A&M Tax Advisor Weekly
On April 4th, the United States District Court for the District of Colorado in Liberty Global Inc. v. United States invalidated a U.S. Treasury Department regulation which attempted to backfill certain aspects of the section 245A dividends received deduction (otherwise known as the participation exemption) enacted in the Tax Cuts and Jobs Act (the TCJA). The court based its decision on the failure of Treasury to comply with the requirements of the Administrative Procedure Act (the APA). As a result, U.S.-based multinational companies may have a refund opportunity.
Putting aside myriad interesting constitutional, statutory, and administrative law issues, as a practical
matter this case presents what could be a substantial cash flow opportunity (a permanent tax savings) to a U.S.-parented multinational company with the following characteristics:
The U.S. parent company has foreign subsidiaries that are controlled foreign corporations (CFCs) and that have U.S. tax years other than the calendar year; and
During the period beginning on January 1, 2018, and through the first day of a CFC subsidiary’s first fiscal year beginning after 2017 (hereinafter the “gap period”), one or more of its CFC subsidiaries entered into related party transactions that resulted in substantial positive earnings.
For example, for a CFC with a U.S. tax year ending on November 30, its gap period would be the period beginning on January 1, 2018, and ending on November 30, 2018. As a result of the varying effective dates of the transition tax (one-time tax under section 965 on deferred earnings of applicable CFCs), the global intangible low-taxed income (GILTI) rules, and the participation exemption, CFC earnings occurring during its gap period could qualify for a permanent exemption from U.S. tax, even if repatriated.
Some U.S.-based multinational companies, like Liberty Global, caused one or more of their CFCs to enter into related party transactions that accelerated income into their gap periods, creating potential substantial tax savings. The savings could arise because the different dates of the TCJA international tax provisions noted above could result in the CFC’s earnings not being subject to any tax with a 100% dividends received deduction. Treasury recognized this gap period planning opportunity and concluded that this was not what Congress intended, even though it was something that clearly followed from the statutory language. To backfill what Treasury felt was Congress’ unintended omission regarding the application of the GILTI rules, Treasury enacted temporary regulations in 2019, with retroactive effect. However, those regulations were purportedly promulgated under the authority Congress gave Treasury with respect to the participation exemption, and not the GILTI provisions. In those temporary regulations, Treasury included a rule that would disallow the 100% dividends received deduction for CFC gap earnings resulting from related party transactions that had the effect of increasing the CFC’s gap period earnings.
Liberty Global challenged the temporary regulations based on three alternative legal theories:
The regulations are invalid because they are contrary to the express language of the statute;
The regulations are invalid because Treasury did not have authority to make the regulations retroactive; and
The regulations are invalid because they were not promulgated in compliance with the notice and comment requirements of the APA.
The court decided in favor of the taxpayer based on the APA argument (with no need to consider the other two) and invalidated the section 245A temporary regulations. Presumably, the court’s reasoning would also apply to other rules not addressed in Liberty Global aimed at preventing tax avoidance under a look-through exception (section 954(c)(6)) for a CFC’s foreign personal holding company income. Treasury may decide to appeal this decision but even if it convinces one or more appellate courts that the APA argument has no merit, it may have to address the other two legal theories advanced by Liberty Global. Nonetheless, considering the hazards of litigation, it is possible that this decision could be reversed on some basis, and therefore the refund opportunity highlighted by this case may not be a sure thing. Because the opportunity could be substantial, affected multinational companies may need to take immediate action due to the looming expiration of the statute of limitations. For example, if a calendar year U.S. parent company received a dividend in 2018 from a CFC’s earnings for the period January 1, 2018, to November 30, 2018, the statute of limitations for the U.S. parent to file a refund claim for 2018 would expire on September 15, 2022 (assuming the maximum extension of the filing date for the original 2018 return).
A&M Taxand Says
Several courts have recently found that the APA applies to tax guidance that was not subject to notice and comment prior to issuance, such as the temporary regulations in Liberty Global, and IRS notices in other recent cases (Mann Construction Inc. v. United States, a Sixth Circuit decision regarding certain employee-benefit trusts and CIC Services LLC v. IRS, a district court case regarding microcaptive transactions). When the courts invalidate regulations or notices, as they did in those cases, taxpayers may be eligible for a refund of taxes, interest, and penalties paid. Relevant to the Liberty Global decision, for companies that have repatriated any CFC gap period earnings and paid U.S. tax based on the temporary regulations, now is the time to file a protective refund claim. If Treasury does appeal the decision in Liberty Global, by the time a court reaches a final conclusion, the statute of limitations may have expired for refund claims. A&M is available to help companies evaluate this opportunity and to assist in filing protective refund claims.