Tuesday, August 7, 2018

Ninth Circuit Withdraws Altera Opinions (8/7/18; 8/13/18)

The Ninth Circuit has withdrawn its opinions in Altera Corp. et al. v. Commissioner, ___ F.3d ___, 2018 WL 3542989, 2018 U.S. App. LEXIS 20524 (9th Cir. 2018), here., The withdrawal is by a one-sentence order dated 8/7/18 here.  The one sentence is:  "The Opinions filed July 24, 2018, are hereby withdrawn to allow time for the reconstituted panel to confer on this appeal."  There is no indication that there will be a need for oral argument, but, I suppose, Judge Graber could make the decision on that.  (That would mean that Judge O'Malley of the Court of Appeals for the Federal Circuit would have to make another trip to San Francisco.)

The reconstituted panel consists of the two on the original panel--Judges Thomas and O'Malley, and a new one, Susan P. Graber, substituted for the deceased Judge.  Readers will recall that the earlier opinions were split with Judge Thomas holding for the Government and Judge O'Malley holding for the taxpayer.  The earlier opinions were issued with the deceased judge, Judge Reinhardt, having indicated his agreement with Judge Thomas prior to death, so Judge Thomas' opinion was the majority opinion.  I presume the reconstitution was caused by the issuance of the opinions after the death of Judge Reinhardt and the commotion that resulted from issuance of the deciding vote after death.

For the write up on the original up see Developments - Federal Tax Procedure Book 2018 Editions and Altera (Federal Tax Crimes Blog 7/25/18; 7/27/18), here.

I am sure that there will be much speculation on which way Judge Graber will decide.  For those with the time and interest in such speculations, perhaps a good place to start is her Wikipedia page here.  She was appointed by President Clinton.

Addendum 8/13/18 10:22AM:

Thursday, August 2, 2018

SSRN Posting of Article on IRS Guidance -- Rulemaking and Deference (8/2/18)

SSRN has posted for review and download my article on IRS Guidance.  titled IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation. Townsend, John A., IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation (July 27, 2018). Available at SSRN: https://ssrn.com/abstract=3212060`.

The Abstract is:
This article deals with one of the key intersections of federal tax law and administrative law: IRS rulemaking. The IRS makes rules that affect the public through regulations and subregulatory guidance. I first discuss the IRS process for issuing such guidance and the principal forms the IRS uses. I then discuss the administrative law concept of deference to agency statutory interpretations. In administrative law, the two key regimes for deference are Chevron deference and Skidmore deference. Chevron deference requires the court to defer to an agency interpretation in formal guidance when the statutory text being interpreted is ambiguous and the agency interpretation is a reasonable interpretation even though the court believes there is a more reasonable interpretation. In the IRS context, Chevron deference applies to Treasury Regulations. Skidmore deference requires the court to defer to an agency interpretation in subregulatory guidance to the extent that the interpretation is persuasive. (That Skidmore formulation may sound a bit odd, but I get into that in the article.)  
The nonmainstream discussion in the article has two interrelated components: First, Chevron does not apply to legislative regulations. Legislative regulations are regulations, exemplified in the tax area by the consolidated return regulations under § 1502, where Congress delegated to the IRS the power to make the law. Second, Chevron does apply to interpretive regulations--regulations which interpret the statutory text. Some authors assert that, if Chevron deference applies to give the interpretation the force of law, then the regulation is a legislative regulation with the APA requirements for legislative regulations--promulgation in the Federal Register and prospective application only. The same argument, presumably, would apply if Skidmore or any other deference is given to an IRS interpretation in subregulatory guidance, because by conferring deference the interpretation has the force of law. I disagree with those authors. I assert that a court adopting--deferring to, if you will--an agency interpretation of ambiguous statutory text does not transform interpretation into legislative rulemaking under the APA. Hence, for such agency interpretations promulgation in the Federal Register is not required and the interpretations can apply retroactively. The IRS usually does issue its formal interpretations in regulations subject to notice and comment, so that is not a key difference. But, IRS interpretive regulations can and often do have retroactive effect.
Additional Notes:

1.  This article started with the related discussion in the 2017 Editions of the Federal Tax Procedure Book.  It was too long for the intended audience of that book, so I excerpted that discussion and shortened the discussion of the topics for the book.  The more summary discussion in the Book is at pp. 37-69 of the Student Edition and pp. 53-94 of the Practitioner Edition.  Readers interested in the subject might first want to review the more summary discussion, particularly in the Practitioner Edition with footnotes.

