TAX CONTROVERSY 360
TAX CONTROVERSY 360
McDermott’s Real-Time Tax Disputes Insights
TAX CONTROVERSY 360
McDermott’s Real-Time Tax Disputes Insights
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IRS Commissioner Asks Congress to Overturn Loving

by and | Apr 22, 2016 | , ,

Following a report by the US Government Accountability Office (GAO) that criticized the Internal Revenue Service (IRS) for failing to protect taxpayer financial information from cybersecurity threats, IRS Commissioner John Koskinen has requested that US Congress give the IRS the power to license tax preparers.  Prior efforts by the IRS to regulate paid tax preparers by forcing them to pass a competency exam and meet continuing education requirements had been struck down in a 2013 federal district court decision which was later affirmed unanimously by the US District Court for the District of Columbia in Loving v. IRS, 742 F.3d 1013 (DC Cir. 2014).

Having failed to achieve its goal in court, in 2014 the IRS turned to Capitol Hill to grant it the authority to enforce nationwide certification requirements on independent tax return preparers.  Imposing competency requirements on tax return preparers is an idea supported not only by the IRS but also by National Taxpayer Advocate Nina E. Olsen and other tax policy leaders.  Proponents have long argued that government regulations are needed to address ineptitude among “mom-and-pop” tax preparers and unscrupulousness among other preparers who take advantage of uninformed taxpayers.  Efforts to pass the legislation in Congress, however, had stalled.

Now, Commissioner Koskinen is using the recently issued GAO report to renew the push to established minimum standards for tax preparers.  It would seem unlikely, however, that these new efforts will bear any fruit.



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Update on APA Challenges to Notice of Deficiency

by and | Apr 21, 2016 | , ,

In an earlier blog post, we discussed the US Tax Court’s ruling in QinetiQ U.S. Holdings, Inc. v. Commissioner, No. 14122-13 (Dec. 27, 2013). The taxpayer had argued that the Internal Revenue Service’s (IRS’) notice of deficiency containing a one-sentence reason for the deficiency determination violated the Administrative Procedure Act (APA) because it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The Tax Court disagreed, emphasizing that it was well settled that the court is not subject to the APA. To refresh, the APA provides a general rule that a reviewing court that is subject to the APA must hold unlawful and set aside an agency action unwarranted by the facts to the extent the facts are subject to trial de novo by the reviewing court. (more…)



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Supreme Court Denies Review in Highly Contested Foreign Tax Credit Case

by and | Apr 19, 2016 | , , ,

On April 18, 2016, the Supreme Court denied certiorari in the foreign tax credit dispute involving Albemarle Corp.  We have previously written about the case here, here, and here, which involved the timeliness of claims for refund pursuant to Internal Revenue Code (IRC) section 6511(d)(3)(A)’s 10-year limitations period.

Generally, a taxpayer must file a claim for refund within the later of three years from the time the original return was filed, or two years from the time the tax was paid.  Congress extended this period for refund claims related to foreign tax credits (FTC).   IRC section 6511(d)(3)(A) extends the refund limitation period to “10 years from the date prescribed by law for filing the return for the year in which such taxes were actually paid or accrued.” Before IRC section 6511(d)(3)(A) was amended in 1997, the statute required that refund claims be made within 10 years from the date prescribed by law for filing the return for the year with respect to which the claim was made.

In the Albemarle case, the taxpayer filed refund claims related to foreign taxes paid that were more than 10 years after the date the tax returns for the years were due, without extension.  The taxpayer argued that the plain language of the statute permitted it to file a claim for refund within 10 years from the date the payment was in fact (actually) made, which was less than 10 years before the claims were filed.  Both the US Court of Federal Claims and the Federal Circuit disagreed, with the latter holding that the term “actually … accrued” is ambiguous and that Congress intended that the relevant period commenced on the due date of the original returns.

Taxpayers with a similar fact pattern to Albemarle, and who desire to dispute the holding in that case, will want to file suit in local district court to avoid the negative precedent and hope that a court not bound by the Federal Circuit will reach a different decision.  Taxpayers may also want to consider filing protective refund claims in situations where it does not appear that a tax payment to a foreign jurisdiction will actually be made (and there will be enough time to file a formal refund claim with the IRS) within 10 years from the date the US federal income tax return was filed to avoid the situation in Albemarle.



