Kies Describes Opinion on Retroactive Downward Attribution Changes

February 6, 2020

The Honorable David Kautter
Assistant Secretary, Tax Policy
United States Department of the Treasury
1500 Pennsylvania Avenue NW, Room 3120
Washington, DC 20220

The Honorable Lafayette G “Chip” Harter
Deputy Assistant Secretary, International Tax Affairs
United States Treasury Department
1500 Pennsylvania Avenue NW, Room 3058
Washington, DC 20220

Re: Legal Opinion on Downward Attribution and Meeting Request

Dear Dave and Chip:

As we have discussed previously, there are a number of serious policy issues raised by any proposal that would retroactively reinstate Internal Revenue Code (“Code”) section 958(b)(4) and enact section 95IB in its place, such has been proposed by some as a “technical correction” to the Tax Cuts and Jobs Act ("TCJA").

A key issue that we have repeatedly stressed is the likelihood that these actions, if undertaken today as described above, would be found to violate the Due Process Clause of the U.S. Constitution based upon the standards articulated in the Supreme Court's Carlton decision. In order to better inform the consideration of such a proposal, I have undertaken deeper analysis of the relevant law on this topic.

Enclosed is a form of the “should”-level legal opinion I would be prepared to issue if asked, that a proposal which (retroactive to the enactment of the TCJA) reinstates Code section 958(b)(4) and enacts Code section 95IB should be found to violate the Due Process Clause (as applied to a negatively-affected taxpayer).

Once you have had an opportunity to review and consider the opinion, I would like to schedule a meeting with you and your team to discuss the matter further.

I greatly appreciate your careful, and thorough attention to this issue. Please contact me at (202) 772-2482 or ken.kies@fpgdc.com if you have any questions. Thank you very much for your assistance.

Very truly yours,

Kenneth J. Kies
Federal Policy Group
Washington, DC

Enclosure

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Form of Opinion Regarding the Constitutionality of a Retroactive Reinstatement of Section 958(b)(4)

February 6, 2020

The Honorable David Kautter
Assistant Secretary, Tax Policy
United States Department of the Treasury
1500 Pennsylvania Avenue NW, Room 3120
Washington, DC 20220

The Honorable Lafayette G “Chip” Harter
Deputy Assistant Secretary, International Tax Affairs
United States Treasury Department
1500 Pennsylvania Avenue NW, Room 3058
Washington, DC 20220

Re: Opinion with Respect to Proposal to Retroactively Reinstate Code section 958(b)(4)¹ and Enact New Code section 95IB

Dear Dave and Chip:

The purpose of this letter is to describe the opinion we would be prepared to give² (hereinafter, this "Opinion") with respect to the validity of the proposal described below under an as-applied challenge under the Due Process Clause of the Fifth Amendment of United States Constitution (“Due Process Clause”).³ This Opinion would be given as with respect to the general facts described below and not with respect to any specific circumstances or transaction.

Based upon the relevant authorities, as well as the facts set forth below, were we asked to (and to agree to) opine on the matter, we would be of the opinion that a proposal such as is described below should be found to violate the Due Process Clause as-applied to negatively affected taxpayers.

Executive Summary

Prior to the enactment of the Tax Cuts and Jobs Act ("TCJA"), section 958(b) applied limited attribution rules in the context of Subpart F, but under section 958(b)(4) did not attribute stock from an owner to an owned entity where the effect would be to treat a U.S. person as owning stock owned by a non-U.S. person (so-called “downward attribution”). The TCJA, however, purposefully eliminated the prohibition against downward attribution in order to curtail so-called “de-control” transactions.

Some have proposed that Congress should reverse course on this topic, retroactively reinstating the general prohibition against downward attribution found in prior section 958(b)(4) and enacting a new provision, section 95IB, that would create the entirely new concepts of “foreign controlled foreign corporations” and “foreign controlled United States shareholder.” To-date, Congress has not adopted this proposal and the idea has not found widespread support.

Separately, the Treasury Department ("Treasury") and Internal Revenue Service ("IRS") have on several occasions taken steps to implement the TCJA changes to section 958(b) — including the repeal of section 958(b)(4) — by Notice, Revenue Procedure, and Treasury Regulation. In so acting, both Treasury and the IRS have not in any way indicated that they believe the repeal of section 958(b)(4) to be a Congressional drafting mistake.

As applied to a negatively-affected taxpayer, changes such as have been proposed with respect to section 958(b) that are described above should be found to violate the Due Process Clause under the standards articulated in the seminal (and controlling) case United States v. Carlton.⁴ Carlton synthesized prior Supreme Court jurisprudence on the application of the Due Process Clause to retroactive tax laws.

Carlton's standard requires that any retroactive tax law have a legitimate legislative purpose furthered by rational means and the test it applied holds that in order for any retroactive tax law to meet this standard (1) the retroactive tax law must have a legitimate, non-arbitrary legislative purpose and (2) the legislators must act promptly with the respect to the law and establish only a modest period of retroactivity.