2.  I substantially revised the longer discussion which I excerpted from the 2017 Book and, hopefully improved on it as I made it even longer.  Those interested in more detail than offered in the Book will find it here.

3.  I do discuss toward the end of the article the current political climate where Chevron deference has become a scapegoat for all the perceived ills of the administrative state.  My own view is that Chevron deference and its related deference forms (Auer and Skidmore) may not be perfect but offer a better framework for dealing with interpretations of complex statutory systems Congress expects agencies to administer.  Nonetheless, as I conclude the article, "But with these cross-currents of politics, repeal of Chevron may be a bad idea whose time has come."

Here is the Table of Contents for the Article:

Sunday, July 29, 2018

Ninth Circuit Calls Rejects Midco Transaction Twice Blessed by Tax Court (7/29/18)

In Slone v. Commissioner, ___ F.3d ___, 2018 U.S. App. LEXIS 20602 (9th Cir. 2018), here, the Ninth Circuit rejected the Midco variant.  The Midco variant itself has subvariants but this example illustrates the basic idea:
A, an individual, owns Corporation X.  Corporation X has assets of $100 with a basis of $10.  There is a built in gain of $90, with a potential tax of $30.  Corporation X is worth, therefore, $70.  Corporation X sells its assets for $100.  Corporation X then has cash of $100, no liabilities except a tax of $30 that will be reported if nothing else happens.  Corporation X is still only worth $70.  So, Corporation Y purchases the Corporation X stock from A for $85 which it finances with the Corporation X cash (the cash moves around incident to the closing, but the $85 in essence comes from the Corporation X cash).  A and his advisors are not real sure why Corporation Y would offer more than the assets are worth.  Corporation Y hints that he has some technique (perhaps tax attributes) that would permit Corporation X to avoid the tax on the sale of the corporate assets.  Immediately after that closing, once the temporary financing for the Corporation X stock is paid off $85 of Corporation's X cash, Corporation X then has $15 cash.  Corporation X buys a bullshit tax shelter for $5 to avoid reporting the gain and the resulting $30 tax.  Corporation Y then takes the net $10 cash as its profits for structuring the transaction.  When Corporation X's bullshit tax shelter is rejected on audit two years later, the IRS assesses the $30 tax plus penalties and interest. Corporation X has no assets to pay the resulting tax, penalties and interest.  Corporation Y is not around to pay. 
Most of the Midco transactions are more complex than that, but when the veneer is peeled back, that is basically it.

The IRS in this situation wants the tax and will look to all involved to get it.  The IRS will look to A and assert transferee liability under § 6901.  A's defense is that he is not a transferee from Corporation X under the transferee liability provisions.  In furtherance of that argument, A will claim that he did not know the tax would not be paid.  He just thought that, magically, the buyer had some technique to avoid having to pay the tax. 

