A Second Review of Ninth Circuit Argument in Altera v. Commissioner

Today we welcome back guest blogger Stu Bassin for his take on the argument in the Altera case. Stu has blogged with us on several occasions. Because of the importance of the case, we are providing two views of the argument in Altera today. Keith

The Ninth Circuit held the long-awaited argument on the Government appeal of the Tax Court’s ruling in Altera Corp. v. Commissioner, 145 T.C., No. 3 (2015), on Wednesday, October 11. The case arose out of an IRS notice of deficiency which invoked Section 482 (and, specifically, Treas. Reg. §1.482-7(d)(2)) to redetermine the transfer prices employed for intra-group transactions amongst Altera corporate affiliates.   The Tax Court’s ruling, which invalidated the regulation under the Administrative Procedure Act (the “APA”) because of defects in the rulemaking process, has drawn wide-spread interest amongst practitioners involved in both transfer pricing and regulation validity matters.


Before the Tax Court, the parties agreed that the law generally requires participants in intra-group transactions to determine transfer prices in accordance with the prices comparable unrelated parties employ in arms-length agreements. The parties disagreed, however, regarding the proper allocation of stock-based compensation costs amongst the affiliates. The IRS supported its deficiency notice with a regulation which specifically required affiliates to share stock-based compensation costs in computing the transfer price, while the taxpayer contended that the regulation was invalid under the APA because it deviated from the comparable arms-length transaction test traditionally employed in computing transfer prices.

According to the taxpayer, during the rule-making process, commenters submitted substantial evidence supporting the proposition that, in practice, cost sharing agreements amongst unrelated entities operating at arms-length do not require sharing of compensation costs. The IRS did not identify any instance of a cost sharing agreement which provided for sharing of compensation costs in the preamble to the final regulations. Instead, it asserted an economic theory-based policy analysis to support its determination that cost sharing agreements must provide for sharing of compensation costs. The taxpayer, therefore, argued that the regulation was invalid because its requirement of sharing compensation costs in computing transfer prices was arbitrary, capricious, and inconsistent with the evidence before the Service during the rulemaking process.

The Tax Court unanimously ruled in favor of the taxpayer, invalidating the regulation and rejecting the proposed Section 482 adjustment.   The Tax Court’s analysis focused upon the second stage of the regulation validity inquiry mandated by Mayo Foundation v. United States— whether the determinations reflected in the regulation were arbitrary and capricious. The opinion criticized the IRS for failing to engage in actual fact-finding, failing to provide factual support for its determination that unrelated parties would share compensation costs in their cost-sharing agreements, failing to respond to significant comments, and acting contrary to the factual evidence before Treasury. Accordingly, the regulation failed to satisfy the reasoned decision-making standard established by Supreme Court precedent under Mayo and related cases.

On appeal, Altera was heard by a panel consisting of Chief Judge Thomas, Judge Reinhardt (the dissenter in the Ninth Circuit’s earlier Xilinx decision in favor of the taxpayer in a similar Section 482 case), and Judge O’Malley of the Federal Circuit. All three judges were appointed by Democratic presidents. Arthur Catterall, one of the top appellate lawyers from the Justice Department’s Tax Division, argued the case on behalf of the Government.   Donald Falk, a general appellate litigation specialist from Mayer Brown, argued the case on behalf of the taxpayer.  Appellate junkies familiar with appellate arguments in tax cases where the panel is largely silent may be surprised to learn that all three judges actively questioned both lawyers and that the argument extended to a full hour.

The Government focused its argument upon the first stage of the Mayo analysis—the agency’s statutory authority to issue a regulation which departed from the comparable arms-length standard for evaluating transfer pricing arrangements. It argued that the Treasury had authority to regulate on the treatment of cost-sharing agreements because of statutory ambiguity produced by tension between the two sentences of Section 482. The text of the statute provides—

“In any case of two or more organizations . . . owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.”

The first sentence, which has been part of the Code for decades and is consistently reflected in many tax treaties, has historically been construed by Treasury and the courts to incorporate a requirement that a taxpayer’s transfer prices be evaluated based upon their comparability to the arrangements negotiated by unrelated entities operating at arms-length. The second sentence, added in 1986 and focusing upon transfers of intellectual property, requires that the income from the transfer be apportioned in a manner “commensurate with income.” According to the Government, the differing results occasionally produced by a commensurate with income standard and comparable arms-length transaction standard create an ambiguity which allows Treasury to issue regulations which deviate from the arms-length standard for cost allocation.

The taxpayer acknowledged that the arms-length comparability standard and the commensurate with income standard are somewhat different and can produce different results in some cases. That difference, however, did not authorize Treasury to abandon the arms-length comparability standard for allocation of stock-based compensation costs. According to the taxpayer, both the statutory language and the legislative history of the 1986 amendment support a far narrower role for the commensurate with income standard. While the legislative history demonstrates that Congress was concerned about problems which had arisen with arms-length comparability analyses employed in connection with intellectual property transfers, the legislative history contains many references endorsing arms-length comparability analysis in other contexts. Similarly, the statutory language of the commensurate with income provision only applies to intellectual property transfers. Ultimately, the taxpayer contended the commensurate with income statutory language did not support abandonment of arms-length comparability in evaluating the allocation of compensation costs under the taxpayer’s cost-sharing agreement.

Virtually all of the panel’s questions focused upon the statutory construction questions and their implications for the scope of Treasury’s authority to promulgate regulations inconsistent with the arms-length comparability standard. The panel appeared to recognize the tension between the arms-length comparability standard and the commensurate with income standard. It questioned, however, the scope of the tension and the range of costs which Treasury could allocate without regard to arms-length comparability analysis. The government contended that the tension allowed Treasury to promulgate regulations governing all aspects of cost sharing agreements, while the taxpayer tried to limit such regulations to the intellectual property transfer arena.

