Challenging Regulations After Mayo And Home Concrete

In the wake of the Supreme Court of the United States' recent tax opinions in Mayo Foundation for Medical Education & Research v. United States, 131 S.Ct. 1836 (2011), and United States v. Home Concrete & Supply, LLC, 132 S.Ct. 1836 (2012) taxpayers have additional arguments at their disposal to challenge U.S. Department of the Treasury regulations. Those arguments are front and center in several pending U.S. Tax Court cases involving challenges to transfer pricing regulations.

Setting the Stage

In Mayo, the Supreme Court ended a decades-long debate over whether the standard of review for regulations issued pursuant to the Internal Revenue Service's (IRS's) general grant of authority under § 7805(a) was different from the standard of review for regulations issued pursuant to a specific directive in the pertinent statute. In reaching this holding, the Supreme Court rejected the idea that it should "carve out an approach to administrative review good for tax law only." Although many initially saw this decision as a victory for the IRS, others recognized the significance of the administrative law statement, which provided a clear signal that the IRS, like other federal agencies, is subject to the Administrative Procedure Act (APA) in promulgating its rules and regulations. The IRS, while acknowledging that it is subject to the APA generally, has taken the position that almost all regulations it issues are "interpretative" regulations not subject to various requirements under the APA.

After Mayo, appellate courts quickly applied the APA to cases involving challenges to regulations. In Burks v. United States, 633 F.3d 347 (5th Cir. 2011), the U.S. Court of Appeals for the Fifth Circuit noted that regulations "are generally subject to notice and comment procedure pursuant to the Administrative Procedure Act" and that the IRS's allowance for such notice and comment after final regulations were enacted was not an acceptable substitute for pre-promulgation notice and comment. In Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011), the U.S. Court of Appeals for the District of Columbia Circuit stated: "The IRS is not special in this regard; no exception exists shielding it—unlike the rest of the Federal Government—from suit under the APA." In Dominion Resources, Inc., v. United States, 681 F.3d 1313 (Fed. Cir. 2012), the U.S. Court of Appeals for the Federal Circuit invalidated regulations under § 263A as violating the APA because Treasury did not provide a reasoned explanation for deciding upon a regulation.

In Home Concrete, the Supreme Court rejected the IRS's attempt to overrule a prior Supreme Court opinion that had addressed the precise question under an almost identical predecessor statute. The Supreme Court pointedly held that its prior interpretation of a statute meant that "there is no longer any different construction that is consistent with [the prior opinion] and available for adoption by the agency." Because of this approach, the Supreme Court found it unnecessary to address several APA arguments advanced by the parties and amici and addressed in some of the lower court opinions on the issue. In comments reported in the tax press following the Supreme Court's decision, high-ranking government officials at both the IRS and the U.S. Department of Justice's Tax Division indicated that pre-Chevron decisions should be generally read as final determinations not subject to change by regulations. As discussed below, these statements are difficult to reconcile with the IRS's litigating position in pending cases involving challenges to transfer pricing...