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3M Company, IRS File Opening Briefs in “Blocked Income” Case

by | Apr 18, 2016 | , , ,

As noted in an earlier post, 3M Co. v. Commissioner, T.C. Dkt. No. 5816-13, involves 3M’s challenge to the Internal Revenue Service’s (IRS’s) determination that Brazilian legal restrictions on the payment of royalties from a subsidiary in that country to its US parent should not be taken into account in determining the arm’s-length royalty between 3M and its subsidiary under Treas. Reg. § 1.482-1(h)(2). The case has been submitted fully stipulated under Tax Court Rule 122, and the parties’ simultaneous opening briefs were filed on March 21, 2016.

Citing First Sec. Bank of Utah and cases following it, 3M first argues that “[c]ase law consistently holds that the Commissioner cannot employ section 482 to allocate income that the taxpayer has not received and cannot receive because a law prevents its payment or receipt.” Under this line of authority the IRS’s proposed allocation of royalty income to 3M is precluded by Brazilian law. This result is not changed by Treas. Reg. § 1.482-1(h)(2) because that regulation is invalid.

The regulation is “procedurally invalid,” 3M argues, because Treasury and the IRS failed to satisfy the requirements of § 553 of the Administrative Procedure Act (APA) when they promulgated the regulation. They did not respond to significant comments criticizing the proposed regulation; nor did they articulate a satisfactory justification or explanation for the regulation. They thus did not engage in the “reasoned decisionmaking” required by the APA and case law such as State Farm and Altera when an agency issues regulations. (more…)



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Ax v. Commissioner: The Tax Court Reaffirms that It Is Not Subject to the APA

by and | Apr 12, 2016 | , , ,

On April 11, 2016, the US Tax Court issued its T.C. opinion in Ax v. Commissioner.  The notice of deficiency in the case determined that certain premium payments made to a captive insurance company were not established by the taxpayer to be (1) insurance expenses and (2) paid.  But this is not a run of the mill captive insurance case—at least not yet.

The Internal Revenue Service (IRS) moved for leave to amend its answer in the case to assert additionally that (1) the taxpayers’ captive insurance arrangement lacked economic substance and (2) amounts paid as premiums were neither ordinary nor necessary (and to allege facts in support of both assertions).  The taxpayers opposed, citing Mayo Foundation for Med. & Educ. Research v. United States, 562 U.S. 44, 55 (2011), and arguing that the Administrative Procedure Act (APA) and SEC v. Chenery, 318 U.S. 80 (1943) barred the IRS from “raising new grounds to support [the IRS’s] final agency action beyond those grounds originally stated in the notice of final agency action.”  The taxpayers also argued that the IRS’s new assertions constituted “new matters” that did not meet required heightened pleading standards under the Tax Court’s Rules of Practice and Procedure.  Ultimately, the Tax Court sided with the IRS.

(more…)



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Deference Principles in Tax Cases and the Unique Challenges of Auer Deference

by and | Mar 28, 2016 | , ,

The Federal Lawyer recently published an article we wrote which discusses how deference principles are applied in tax cases. The article can be accessed here. The Supreme Court of the United States, in Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44, 55 (2011), confirmed that tax laws are subject to the same deference principles as other federal laws.

In general, these deference principles can be grouped into three levels, commonly referred to as Chevron, Skidmore, and Auer deference.  Chevron is often regarded as the strongest level of deference, and can apply where Congress explicitly leaves a gap for an agency to fill and the agency intends for its interpretation to have the force of law. Tax regulations can be entitled to Chevron deference. Skidmore deference, which is limited to an interpretation’s persuasive power, can apply to other IRS interpretations that are thoroughly considered, well-reasoned, and consistent with earlier and later IRS pronouncements.  Skidmore deference, which is generally considered a lesser level of deference than Chevron, can apply to revenue rulings and revenue procedures. The last level of deference, Auer, is a special level of deference that can apply when an agency interprets its own regulations. In Auer v. Robbins, U.S. 452, 461 (1997), the Supreme Court accorded deference to an agency’s amicus brief. The theory behind Auer is that an agency is uniquely positioned to interpret any ambiguity in its own regulations.  Courts have increasingly placed limitations on Auer and its continuing validity has been questioned by sitting members of the Supreme Court.

