923 F.3d 296
3d Cir.2019Background
- SIH Partners (domestic partner) owned two controlled foreign corporations (CFCs); SIH affiliate SIG borrowed $1.5 billion from Merrill Lynch in 2007 on a loan guaranteed by many SIH affiliates, including those two CFCs. The CFCs’ combined assets were far smaller than the loan.
- IRS applied 26 U.S.C. § 956 and implementing regulations (26 C.F.R. §§ 1.956-1(e)(2), 1.956-2(c)(1)) to treat each CFC as holding the guaranteed obligation and included in SIH’s income the CFCs’ applicable earnings attributable to that obligation, resulting in a $378M additional tax assessment.
- IRS’s inclusion accelerated taxation from the year dividends were distributed (2011) back to the year of the guarantees (2007) and the IRS taxed the inclusion as ordinary income (35%) rather than as qualified dividend income (15%).
- SIH Partners challenged the regulations as arbitrary and capricious under the APA and argued the § 956 inclusion should be taxed at dividend rates.
- The Tax Court granted summary judgment to the Commissioner; the Third Circuit, exercising plenary review, affirmed the Tax Court’s decision in full.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Validity of IRS § 956 regulations (1964) under APA | Regulations are arbitrary and capricious because they can produce multiple § 951 inclusions that in aggregate exceed the underlying loan and ignore facts-and-circumstances (necessity of guarantees) | Regulations mirror § 956(d) and were reasonable when promulgated; post‑promulgation practice or hindsight cannot show they were arbitrary; IRS considered but declined later changes | Regulations are not arbitrary or capricious; court confines review to the administrative record at promulgation and defers to agency interpretation under Chevron where reasonable |
| Whether IRS must apply a facts-and-circumstances test (e.g., necessity of guarantee) | IRS should assess whether guarantees were essential to obtain the loan and treat only truly repatriative guarantees as § 956(c)(1)(C) inclusions | Statute and regulations are categorical; revenue rulings/internal guidance are nonbinding and do not override regulations; purpose of guarantee is irrelevant under existing rule | No remand; facts-and-circumstances test not required; inclusion proper under regulations as applied |
| Proper tax characterization (dividend rate vs. ordinary income) of § 956(c)(1)(C) inclusions | § 956 inclusions are “as if a dividend” and thus should receive favorable qualified dividend rates | § 956 treats certain CFC investments "as if" dividend for inclusion purposes only; actual dividend treatment for tax rate requires distribution/benefit to shareholder and Congress specifically designates when § 951 inclusions are dividends | § 956 inclusions are not dividends for purposes of favorable dividend rates; taxed as ordinary income absent specific statutory designation |
| Remedy sought (invalidate regs or remand) | Invalidate or require IRS to reconsider under facts-and-circumstances | Uphold regulations and application; no agency action unlawfully withheld | Court affirms Tax Court; no invalidation or remand granted |
Key Cases Cited
- Duquesne Light Holdings, Inc. v. Comm’r, 861 F.3d 396 (3d Cir.) (standard of plenary review in this context)
- Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (U.S. 1984) (agency’s reasonable statutory interpretation entitled to deference)
- FERC v. Elec. Power Supply Ass’n, 136 S. Ct. 760 (U.S. 2016) (narrow scope of arbitrary-and-capricious review)
- Rodriguez v. Comm’r, 722 F.3d 306 (5th Cir.) (§ 956 inclusions are not actual dividends)
- Pension Benefit Guar. Corp. v. LTV Corp., 496 U.S. 633 (U.S. 1990) (courts shouldn’t invalidate agency action based on argument that agency failed to consider every statutory policy)
- Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402 (U.S. 1971) (review limited to administrative record for APA arbitrary-and-capricious review)
- Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545 U.S. 967 (U.S. 2005) (agency construction controls if reasonable and statute ambiguous)