Tax Talk: Volume 10, Issue 3

CHAMBER OF COMMERCE: DISTRICT COURT HOLDS ANTI-INVERSION REGULATION INVALID ON PROCEDURAL GROUNDS

On October 16, 2017, a United States District Court in Texas invalidated temporary Treasury Regulations that target so-called "serial inverters" (i.e., foreign acquiring corporations that have acquired domestic corporations in the past) (the "Serial Inversion Rule"). The plaintiffs argued that the Serial Inversion Rule violated the Administrative Procedures Act (the "APA") because the Internal Revenue Service (the "IRS") lacked statutory authority to issue the Serial Inversion Rule, the Serial Inversion Rule was arbitrary and capricious, and the IRS failed to provide adequate notice and opportunity for comment. The court ultimately invalidated the Serial Inversion Rule on the basis that the IRS failed to provide adequate notice and opportunity for comment as required by the APA.

Temporary Treasury Regulation section 1.7874-8T,1 which was published on April 8, 2016 applied to domestic entity acquisitions completed on or after April 4, 2016, operated to discount the value of the foreign acquirer to the extent it included the value of domestic corporations acquired in the thirty-six months prior to the signing date of a binding agreement regarding the domestic entity acquisition at issue. Application of the Serial Inversion Rule caused the domestic entity acquisition at issue to be more likely to fall within the scope of the punitive inversion taxation regime.

The Serial Inversion Rule, effective upon issuance, was issued simultaneously with identical provisions in proposed Treasury Regulations that would not become effective until they were issued in temporary or final form. Because the Serial Inversion Rule was effective immediately, the IRS failed to comply with the APA's requirement to provide affected parties with a thirty-day notice period and an opportunity to comment. The IRS did not argue that it had complied with the notice-and-comment requirement but argued that the Serial Inversion Rule was excused from the requirement because it was (a) a temporary regulation and (b) an interpretive regulation. The court held that even temporary Treasury Regulations were subject to the notice-and-comment requirement of the APA. The court also held that the Serial Inversion Rule was a legislative or substantive regulation that created law rather than an interpretative regulation that merely advised the public of the IRS's interpretation of a statute. As a result, the court held that the issuance of the Serial Inversion Rule violated the APA.

Although a seeming victory for the plaintiffs, the court's holding was narrow and upheld the substantive provisions of the Serial Inversion Rule. The court determined that the IRS did not exceed its statutory authority in issuing the Serial Inversion Rule. The Code grants broad authority to the Secretary to prescribe regulations to determine whether a corporation has inverted, including regulations "to treat stock as not stock," and to prevent the avoidance of the purposes of section 7874.2 The court held that the Serial Inversion Rule was within Congress' grant of authority "to treat stock as not stock." The court also determined that the Serial Inversion Rule was not arbitrary and capricious because it plausibly addressed Congress' concern regarding inversions.

The IRS had moved to dismiss the case on two grounds, which the court ultimately decided in favor of the plaintiffs. The IRS had argued that the plaintiffs, the Chamber of Commerce of the United States of America and the Texas Association of Business, lacked standing to sue. The court determined that the plaintiffs had associational standing because Allergan, plc, a member of the Chamber of Commerce, would have had standing to sue in its own right on the basis that Allergan was prevented from engaging in transactions that the Serial Inversion Rule would have caused to be subject to the inversion rules, and that the IRS targeted Allergan in its promulgation of the Serial Inversion Rule. The IRS had also argued that the plaintiffs' claims were barred by the Anti-Injunction Act, which prohibits lawsuits that restrain the assessment or collection of a tax. The court determined, however, that the enforcement of the Serial Inversion Rule involved neither the assessment nor the collection of a tax.

Although notable for invalidating an existing regulation in the controversial area of inversions, the court's decision does not necessarily signal the end of the Serial Inversion Rule. The IRS is not barred from issuing the same provisions in finalized Treasury Regulations because the court upheld their substance. In addition, the IRS may appeal the decision. Moreover, tax reform proposals currently being considered in Congress would generally make inversions less attractive.