When we wrote the article, Justice Scalia was the leading member of the Supreme Court advocating for the abandonment of Auer. But he was not alone. Other justices have openly either written about the risks of Auer or indicated a willingness to reconsider the principles of Auer. In addition, all current justices have either written or joined in an opinion that casts serious doubts about Auer or expressed an indication to revisit the deference standard in an appropriate case. With Justice Scalia’s passing, it remains to be seen whether the Court will continue to seek such a case. But considering the increasing wave of limitations being placed on Auer, it would not come as a surprise if further limitations were issued.



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IRS and Taxpayers Continue Fight over Regulations Intended to Overrule Judicial Precedent

by | Mar 15, 2016 | , , ,

In March 2013, 3M filed a petition with the US Tax Court challenging the Internal Revenue Service’s (IRS) determination that additional royalty income should be allocated to 3M’s US headquarters from its Brazilian subsidiary.  See 3M Co. v. Commissioner, T.C. Dkt. No. 5186-13.  Specifically, the IRS determined that Brazilian legal restrictions on the payment of royalties to the US parent should not be taken into account in determining the arm’s-length price between 3M and the subsidiary under Treas. Reg. § 1.482-1(h)(2).  3M’s position will require the Tax Court to revisit its earlier, pre-regulations holdings on the subject and to decide whether the Supreme Court of the United States has already resolved the issue.

The parties recently submitted the case fully stipulated under Tax Court Rule 122, with simultaneous opening briefs due on March 21, 2016.  The parties will then have the opportunity to submit reply briefs responding to each other’s arguments.

More than 40 years ago, the Supreme Court in Commissioner v. First Sec. Bank of Utah, 405 U.S. 394 (1972), rejected the IRS’s attempt to apply section 482 where federal law prohibited the taxpayer from receiving the income the IRS was seeking to allocate to it.  Subsequent Tax Court and appellate court decisions applied the Supreme Court’s holding to restrictions under foreign and state law.  In 1994, the IRS promulgated current Treas. Reg. § 1.482-1(h)(2), which provides, in part, that “a foreign legal restriction will be taken into account only to the extent that it is shown that the restriction affected an uncontrolled taxpayer under comparable circumstances for a comparable period of time.”  Although the regulation also contains a deferred income election that permits the deferred recognition of restricted income, subject to a matching deferral of deductions, it may be difficult in most situations to meet these requirements.

Whether 3M succeeds may depend on how the Tax Court applies the recent Supreme Court decision in U.S. v. Home Concrete & Supply LLC, 132 S.Ct. 1836 (2012).  There, the Supreme Court held that its prior interpretation of a statute meant that “there is no longer any different construction that is consistent with [the prior opinion] and available for adoption by the agency.”  This is an important case for all taxpayers, not just those dealing with the blocked income issue, and the Tax Court’s determination may have a broad impact on future challenges to tax regulations.



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New Post-Validus Revenue Ruling Applies to Foreign Reinsurance Transactions

by and | Feb 24, 2016 | , ,

In mid-2015, the United States Court of Appeals for the District of Columbia Circuit affirmed (although on narrower grounds) the decision of the United States District Court for the District of Columbia in Validus Reinsurance, Ltd. v. United States.  In Validus, 786 F.3d 1039, the D.C. Circuit ruled that there was no statutory authority for the imposition of a so-called “cascading” federal excise tax (FET) to foreign retrocession transactions – a transaction involving a policy of reinsurance issued by a foreign reinsurer to another foreign reinsurer.

The D.C. Circuit relied on two principles in rejecting the application of a “cascading” FET to foreign retrocession transactions:  (1) the presumption against extraterritoriality and (2) FET should not be imposed more than once on the same transaction (that is, on the same premium amounts).  The D.C. Circuit declined, however, to specifically speak on the issue of foreign reinsurance transactions – a transaction involving a policy of reinsurance issued by a foreign reinsurer to another foreign insurer (rather than reinsurer) – despite the fact that both principles might equally apply to these transactions as well.

However, the recently released Revenue Ruling 2016-03 specifically notes that “the IRS will no longer apply the one-percent excise tax imposed by section 4371(3) to premiums paid on a policy of reinsurance issued by one foreign reinsurer to another foreign insurer or reinsurer ….”  (emphasis added).  Thus, under Revenue Ruling 2016-03, there is no distinction between foreign retrocession and foreign reinsurance transactions.  For those taxpayers with foreign reinsurance transactions, who have been stuck in limbo after the Validus decision, Revenue Ruling 2016-03 may provide relief from an IRS examiner’s inappropriate imposition of a “cascading” FET.



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