Notice & Comment

Corporate Inversions and in Terrorem Rulemaking

This week, the Treasury and IRS released a notice addressing so-called corporate inversions, through which U.S. companies essentially shuffle their legal structures to reduce the amount of income subject to U.S. taxes.  It’s not surprising that this guidance came out, given that President Obama himself has lambasted the alleged “corporate deserters” who have taken advantage of the tax benefits associated with inversions.

However, the immediate impact of the IRS notice might come across as a surprise to those accustomed to the APA’s default procedural framework.  Usually, to promulgate substantive rules, like those relating to inversions, an agency must first issue a notice of proposed rulemaking and solicit comments.   Under the APA, substantive rules generally take effect only on the completion of this process.

Consistent with the APA, the IRS notice does not purport to provide any immediately effective rules.  Rather, it simply announces that it will, at some point, issue regulations targeting inversions.  Yet news outlets correctly report that the IRS’s notice will have immediate effect and that any company undergoing an inversion on or after the date of the notice (Sept. 22, 2014) will face tighter restrictions.

So what’s going on here?  Under Section 7805(b)(1)(C) of the tax code, the Treasury enjoys the authority to issue regulations retroactive to the date on which any notice describing the anticipated regulations is issued.  Consequently, a mere notice can alter taxpayer behavior, even in the absence of any actual rulemaking activity.  The in terrorem effect of retroactive regulations will encourage taxpayers to immediately take IRS notices into account, whether or not the agency follows through with rulemaking.

I think Section 7805(b)(1)(C) makes sense in some circumstances, especially where urgent or unusual situations establish the need for quick agency action.  But I’m skeptical that the present circumstances warrant the use of the Treasury’s authority.  Inversions have been around a long time and implicate complex code provisions, which tells me that reform should proceed thoughtfully and with Congressional involvement, not through the quick promulgation of an IRS notice apparently prompted by election-year considerations.

Section 7805(b)(1)(C)’s short-circuit of standard rulemaking procedures also concerns me,  given that IRS notices frequently fail to lead to any actual rulemaking.  Having stifled behavior through the threat of retroactive regulations, the IRS moves on to other priorities, and the public never enjoys a meaningful opportunity to comment on the agency’s proposed guidance or to question the agency’s policy decision.

I would prefer that a statutory “good cause” standard apply whenever the IRS uses a notice to threaten retroactive regulations.  This will help ensure that the notice procedure is actually used for pressing matters, and not as an end around the notice and comment safeguards designed to protect the public.  But I’m not holding my breath for any statutory amendment.

Andy S. Grewal

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