group, and I'm standing in for Gabrielle Hirz, the regular host of this podcast. Today I'm joined by Kat Gregor, a tax partner and co-founder of the firm's tax controversy group; and David Saltzman, a partner in the tax group who concentrates on international tax matters. In today's podcast, we are going to discuss a notable court decision from the fourth quarter of 2017, which we've chosen as our case of the quarter. This case, Chamber of Commerce v. Internal Revenue Service, concerned the validity of the Internal Revenue Service's "Multiple Domestic Entity Acquisition Rule" under the Administrative Procedure Act. The Rule, which was issued by Treasury in April 2016 and had an immediate effective date, was aimed at deterring certain corporate inversions by decreasing the tax benefits of those transactions.

David, let's start with a little background. I understand that the Internal Revenue Code contains rules designed to deter corporate inversions. Can you tell us a little about corporate inversions and the rules in the Code that govern them?

David Saltzman: Sure, Brandon. Prior to the enactment of the Tax Cuts and Jobs Act, which took effect at the start of this year, the top U.S. tax rate for corporations was 35 percent. That rate was high by world standards, though for many multinationals, the effective rate on earnings could be lower. Unlike many other countries that have territorial tax systems, which exempt earnings from foreign subsidiaries, the U.S. taxed foreign subsidiaries' active business earnings only when those earnings were repatriated to the U.S. parent, but taxed the foreign passive earnings currently. U.S. multinationals kept their active profits offshore to defer tax and to obtain favorable financial accounting treatment. Foreign multinationals did not have the same issues and could strip earnings from the U.S. and pay less U.S. taxes than a U.S. corporation without a foreign parent. So some companies decided to try to flee the U.S. tax system.

Brandon Dunn: So, did they actually expatriate?

David Saltzman.: Hardly. In early inversion transactions, the companies created a new foreign holding company and flipped the former U.S. company's shareholders up to become shareholders of the new foreign parent. The foreign company was a shell and its shareholders were identical to the former shareholders of the U.S. company. The U.S. corporation continued to operate in the U.S and typically kept its senior management here too. Through elaborate intercompany planning, the earnings were stripped from the U.S. corporation and landed in its low-tax parent, which also acquired majority control of the foreign subsidiaries out from under the U.S. company. Congress enacted rules hoping to deter these transactions and where the new foreign company was a shell, they treated it as an U.S. corporation when the shareholders before and after were identical or nearly so.

Brandon Dunn: Could you explain to us, David, how those rules work?

David Saltzman: If you have an hour or two, I can do it. To oversimplify, the rules look at...