Page 6 - Altera: Why the Government Can't Count on Chevron Step Two

COMMENTARY / SPECIAL REPORT
regulation maintained that stock-based compensa- tion must be taken into account for qualified CSAs. Treasury and the IRS justified that position as being consistent with the legislative intent of Congress under section 482, with the objectives under the arm’s-length standard policy objective, and with transfer pricing rules set forth under applicable tax treaties and the OECD transfer pricing guidelines.
It is interesting, particularly in light of the Ninth Circuit’s decision in Xilinx, that the preamble to the final regulations announced that Treasury and the IRS determined that APA section 553(b), the notice and comment rules, did not apply.
C. Notice and Comment Requirements
The APA requires that in promulgating regula- tions through informal rulemaking, an agency must go through a process of publishing a notice, inviting comments through the forms of written or oral presentation, and then incorporating in the rules a concise general statement of their basis and pur- pose. Those requirements do not apply to interpre- tative rules or when the agency for good cause finds that notice and public procedure for the particular rulemaking exercise are ‘‘impracticable, unneces- sary, or contrary to the public interest.’’33
The notice and comment requirements under APA section 533 are intended to assist the courts to ensure the agency has provided fair treatment for persons affected by the rule. To comply with the fairness and notice aspects, there must be an ex- change of view, information, and even criticism between interested parties and the agency. The agency is required to respond to significant com- ments, although failure to respond to comments is important only insofar as it demonstrates that the agency’s decision was not based on a consideration of the relevant factors.34
D. The Tax Court’s Decision
The Tax Court held that the 2003 CSA regulation is a legislative rule and thus subject to the APA’s notice and comment procedures. Writing for the court, Judge L. Paige Marvel cited two reasons for concluding that the regulation has legislative status: The parties stipulated and the court agreed that the adjustments being proposed could only be sus- tained based on the regulation; and in issuing that regulation, the IRS invoked its general legislative rulemaking authority under section 7805(a). She
33APA, 5 U.S.C. section 553(b).
34Sherley v. Sebelius, 689 F.3d 776, 784 (D.C. Cir. 2012) (quoting Covad Communications v. FCC, 450 F.3d 528, 550 (D.C. Cir. 2006)).
noted that ‘‘legislative rules, unlike interpretative rules, have the force of law.’’35
Based on Ninth Circuit precedent, the Tax Court stated:
We can infer that an agency intends for a rule to have the force of law . . . where: (i) in the absence of the rule, there would not be an adequate legislative basis for enforcement ac- tion; (ii) when the agency has explicitly in- voked its general legislative authority; or (iii) when the rule effectively amends a prior leg- islative rule or changes existing law. (citations omitted). In determining whether a rule is interpretive or legislative ‘‘we need not accept the agency characterization at face value.’’36
The court next discussed APA section 706(2)(A), which states that a court must ‘‘hold unlawful and set aside agency action, findings, and conclusions that the court finds to be arbitrary, capricious, an abuse of discretion or otherwise not in accordance with law.’’ Marvel drew heavily from State Farm, reciting its reasoned decision-making standard.
The court concluded that the State Farm standard had to be followed. Therefore, it determined that its job was to decide whether the IRS met its obliga- tions under APA section 553(b) and (c) in issuing the final regulation.
In considering the primary rule or principle involved in transfer pricing matters, the Tax Court looked at reg. section 1.482-1(b)(1), which provides that ‘‘in determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer.’’ Citing its decision in Xilinx, the court reiterated that the arm’s-length standard always requires an analysis of what unrelated entities do under comparable circumstances. Similarly, in promulgating the final rule, the IRS considered whether unrelated parties would share stock-based compensation costs under a qualified CSA.37 The IRS necessarily decided an empirical question when it concluded that the final rule was consistent with the arm’s-length standard.
The regulation was flawed, according to the court, because the preamble to the final regulation
35Quoting Am. Mining Cong. v. Mine Safety & Health Admin., 995 F.2d 1106, 1109 (D.C. Cir. 1993)); see also Chrysler Corp. v. Brown, 441 U.S. 281, 301-302 (1979).
36Hemp Indus. Ass’n. v. DEA, 333 F.3d 1082, 1087 (9th Cir. 2003) (citing Gunderson v. Hood, 268 F.3d 1149, 1154, n.27 (9th Cir. 2001)).
37See T.D. 9088 (‘‘Treasury and the IRS believe that if a significant element of that compensation consists of stock-based compensation, the party committing employees to the arrange- ment generally would not agree to do so on terms that ignore the stock-based compensation’’).
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TAX NOTES, June 6, 2016