Here is what the Court said (cleaned up):
Reasonable actors in Petitioners' position would have been on notice that Berlinetta intended to avoid paying Slone Broadcasting's tax obligation. Berlinetta communicated its intention to eliminate that tax obligation, and Slone's leaders and advisors, despite their suspicions surrounding the transaction, asked no pertinent questions. In Berlinetta's earliest solicitations to Slone Broadcasting, Berlinetta marketed its ability to pay the shareholders a premium on account of its ability to eliminate the company's tax liabilities. Berlinetta's affiliate company, Fortrend, wrote in a letter to Jack Roberts, Petitioners' longtime accountant, that Fortrend could pay a premium purchase price because of its ability to "resolve liabilities at the corporate level." This proposal raised justified suspicions in Slone Broadcasting's leadership. Mr. Slone, the company's president, testified that upon learning that an entity wanted to purchase Sloan Broadcasting, after it had already been effectively sold to Citadel, he asked Jack Roberts, "can that be done?" Unsure, Roberts replied, "well, I'm going to find out." 
That Berlinetta provided little information regarding how it would eliminate Slone Broadcasting's tax liability, coupled with the structuring of the transactions, provided indications that would have been hard to miss. Slone Broadcasting's advisors understood that the transaction made sense from Berlinetta's perspective only if Slone Broadcasting's tax liability were eliminated. This deal was, after all, an uneven cash-for-cash exchange in which Berlinetta paid Petitioners most of what Slone Broadcasting should have paid in taxes. Yet Petitioners' retained counsel testified that when he and Jack Roberts asked for details, Berlinetta told them "it was proprietary, it was a secret, and it was theirs, and we weren't going to be a party to it, and I said fine." And in a lengthy memo retained counsel prepared in November of 2001 analyzing the subject of potential transferee liability, counsel wrote that Berlinetta would distribute almost all of Slone Broadcasting's cash to repay the loan used to finance the deal. The memo never analyzed how Berlinetta could legally offset Slone Broadcasting's taxable gain from the asset sale. The memo merely concluded that Petitioners would not be liable as transferees of the proceeds of Slone Broascasting's asset sale if the Commissioner successfully challenged the entity's attempt to offset the tax liability. 
The Tax Court misinterpreted Petitioners' suspicions and Berlinetta's reassurances to mean Petitioners lacked actual or constructive knowledge of the tax avoidance purpose of the scheme. This record establishes that the Petitioners were, at the very least, on constructive notice of such a purpose. In reaching a contrary conclusion, the Tax Court confused actual and constructive notice, in effect allowing Petitioners to shield themselves through the willful blindness the constructive knowledge test was designed to root out. It is clear that Petitioners' stock sale to Berlinetta, in which Berlinetta assumed Slone Broadcasting's tax liability, and Berlinetta paid Petitioners an amount representing the net value of the company after the asset sale and most of the amount that should have been paid in taxes on that asset sale, operated in substance as a liquidating distribution by Slone Broadcasting to Petitioners, but in a form that was designed to avoid tax liability. Slone Broadcasting's distribution to Petitioners was thus a constructively fraudulent transfer under the Arizona UFTA. Petitioners are liable to the government for Slone Broadcasting's federal tax obligation as "transferees" under 26 U.S.C. § 6901.
REVERSED and REMANDED for entry of judgment in favor of the Commissioner.

Saturday, July 28, 2018

D.C. Circuit Reverses the Tax Court on Chevron Application (7/28/18)

This week was not a good week for the Tax Court in the Courts of Appeals.  I have not attempted a complete survey of all Tax Court appeals in the Courts of Appeals or the percentage won/loss for this past week.  But here are three dramatic reversals.

  • Altera Corp. et al. v. Commissioner, 145 T.C. 91 (2015), here, rev’d ___ F.3d ___, 2018 WL 3542989, 2018 U.S. App. LEXIS 20524 (9th Cir. 2018), hereAltera was a Government win on appeal.  I have written on the Ninth Circuit reversal:  Developments - Federal Tax Procedure Book 2018 Editions and Altera (7/25/18; 7/27/18), here.
  • Good Fortune Shipping SA v. Commissioner, 138 T.C. ___ No. 10 (2017), here, rev'd  ___ F.3d ___, 2018 U.S. App. LEXIS 20880 (D.C. Cir. 2018), hereGood Fortune was a Government loss on appeal.  I write on this below.
  • Slone v. Commissioner, T.C. Memo. 2016-115, here, rev'd ___ F.3d ___, 2018 U.S. App. LEXIS 20602 (9th Cir. 2018), hereSlone was a Government win on appeal.  I may write on Slone in a later blog.

I write in detail today on Good FortuneGood Fortune, like Altera, was a Chevron driven outcome.  Chevron and its ramifications (including deference generally) has occupied a good deal of my time having recently completed an article titled IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation (currently under submission to SSRN).

The issue in Good Fortune was whether Good Fortune's use of bearer shares -- a type of shares always suspect to parties (including Governments) wanting to know who owns foreign corporations -- precluded it from the tax benefit it sought.  The Code provision said that the benefit was not available if 50% or more of the owners of the stock of the foreign corporation is owned by residents of a country that did not provide reciprocal benefits.  The regulations provided that bearer shares could not be counted whether or not they were owned by otherwise qualifying shareholders.  The problem was that the Regulations provided a qualifier -- bearer shares not counted -- that the statute did not provide.

