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.

I digress a bit on the Chevron issue in paragraph 2 above.  The Chevron test asks:
Step One: Is the statutory text ambiguous? If not ambiguous, the unambigous statute applies regardless of the agency interpretation.  If it is ambiguous, go to Step Two. 
Step Two: Is the IRS interpretation reasonable?  If so, the IRS interpretation controls.  If not, the agency interpretation does not apply, and the Court reaches its own interpretation (which perforce would be different from the agency interpretation that the court found to be unreasonable).
In short, the Chevron test is outcome determinative only where the agency adopts a reasonable interpretation when the reviewing judge believes that there is a more reasonable interpretation than the agency adopts.  In this circumstance, the agency reasonable interpretation (rather than the judge more reasonable interpretation) controls.  Thus, at Step One, an agency interpretation other than the unambiguous statute is per se unreasonable and doesn't control.  At Step Two, an agency unreasonable interpretation of an ambiguous statute does not control and the judge supplies the most reasonable interpretation.

Background on the Altera panel:
  • Sidney R. Thomas (Wikipedia here) was appointed by Bill Clinton.
  • Stephen Reinhardt (Wkipedia here) was appointed by Jimmy Carter.  Reinhardt is now deceased but had concurred in the majority opinion prior to his death.
  • Kathleen M. O'Malley (Wkipedia here), Circuit Judge from the Court of Appeals for the Federal Circuit, appointed by Barack Obama.  She wrote the dissent.
The Ninth Circuit could agree to en banc review.  Back when I was doing appellate litigation (with DOJ Tax Appellate in the early 1970s), en banc review was very rare, particularly in circuits like the Ninth with a large number of judges.  I have not seen recent statistics on en banc review.  But, I doubt that anyone can predict. Either it will happen or not.  And I have no prediction if it does happen.

I can make a prediction though if the Supreme Court were to accept certiorari.  The odds of the Supreme Court screwing it up are higher than normal.  E.g., Commissioner v. First Sec. Bank of Utah, 405 U.S. 394 (1972) (a transfer pricing case).  (I could name other indicators supporting my calling of the odds, but I will forego that for now.)

For additional comment, see
Upon reviewing Professor Walker's comment, I was reminded of the following footnote in the opinion (p. 25):
   n5 Because the Commissioner does not contest the applicability of the APA or Chevron in this context, this case does not require us to decide the broader questions of the precise contours of the application of APA to the Commissioner’s administration of the tax system or the continued vitality of the theory of tax exceptionalism. See generally, e.g., Stephanie Hoffer and Christopher J. Walker, The Death of Tax Court Exceptionalism, 99 MINN. L. REV. 221 (2014); Kristin E. Hickman, Coloring Outside the Lines: Examining Treasury’s (Lack of) Compliance with Administrative Procedure Act Rulemaking Requirements, 82 NOTREDAME L.REV. 1727 (2007).
I think the relevance to this footnote is that the IRS argued at the Tax Court level that the regulation was an interpretive regulation that was not required by the APA to be published after notice and comment which, in this view, would have exempted it from the reasoned decisionmaking requirements of the APA.  Motor Vehicle Manufacturers Association of the United States v. State Farm Mutual Auto Insurance Co., 463 U.S. 29 (1983).  There is a lot to unpack there.  Suffice it to say that, in my article that is currently being reviewed by SSRN for posting on my SSRN author web page here, I take the position that interpretive regulations in the traditional APA meaning (pre-Chevron) are not subject to the notice and comment requirement in the APA for legislative regulations.  Others take the position that, conferring Chevron deference (which notice and comment does), makes a regulation legislative and hence subject to the notice and comment requirement even if they might otherwise be characterized as interpretive regulations.  It seems to me that, having gone through the notice and comment requirement (as the IRS typically does even for regulations that it views as interpretive), the IRS subjected itself to State Farm's requirement for regulations that its rulemaking be reasoned.  I don't think that commands the conclusion that interpretive rulemaking that goes through notice and comment is legislative simply because it receives Chevron deference.

A Bit of a Diversion (added 7/27/18 12:45pm):

Altera was a reviewed opinion in the Tax Court with no dissents (see opinion here).  The Ninth Circuit reversed the Tax Court for reasons that, it seems to me, are straightforward.  So, how did the Tax Court miss it?  Well, readers can reach their own conclusion, but I had a similar situation with a different result early in my career.

When I was a fledgling lawyer starting at the DOJ Tax Division, I was in the Appellate Section.  I was assigned a case that, when decided, was Morris Est. v. Commissioner, 454 F.2d 208 (4th Cir. 1972), hereMorris was an appeal from a reviewed opinion in the Tax Court.  The reviewed opinion holding against the IRS was written by Judge Tannenwald, a giant among lawyers and judges.  Four judges dissented.  It was not clear from  the majority opinion how many judges voted with the majority, but obviously it had to be a majority.  So that invites the question of (i) how many judges total were on the Tax Court bench at the time and (iii) whether any other than the dissenting judges did not participate in the reviewed majority opinion.  What was the split?

The case was a Government appeal from a loss in the Tax Court, so I was first up at the oral argument in the Fourth Circuit.  The senior judge, Judge Sobeloff, hit me with the first question starting with a preface as follows (these are paraprased given the laps of time).
Judge Sobeloff:  This is an appeal from the Tax Court, the expert judges in the tax law.  And it was a reviewed opinion.  Mr. Townsend can you tell me what the break down was in the Tax Court -- how many for and how many against the Government's position?
Me:  I do not know.  Perhaps my opposing counsel, Mr. Ed Smith, knows since he was formerly with DOJ Tax.  
Mr. Smith:  I think there are 16 judges from which I infer (in the absence of any contrary indication) that the breakdown was 12-4. 
Judge Sobeloff:  Well, isn't that the end of it.
I knew then that I had an uphill climb in oral argument.  (Reflecting the Tax Court judge split, the Government position had technical merits but little in the way of equity or fairness.)  The forthcoming decision against the Government confirmed that I had not succeeded in the uphill climb.

The point being, of course, that Altera was a unanimous Tax Court decision, with 15 judges voting for and two not participating.  Not a single dissent.  And the number voting for could be counted from the decision itself (at the bottom).  The Ninth Circuit was not influenced by the lopsided vote in the Tax Court.

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