Tax and Administrative Law

• Publication year: 2018
• Author: By Lacey Strachan and Evan Davis

Tax and Administrative Law

By Lacey Strachan and Evan Davis

Will Courts Limit or Eliminate So-Called Chevron Deference to Administrative Regulations?

Introduction

Tax litigation is about the Tax Code, right? Well, partly right. It's as much, or more, about tax regulations. For a variety of reasons—respect for the Treasury Department's expertise, unwillingness to make hard political decisions—Congress routinely passes broad-brush tax legislation and relies on the Treasury Department to paint the details through regulations and other publications. Taxpayers may not like Treasury's judgment calls. What happens when they fight tax regulations in court? That depends in large part on how deferential courts are to Treasury's regulations.

On July 24, 2018, the Ninth Circuit released its 2-1 opinion in Altera Corp. v. Commissioner of Internal Revenue,¹ reversing the Tax Court's decision invalidating a transfer pricing regulation under Internal Revenue Code § 482 that requires companies' employee stock option expenses to be shared with foreign subsidiaries in cost-sharing arrangements. Applying Chevron deference to the Treasury Regulations, pursuant to the Supreme Court's 1984 decision Chevron U.S.A. Inc. v. Natural Resources Defense Council,² the Ninth Circuit held that Treasury Regulation 1.482-7A(d)(2) was valid, handing the IRS a major victory. The majority's reversal of the Tax Court, relying on Chevron deference, was hardly a given, as the Supreme Court and lower courts have been eroding, in practice, Chevron's deference to agency action. With transfer pricing—multinational corporations shifting income, expenses, and assets between countries to minimize taxes—being a heavily scrutinized tax issue, the Ninth Circuit's reversal of the Tax Court in Altera underscored that Chevron deference was alive and well in the Ninth Circuit. Two weeks later, however, the Ninth Circuit withdrew its Altera opinion, because Judge Stephen Reinhardt, one of the judges in the majority, had passed away before its publication. A reconstituted panel will now confer on the appeal, creating the possibility that the case may have a different outcome.³ Until a new opinion is issued, the Tax Court's decision invalidating the transfer pricing regulation will stand. The outcome of the Altera case is important not only for its transfer-pricing impact, but, perhaps more importantly, for evaluating Chevron's strength in the Ninth Circuit going forward.

Chevron has been the subject of criticism over the years, with 2018 bringing notable developments in the law. Will 2019 set a new course? Merely because Congress and the courts have deferred to the executive branch in recent decades does not mean this approach is set in stone.

Background on Chevron Deference, Including in Tax Cases

The Supreme Court has "long recognized that considerable weight should be accorded to an executive department's construction of a statutory scheme it is entrusted to administer, and the principle of deference to administrative interpretations."⁴ In Skidmore v. Swift & Co.,⁵ the Supreme Court addressed generally the deference afforded to an agency's interpretation of a statute, whether in rulings or other forms of guidance. Explaining that an administrator's policies are entitled to respect, the Supreme Court recognized that such policies "are made in pursuance of official duty, based upon more specialized experience and broader investigations and information than is likely to come to a judge in a particular case."⁶ The Court concluded that the Administrator's rulings, interpretations, and opinions constitute "a body of experience and informed judgment to which courts and litigants may properly resort for guidance."⁷

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In determining the amount of weight to afford an agency's interpretation, the Supreme Court identified the following factors: "the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control."⁸ Referencing Treasury regulations specifically, the Supreme Court in Skidmore stated that the Court "has long given considerable and in some cases decisive weight to Treasury Decisions and to interpretive regulations of the Treasury...."⁹

In 1979, the Supreme Court reiterated Skidmore in National Muffler Dealers Assn., Inc. v. U.S.,¹⁰ stating that it "customarily defers to [a Treasury] regulation, which, 'if found to 'implement the congressional mandate in some reasonable manner,' must be upheld.'"¹¹ To determine whether a particular regulation "carries out the congressional mandate in a proper manner,"¹² and, thus, "must be upheld" the National Muffler Court explained:

