Thursday, May 7, 2020

Tax Court Conflates Standards for Testing Interpretive and Legislative Regulations (5/7/20; 5/11/20)

In Whirlpool Financial Corp. v. Commissioner, 154 T.C. ___ No. 9 (2020), here, the Tax Court (Judge Lauber) held that income from a foreign manufacturing and sales structure was foreign base company sales income (FBCSI) under § 954(d).  Whirlpool’s tax shenanigans to avoid that result failed.  I won’t get into the details of the underlying tax issues.  I focus here on the Court’s explanation of how it applied Chevron to approve a regulation interpretation that was important to the result.

The Court discusses the Chevron analysis at Slip Op. pp. 54-62.  The regulation in question interpreted § 954(d)(2).  Although the Court did not state whether the regulations were interpretive or legislative regulations, it seemed to treat the regulations as interpretive regulations, testing the regulations under “the familiar two-step test of Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).”  (Slip Op. p. 54.)  As I have noted before, Chevron applies to an interpretive regulation, ultimately testing the reasonableness of an agency interpretation of ambiguous statutory text.  The questions are (i) is the interpretation within the scope of the statutory ambiguity and (ii) is the interpretation reasonable (sometimes called permissible).  By contrast, legislative regulations (such as the consolidated return regulations) are the law within the scope of the delegation and are not interpretations of the law, so testing a legislative regulation for reasonableness of the interpretation is an oxymoron.  Rather, legislative regulations are tested under the arbitrary, capricious or manifestly contrary to the statute standard under 5 U.S.C. § 706(2)(A); and Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983), focusing on the procedural regularity of the regulations promulgation process.  Questions I sometimes ask to those I engage on the subject are:  Do courts defer to statutes (deference being meaningful only to interpretations of statutes)? Since legislative regulations within the scope of the authority granted are the law just as if they were statutes and are not interpretations of the law, how exactly does a court defer to the legislative regulation?

As other courts have misread Chevron and subsequent cases, the Court conflated the two standards.  But, they are not the same standard, and the two standards do not apply to the same type of regulation.  I cite readers to my article, John A. Townsend, The Report of the Death of the Interpretive Regulation Is an Exaggeration (SSRN 1/25/20), here.  (Caveat, the main theme of the article and the points I make in this blog are rejected by many, if not most, scholars addressing the issue, as I note in setting up the discussion in the article; if error there be in my view, I still stick with it.)

These are the parts of Judge Lauber’s opinion that I think improperly conflate (or at least confuse) the two standards:
If the statute is silent or ambiguous with respect to the question at issue, step two of Chevron requires the court to give deference to the agency’s construction, so long as it is permissible and not “arbitrary, capricious, or manifestly contrary to the statute.” Chevron, 467 U.S. at 844; see United States v. Mead Corp., 533 U.S. 218, 227 (2001).
* * * *
Under step two we must evaluate whether the regulations are a “reasonable interpretation” of the statute. Chevron, 467 U.S. at 844. We will give deference to the agency’s construction unless it is “arbitrary, capricious, or manifestly contrary to the statute.” See id. at 844. We have no difficulty concluding that the manufacturing branch regulations pass muster under this test.
* * * *
“[W]e conclude that the Secretary’s manufacturing branch regulations are a “reasonable interpretation” of the statute. * * * * The statute does not “unambiguously foreclose[] the * * * interpretation” set forth in those regulations. * * * And because the manufacturing branch regulations are fully consistent with Congress’ intent as expressed in the legislative history, we cannot find those regulations to be “arbitrary, capricious, or manifestly contrary to the statute.”
I address this issue in considerably more detail in the article pp. 85-99 (and see particularly the discussions of United States v. Mead Corp., 533 U.S. 218 (2001); Mayo Foundation for Med. Educ. v. United States, 562 U.S. 44 (2011); and  Judulang v. Holder, 565 U.S. 42 (2011)).  I also address the issue in Legislative Rules And Chevron Deference An Oxymoron? (Federal Tax Procedure Blog 1/31/20; 2/10/20), here.

