592 F.Supp.3d 677
E.D. Tenn.2022Background
- In November 2016 the IRS issued Notice 2016-66 designating certain "micro-captive" insurance arrangements as "transactions of interest" and directing taxpayers and material advisors to disclose participation, with potential penalties for noncompliance.
- CIC Services, a manager of captive insurance companies, sued, alleging the Notice is a legislative rule promulgated without APA notice-and-comment and is arbitrary and capricious; the case returned to district court after the Supreme Court held the Anti-Injunction Act did not bar jurisdiction.
- The administrative record submitted by the IRS consisted largely of prior notices, press releases, selected cases, e‑mails circulating drafts, and case law — but contained no underlying facts or data demonstrating the asserted widespread abusive use of micro-captive arrangements.
- The Sixth Circuit’s decision in a related case rejecting the IRS’s contention that similar disclosure notices are interpretive rules (and holding such notices are legislative rules) was treated as binding by the district court.
- The court concluded the Notice is both a legislative rule issued without required notice-and-comment and arbitrary and capricious for lack of factual support, vacated the Notice in its entirety, and ordered the IRS to return documents and information produced pursuant to the Notice to taxpayers and material advisors.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Notice 2016-66 is a legislative rule requiring APA notice-and-comment | Notice sets binding disclosure obligations and is legislative in effect; APA required notice-and-comment | Notice is interpretive or Congress exempted IRS disclosure rules from APA | Held: Notice is a legislative rule; APA notice-and-comment required (Sixth Circuit precedent applied) |
| Whether the Notice was arbitrary and capricious | Administrative record lacks underlying facts/data showing micro-captives have potential for tax avoidance/evasion | Administrative record (prior notices, cases, press releases) suffices to support the designation | Held: Arbitrary and capricious — record fails to show relevant data or reasonable factual basis for the designation |
| Appropriate remedy (vacatur, remand, scope of injunctive relief) | Vacatur of the Notice in toto; return or destruction of documents obtained under the Notice; bar use of such materials in proceedings | Remand for further proceedings; limit vacatur to CIC; no broad relief returning documents | Held: Vacatur of Notice in its entirety; IRS ordered to return documents produced under the Notice; court declined to bar agencies from using those documents in future lawful proceedings |
| Discovery/supplementation of the administrative record | Seek discovery into IRS basis and supplementation of the record | Opposed; argued review should be on administrative record | Held: Court found relief on the existing record and therefore overruled discovery objections as moot (also agreed with magistrate judge’s denial on the merits) |
Key Cases Cited
- Department of Commerce v. New York, 139 S. Ct. 2551 (2019) (describing APA arbitrary-and-capricious review and requirement that agency examine relevant data and provide a satisfactory explanation)
- Motor Vehicle Manufacturers Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983) (framework for arbitrary-and-capricious review)
- Baltimore Gas & Elec. Co. v. Natural Resources Defense Council, 462 U.S. 87 (1983) (agency action upheld if its path may reasonably be discerned)
- Allied-Signal, Inc. v. U.S. Nuclear Regulatory Comm'n, 988 F.2d 146 (D.C. Cir. 1993) (vacatur is discretionary and depends on seriousness of deficiencies and disruptive consequences)
- Atrium Medical Center v. U.S. Dep't of Health & Human Services, 766 F.3d 560 (6th Cir. 2014) (agency must act within lawful authority and use logical, rational decisionmaking)
- CIC Services, LLC v. I.R.S., 141 S. Ct. 1582 (2021) (Supreme Court held Anti-Injunction Act did not deprive district court of jurisdiction to hear challenges to IRS notice)