In Chamber of Commerce et al. v. IRS et al., the plaintiffs scored a major victory in their challenge to the validity of some “anti-inversion” regulations issued under Section 7874 of the Internal Revenue Code. That statute, generally speaking, limits the tax benefits that might otherwise arise when a U.S. company re-incorporates as a foreign one. Aside from the specific statutory restrictions, Section 7874 grants the Treasury and the IRS the authority to modify how the statute applies when doing so would “prevent the avoidance of [its] purposes.” See Sections 7874(g) & (c)(6).
Under the statutory authority, the IRS in 2016 issued temporary regulations designed to thwart the tax benefits sought through the proposed $160 billion pharmaceutical merger between Pfizer Inc. and Irish drugmaker Allergan PLC. See TheStreet, “Treasury Department Was ‘Targeting’ Pfizer-Allergan Deal,” (Apr. 26, 2016). These regulations, issued without the notice-and-comment safeguards that ordinarily precede the implementation of legislative rules, had their intended effect — Pfizer and Allergan abandoned their merger plans because of the IRS’s action. See Financial Times, “Collapse of $160bn Pfizer and Allergan merger shocks corporate US,” (Apr. 6, 2016). See Treas. Reg. 1.7874-8T.
Two industry groups subsequently filed a lawsuit arguing that the regulation’s issuance violated the Administrative Procedure Act, and the district court, in a relatively brisk opinion, agreed. Notably, the court held that Section 7421, commonly referred to as the Anti-Injunction Act, did not preclude jurisdiction in this pre-enforcement challenge to the IRS’s regulation. This breaks from the common (though not necessarily correct) understanding of that statute. See Grewal, Yale J. Reg., “Fighting IRS Regulations Might Become Easier,” (Feb. 7, 2016). Taxpayers have typically had to wait until the IRS applied regulations to them before mounting a judicial challenge, and the district court’s blessing of a pre-enforcement challenge, if accepted more broadly, would expand taxpayers’ opportunities to set aside unlawful IRS regulations.
Aside from issues related to the Anti-Injunction Act, the court’s approach to temporary regulations merits attention. The IRS routinely argues that Section 7805(e) allows it to skip notice-and-comment procedures for any regulation issued in “temporary” form even where, as here, that regulation affects billions of dollars of economic activity. The IRS believes that because Congress specifically restricted the duration of temporary regulations to 3 years, that restriction displaces the APA’s general requirement that regulations become final only following a notice and comment process. But the court properly rejected that argument, see generally Grewal, Legislative Entrenchment Rules in the Tax Law, 62 Admin. L. Rev. 1011 (2010), and the IRS’s routine failure to observe APA requirements, without any showing of good cause, should be corrected. The court also rejected the IRS’s claim that the anti-inversion regulation was exempt from the APA as an interpretive rule, emphasizing that the regulation had been issued under a specific grant of authority and changed how the statute applied.
Because Chamber of Commerce could open the floodgates to pre-enforcement challenges of temporary regulations, the DOJ, in ordinary times, would surely appeal the decision. However, regulatory overreach was one of the early concerns of the Trump Administration, and the anti-inversion regulations, issued under the Obama Administration, were particularly controversial among business groups. Thus, the Trump Administration might be content to let the district court’s decision stand. And doing so would not necessarily allow companies to freely invert — the Chamber of Commerce case addressed only one part of the various regulatory anti-inversion measures, see Treas. Reg. 1.7874-8T, and Section 7874 itself has various rules that operate independently of any IRS regulations. It may thus be prudent for the IRS to focus on correcting any procedural defects with its other anti-inversion guidance rather than continue litigating its asserted authority to bypass the APA. (The court in Chamber of Commerce did not doubt the IRS’s authority to issue Treas. Reg. 1.7874-8T, if it were properly promulgated.)
Nonetheless, appealing Chamber of Commerce might be attractive to the White House. The President often laments corporations departing the United States, and his concerns would seem broad enough to reach any company that even nominally “flees” through inversion transactions. Ultimately, it’s probably best if the decision to appeal is determined through the usual channels, with the approval of the Solicitor General, rather than through the whims of the Oval Office. (UPDATE: On November 27, 2017, the DOJ filed its notice of appeal in Chamber of Commerce).
Follow me on Twitter: @AndyGrewal