NOTICE EXTENDS PHASE-IN OF SECTION 871(M) REGULATIONS

On August 4, 2017, the IRS released Notice 2017-42 (the "Notice")3 which further extends the phase-in of regulations under section 871(m) of the Code (the "Regulations"). Section 871(m) is the Code provision that treats "dividend equivalents" paid under certain contracts as dividends from sources within the United States and therefore subject to U.S. withholding tax if paid to a non-U.S. person. We have followed the evolution of the rules in several prior Client Alerts. 4

The Notice extends effective dates found in certain provisions of (a) IRS Notice 2016-76, (b) amendments to the Regulations pursuant to Notice 2016-76, and (c) the final Qualified Intermediary Agreement. The extensions are as follows:

Phased-in Application for Delta-One and Non-Delta-One Transactions. The Notice provides an extension to the phased-in application of the Regulations to potential section 871(m) transactions5 that do not have a delta of one (as determined under the Regulations). Now, the Regulations will not generally apply to non-delta-one transactions entered into before January 1, 2019. The Regulations will continue to apply to any potential section 871(m) transaction that has a delta of one entered into on or after January 1, 2017, including combined transactions, but the Notice states that now both 2017 and 2018 will be phase-in years6 for such transactions. Phase-in Year for Qualified Derivatives Dealers. The Notice extends three portions of the QDD rules. First, previous guidance provided that a QDD will not be subject to tax on dividends and dividend equivalents received in the QDD's equity derivatives dealer capacity until January 1, 2018, which the Notice extends to January 1, 2019. Second, previous guidance provided that a QDD will be required to compute its section 871(m) tax liability using a "net delta" approach beginning in 2018; the Notice extends this effective date for the net delta approach to begin in 2019. Finally, the final QI Agreement provides that a QDD must perform certain periodic reviews with respect to its QDD activities, but only beginning on January 1, 2018. The Notice extends this to January 1, 2019. Simplified Standard for Determining Whether Transactions Are Combined Transactions. Notice 2016-76 and the subsequent final regulations provide for a simplified standard for withholding agents to determine when two or more transactions should be combined in order to determine whether the transactions are subject to section 871(m), but the simplified method only applied for transactions entered into in 2017.7 The Notice extends the period during which this simplified standard applies to 2018. Looking Ahead

On February 24, 2017, President Trump issued Executive Order 13777, which directed U.S. agencies to reduce the regulatory burdens created by such agencies. The Notice states that pursuant to that executive order, the Treasury Department and IRS will continue to evaluate the Regulations and consider possible agency actions that may reduce unnecessary burdens imposed by the Regulations. On October 2, 2017, the U.S. Department of the Treasury delivered a report to President Trump that proposes substantial revisions to eight sets of U.S. federal income tax regulations. While the section 871(m) regulations were not one of the eight, the report states that the Treasury is considering possible reforms to the Regulations.8 Additionally, on October 26, 2017, the IRS published corrections to the Regulations; these corrections were generally non-substantive in nature.9 Finally, Dana Trier, Department of Treasury deputy assistant secretary for tax policy, suggested at a District of Columbia Bar Taxation Community luncheon that section 871(m) could potentially be limited to delta-one transactions only.10

The Notice states that taxpayers are permitted to rely on it until the Regulations and the final QI Agreement are amended to reflect the extensions provided for in the Notice.

IRS MAY END SOME CORPORATE RULINGS

Earlier this year, the IRS released Notice 2017-52, which announced a pilot program to expand the IRS' letter ruling policy with respect to transactions intended to qualify under section 368(a)(1)(D) and 355.11 Despite the allowance for new rulings, on October 13, 2017, the IRS announced that it was reconsidering its views regarding certain issues as to which it has previously provided favorable rulings under these Code sections. The announcement states that the IRS is studying these issues, and new guidance may be issued. In the meantime, the statement provides that the IRS will process ruling requests in accordance with the following guidelines.

First, in connection with a worthless stock loss under section 165(g)(3)(B), the IRS will no longer rule on whether the character of gross receipts received by a consolidated group member in an intercompany transaction may be redetermined by reference to the character of the source funds possessed by the counter party to the intercompany...

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