The Obama administration erred last year when it cracked down on tax-slicing “inversion” mergers without subjecting its rule to a notice-and-comment period, a federal court in Texas has ruled.
The U.S. District Court for the Western District of Texas invalidated the anti-inversion rule. In so doing, it sided with two business groups in deciding that the Internal Revenue Service (IRS) and its parent agency, the U.S. Treasury Department, were required to give public notice and solicit public comment before implementing their crackdown on inversion mergers.
However, the federal court rebuffed the business groups—the Chamber of Commerce of the United States, and the Texas Association of Business—on their two other arguments against the inversion crackdown. The court decided that, contrary to the contentions of the plaintiffs, the IRS and Treasury Department had not exceeded their authority and had not acted in an “arbitrary and capricious” manner.
The inversion rule effectively torpedoed plans by Pfizer to acquire Allergan for $160 billion, in what would have been the largest-ever inversion merger. Allergan is a member of the Chamber as well as the Greater Waco Chamber of Commerce, one of the groups that comprise the Texas Association of Business—which thus had standing to sue, according to the court.
At issue was a rule by the IRS and Treasury Department restricting the ability of companies to carry out inversion mergers.
The rule changed how the Treasury Department decided whether to impose penalties that reduce tax benefits for companies planning such deals where a non-U.S. company is 60% or more owned by U.S. shareholders due to acquiring U.S.-based companies within the previous 36 months. In computing that ownership percentage, the Treasury Department was allowed to exclude stock of foreign companies consisting of shares acquired from an American company within three years of the signing date of its latest acquisition.
‘Substantive,’ Not ‘Interpretive’
The IRS and Treasury Department asserted that they were exempt from notice-and-comment by arguing that their inversion rule was “interpretive.”
The court disagreed, holding that the inversion crackdown was a substantive or legislative rule subject to notice-and-comment under the Administrative Procedures Act—“not surprisingly,” the law firm Davis Polk & Wardwell stated in a brief commentary.
“Adjustments to application and treating stock as if it were not stock are not mere interpretations of the statute, but substantive modifications to the application of the statute,” the federal court concluded in its 15-page decision.
The court said the IRS and Treasury Department acted within their authority. They cited the Internal Revenue Code, which allows the IRS to “prescribe such regulations as may be appropriate to determine whether a corporation is a surrogate foreign corporation, including regulations (A) to treat warrants, options, contracts to acquire stock, convertible debt interests, and other similar interests as stock, and (B) to treat stock as not stock.”
The federal government has not said whether it plans to appeal the decision. The Treasury Department at deadline had not responded to a GEN query on the topic.