Interestingly, the argument gave relatively little attention to the second stage of the Mayo analysis—the arbitrariness of Treasury’s determination.   The government did not challenge the Tax Court’s conclusions that the regulation was contrary to the evidence regarding comparable arms-length transactions. Instead, it argued that Treasury had almost unlimited discretion to prescribe the allocation of costs if the court agreed that Treasury had authority to prescribe rules contrary to the arms-length comparability evidence. To the contrary, the taxpayer argued that the absence of any arms-length comparability evidence rendered the regulation arbitrary and capricious. The panel, however, did not pursue this line of argument, notwithstanding the Tax Court’s focus on the issue.

The panel gave no indication of when it would render its decision in Altera. Full opinions on appeals to the Ninth Circuit tend to take a long time, so it seems likely that it will be several months before a decision is issued.








The Altera Oral Argument

We welcome back guest bloggers Professor Susan C. Morse from University of Texas School of Law and my colleague Senior Lecturer on Law Stephen E. Shay from Harvard.  Professors Morse and Shay, build on their post last week to fill us in on what happened before the 9th Circuit in Altera. Keith

At the Ninth Circuit on Wednesday October 11, government counsel carefully threaded the needle of statutory and regulatory interpretation in Altera, a case about transfer pricing and administrative law. Taxpayer counsel appeared to overreach. It refused to concede that Treasury has any authority to regulate the pricing of intercompany intellectual property sharing under qualified cost sharing arrangements (QCSAs) unless the guidance proceeds from the starting data point of unrelated party dealings, otherwise known as comparability analysis.


The panel included Ninth Circuit Chief Judge Sidney Thomas, Ninth Circuit Judge Stephen Reinhardt, and D.C. Circuit Judge Kathleen O’Malley, sitting by designation. Reinhardt joined the first Ninth Circuit Xilinx decision overturning the Tax Court decision, which interpreted the prior cost sharing regulation to allow the IRS to include stock option costs in the pool of shared costs. After a rehearing, Reinhardt dissented in the superceding Ninth Circuit Xilinx opinion that upheld the Tax Court. In Xilinx, he would have allowed the government to require inclusion of stock option costs in a cost-sharing pool even under earlier regulations that did not explicitly address stock options. The final regulations at issue in Altera, the current case, plainly say that stock option costs must be included in a QCSA cost pool, to the disadvantage of U.S. multinational groups which as a result may take fewer tax deductions resulting from the exercise of stock options. Billions of dollars of tax revenue are at stake in Altera.

The oral argument featured three important threads: The imposition of an administrative law framework with a Chevron starting point; the argument that “arm’s length” is not synonymous with “comparability analysis”; and the idea that the second sentence of section 482, which refers to “commensurate with income” payment for intellectual property “transfers”, specifically envisioned transfer pricing not tethered to unrelated party data points.

Judge O’Malley, who brought seven years’ worth of D.C. Circuit administrative law experience    to the hearing, repeatedly insisted on a textbook administrative law analysis. She asked both parties whether there is statutory authority for these regulations under Chevron. Yes, replied the government. Chief Judge Thomas asked whether the government has the statutory authority to “eliminate” comparability analysis altogether, for all transactions. No, replied the government, here trying to thread the needle. The statute does not say “arm’s length,” let alone comparability. Both are described in regulations. But there is “too much history.”

Well, then if the government cannot erase the arm’s length standard, how can it write regulations that set aside unrelated party data, like the agreements taxpayers point to under which unrelated parties develop technology together without mentioning stock options? Judge Reinhardt suggested that the validity of the regulation had to do with its subject: the sharing of intangible assets. Perhaps comparability analysis is not relevant for transactions involving intangibles in particular, he suggested. Agree, with respect to cost-sharing arrangements, replied the government.

But why doesn’t the departure from comparability analysis for intangibles violate the arm’s length standard? In response to prompts from the panel, the government agreed that arm’s length and comparability do not “go hand in hand” and are “not synonymous.” There are several “means to [the] end” of an arm’s length result. In the case of QCSAs, unrelated party data is “inherently not comparable” and cannot support clear reflection of income.

Taxpayer counsel, in contrast, contended that “it has to be an empirical analysis” and that “you have to take comparables as far as they will go,” and appeared to argue that this approach was required by the statute itself. “What if [the comparables] don’t go anywhere?” asked Chief Judge Thomas. Well, replied taxpayer counsel, then the government should “erase” regulations’ reference to an arm’s length standard. In rebuttal, the government further argued that the term “arm’s length standard” is a “term of art” and that Treasury’s interpretation is entitled to deference.

The second sentence of Section 482, added in 1986, allows the government to adjust related parties’ inclusions from “transfer” of intangibles so that they are “commensurate with income.” As the government pointed out, the legislative history clearly explains that unrelated party data points – i.e., comparability analysis – are not sufficient to allow clear reflection of income in these situations involving intangibles. This is strong evidence of statutory authority for the government to write regulations that depart from comparability analysis. Taxpayer counsel suggested that a QCSA might not qualify as a “transfer” under this sentence of the statute, so that perhaps it was not statutory authority at all. But government counsel disagreed, arguing that the word “transfer” was broad enough to encompass QCSAs and noting that this issue was apparently briefed, and ignored, in Xilinx.