Though no fewer than 189 post-Carlton cases cite such opinion, only twelve are potentially relevant to the analysis of this Opinion. These post-Cnr/ton judicial authorities do not alter the standard and test articulated above and none are dispositive in any way with respect to the factual circumstances evaluated in this Opinion.

As applied to a negatively affected taxpayer, a proposal that would reinstate prior section 958(b)(4) (retroactive to the enactment of the TCJA) and enact proposed section 95 IB instead should be found to violate the Due Process Clause because in so doing Congress would not have acted promptly with respect to the matter and the period of retroactivity that would apply to such change would not be modest. If, however, changes were made to section 958(b) on a prospective basis, or which were only electively retroactive to the enactment of the TCJA, such changes would not give rise to an as-applied Due Process Clause violation.

Background: Facts

Pre-TCJA, the Code contained somewhat limited constructive ownership rules in the context of Subpart F sections 951(b), 954(d)(3), 956(c)(2), and 957 — the latter of which defines a controlled foreign corporation ("CFC") for all purposes of the Code. Per the pre-TCJA version of this constructive ownership rule, the constructive ownership rules of section 318(a):

[Shall apply to the extent that the effect is to treat any United States person as a United States shareholder within the meaning of section 951(b), to treat a person as a related person within the meaning of section 954(d)(3), to treat the stock of a domestic corporation as owned by a United States shareholder of the controlled foreign corporation for purposes of section 956(c)(2), or to treat a foreign corporation as a controlled foreign corporation under section 957. . . .

Sec. 958(b) (2016). This general rule had four exceptions, however. See sec. 958(b)(1)-(4) (2016). One of these exceptions provided that “[subparagraph (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person.” Sec. 958(b)(4) (2016). Thus, this provision turned off the rules in section 318 that provide for so-called “downward attribution” of stock from an owner to an owned entity where the effect would be to treat a U.S. person as owning stock owned by a non-U.S. person.

As part of the TCJA, Congress sought to modify a number of the Code's international tax rules in order to address a variety of policy issues and problems that existed with respect to the pre-TCJA Code. In relevant part, Congress wished to prevent so-called “de-control transactions,” which are generally transactions undertaken by a newly-foreign-parented (and formerly-domestic-parented) entity to cause its former lower-tier CFCs to become non-CFCs through a transfer to a now-related, non-U.S. person. Starting with the original House bill, the TCJA contained a provision that sought to address de-control transactions by repealing the prohibition against downward attribution contained in prior section 958(b)(4). Section 4205 of the original House bill text for H.R. 1 provided for this outcome as follows:

(a) In general. — Section 958(b) is amended —

(1) by striking paragraph (4), and

(2) by striking “Paragraphs (1) and (4)” in the last sentence and inserting “Paragraph (1)”.

(b) Application of certain reporting requirements. — Section 6038(e)(2) is amended by striking “except that —” and all that follows through “in applying subparagraph (C)” and inserting “except that in applying subparagraph (C)”.

(c) Effective date. — The amendments made by this section shall apply to taxable years of foreign corporations beginning after December 31, 2017, and

to taxable years of United States shareholders in which or with which such taxable years of foreign corporations end.

This provision passed the House and was sent to the Senate. The Senate made minor modifications to the text of section 4205, and renumbered it as section 14214.⁵ The text provided as follows:

(a) In general. — Section 958(b) is amended —

(1) by striking paragraph (4), and

(2) by striking “Paragraphs (1) and (4)” in the last sentence and inserting “Paragraph (1)”.

(b) Effective date. — The amendments made by this section shall apply to —

(1) the last taxable year of foreign corporations beginning before January 1, 2018, and each subsequent taxable year of such foreign corporations, and

(2) taxable years of United States shareholders in which or with which such taxable years of foreign corporations end.

The only material difference between these two versions of the bill text is that the Senate version (i.e., section 14213 of the Senate version of the TCJA) lacked the House-passed reporting requirement (i.e., section 4205(b) of the House version of the TCJA). The House Ways and Means Committee Report ("House Report") for the provision (then-section 4205) explained the provision as follows:

The provision amends the ownership attribution rules of section 958(b) so that certain stock of a foreign corporation owned by a foreign person is attributed to a related U.S. person for purposes of determining whether the related U.S. person is a U.S. shareholder of the foreign corporation and, therefore, whether the foreign corporation is a CFC. In other words, the provision provides “downward attribution” from a foreign person to a related U.S. person in circumstances in which present law does not so provide. The pro rata share of a CFC's subpart F income that a U.S. shareholder is required to include in gross income, however, continues to be determined based on direct or indirect ownership of the CFC, without application of the new downward attribution rule. The Secretary is granted authority to alleviate any unnecessary reporting burdens that may be triggered by the provision.⁶

As is obvious from the text above, there is no mention in this explanation of any requirement that the taxpayer be related to the foreign corporation at issue in order for the foreign corporation be considered a CFC with respect to such taxpayer. Rather, the explanation notes that the consequences of downward attribution with respect to the foreign corporation are universal, applicable for purposes of “determining” whether “the foreign corporation is a CFC” (emphasis added).⁷ The House Report description of the “Reasons for Change” also makes no reference or allusion to limiting the consequences of the provision to related parties:

The Committee is aware of certain transactions used to avoid subpart F provisions. One such transaction involves effectuating “de-control” of a foreign subsidiary, by taking advantage of the section 958(b)(4) rule that effectively turns off the constructive stock ownership rules of 318(a)(3) when to do otherwise would result in a U.S. person being treated as owning stock owned by a foreign person. Accordingly, such a transaction converts former CFCs to non-CFCs, despite continuous ownership by U.S. shareholders. The Committee believes this provision is necessary to render de-controlling transactions ineffective as a means of avoiding the subpart F provisions.⁸

To restate, the original drafters of the provision that repealed section 958(b)(4)(a) did not indicate any limitation of the provision and (b) explicitly noted that the outcome of repealing section 958(b)(4) would be that some non-CFCs would become CFCs.

The Senate Finance Committee did not prepare an official report of its version of H.R. 1. The Senate Budget Committee did prepare an unofficial Committee Print ("Budget Committee Print"),⁹ however, that includes a description of section 14213. As noted in the Budget Committee Print, “[t]his document has not been officially approved by the Committee and may not reflect the views of its members.”¹⁰ The Budget Committee Print's recitation of the “Reasons for Change” is identical to the House Report.¹¹ Its “Explanation of Provision,” is somewhat different, however, as follows:

The provision amends the ownership attribution rules of section 958(b) so that certain stock of a foreign corporation owned by a foreign person is attributed to a related U.S. person for purposes of determining whether the related U.S. person is a U.S. shareholder of the foreign corporation and, therefore, whether the foreign corporation is a CFC. In other words, the provision provides “downward attribution” from a foreign person to a related U.S. person in circumstances in which present law does not so provide. The pro rata share of a CFC's subpart F income that a U.S. shareholder is required to include in gross income, however, continues to be determined based on direct or indirect ownership of the CFC, without application of the new downward attribution rule.

This provision is not intended to cause a foreign corporation to be treated as a controlled foreign corporation with respect to a U.S. shareholder as a result of attribution of ownership under section 318(a)(3) to a U.S. person that is not a related person (within the meaning of section 954(d)(3)) to such U.S. shareholder as a result of the repeal of section 958(b)(4).¹²

This description in the Budget Committee Print thus differs from that of the House Report in two ways. First, it does not include a reference to the Secretary of the Treasury being granted regulatory authority to address reporting burdens caused by the provision. Such a divergence was necessary because the sole change made by the Senate Finance Committee to the House-passed text of the provision was to drop the reporting obligations that were contained in the House version of the bill.

In addition, the description of the provision in the Budget Committee Print contains language that touches on how someone involved in the legislative process (it is not clear whom, given the lack of attribution or acknowledgment) saw the provision operating in the case of U.S. taxpayers that are not related to the entity in question, specifically, that the foreign corporation is not to become a CFC with respect to such an unrelated U.S. person.¹³ As noted above, however, the Senate did not change the legislative text of the provision to reflect such a view — notwithstanding that the Senate did modify the legislative text to omit the House-passed reporting provision.

Finally, the Conference Committee prepared a report on the provision as contained in the agreed-to compromise bill ("Committee Report").¹⁴ The Committee Report contained a description of the House-passed bill, a description of the Senate-passed bill, as well as a description of the Committee-passed bill. The Committee Report description of the provision in the House-passed bill is as follows:

The provision amends the ownership attribution rules of section 958(b) so that certain stock of a foreign corporation owned by a foreign person is attributed to a related U.S. person for purposes of determining whether the related U.S. person is a U.S. shareholder of the foreign corporation and, therefore, whether the foreign corporation is a CFC. In other words, the provision provides “downward attribution” from a foreign person to a related U.S. person in circumstances in which present law does not so provide. The pro rata share of a CFC's subpart F income that a U.S. shareholder is required to include in gross income, however, continues to be determined based on direct or indirect ownership of the CFC, without application of the new downward attribution rule.

It also conforms the reporting requirements of section 6038 to require that entities that are treated as CFCs by reason of the rules on constructive ownership are within the scope of the reporting requirements.¹⁵

The Committee Report description of the provision in the Senate-passed bill is as follows:

The Senate amendment is similar to the House bill, except that it does not adopt the change to the reporting requirements of section 6038 and has a different effective date. Furthermore, the Senate Finance Committee explanation states that the provision is not intended to cause a foreign corporation to be treated as a controlled foreign corporation with respect to a U.S. shareholder as a result of attribution of ownership under section 318(a)(3) to a U.S. person that is not a related person (within the meaning of section 954(d)(3)) to such U.S. shareholder as a result of the repeal of section 958(b)(4).¹⁶

In its description of the Senate-passed bill, the Committee Report included a citation to the above-referenced language in the Budget Committee Print — again without any reference to which Member supported the description (or if any Member did).¹⁷ Finally, the Committee Report contained a description of the provision as agreed to by the Conference Committee, as follows:

The conference agreement follows the Senate amendment. In adopting this provision, the conferees intend to render ineffective certain transactions that are used to as a means of avoiding the subpart F provisions. One such transaction involves effectuating “de-control” of a foreign subsidiary, by taking advantage of the section 958(b)(4) rule that effectively turns off the constructive stock ownership rules of 318(a)(3) when to do otherwise would result in a U.S. person being treated as owning stock owned by a foreign person. Such a transaction converts former CFCs to non-CFCs, despite continuous ownership by U.S. shareholders.¹⁸

Thus, the “Committee Report” — which reflects the bicameral negotiated agreement with respect to H.R. 1 — contains a description of this section of the bill that does only two things. First, it notes that the negotiated agreement textually follows the Senate version of the bill (i.e., the version without any information reporting). Second, it indicates that the conferees of the Conference Committee intended that the provision would “render ineffective certain transactions that are used as a means of avoiding subpart F,” including so-called “de-control” transactions. This expression of the conferees' intent is similar to that found in both the House Report and the Budget Committee Print — but lacks any reference to the “related party” understanding that is found in the Budget Committee Print description.

Congress ultimately enacted the following text as section 14213 of the TCJA:

(a) In general. — Section 958(b) is amended —

(1) by striking paragraph (4), and

(2) by striking “Paragraphs (1) and (4)” in the last sentence and inserting “Paragraph (1)”.

(b) Effective date. — The amendments made by this section shall apply to —

(1) the last taxable year of foreign corporations beginning before January 1, 2018, and each subsequent taxable year of such foreign corporations, and

(2) taxable years of United States shareholders in which or with which such taxable years of foreign corporations end.

This text is identical to the Senate-passed version of the TCJA, and thereby identical to the House-passed version of the TCJA (save for its lack of the House-passed version's information reporting provision).

Weeks before the TCJA was enacted (or the Senate version passed), certain tax practitioners pointed out to Congress that tackling de-control transactions in the manner reflected by the ultimately-adopted change could have unforeseen consequences.¹⁹ Following the TCJA's adoption of modifications to section 958(b) that lack the pre-TCJA prohibition against downward attribution, some have argued that Congress should enact a “technical correction” to reinstate section 95 8(b)(4)'s limitation.²⁰ Still others have argued that a “technical correction” of section 958(b) would be inappropriate in this context.²¹

To-date, Congress has not adopted any further change to section 958(b) — nor yet even attempted to enact any “correction” of section 958(b) in the manner that is customary with respect to “technical corrections.”²² The first attempt that was made at modifying the repeal of section 958(b)(4) was done on a partisan, unicameral basis, when a provision to retroactively reinstate section 958(b)(4) and implement in its place a new Code provision, section 95IB, was included as section 501(f) in a House amendment to the Senate amendment to H.R. 88 (115th Cong.). The change, which purported to be a “technical correction” despite not having been agreed to by any staff other than the then-Ways and Means Committee Majority Republican staff, provided as follows:

(1) Section 958(b) is amended —

(A) by inserting after paragraph (3) the following:

“(4) Subparagraphs (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person.”, and

(B) by striking “Paragraph (1)” in the last sentence and inserting “Paragraphs (1) and (4)”.

(2) Subpart F of part III of subchapter N of chapter 1 is amended by inserting after section 951A the following new section:

“SEC. 95IB. Amounts included in gross income of foreign controlled United States shareholders.

“(a) In general. — In the case of any foreign controlled United States shareholder of a foreign controlled foreign corporation —

“(1) this subpart (other than sections 951 A, 951(b), 957, and 965) shall be applied with respect to such shareholder (separately from, and in addition to, the application of this subpart without regard to this section) —

“(A) by substituting 'foreign controlled United States shareholder' for 'United States shareholder' each place it appears therein, and

“(B) by substituting 'foreign controlled foreign corporation' for 'controlled foreign corporation' each place it appears therein, and

“(2) sections 951A and 965 shall be applied with respect to such shareholder —

“(A) by treating each reference to 'United States shareholder' in such sections as including a reference to such shareholder, and

“(B) by treating each reference to 'controlled foreign corporation' in such sections as including a reference to such foreign controlled foreign corporation.

“(b) Foreign controlled United States shareholder. — For purposes of this section, the term 'foreign controlled United States shareholder' means, with respect to any foreign corporation, any United States person which would be a United States shareholder with respect to such foreign corporation if —

“(1) section 951(b) were applied by substituting 'more than 50 percent' for '10 percent or more', and

“(2) section 958(b) were applied without regard to paragraph (4) thereof.

“(c) Foreign controlled foreign corporation. — For purposes of this section, the term 'foreign controlled foreign corporation' means a foreign corporation, other than a controlled foreign corporation, which would be a controlled foreign corporation if section 957(a) were applied —

“(1) by substituting 'foreign controlled United States shareholders' for 'United States shareholders', and

“(2) by substituting 'section 958(b) (other than paragraph (4) thereof)' for 'section 958(b)'.

“(d) Regulations. — The Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the purposes of this section, including regulations or other guidance —

“(1) to treat a foreign controlled United States shareholder or a foreign controlled foreign corporation as a United States shareholder or as a controlled foreign corporation, respectively, for purposes of provisions of this title other than this subpart, and

“(2) to prevent the avoidance of the purposes of this section.”.

(3) The amendments made by paragraphs (1) and (2) shall apply to —

(A) the last taxable year of foreign corporations beginning before January 1, 2018, and each subsequent taxable year of such foreign corporations, and

(B) taxable years of United States persons in which or with which such taxable years of foreign corporations end.

Despite passing the House on an all-Republican basis,²³ H.R. 88 was not taken up by the Republican-controlled Senate and it lapsed at the end of the 115th Congress. The next instance of a proposed modification to the TCJA's repeal of section 958(b)(4) surfaced in the final days of the 115th Congress, as Republicans were about to cede control of the House to the Democrats. Then-Chairman Kevin Brady introduced a “discussion draft” of “technical corrections,” section 4(jj) of which was the same provision proposing to reinstate section 958(b)(4) and enact new section 95IB that had been slipped into H.R. 88.²⁴

A proposal to enact a “technical correction” to reinstate section 958(b)(4) did not first appear in the 116th Congress until September 26, 2019 when two identical bills were introduced on the topic: H.R. 4509 (116th Cong.) in the House, introduced by Rep. John Lewis (D-GA) and S. 2589 (116th Cong.) in the Senate, introduced by Sen. Johnny Isakson (R-GA). To-date, no action has been taken on either bill in either Chamber.

Notwithstanding the controversy surrounding the repeal of section 958(b)(4), the IRS and Treasury have on several occasions undertaken actions to implement the repeal. For example, on February 5,2018 the IRS promulgated Notice 2018-13 which provided preliminary guidance on the application of the repeal of section 958(b)(4). See Notice 2018-13, 2018-6 I.R.B. 341. While Notice 2018-13 did not indicate that the IRS or Treasury were considering disregarding the repeal of section 958(b)(4), the notice solicited public comment on:

[Whether, in light of the repeal of section 958(b)(4), it would be appropriate for the Treasury Department and the IRS to reconsider the provisions of any form, publication, regulation, or other guidance that reference CFCs, and if so, what revisions may be appropriate.

Notice 2018-13, sec. 7, 2018-6 I.R.B. at 348. To restate, Notice 2018-13 gave no hint that Treasury or the IRS believed the repeal of section 958(b)(4) was unintended (or a mistake requiring Congressional correction). Rather, they merely solicited comment on whether “in light of' the provision's repeal there were areas of guidance of forms that needed to change. In short, in Notice 2018-13 both Treasury and the IRS committed to implementing the change.

The IRS and Treasury again addressed the implications of the repeal of section 958(b)(4) in final and temporary regulations under sections 245A and 6038 that were promulgated on June 18, 2019. See Limitation on Deduction for Dividends Received From Certain Foreign Corporations and Amounts Eligible for Section 954 Look-Through Exception 84 Fed. Reg. 28,398, 28,402 (June 18, 2019) (to be codified at 26 C.F.R. pt. 1). In relevant part, this guidance package provided rules with respect to the section 245A deduction that were necessitated by the repeal of section 958(b)(4) in order to prevent a potentially abusive transaction referred to by some as the “GILTI holiday.” See id.

Finally, on October 2, 2019 Treasury and the IRS promulgated proposed regulations that “propose[d] changes” to regulations under several Code sections “that are generally intended to ensure that, in appropriate circumstances, the operation of certain rules is consistent with their application before the repeal of section 958(b)(4)” ("Proposed 958(b)(4) Regulations"). Ownership Attribution Under Section 958 Including for Purposes of Determining Status as Controlled Foreign Corporation or United States Shareholder, 84 Fed. Reg. 52,398, 52,399 (proposed Oct. 2, 2019) (to be codified at 26 C.F.R. pt. 1). As noted in the Preamble language cited above, the Proposed 958(b)(4) Regulations proposed making targeted changes to regulations under Code sections 267, 332, 367, 672, 706, 863, 904, 958,1297, and 6049 to reflect the repeal of section 958(b)(4). As to the modified guidance under section 958(b), the Preamble to the Proposed 958(b)(4) Regulations noted the following:

To ensure that the regulations under section 958 are consistent with the amended statute, this notice of proposed rulemaking removes the rule in § 1.958-2(d)(2) that corresponds to section 958(b)(4). It also revises Example 4 in § 1.958-2(g) to illustrate the application of the ownership attribution rules in section 958 in the absence of section 958(b)(4).

Id. at 52,402. Concurrent with the promulgation of the Proposed 958(b)(4) Regulations, the IRS issued a Revenue Procedure that helped further clarify the rules resulting from the repeal of section 958(b)(4). Rev. Proc. 2019-40, 2019-43 I.R.B. 982. As noted in this Revenue Procedure, its intent was not to limit the application of the repeal of section 958(b)(4) but to provide needed guidance (and safe harbors) to taxpayers in light of the fact that:

[I]n certain circumstances, taxpayers are required to include in gross income amounts under sections 951 (“subpart F inclusion amounts”) and 951A (“GILTI inclusion amounts”) attributable to, and report amounts with respect to, foreign corporations that are CFCs solely because of the repeal of section 958(b)(4), even though those taxpayers may have limited ability to determine whether such foreign corporations are CFCs and to obtain the information necessary to accurately determine these amounts.