The Tax Court held under the Chevron Framework that (i) the statute was ambiguous on the issue of bearer shares for this test (Congress had not spoken), therefore getting past Step One, and (ii) that the IRS regulations' interpretation was "reasonable because it provided certainty and resolved the difficult problems of proof associated with establishing ownership of bearer shares." (quote cleaned up).

Applying the same Chevron Framework the Court of Appeals reached a different conclusion.  First, it did not resolve the issue of whether the statute was sufficiently ambiguous to permit the IRS to interpret the stock ownership requirement.  Finding of ambiguity is essential in Chevron Step One to permit Chevron space in which the agency can provide a reasonable interpretation. Rather, the Ninth Circuit assumed that the statute was ambiguous.  Second, moving to Step Two on that assumption, the Ninth Circuit said that, based on the reasons the IRS articulated (such as they were) for the exclusion of bearer shares, the Regulation was not reasonable and therefore failed Step Two.
The Court said (cleaned up) the following (blending Step One into Step Two):
Even if § 883 grants the IRS significant discretion to establish how to prove ownership, it hardly authorizes the agency to categorically deny consideration of a recognized form of ownership based on only a single, undeveloped statement that it is difficult to reliably track the location of a given owner. If the IRS found that the transferable nature of bearer shares made substantiation impossible, we might conclude that the 2003 Regulation reasonably implemented that finding. Indeed, a kind of stock that is entirely impossible to track might not constitute a form of ownership contemplated by § 883(c)(1). But the IRS has never made (much less adequately supported) such an absolute claim of impossibility with regard to bearer shares. The IRS's interpretation instead appears to rewrite § 883(c)(1) to require not only valid ownership, but ownership that is not difficult to track. Even if this regulatory amendment to § 883 is not unambiguously foreclosed by the statute's language, its unsubstantiated treatment of ownership comes close to violating the plain language of the statute—indicating that the 2003 Regulation is unreasonable at Chevron Step Two. 

District Court Holds that Santander's Arguments to Avoid Penalty for Bullshit Tax Shelter (No Substance) Lack Substance (7/24/18)

Here is an entry that I posted a few days ago on my Federal Tax Crimes Blog.  It is equally interesting to Federal Tax Procedure enthusiasts.

In Santander Holdings USA, Inc. v. United States (D. Mass. Dkt. 09-11043-GAO Dkt Entry 344 7/17/18), here, Santander previously lost the merits of its bullshit tax shelter on appeal, with the Court of Appeals holding that the shelter lacked economic substance.  Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016), here, cert. denied sub nom. Santander Holdings USA, Inc., & Subsidiaries v. United States, 137 S. Ct. 2295 (2017).  See my discussion of the Court of Appeals decision, First Circuit, Reversing the District Court, Rejects Santander's Bullshit Tax Shelter (Federal Tax Crimes Blog 12/17/16), here.

Santander argued that, although its tax shelter lacked economic substance -- i.e., was bullshit -- it should be able to avoid the accuracy related penalty.  Well, basically, the district court held that that argument too lacked substance -- was bullshit.  The opinion is short and, I think, predictable, so I forego addressing it further.

However, the district court did include a quote from the Court of Appeals' decision that I had included in my prior write up but was in a larger quote so that I had not focused on it.  The district court did focus on it as follows.  This is the quote (cleaned up):
When a transaction is one designed to produce tax gains not real gains—such as when the challenged transaction has no prospect for pre-tax profit—then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.
The district corut did not quote the whole paragraph from the Court of Appeals which includes "tax evasion" twice, so I offer the whole paragraph (cleaned up):
The economic substance doctrine is centered on discerning whether the challenged transaction objectively lies outside the plain intent of the relevant statutory regime. A transaction fails the economic substance test if, though it actually occurred and technically complied with the tax code, it was merely a device to avoid tax liability. Courts may disregard the form of transactions that have no business purpose or economic substance beyond tax evasion. In other words, when a transaction is one designed to produce tax gains not real gains -- such as when the challenged transaction has no prospect for pre-tax profit -- then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.
Readers of this blog will recognize the term "tax evasion."  At least in this blog and in other authorities on criminal tax matters, tax evasion is a term of art.  Narrowly, it means the specific tax evasion crime in § 7201, but is often used to cover the panoply of tax crimes where tax was evaded (e.g., the Sentencing Guidelines require that for a tax loss as the first step in the sentencing calculation).  But, the term usually does connote conduct that is criminal.  See e.g., the Wikipedia entry for Tax Evasion, here.