The Tax Court cited State Farm, which requires reasonable explanation of policy changes, in its decision to set aside the Treasury’s regulations. Other reasonable explanation cases include Fox Television and Encino Motorcars, both of which came up during oral argument. O’Malley asked government counsel why the regulations requiring cost sharing were not a change; the government replied that the policy of requiring stock options costs to be included in pools had existed since 1997, years before the regulations were promulgated. Later, taxpayer counsel pushed the State Farm argument, insisting that some of the government’s arguments in litigation were “not what they said” in the preamble. But the panel did not pursue the specifics of the preamble’s language. And taxpayer counsel’s assertion that Chevron should be the “last step” of the analysis of regulatory validity was met with silence by the court.

Stay tuned for our analysis of the Ninth Circuit’s Altera decision – we’ll blog it here in due course.







Court Sustains Competent Authority Decision to Not Grant Treaty Relief

The other day I discussed Starr International v US, and the lead up to an opinion earlier this month concerning the application of the US –Swiss income tax treaty. Before the court was able to resolve the matter on the merits, the district court addressed its jurisdiction to hear a challenge to the US Competent Authority’s decision to not grant discretionary relief under the treaty. While concluding that it could not order monetary relief, its prior opinion opened the door to Starr challenging the Competent Authority’s decision not to grant a lower withholding rate under the APA.


The amount at issue was substantial. Starr was one of the largest shareholders in AIG. It received about $190 million in dividends. The US has treaties with many countries; those treaties generally provide exceptions or reduction to the default 30% withholding on some US sources of income, including dividends. The US Swiss treaty reduced withholding to either 5% or 15 %, depending on the Swiss entity’s ownership of the US corporation.

Most treaties have some form of anti-treaty shopping provisions that are meant to ensure that only bona fide residents of contracting states can take advantage of the treaty. The Swiss treaty has such a provision, Article 22, which, according to the treaty’s technical explanation (sort of treaty analogue to legislative history, which Treasury staffers draft and present to the Senate during the Senate’s treaty ratification process), denies treaty benefits to those who establish “legal entities . . . in a Contracting State with a principal purpose to obtain [treaty] benefits.”

Article 22 has a number of objective tests; an entity can establish that it is a bona fide resident if it meets any of the objective tests. The treaty recognized, however, that a party might be entitled to treaty relief even if it were unable to satisfy any of the objective tests. To effectuate that policy, the treaty provides:

A person that is not entitled to the benefits of this Convention pursuant to the provisions of the preceding paragraphs may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.

It was this discretionary benefit position that was at issue in Starr International. For international tax folks, the opinion has an important discussion of the precise contours of the anti-treaty shopping provision; Starr wanted a more mechanical approach to the issue but the opinion agreed with the government that the test is one that pivots off of a finding that the party seeking the benefits “has or had as one of its principal purposes the obtaining of [treaty] benefits.”

After agreeing that the treaty rule revolves around a principal purpose analysis, the court turned to the APA. Under the APA a reviewing court must “hold unlawful and set aside agency action, findings, and conclusions found to be . . . arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 USC 706(2). As we have discussed, this is generally a deferential standard; the opinion, citing the Supreme Court State Farm decision, notes that by way of example that “[a]gency action is arbitrary and capricious…if the agency ‘entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of agency expertise.’”

In arguing that the Competent Authority decision was arbitrary and capricious, Starr essentially made two main points: the Competent Authority considered irrelevant information and failed to consider the relevant information.

In finding that the Competent Authority did not consider irrelevant information, the opinion squarely addresses how much it should consider Starr’s prior moves. One of the main points Starr made was that its move to Switzerland was from Ireland, which had an automatic treaty reduction; in other words, it could not have had a principal purpose to get treaty benefits if it moved from a jurisdiction where it already was entitled to benefits. The government noted that Starr had moved previously, and wanted to consider the entity’s history of moving as to show that tax was often a if not the main reason for location.

The court agreed with the government, looking mainly to the treaty’s explanation:

[Starr’s] argument, however, assumes a much narrower inquiry than is called for by the Technical Explanation, which directs the Competent Authority to determine “whether the establishment, acquisition, or maintenance” of a company in the relevant jurisdiction had a principal purpose of obtaining treaty benefits. Technical Explanation 72. Notably, the Explanation does not direct the Competent Authority to ask merely what made a company’s current jurisdiction more favorable than its previous one—although that might be part of the analysis—but rather why a company chose to “establish” or “maintain” itself where it did. In other words, here the question was not simply why Starr chose Switzerland over Ireland, but rather why Starr chose Switzerland over any other jurisdiction where it might have moved.

This broader inquiry required not just a look at Starr’s recent move, but also its overall history of moves.

Starr also argued that the Competent Authority failed to consider the implications of how other bilateral treaties automatically allow treaty benefits to similarly structured entities (a for profit company owned by a charitable entity). Starr argued that there was strong evidence that the US and the Swiss did not consciously exclude that structure from benefits. The opinion gives short shrift to this point:

This argument is a nonstarter. Starr essentially asks the Court to find that the Competent Authority acted arbitrarily and capriciously because it failed to definitively conclude that the text of the U.S.-Swiss Treaty should be overwritten by text in other bilateral tax treaties, and because there is no legislative history to the contrary. But “[t]he interpretation of a treaty, like the interpretation of a statute, begins with its text.” Starr I, 139 F. Supp. at 226 (quoting Abbott v. Abbott, 560 U.S. 1, 10 (2010)). So at the very least, it was not unreasonable for the Competent Authority to decline to read into the treaty a provision that was not there. Moreover, it bears emphasizing that the Competent Authority reached no conclusion one way or the other on the matter, and therefore the analysis appears not to have grounded its final determination. It is therefore misleading for Starr to characterize it as a “justification,” although perhaps accurate to call it “irrelevant.”