Id. Thus, as demonstrated above rather than seeking to prevent the implementation of the repeal of section 958(b)(4), Treasury and the IRS have consistently sought to further it post-TCJA.

Background: Proposal

For purposes of this Opinion, the “Proposal” is defined as a legislative proposal to reinstate section 958(b)(4) with retroactive effect to the effective date of its repeal by the TCJA, and which includes the proposed enactment of a new Code section that implements a different (and limited) approach to downward attribution in the context of the Subpart F rules, such as was included as an amendment to H.R. 88 (115th Cong.), as described in greater detail above. As alluded to in the description of the “Background: Facts” section of this Opinion, there are some stakeholders who believe that a “technical correction” along these lines is appropriate and warranted, and likewise some who believe such legislation to be inappropriate and unwarranted. In a similar manner, some taxpayers would benefit from this type of change, while others would be harmed by it.²⁵

In addition, for purposes of the analysis of this Opinion, the “Proposal” described in the prior paragraph is assumed to exist in the context of all of the relevant facts (as applicable) as are described in the “Background: Facts” section of this Opinion, including the fact that the legal challenge that is being evaluated with respect to the Proposal is an “as-applied” challenge brought by at least one negatively-affected taxpayer.²⁶

Applicable Authorities

Generally

As noted above, the core issue examined in this Opinion is whether or not a retroactive change such as is described above would be found to violate the Due Process Clause as-applied to a negatively impacted taxpayer. In the context of tax legislation, the controlling authority that sets forth the Supreme Court's standards on the retroactivity of tax legislation is found in United States v. Carlton. This standard controls the analysis of this Opinion. Nonetheless, it is worth examining some of the background in which Carlton was decided.

Due Process, as Applied to Tax Statutes Pre-Carlton

While there is some “mix” to the results, Courts have generally been reluctant to strike down retroactive tax statutes or regulations. Compare, e.g., Untermyer v. Anderson, 276 U.S. 440 (1928) (unconstitutional); Simpson v. United States, 423 F. Supp. 720 (S.D. Iowa 1976) (unconstitutional) with Licari v. Comm'r, 946 F.2d 690 (9th Cir. 1991) (constitutional); Wiggins v. Comm'r, 904 F.2d 311 (5th Cir. 1990) (constitutional). Many of the cases that invalidated retroactive tax laws under the Due Process Clause were based upon a series of Supreme Court decisions²⁷ that Carlton described as having been “decided during an era characterized by exacting review of economic legislation” that is no longer utilized. See Carlton, 512 U.S. at 34 (citing Nichols v. Coolidge, 274 U.S. 531 (1927); Blodgett v. Holden, 275 U.S. 142 (1927); Untermyer, 276 U.S. at 440. Nonetheless, Carlton explicitly did not overrule these cases. See id.

Prior to Carlton, the Supreme Court had given lower courts a fair amount of leeway in determining what standards applied in judging whether a retroactive tax statute violated the Due Process Clause. Various formulations had been given for making this determination, including “palpably arbitrary and unreasonable” and “harsh and oppressive.” See Milliken v. United States, 283 U.S. 15, 20-21 (1931) (arbitrary and unreasonable); United States v. Hudson, 299 U.S. 498 (1937) (not unreasonable); Welch v. Henry, 305 U.S. 134 (1938) (harsh and oppressive); United States v. Darusmont, 449 U.S. 292, 299 (1981) (same); United States v. Hemme, 476 U.S. 558 (1986) (same). In Carlton, the Supreme Court “unified” these formulations into a single rule.

Prior to Carlton, the Supreme Court had also not expressed any specific temporal limitation for retroactive tax legislation. For example, pre-Carlton the Supreme Court had “indirectly sustained”²⁸ respective determinations that statutes three years retroactive and three to six years retroactive, as applied, were unconstitutional because they violated due process. See Comptroller of the Treasury v. Glenn Martin Co., 216 Md. 235 (1958), cert. denied 358 U.S. 820 (1958); Commonwealth v. Budd Co., 379 Pa. 159 (1954), cert. denied sub nom Pennsylvania v. Budd Co., 349 U.S. 935 (1955). On the other hand, pre-Carlton the Supreme Court had also “indirectly sustained” respective determinations that statutes four years retroactive were constitutional and did not violate due process. See Canisius Coll. v. United States, 799 F.2d 18 (2d Cir. 1986), cert denied 481 U.S. 1014 (1987); Temple Univ. v. United States, 769 F.2d 126 (3d Cir. 1985), cert. denied 476 U.S. 1182 (1986).

As Justice O'Connor observed in her concurring opinion in Carlton, however, all of the pre-Carlton cases that the Supreme Court had actually decided with respect to retroactive tax legislation involved circumstances where “the law applied retroactively for only a relatively short period prior to enactment,” citing Hemme (1 month), Darusmont (10 months), Hudson (just over 1 month), and Welch v. Henry (over a year but in the next legislative session). 512 U.S. at 38.