[W]e look to see whether the regulation harmonizes with the plain language of the statute, its origin, and its purpose. A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the manner in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent re-enactments of the statute.¹³

Chevron followed in 1984 and was a departure from the multi-factor standard of deference the Court relied on in Skidmore and National Muffler, creating a significantly more deferential standard for determining a regulation's validity. Chevron set forth a two-step analysis.¹⁴ The first step is to determine whether the statute unambiguously answers the precise question before the court. If it does, the inquiry ends there and the language of the statute controls. If the court finds the statute to be silent or ambiguous as to the question at issue, then the next step is to determine whether the regulation is "a permissible construction of the statute."¹⁵ What does "permissible" mean? Under Chevron, an agency's regulation is permissible as long as it is not "arbitrary or capricious in substance, or manifestly contrary to the statute," even if the court considers it to be an inferior—or even an "unwise"¹⁶—interpretation.¹⁷ This standard of review means agencies are the last word on a wide range of issues, with the sole limiting factors being whether the regulation is arbitrary or capricious, or directly contrary to statute.

Given that Chevron did not specifically overrule National Muffler, citizens challenging tax regulations hoped that Chevron was a problem for everyone except them. Indeed, between Chevron in 1985 and 2011, courts were left to wonder whether Chevron, or the less-deferential tax-specific National Muffler standard, applied to Treasury Regulations. The question was ultimately answered in the government's favor in Mayo Foundation for Medical Education and Research v. U.S.,¹⁸ which held that tax regulations are not special, and the more-deferential Chevron standard applies the same to Treasury Regulations as to all other agency regulations. Applying Chevron to tax regulations was particularly significant because Congress frequently broadly authorizes the Treasury Department to issue regulations to fill in details on new tax legislation. The Supreme Court in Mayo held that Chevron deference applied not only to Treasury Regulations where Congress had specifically delegated authority to the IRS to issue a regulation on a particular issue, but also to Treasury Regulations promulgated under the Treasury Department's general authority under IRC § 7805(a) to "'prescribe all needful rules and regulations for the enforcement' of the Internal Revenue Code."¹⁹

The Treasury Department must issue regulations, as opposed to other forms of guidance, to avail itself of Chevron deference because Chevron deference applies only to agency interpretations that Congress intended to carry the force of law.²⁰ The multi-factor standard for deference set forth in Skidmore continues to apply to other interpretations of a statute by an agency charged with implementing the statute; in the tax context, this includes Private Letter Rulings and Revenue Procedures.²¹ The Supreme Court in U.S. v. Mead Corp.,²² explained that the Court "said nothing in Chevron to eliminate Skidmores recognition of various justifications for deference depending on statutory circumstances and agency action."²³ The Skidmore standard remains as guidance to courts reviewing agency interpretations where Chevron does not apply.

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Criticism of Chevron Deference

Proponents of Chevron deference point to its practical benefits including that it promotes national uniformity, which has heightened relevance to tax matters. Even with Chevron deference, interpretation of certain tax laws and regulations can vary from circuit to circuit, but eliminating such deference will eliminate one factor tamping down inter-circuit variation. In recent years, however, then and future Supreme Court Justices have criticized Chevron deference for impeding Congress' constitutional duty to pass laws and, perhaps more importantly to those Justices, the Court's constitutional duty to interpret them.

In 2015, Justice Thomas questioned the constitutionality of Chevron deference in a concurring opinion he wrote in Michigan v. Environmental Protection Agency²⁴ explaining that the EPA's request for deference to its interpretation of a phrase in the Clean Air Act "raises serious questions about the constitutionality of our broader practice of deferring to agency interpretations of federal statutes."²⁵ Justice Thomas set forth the case for Chevron deference as a violation of separation-of-powers, by noting that it precludes judges from exercising their independent judgment in interpreting and expounding upon the laws, "forcing them to abandon what they believe is the 'best reading...