On the merits, the opinion is a major victory for the government. Yet it is  an important procedural victory for taxpayers. It is another defeat of the reflexive government argument that some of its decisions are completely insulated from court review. It also is a roadmap for showing how parties can use the APA to challenge the somewhat murky world of Competent Authority decisions under treaties.

Summary Opinions for August 1st to 14th And ABA Tax Section Fellowships

Before getting to the tax procedure, we wanted to let everyone know the application for the ABA Tax Section fellowships is now open.  Here is a link to the release regarding the applications and the Christine A. Brunswick Public Service Fellowships.   Here is another link regarding the process, which also highlights recent winners.   I’ve had the pleasure of meeting many of the recipients, and it is an esteemed group providing amazing services thanks to the ABA Tax Section.

A few quick follow ups to some items from last week.  We had a wonderful post from Robin Greenhouse on the BASR Partnership case dealing with the statute of limitations and fraud of the tax preparer, which can be found here.  Ms. Greenhouse and Les were both also quoted in a story on the topic for Law360, which can be found here (may be behind a subscription wall, sorry).  Keith posted on the Ryscamp case, which dealt with jurisdiction to review a determination that a taxpayer’s position is frivolous.  Keith was also quoted about the case in the Tax Notes article, which can be found here (also behind subscription wall, sorry again).

Here are some of the other tax procedure items we didn’t otherwise cover:

  • We flagged earlier in the month that Congress has overturned Home Concrete with the new Highway Bill.  The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 has a few other changes to tax procedure laws.  Probably the biggest news is that partnerships and s-corps will need to file tax returns three months and fifteen days after the close of their tax years (for calendar filers, that will be March 15).  This is a change for partnerships, but not s-corps.  C-corporations, however, will not have to file until four months and fifteen days after the close of the tax year (April 15 for calendar year filers).  The goal of this is to get k-1s to individuals prior to the April 15 filing deadline.  I assume c-corps were pushed back a month on work flow concerns for preparers.  The act also revised the extended due dates for various types of returns.  In addition, next year, FBARs will be due April 15, and there will be a possible six month extension.
  • The District Court for the District of New Jersey decided a lien priority case where a bank recorded a mortgage regarding a home equity line of credit (HELOC), some portion of which may have been withdrawn after a federal tax lien was filed.  In US v. Balice, the bank argued that the withdrawal date of the funds on the HELOC was irrelevant and state law directed that the date related back to the original recording date (the Court declined to offer an opinion about whether or not this is the actual NJ law).  The government argued that federal law applied, which held first in time is first in right, but only to the extent the funds were already withdrawn.  The Court held that state law defined the property rights, but federal law governed the lien priority.  Under federal the federal statute, the security interest was only perfected when the funds were actually borrowed.  See Section 6323(a).
  • The IRS has issued two important Revenue Rulings in the international arena.  The first outlines the procedures for making competent authority requests.  The second is for taxpayers seeking advanced pricing agreements, and can be found here.
  • Jack Townsend on his Federal Tax Procedure blog has a discussion of Sissel v. US Dept. HHS, where the majority, concurring and dissenting opinions all review the Originations Clause of the Constitution and its application to Obamacare.
  • I unabashedly praised John Oliver’s sultry singing about the IRS with Michael Bolton previously in our pages.  In that ditty, Oliver pointed out we should be hating on Congress, not the IRS.  Peter Reilly over at Forbes makes a good point that in Oliver’s new IRS bit, he should probably be complaining about Congress again and not the IRS about the lack of church audits (check out Section 7611, which is Congress’ doing).
  • Service issued guidance to its new international practice unit on transactions that might generate foreign personal holding company income under subpart F.  Caplin & Drysdale have coverage here.
  • The Tax Court seems to have just thrown an assist to the Service in Summit Vineyard Holdings v. Comm’r, holding that an individual had apparent authority to execute an extension for the statute of limitations, even though the individual lacked actual authority.  The Court somewhat saved the Service, because it probably should have known that the TMP was a different entity in the year in question, as it had been informed of the switch.  The Court noted the auditing agent had very limited TEFRA knowledge (I’m not sure that excuses the IRS from properly following the rules).  The agent had the manager of the then current TMP sign, instead of the TMP for the year in question.  There appears to be somewhat of a split on this, but the Court determined that the Ninth Circuit (where the appeal would lie) would apply state law and find apparent authority based on the evidence and actions taken by the individual.  Saved by the Court!  Based on the facts, it does not seem that unfair though, as the individual was the manager of both TMPs, and it seems like he also thought he was properly executing the paperwork and extending the SOL.
  • In Chief Counsel Advice, the Service has concluded it can only apply the Section 6701 aiding and abetting penalty one time against a person who submitted false retirement plan application documents.  This is the case even though multiple documents could be submitted with fraudulent information, and even though it could result in an understatement for the plan and each participant.
  • The Service has also released PMTA 2015-11, which outlines the application of the penalty under Section 6662A(c) for taxpayers who failed to disclose participation in listed transactions involving cash value life insurance to provide welfare benefits.  This is a very specific issue, so I won’t go into much detail, but the guidance is fairly thorough and provides good insight into the Service’s thoughts on the matter.
  • And another Section 7434 case.  I wrote about the Angelopolous case earlier in the week, which dealt with who was the “filer” of the information return.  In US v. Bigley, the District Court for the District of Arizona reviewed whether an employee’s claim against his employer for false returns was time-barred.  The suit was well past the six year statute, and the employee clearly had knowledge over the last year.  Section 7343(c) outlines the statute of limitations, and states the statute is the later of six years or one year after the return is discovered by exercise of reasonable care.    The Court found that the employee received the information returns upon filing, so the six year statute clearly applied, and it would be impossible to have the one year statute in that situation.  The actual language is “1 year after the date such fraudulent information return would have been discovered by exercise of reasonable care.”  I wonder if it would be possible to create a larger fraudulent scheme, whereby the recipient would receive the information return but not realize it was fraudulent until a later date.  Would the one year statute then apply?
  • My brother-in-law just got a Ph.D. (congrats Alex! I doubt he will ever read this).  In honor of that esteemed accomplishment, here is an infographic highlighting all kinds of negative financial and other statics related to Ph.Ds.  I make no assurances to the veracity of the graphic’s claims, and I am generally in favor of graduate degrees, but I found the stats interesting.