Given the tensions within the holdings of the pre-Carlton caselaw, this Opinion focuses on applying the standards articulated by the Carlton decision itself (which control from an analytical standpoint) to the facts described in the Background section above, and evaluates the applicable post-Car/ton guidance that could impact the contours of the aforementioned standard.

Due Process under Carlton

Carlton is a case grounded in an errant estate tax provision. In October 1986, the Tax Reform Act of 1986 ("'86 Act") modified section 2057 to provide an estate tax deduction for half of the amount realized by “any sale of employer securities by an executor of an estate” to an Employee Stock Ownership Plan (“ESOP”). 512 U.S. at 28. As originally enacted, the text of this provision did not actually require the decedent to have owned the securities prior to death. Id. Jerry Carlton was the executor of an estate, and took advantage of the change to section 2057 by purchasing 1.5 million shares of Mcl Communications Corporation ("Mcl") on December 10, 1986, and selling them two days later to the Mcl ESOP. Id. Carlton then took an estate tax deduction for the sale, pursuant to section 2057. Id. Carlton's benefit was to be shortlived, however, as the IRS announced in January 1987 that pending the enactment of “clarifying legislation” it would only allow the section 2057 deduction for decedents who owned the securities immediately before death. Id. at 29; see also Notice 87-13, 1987-1 C.B. 432, 444.

Members of Congress agreed with the IRS's view, and realizing the drafting mistake which had been made the Ways and Means Committee Chairman Dan Rostenkowski and the Senate Finance Committee Chairman Lloyd Bentsen each introduced legislation²⁹ on February 26, 1987 to retroactively change section 2057 so that the deduction only applied where the decedent owned the securities before death. 512 U.S. at 29. The changes to section 2057 proposed by these bills were enacted into law on December 22, 1987 as section 10411(a) of the Omnibus Budget Reconciliation Act of 1987 ("OBRA '87"), but had an effective date that mirrored the original provision. Id.

The IRS denied Carlton's section 2057 deduction. Id. Carlton paid the deficiency and sued for a refund in the District Court for the Central District of California. Id. The District Court granted summary judgment in the government's favor, finding that the several months retroactive change to section 2057 did not violate the Due Process Clause. The Ninth Circuit Court of Appeals reversed, finding that it did violate due process.

In the Ninth Circuit's view, two aspects weighed most heavily in analyzing whether or not a retroactive tax statute violated the Due Process Clause. First, the Ninth Circuit was concerned about whether the taxpayer had actual or constructive notice that the tax statute would be retroactively amended. See id. at 29-30; see also Carlton v. United States, 972 F.2d 1051, 1059 (9th Cir. 1992). Second, the Ninth Circuit heavily examined whether the taxpayer reasonably relied to his detriment on pre-amendment law. Id. One judge of the three-judge panel authored a robust dissent that covered a wide variety of arguments, from challenging the majority's test to challenging the majority's factual conclusions. See 972 F.2d at 1062-1066 (Norris, J. dissenting). The United States appealed the decision, and the Supreme Court granted certiorari. See 510 U.S. 810 (1993).

In a unanimous decision, the Supreme Court reversed the Ninth Circuit, finding that the retroactive change to section 2057 did not violate the Due Process Clause. The Court concluded that its prior guidance stood for the proposition that retroactive tax law changes would not violate the Due Process Clause “'[provided that the retroactive application of a statute is supported by a legitimate legislative purpose furthered by rational means. . . .'” 512 U.S. at 30-31 (citing Pension Benefit Guaranty Corporation v. R.A. Gray & Co., 467 U. S. 717, 729-730 (1984)). The Court then explained how it made this conclusion, as follows:

We conclude that the 1987 amendment's retroactive application meets the requirements of due process. First, Congress' purpose in enacting the amendment was neither illegitimate nor arbitrary. Congress acted to correct what it reasonably viewed as a mistake in the original 1986 provision that would have created a significant and unanticipated revenue loss. There is no plausible contention that Congress acted with an improper motive, as by targeting estate representatives such as Carlton after deliberately inducing them to engage in ESOP transactions. Congress, of course, might have chosen to make up the unanticipated revenue loss through general prospective taxation, but that choice would have burdened equally "innocent" taxpayers. Instead, it decided to prevent the loss by denying the deduction to those who had made purely tax-motivated stock transfers. We cannot say that its decision was unreasonable.

Second, Congress acted promptly and established only a modest period of retroactivity.

Id. at 32. In the Court's mind, Congress' timely “curative” change to section 2057 as originally enacted by the '86 Act was meant to perfect its original purpose in enacting the provision — i.e., “to create an 'incentive for stockholders to sell their companies to their employees who helped them build the company rather than liquidate, sell to outsiders or have the corporation redeem their shares on behalf of existing shareholders'” — which purpose had been subverted by Congress failing to specify that the shares had to have been owned prior to the death of the decedent in order to claim the deduction. Id. at 31-32 (quoting Joint Committee on Taxation, Tax Reform Proposals: Tax Treatment of Employee Stock Ownership Plans (ESOPs), 99th Cong., 2d Sess., 37 (Joint Comm. Print 1985)). As a result of Congress' unintentional omission, section 2057 as originally enacted incentivized what were '“essentially sham transactions.'” Id. at 32. The change that was retroactively enacted as part of OBRA '87 thus naturally flowed from (and reflected the legislative purpose behind) the originally-enacted provision.

