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), GS here, rev’d 926 F.3d 1061 (9th Cir. 2018), here.  Altera 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. [Note the 9th Cir. denied rehearing en banc and the Supreme Court denied petition for writ of certiorari - reh. en banc den. 941 F.3d 1200 (9th Cir. 2019), cert. denied, 591 U.S. ___, 141 S.Ct. 131 (2020).]
• Good Fortune Shipping SA v. Commissioner, 148 T.C. 262  (2017), here, rev'd  897 F.3d 256  (D.C. Cir. 2018), GS here.  Good Fortune was a Government loss on appeal.  I write on this below.
• Slone v. Commissioner, T.C. Memo. 2016-115,  GS here, rev'd 896 F.3d 1083 (9th Cir. 2018), GS here.  Slone was a Government win on appeal.  I may write on Slone in a later blog.

I write in detail today on Good Fortune.  Good 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. 

The Court gave some additional support for its conclusion, but the foregoing is the crux of the holding based on Chevron.  The decision holds open that, had the IRS given more reasoned analysis to support its conclusion that bearer shares should be excluded, it might have reached a different conclusion.  In doing so, I think the Court echoed analyses from two other administrative law cases (although it did not cite them): Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983); and SEC v. Chenery Corp., 318 U.S. 80 (1943).

In short, the D.C. Circuit read the Chevron tea leaves differently than the Tax Court.

I note also that in Altera the Ninth Circuit panel also reversed the Tax Court on its Chevron analysis.  Undoubtedly there will be some learning (growing) pains as tax lawyers get over any claim of exceptionalism.  And, as Justice Scalia said:  “administrative law is not for sissies.”  Antonin Scalia, Judicial Deference to Administrative Interpretations of Law, 1989 Duke L.J. 511, 511.