International Collection Efforts by the IRS – Expanding the Number of Treaties in which We Have Collection Language    


The United States has treaty language that allows us to work with the taxing authorities in other countries to collect U.S. taxes owed from U.S. Citizens or their property located in those countries and to allow those countries to have IRS collect from their citizens or property located in the U.S.  (For an example of the treaty language used to effectuate bilateral assistance and support in collecting tax, see U.S.-France Income Tax Treaty, Article 28).  In the countries where this treaty language exists, U.S. collection officials initiate the contact with the treaty partners though the competent authority to request that the collection officials in the treaty country take action to collect the unpaid taxes from the assets available in their country.  Currently, the U.S. has this treaty language allowing collection with only five countries – Canada, France, Holland, Denmark and Sweden.  The treaties containing this language were written long ago and the U.S. has not sought to insert this language into treaties in the recent past (For a brief discussion of the history of this treaty language, see Brenda Mallinak, , 16 Duke J. Comp. & Int’l L. 79, 94 (2006)).

As I was writing this post, I received a Treasury Inspector General for Tax Administration (TIGTA) report, Reference Number: 2014-30-054 dated September 12, 2014.  I want to talk about that report and how I think it highlights the problems in international collection while missing the mark because it fails to address the gaping hole in our treaty language as a major source of improving international collection.


The TIGTA report looks at the international collection efforts of the IRS and finds them lacking.  I agree with the conclusion but find that blaming the IRS collectors badly misplaces the blame for the failures in this area.  Congress makes a lot of noise about offshore issues and has implemented some reasonably good legislation to seek to improve matters on the liability side while doing almost nothing to assist IRS collectors in their efforts to put money into our coffers that has moved overseas.  Similarly, Treasury makes a lot of noise about offshore liability issues but has not aided the problem because it has not moved to put collection language into treaties leaving IRS collectors with meager remedies to seek to collect from persons keeping themselves and their assets offshore.  The TIGTA report does not to address the structural problems with the offshore collection system.  Without structural changes the IRS collectors will continue to experience frustration and obtain victories on the margins while losing the battle to those parking themselves and their assets out of the reach of the IRS given the current legal situation.

As the world has gotten smaller and as the movement of people and assets offshore has become routine, the IRS finds itself in a situation not unlike creditors seeking to collect when the Articles of Confederation rather than the Constitution existed.  One of the big reasons for ditching the Articles and moving to the Constitution stemmed from the inability of creditors to collect from persons moving from one state to another.  We now face that situation on a more global level.  We have recognized it over the past fifteen years in the area of finding the money parked offshore in tax havens but we have not yet addressed it in the collection area.

The TIGTA report spends most of its energy talking about failures of vision and implementation in the IRS collection division with respect to its international collection efforts.  I will return to that but want to point out that despite the failures discussed in the report, the 40 or 41 International Revenue Officers collected over $53 million in both fiscal years.  Without knowledge of how the amounts reported were calculated, this seems like a great return on investment for the very small number of people working these cases and a much higher return than normal for dollars invested with the IRS.  Without more context, however, it is impossible to know if this $53 million collected in the past two years is a significant, or I suspect, insignificant amount of the total dollars that might have been collected from citizens and assets parked offshore.

TIGTA criticizes the IRS for a lack of management oversight, the lack of a legitimate strategy and poor procedures and policies for the revenue officers attempting to collect.  While these criticisms undoubtedly have some merit, TIGTA offers little guidance on how the revenue officers might better perform the task of collecting where the money and the taxpayer sit offshore.  Better policies and better training can only do so much when the structure of the system stymies the IRS collection efforts at every turn.

In domestic collection the IRS can file the notice of federal tax lien against the delinquent taxpayer and cripple the person’s credit rating.  It can levy on assets it identifies and obtain property without having to work through a court or through another agency.  Those types of collection efficiencies do not exist for the international collection efforts and may never exist but if international collection has a chance of becoming more efficient, it needs a structure that keeps people from avoiding collection simply by moving themselves and their assets offshore.  If the Government has serious intentions of collecting delinquent taxes from persons moving themselves and their money around the globe, it needs to look to multilateral efforts to solve the problem and not try to go it alone squeezing marginal gains out of an understaffed group of revenue officers.

The TIGTA report mentions the one “easy” collection tool available for collecting taxes from individuals who have parked their money and their assets overseas – the “Customs Hold.”   The report explains this devise as follows:

 International revenue officers can request that a Customs Hold be input into the Treasury Enforcement Communication System (TECS) for delinquent taxpayers.  Once the taxpayer is on the TECS, the U.S. Department of Homeland Security (DHS) notifies the IRS whenever the taxpayer travels into the United States.

