Two recent federal district court decisions evaluated whether the process historically utilized by the Department of Treasury and the Internal Revenue Service ("IRS") to issue guidance satisfied the requirements of the Administrative Procedure Act ("APA"). The decisions, CIC Services and Liberty Global, considered the validity of a transaction-of-interest notice and temporary regulations, respectively. The taxpayers contended the guidance required pre-promulgation notice and comment. The district judges agreed and invalidated the guidance.
CIC Services1
Last year, the U.S. Supreme Court permitted CIC Services to proceed with its APA litigation against the IRS's micro-captive Notice (Notice 2016-66).2 On remand, the district court determined that the Notice was a legislative rule subject to the APA's notice and comment procedures and other requirements. Because the IRS did not satisfy these APA requirements in the issuance of the Notice, the court ruled that the Notice was invalid under the APA.3
In addition, the court found that the Notice must be set aside under the APA as agency action that is arbitrary and capricious. The court's analysis on this point is consistent with that of the Tax Court in Altera where the court found that Treasury's unsupported belief that something is true is not sufficient to support a rule (in Altera, "Treasury's belief that unrelated parties entering into [qualified cost-sharing agreements] would generally share stock-based compensation costs" and, in CIC, the IRS's "belie[f] this transaction ('micro-captive transaction') has a potential for tax avoidance or evasion").4 We note that the Tax Court in Altera also discussed the deficient manner in which Treasury responded to the comments it received regarding the proposed cost-sharing rule as further grounds to conclude that Treasury's rule was arbitrary and capricious. These two critical facts, i.e., the unsupported nature of Treasury's belief and its procedural mishandling of relevant comments, together led to its conclusion that the cost-sharing rule violated the APA.
In CIC, the administrative record for the Notice contained no comments or other evidence of IRS engagement with the public. The court thus looked solely to the quality of support for the IRS's belief to evaluate whether it passed muster under the APA:
