The Treasury Department has an array of steps it can take in what will likely be a years-long legal battle over what it sees as a multi-billion dollar loophole in the 2017 tax overhaul.
A federal district court judge in Colorado—in a case brought by telecommunications company Liberty Global Inc. over a nearly $110 million dollar refund claim—held earlier this month that temporary Treasury rules blocking foreign-sourced corporate income from qualifying for a tax deduction were invalid.
Tax practitioners and former government officials said the big-dollar issue is far from settled. The federal government could opt to appeal, continue to fight for more favorable rulings in other federal courts, and explore another regulatory solution.
“This is just one case, one taxpayer, one court, so this has a long, long way to go,” said Eric Solomon, a partner at Steptoe & Johnson LLP and former assistant secretary for tax policy at Treasury.
The 2019 temporary rules (T.D. 9865) retroactively blocked companies from escaping taxation on income they repatriated to the U.S. in 2018 by addressing a purported mismatch between the effective dates of different provisions of the 2017 tax law. Treasury had said in a court filing that billions of dollars were at stake when it issued the regulations, which it said were needed to address transactions by large U.S. corporations that “would permanently eliminate taxation of their foreign earnings.”
The Treasury and Justice Departments didn’t respond to requests for comment on their plans in light of the decision in Liberty Global v. U.S..
Procedural Defect
In his decision, Judge R. Brooke Jackson of the U.S. District Court for the District of Colorado seemed to agree with Treasury that the rules were addressing an unintended loophole in the 2017 tax law. The judge said the history behind the law suggests Congress only meant for earnings exempt from a new international tax regime—the global intangible low-taxed income (GILTI) tax—to qualify for a deduction under tax code Section 245A.
Without the regulatory fix, companies with a non-calendar tax year would have had a potentially months-long window to claim that deduction and thereby escape any taxation on their foreign-sourced income.
Nonetheless, Liberty Global successfully argued that the rules needed to go through a notice-and-comment period under the Administrative Procedure Act, the statute that lays out the process federal agencies must follow in issuing regulations. Jackson rejected Treasury’s position that a law saying temporary Treasury rules must also be issued as proposed regulations—tax code Section 7805(e)—meant the temporary rules were exempt from those APA requirements.
The Colorado court also rejected two other arguments that could have saved the rules: that Treasury had good cause to skip the notice-and-comment process, or that any error was harmless.
Kristin Hickman, a University of Minnesota law professor who specializes in tax and administrative issues, said this was the first set of regulations she knew of for which a court had to evaluate a Treasury good cause claim.
More Litigation Likely
Treasury can appeal Jackson’s ruling to the U.S. Court of Appeals for the Tenth Circuit.
Hickman, who served as special adviser to the administrator of the Office of Information and Regulatory Affairs during the Trump administration, said the Tenth Circuit “very well might resolve differently” both the good cause and harmless error arguments.
“Whether or not a particular claim of good cause is valid for APA purposes is a very situation-specific sort of an argument that I don’t think is a slam dunk either way in this case,” she said. “Correspondingly, the court’s conclusion about harmless error also, I think, is a hard question.”
Monte Jackel, an attorney at Leo Berwick who previously served in various roles at Treasury’s Office of Tax Policy and the IRS Office of Chief Counsel, said he viewed the chances of a successful appeal at the Tenth Circuit as “probably 50-50.”
The department could also end up litigating the validity of its temporary regulations in other jurisdictions.
California-based company Maxim Integrated Products Inc., for example, wrote in an SEC filing that it plans to “vigorously defend its position” that the rules weren’t validly issued, and referenced the potential for a court to rule on the company’s stance. The company didn’t respond to a request for comment on the filing and its plans.
Unresolved Issues
While Jackson’s ruling invalidated the temporary regulations on procedural grounds, it didn’t address an argument challenging Treasury’s legal authority to issue the rules.
Liberty Global has said the plain language of the 2017 tax law is clear, and therefore didn’t provide any ambiguity that Treasury would have been permitted to resolve.
The issue of whether Treasury had the authority to issue the regulatory fix “seemed more obvious” than the notice-and-comment question the court answered, said Caitlin Tharp, an associate at Steptoe & Johnson LLP who focuses on federal tax controversy and litigation.
“The statute says one thing and then the temp regs say something that’s contrary to the text, so how are you going to meet that Chevron standard of ambiguity?” she asked.
The Chevron doctrine, established by the U.S. Supreme Court in a 1984 ruling, instructs courts to defer to reasonable agency interpretations of federal law when a statute is ambiguous or silent on an issue.
But Treasury, too, appears to have a further avenue of argument, at least when it comes to the Liberty Global’s specific refund claim. Jackson only granted Liberty Global a partial win, saying that even given his decision on the rules, “there is still an issue of fact” concerning whether the company’s actions and transactions tied to the case complied with applicable tax laws.
A Regulatory Fix?
If Treasury’s rulemaking process is struck down by the courts, but its authority to issue rules is upheld, it might be able to issue new retroactive rules years later under a separate source of authority, tax code Section 7805(b)(3). That provision authorizes retroactive rules in order to prevent abuse, without an explicit deadline for doing so.
Solomon said he didn’t know whether Treasury could take that approach later on, although he described such a move as “awkward” given Treasury already issued rules without invoking that basis of authority.
“If I was a taxpayer, I would say, look, they already conceded this point,” Solomon said.
Raj Madan, a partner who heads the Washington tax group at Skadden, Arps, Slate Meagher & Flom LLP, and represents Liberty Global, declined to comment for this story. But during oral arguments, Jackson asked him about another possible next step: whether Treasury would be able to go back later and provide notice and a chance to comment on the already-issued temporary regulations.
“We would prevail anyway because they failed to meet the notice-and-comment period prior to issuance of the temporary reg,” Madan replied.