The TECS is a database maintained by the DHS and is used extensively by the law enforcement community.  Taxpayers are informed with a Letter 4106, Letter Advising Taxpayer of Department of Homeland Security Notification, that an international revenue officer has taken action to advise the DHS that the taxpayer has outstanding tax liabilities and that this may result in an interview by a Customs and Border Protection Officer if the taxpayer attempts to enter the United States.  There is a Memorandum of Understanding [create link to memo] between the IRS and the DHS that allows Customs and Border Protection Officers to stop delinquent taxpayers identified on the TECS to collect their contact information of where they will be staying while in the United States.

According to the TECS Coordinator, the international revenue officer must submit a completed Form 6668, TECS Entry Request, to have a Customs Hold placed on a taxpayer.  The form is sent to the group manager for a signature and e-mailed to the TECS Coordinator.  The TECS Coordinator maintains a spreadsheet to document taxpayer added to or deleted from the TECS.  According to the Spreadsheet there are approximately 1,700 taxpayers on the TECS with approximately $1.6 billion in delinquent tax assessments.  This includes assessments of approximately $1.1 billion solely owed by international taxpayers.

In an earlier post I wrote about the writ ne exeat.  This is a labor intensive option available to the IRS to seek to stop a taxpayer from leaving the country with their money.  The taxpayer discussed in that case was stopped at the border undoubtedly because of a “Customs Hold” as he sought to return to the United States while taxes remained unpaid.  That example demonstrates part of the power of the “Customs Hold” but does not tell the whole story.  Just because someone gets stopped as they seek to reenter the U.S. and sent to a little room off in the corner of an airport does not mean that they will pay the tax or that they will be held in the little room for a long period of time.  Holding individuals as they seek to return to the U.S. no doubt raises revenue but it only works if the individual seeks to return and only when the hold itself proves effective as a means for convincing them to pay.

It is time to expand the list of countries with whom we have collection treaties, to make it a regular part of our bilateral treaties or to begin an effort to make cross border collection of taxes a part of a multilateral effort.  The international revenue officers have only labor intensive tools that rely on the taxpayer living in one of five countries or returning to the U.S.  Their arsenal of weapons no longer matches the ability of individuals to move themselves and their money.  The TIGTA report may have found problems in the operation of the current program but misses the overall problem.  If we want to collect globally we need to ban together with other countries the way we have done with FATCA.  Trying to catch these individuals one by one as they return to the country does not solve the problem.



Summary Opinions for 9/26/14

photo Short but sweet this week.  We have posts in the hopper on many of the larger developments for the week of Sept. 26th, so SumOp is a little light this week.  We do, however, touch on inversions, dealing with the media, informal abandonment of residence status, and if your online gambling problem is causing you and IRS FBAR problem…very international:

  • The Service has issued a notice of proposed rulemaking to provide regulations that it hopes will curb inversions.  Most folks seem to be against inversions.  I had an inversion over the weekend, and it wasn’t that bad.  Not the most flavorful IPA, but definitely drinkable.
  • Sticking with the inversion notice of rulemaking, our former guest blogger, Professor Andy Grewal, has a terrific post on the in terrorem  effect of the notice  in the relatively new and exceedingly high quality Yale Journal on Regulation blog  “Notice and Comment”.  The post discusses how “under Section 7805(b)(1)(C) of the tax code, the Treasury enjoys the authority to issue regulations retroactive to the date on which any notice describing the anticipated regulations is issued.  Consequently, a mere notice can alter taxpayer behavior, even in the absence of any actual rulemaking activity.”
  • Frank Agostino’s firm’s October newsletter is out, and can be found here.  Both are articles are good, but I particularly liked the article on the use of media (traditional and new) in the area of tax controversy.  Most of my clients don’t want anyone to know they have an issue with the Service (even the ones who are not guilty), but for some clients a media strategy is a necessity.
  • In Topsnik v. Comm’r, the Tax Court held that a foreign individual was a lawful permanent resident (LPR), and subject to tax on his worldwide income, even though he had sold his US residence, and only made infrequent visits to the United States during the year in question.  The taxpayer could not “informally” abandon his status as a LPR, and instead had to follow the appropriate procedures. Here is an additional post on this case from the “Private Equity, VC, and Hedge Fund Taxation” Blog, which I was not familiar with.  The post points out how this case highlights what the Court will look at in these residency cases, and shows how the IRS will obtain information about a taxpayer from a treaty country.  Mr. Topsnik’s tax controversies have graced our pages before, with a Ninth Circuit opinion discussed in a February SumOp found here, discussing appropriate venue for a foreign individual’s refund claim.
  • My ad (hom)inem commentary on Mr. Hom’s prior pro se efforts were somewhat tongue in cheek, as he seemed to make clever legal arguments, which didn’t prevail (I don’t actually think I was attacking Mr. Hom personally, but my bad pun generator is not working well).  As previously mentioned , Joseph DiRuzzo of Fuerst Ittleman, has agreed to represent Mr. Hom in his appeal from the determination that his online poker accounts were bank accounts that had to be disclosed on his FBARs, which we covered here with a link to Jack Townsend’s far superior write up found here.  The matter has potentially far reaching implications, and I am happy to see a quality lawyer assisting Mr. Hom on this matter.  Mr. DiRuzzo shared his initial brief with me, and indicated I could share the same on PT.  Instead of reproducing it in its entirety, I recreate the summary of arguments below.  If you are interested in reviewing the brief, please let me know, and I will be happy to share.  Any mistakes in the below content are almost certainly mine:




MOTION FOR SUMMARY JUDGMENT…………………………………………………………. 13

A. The Report of Foreign Bank and Financial Accounts & Penalty

Regimes Under the Bank Secrecy Act and its Implementing

Regulations. ………………………………………………………………………………………… 13

B. PokerStars, PartyPoker, and FirePay are not engaged in the business

of banking nor do they function as banks. Thus, the accounts

maintained with each are not “bank accounts” under the BSA. ………………. 16

1. Construing undefined terms in accordance with their ordinary and

natural meanings, the accounts at issue were not “bank accounts”

because PokerStars, PartyPoker, and FirePay do not “engage in the

business of banking.” …………………………………………………………………………. 17

2. When the BSA is read in pari materia with other banking and tax

statutes, it is evident the companies do not engage in the business

of banking. Thus, Hom’s accounts were not bank accounts and did

not trigger a filing obligation. ………………………………………………………….. 21

3. The lower court’s reliance on Clines is misplaced. ………………………………. 25

C. The accounts at issue would not properly be classified as “other

financial accounts” because PokerStars, PartyPoker, and FirePay do

not act as financial agencies. ………………………………………………………………. 28

D. The accounts are not “bank accounts” or “other financial accounts”

under the BSA. ………………………………………………………………………………………. 31






A. The preamble is irrelevant. …………………………………………………………………. 33

B. The preamble is consistent with the position of the IRS and FinCEN

and advanced by Hom in the lower court that it is the geographic

location of the account funds not the location of the host institution

which is determinative of whether an account is “foreign” under the

BSA. ………………………………………………………………………………………………………. 34

C. The preamble is not entitled to Chervon deference. ………………………………….. 37

1. The regulation is unambiguous. Therefore the District Court erred

in considering the preamble. …………………………………………………………. 38

2. Assuming arguendo that the regulation is ambiguous, the preamble

would not be entitled to Chevron deference. Thus, the District

Court erred. ………………………………………………………………………………………… 40

3. Under the appropriate level of deference, the Court erred in relying

on the preamble as it is an unreasonable interpretation of the

regulation. …………………………………………………………………………………….. 42

4. To the extent the Government relies on the preamble as its basis

for enforcement of the FBAR reporting requirements against

Hom, the preamble violates the APA as an improperly

promulgated legislative rule. ……………………………………………………………….. 43





LOCATED IN A FOREIGN ACCOUNT. ……………………………………………………… 45


Summary Opinions for 03/28/14

This week’s report contains lots of interesting statistics from the Service, including a look into the APA program, and filing and enforcement statistics.  There is also a recap of a recent tax court case looking at material participation by a trust in real estate activities, which is going to be a very big deal this year due to Obamacare. Plus an interesting Service loss in a bankruptcy case, where the Court found the Service incorrectly determined a taxpayer’s business when reallocating income under Section 482.  Also, more West Coast administrators failing to file estate tax returns.  To the roundup:

  • The Bankruptcy Court for the Middle District of North Carolina had an interesting ruling in In Re: Decoro USA, LTD  (couldn’t find for free yet).  The Court sustained the taxpayer’s objections that additional tax allocated to it in a Section 482 adjustment were inappropriate because the transfer pricing analysis by the Service was unreasonable.  Section 482 allows the Service to reallocate tax items between related entities doing business together.  Here, the Service took the position that the taxpayer acted as a distributor for its parent in selling leather furniture, and then increased the taxpayer’s income to be more in line with a distributor.  The taxpayer argued it was more of a “facilitator” to distributors, and its income was in line with similar businesses that did the same.  The Court looked a variety of factors and found that the taxpayer’s interpretation of its business was more accurate, resulting in the IRS allocation losing the presumption of correctness.
  • Announcement 2014-14 issued by the Service this week reports on the status of the advanced pricing agreement programs.  Highlights include increased efficiency and a greater use of the program.  Part 1 of the report has a comprehensive summary of the programs, part 2 has the 2013 statistics, and part 3 discusses the types of items resolved by APAs.  Interestingly, more than 50% of the APAs executed were with Japan.
  • More stats, the Service has also issued its 2013 IRS Data Book, which generated headlines about the rich not getting audited as much (apparently, the Service didn’t care for the GAO report last year arguing the Service should audit the wealthy more often).  Table 9b shows that less than 1% of individuals were audited.  Those making over $10MM a year get a hard look the most, followed by those making over $5M.  Individuals making over $1MM, but less than $5M are audited at a 9% rate.  The next highest group to be audited are those making no money, with 6% audited.
  • Estate administration lawyers in California apparently don’t understand the filing deadline for estate tax returns.  In American Contractors Indemnity Company v. United States, the District for Northern CA denied the Service’s motion for summary judgment in a case where an administrator of an estate was claiming reliance on an attorney as reasonable cause for penalties for failure to file and failure to pay estate tax.  The named party in this case is the surety company that ended up stepping into the shoes of the administrator.  The Court found there was a genuine dispute as to whether the administrator relied on the attorney to file or relied on erroneous advice on filing or when to file.  In coming to the conclusion and looking at the distinction, the Court reviewed Boyle, Baccei, and Knappe (the last two are also Cali or West Coast cases of executors failing to file), which we covered before in great detail here and here.
  • Joe Kristan on his Roth & Co. blog has a good write up of the Frank  Aragona Trust case decided by the Tax Court this week, which allowed a trustee to “materially participate” in rental activities.  This used to be only a huge deal for passive activity gains and losses, but the Obamacare 3.8% net investment income tax follows the same rules.  The trust “materially participating” allows the net income to be exempt from tax.  There is a lot of interest in this right now.  I have two clients going through this analysis for trusts, and a call with an accountant on a third this afternoon.  If you have clients with trusts that hold majority interests in closely held companies, this is probably worth a look.

Summary Opinions for 11/29/2013

Happy Holidays!  Sorry for the delay in posting, hectic weekend, but what a great weekend.  Thanksgiving, the start of Hanukkah, Keith had his first grandson, and it seemed like every third car had a Christmas tree tied to the top.  Although it was a short week, there was still some excellent procedure news.  Let’s start with a few Thanksgiving related items.

  • I found this estimate of the amount of taxes paid on the average Thanksgiving dinner on Accounting Today.  The Tax Foundation has a summary of travel taxes and tolls (road taxes) for travel along the northeast found here.  I’m not sure how accurate either are, but interesting posts about Thanksgiving and taxes.
  • Jack Townsend’s Tax Procedure Blog has a summary of Eichelburg v. Comm’r, where the taxpayer’s claim was tossed for failing to timely file under the timely mailing is timely filing rule in Section 7502.  His sin—thriftiness (and not following the rules).  He went for the FedEx Express Saver, which is not an enumerated acceptable private delivery service under Notice 2004-83.
  • From the Freakanomics blog, a podcast regarding fighting poverty. This post has to do with charity, but I think the concepts apply to the reallocation of assets (EITC) under the Code and the incentives that could raise a family up the socioeconomic ladder (student loan interest deduction, mortgage interest deduction).  Oversimplifying the post, cash infusions are great at doing certain things like eliminating a current need, but not very good at assisting a family in moving out of poverty.  Although this is not a stunning revelation, the stories and examples are very interesting, and made me wonder if we had good evidence behind a lot of the incentives and deterrents under the code.  More behavioral economics.  Perhaps we should change this to a behavioral economics blog.
  • MauledAgain has a discussion of the Tax Court’s holding in Jibril v. Comm’r, where the Court disallowed dependency exemptions for a taxpayer’s cousins.  The Court held that cousins did not fall within “qualifying children” under Section 152(c)(2) or “qualifying relatives” under Section 152(d)(2).  Although this is not a novel holding, the last paragraph of Jim Maule’s post highlights the Court’s comments regarding the “sympathetic” taxpayer, and outlines some suggestions  from Professor Maule on how to eliminate the harsh application of the statue when family members are supporting family members not specifically outlined in the statute.
  • Messrs. Lipton, Richardson, and Jenner, attorneys at Baker & McKenzie, have written an article published at 119 Journal of Taxation 267 (December 2013), about the Tax Court holding in Barnes Group, Inc. v. Comm’r, concluding that the Tax Court wrongly applied the step transaction doctrine and discussing the imposition of penalties even though the taxpayer had a “substantial authority” opinion from PWC.  The Baker attorneys disagree with the collapsing of the transaction under step-transaction, arguing that the transaction was very similar to a Rev. Rul. previously issued, and the differences were minor technicalities. What caught my eye was the discussion regarding the imposition of penalties even though PWC had issued a substantial authority opinion.  Initially, I thought this was going to be more like the Canal Corp case, where the Court found the messy, aggressive opinion by PWC was not reasonable to rely upon.  However, upon reviewing Barnes, the holding regarding the penalty was that Barnes failed to follow PWC’s advice when it did not comply with the “mere technicalities”, and waived its right to rely on PWC’s opinion.  The Baker attorneys felt reasonable cause should be available, since the taxpayer relied on a competent advisor and that this opinion created substantial issues regarding advisor reliance.  I, personally, thought the step-transaction doctrine was the key, and the case did not tread any new ground on advisor reliance.
  • The Tax Court, in Meyer v. Comm’r, remanded a case back to Appeals for review after the SO failed to properly verify that statutory notice had been issued after the IRS issued a substitute for return.  The case has a good discussion of the IRS procedures in this area, including how an SFR relates to a stat notice and how Appeals is supposed to verify that the IRS issued a stat notice when the taxpayer claims to have not received it.  In light of Appeals not having adequately verified the stat notice’s issuance, there was also a discussion regarding whether the Court should remand or simply hold for the taxpayer. In this case, the Tax Court remanded, though it suggested that in the future, it may toss not remand and find for the taxpayer, and invalidate the assessment. If time permits, we may have more on this case later in the week or next week.
  • Chief Counsel has issued advice, found here, regarding whether the Service must apply restitution payments required because of corporate income tax to the income tax, or whether it may be applied to other unpaid liabilities.  Counsel determined that the Service can apply the payments as involuntary payments, in the Service’s best interests.  Counsel relied on US v. Pepperman, out of the Third Circuit, which held that involuntary payments are defined as “any payment received by…the United States as a result of distrait or levy or from a legal proceeding in which the Government is seeking to collect its delinquent taxes or file a claim therefor.”  Counsel determined that restitution only comes from court orders or settlements, and therefore was an involuntary payment.  I would be surprised if there was not some argument to the contrary. This notice relates to restitution that arose prior to the effective date of Section 6201(a)(4), which allows IRS to assess certain orders of restitution.  Either way, practitioners should be cognizant of this issue. Saltzman and Book Chapter 10 (revised and coming out next month) has a thorough discussion on the new restitution provisions, and I suspect a post on this coming up soon.
  • Last week we touched on Notices 2013-78 and 2013-79, which contained draft procedures for seeking competent authority assistance and advance pricing agreements.  KPMG provides a small summary of some of the changes in the new notices. I will either try to provide more information regarding these notices in the coming days and weeks, or find other good summaries, as the changes are substantial and important.