Addendum on 5/11/20 1:30pm:

I picked up a similar conflation of the standards in Baptist Mem. Hosp. - Golden Triangle, Inc. v. Azar, 2020 U.S. App. LEXIS 12555 (5th Cir. 2020), here, as follows (Slip Op. 4-5, footnotes omitted):
The Hospitals sued the Secretary, claiming the 2017 Rule exceeds his authority in violation of 5 U.S.C. § 706(2)(C). The district court agreed, relying almost entirely on Children's Hospital Association of Texas v. Azar, a district court decision 5]  invalidating the 2017 Rule.  After the Secretary appealed and the parties briefed this case, the D.C. Circuit overturned the district court decision in Children's Hospital and upheld the 2017 Rule [Children's Hosp. Ass'n of Tex. v. Azar, 933 F.3d 764 (D.C. Cir. 2019)].
In reviewing a challenge to an administrative agency's statutory construction in a final rule, we apply Chevron's two-step framework.  We first employ the "traditional tools of statutory construction" to determine "whether Congress has spoken to the precise question at issue."  "If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress."  But if "the statute is silent or ambiguous with respect to the specific issue," we must defer to the agency's interpretation so long as it "is based on a permissible construction of the statute."  We also must defer when the statute expressly delegates an agency authority "to elucidate a specific provision of the statute by regulation."  The agency's "legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute."
Baptist Mem. Hosp. seems to be a case about interpretation (an interpretive rule) rather than about whether the agency had specifically congressional delegated authority to determine the law (legislative rule).

So, I looked to the parallel case in the D.C. Circuit cited in the opinion, Children's Hosp. Ass'n of Tex. v. Azar, 933 F.3d 764 (D.C. Cir. 2019), here.  I found something interesting in that case that differentiates between review under subparagraphs (A) and (C) of § 706(2).  I have commonly cited subparagraph (A) as the provision under which State Farm-type procedural challenges are made, but I had not previously connected Chevron challenges to subparagraph (C).  Just as a reminder, here are the relevant provisions of § 706:
To the extent necessary to decision and when presented, the reviewing court shall decide all relevant questions of law, interpret constitutional and statutory provisions, and determine the meaning or applicability of the terms of an agency action. The reviewing court shall—
(1)compel agency action unlawfully withheld or unreasonably delayed; and
(2)hold unlawful and set aside agency action, findings, and conclusions found to be—
  (A)arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law;
  (B)contrary to constitutional right, power, privilege, or immunity;
  (C)in excess of statutory jurisdiction, authority, or limitations, or short of statutory right;
  (D)without observance of procedure required by law;
  (E)unsupported by substantial evidence in a case subject to sections 556 and 557 of this title or otherwise reviewed on the record of an agency hearing provided by statute; or
  (F)unwarranted by the facts to the extent that the facts are subject to trial de novo by the reviewing court.
In making the foregoing determinations, the court shall review the whole record or those parts of it cited by a party, and due account shall be taken of the rule of prejudicial error.
In Children’s Hosp. Ass’n, the D.C. Circuit panel was careful to address the types of review under these provisions, the Court differentiated as follows:

review under subparagraph (C) is the “familiar Chevron framework. (See pp. 769-780.)
subparagraph (A) is the arbitrary and capricious (“arbitrary or capricious”) review.  That review is (p. 773):
An agency rulemaking is arbitrary and capricious "if the agency has relied on factors which Congress has not intended it to consider, entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of agency expertise." Motor Vehicle Mfrs. Ass'n of U.S. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43, 103 S.Ct. 2856, 77 L.Ed.2d 443 (1983).
Off Topic Addendum (On Original Post): On a rant point I posted on earlier about the Tax Court’s seemingly inconsistent use of periods inside or outside end quotation marks, my anecdotal checks indicated that Judge Lauber appeared to use the period outside the quote less than other judges.  See Updates on the Tax Court's Continued Love Affair with Periods Outside Quotations (Federal Tax Procedure Blog 1/4/20; 2/29/20), here.  I noted that, apparently, the Tax Court has a style manual that permits such differences, where, by contrast, the Supreme Court Style Manual compels the period inside the end quote.  In Whirlpool, Judge Lauber continues with 97 periods inside the end quotes and zero periods outside the end quotes.  As I was told about the Tax Court secret style manual, judges are not compelled to comply.  Perhaps Judge Lauber just chooses to use the general American and Supreme Court style (periods inside end quotes), although last year he swung both ways in one opinon (one out of four).

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