Wednesday, July 25, 2018

Developments - Federal Tax Procedure Book 2018 Editions and Altera (7/25/18; 7/27/18)

The 2018 editions of the Tax Procedure Book (Student Edition and Practitioner Edition) are available for download on SSRN as of 7/17/18.  The SSRN postings are linked on the page to the right titled "2018 Federal Tax Procedure Book & Supplements (7/17/18)."  

I am posting on this blog today a dramatic new development -- the Ninth Circuit's decision in Altera Corp. v. Commissioner, ___ F.3d ___ (9th Cir. 2018), here, sustaining the relevant § 482 regulations and reversing the Tax Court decision which struck them down.  I did not include this Ninth Circuit decision in my new editions of the book, so will include it in the new cumulative update that I provide from time to time to

In Altera, the Court decided 2-1 that the IRS's regulations requiring the inclusion of of employee stock-based compensation in cost-sharing arrangements which, if valid, avoid Section 482 adjustments.  The opinions (majority and dissenting) are quite good.

In high level summary, the majority concludes (i) from the APA procedural perspective, the regulations are valid (promulgated with the appropriate notice and comment and reasonable consideration as to the final contents of the regulations); and (ii) from the substantive perspective, the regulations are entitled to Chevron deference (Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984)), thus upholding the inclusion of employee-stock based compensation.

These types of issues are discussed in some detail in the new editions of the Federal Tax Procedure Book and in the article.  The genre of issue is fairly standard in administrative law.  Readers who are not familiar with the issues, should read the majority and dissenting opinions.

The two issues in a little more detail are:

1.  APA Procedure.

The majority opinion concludes that the notice and comment and regulations pre-amble discussion did fairly cover the final content of the regulations and thus the regulations were procedurally valid.  The dissenting opinion disagrees and, like the Tax Court, does not think that there was sufficient notice or reasoned explanation for the final regulation to be sustained procedurally under the APA.

2.  Substantive Interpretation.

The majority opinion concludes that the regulation is entitled to Chevron deference.  The dissenting opinion concludes that no Chevron deference at all is warranted because of the procedural defect the dissenting judge found (see paragraph 1 above).  This permits the dissenter to then reach a substantive interpretation unfettered by Chevron deference.  In Chevron parlance, the reviewing court unconstrained by Chevron deference can then reach its own most reasonable interpretation of the statute even if the IRS interpretation is reasonable, albeit less reasonable than the Court's most reasonable interpretation.  But, the dissenting judge goes one step farther -- she concludes that the IRS's interpretation was not even a reasonable interpretation and was inconsistent with the "plain language of the statute."  She then states:  "For at least this reason, I also disagree with the majority’s conclusion that Treasury’s reading of § 482 satisfies the second step of the Chevron test."  It is not clear whether the dissenting judge would stop the Chevron inquiry at Step One or would get to Step Two and hold the IRS interpretation unreasonable.  Either way, for the dissenting judge the IRS would lose on the substance because she interprets the substance differently than the IRS.  But, of course, the dissenting judge lost the battle of ideas on the panel.

Saturday, April 21, 2018

Whistleblower Matters - Update (4/21/18)

I have made updates to the working draft of the Federal Tax Procedure book based, in part, on a recent posting on the Procedurally Taxing Blog -- Keith Fogg, Don’t Expect a Whistleblower Award for Giving the IRS Privileged Information and General Information from the Judicial Conference on this Issue (Procedurally Taxing Blog 4/16/18), here.  Also included in the updates are the recent statutory changes to the whistleblower awards program.  I link here a pdf of a red-line of the Whistleblower chapter -- Chapter 19.  Whistleblower Awards -- showing the changes in the working draft from the 2018 edition.  This is a footnoted edition of the draft of the chapter.  The principal new items covered are:]

  • The change in the statute from "collected proceeds" to "proceeds" with a broadening of the base for whistleblower awards to clearly encompass non Title 26 collections (such as FBAR penalties and criminal fines related to tax crimes).
  • The scope of review for Tax Court whistleblower cases.
  • Appellate venue to the D.C. Circuit Court of Appeals for Tax Court whistleblower cases.
  • The WBO's fye 2017 statistics for whistleblower cases.