Following this, the Court examined the two facets specifically focused upon by the Ninth Circuit in its opinion — i.e., detrimental reliance and notice — and rejected their use as a controlling standard. Id. at 33-34. Finally, it further distinguished the Lochner-zra. cases upon which the Ninth Circuit relied as coming from an era of an “exacting” review of economic legislation which “do[es] not control here." Id. at 34.

Apart from the majority opinion, the Carlton decision had two others. First, Justice O'Connor authored a concurrence that will be discussed in more detail below. See id. at 35-39 (O'Connor, J., concurring). Second, Justice Scalia authored a concurrence that was joined by Justice Thomas whose principal aim was to highlight the “oxymoron[fic]” nature of substantive due process jurisprudence. See id. at 39-42 (Scalia and Thomas, J.J., concurring). As noted above (and as will be further discussed below), Carlton is the controlling authority for purposes of this Opinion.

Post-Carlton Cases. General

We have identified 189 post-Carlton judicial opinions that cite Carlton in some form or another, but nearly all are distinguishable and are not precedential for purposes of evaluating the Proposal. Of these cases, 107 were either state court decisions and/or decisions reviewing a state statute. Of those remaining, seven cited Carlton for a point other than with respect to the constitutional validity of retroactive tax legislation, six were criminal cases, twenty-three were not related to tax legislation, twenty-four did not examine a statute that was by its own terms retroactive,³⁰ two turned on issues of contract law, one was overturned on appeal and not subsequently reissued, and one failed to raise a Due Process Clause challenge. Of the remaining eighteen opinions, six were “preliminary” (i.e., an initial opinion that was later taken up by a higher court or as part of a rehearing), and twelve were “final” (i.e., the last dispositive opinion).

It is this pool of twelve cases that form the core of potential post-Carlton authorities, and each is discussed below.

Post-Carlton Cases. Potential Authorities

While there is a diverse group of cases that cite to Carlton, as discussed above only a select few potentially have precedential relevance to the issue of whether or not the Proposal would be found to violate the Due Process Clause as-applied to a negatively affected taxpayer. These cases are reviewed in the following section, and are categorized into a general “type” of case where useful.

Estate Tax Rate Increase Cases; NationsBank, Quarts. and National Taxpayers Union

In a trio of cases, the D.C. Circuit Court of Appeals, Ninth Circuit Court of Appeals, and Court of Appeals for the Federal Circuit each respectively upheld the validity of the retroactive reversion of the top estate and gift tax rates of 53 percent and 55 percent, respectively. See, e.g., Nat'I Taxpayers Union v. United States, 68 F.3d 1428, 1430 (D.C. Cir. 1995).

Originally enacted to apply only to the calendar year 1984, after which the top rate for each was scheduled to drop to 50 percent, in 1984 Congress extended the 53 and 55 percent estate and gift tax rates through 1987. Id. at 1430 n.l. In 1987, Congress again extended these top rates through December 31,1992. Id. Congress attempted to extend the rates again in 1992, but the bill was “pocket-vetoed” by President George H.W. Bush. Id. Thus, on January 1, 1993, the top estate and gift tax rates automatically reverted to 50 percent. Id. In February 1993, newly-inaugurated President Bill Clinton proposed raising the rates back to 53 and 55 percent. Id. On August 10,1993, the Omnibus Budget Reconciliation Act of 1993 ("OBRA '93") was enacted, section 13208 of which raised the rates as described above, retroactive to January 1, 1993. Id.', see also 107 Stat. 311, 469.

In National Taxpayers Union v. United States, the D.C. Circuit Court of Appeals was the first federal appellate court to consider the propriety of the nearly eight-month retroactive change to the top estate and gift tax rates. The plaintiff, the National Taxpayers Union (“NTU”), had raised a number of arguments, but the appeal dealt entirely with the NTU's standing to bring a pre-deficiency action against the change. The District Court for the District of Columbia had held that it lacked subject matter jurisdiction because of the Anti-Injunction Act (“ALA”) and the Declaratory Judgment Act (“DJA”). 68 F.3d at 1430. The D.C. Circuit Court of Appeals affirmed the District Court. Id. While the District Court had not addressed the issue of standing, the D.C. Circuit did, finding that although the NTU lacked its own standing to challenge the rate change it had standing on behalf of its members. Id. The D.C. Circuit found that notwithstanding the fact that the NTU had standing to sue, it was nonetheless barred because of the AIA and DJA. Id.

The Ninth Circuit was the next federal appellate court to address the statutory changes, and the first to reach the Due Process Clause implications. See Quarty v. United States, 170 F.3d 961 (9th Cir. 1999). In Quarty v. United States, the taxpayers — an estate and a gift recipient — had both seen their respective tax liabilities increased as a result of the retroactive change. Id. at 964. The taxpayers had each paid the additional taxes and then filed claims for refunds with the IRS, which were denied. Id. Following this, the taxpayers had each sued for a refund in the District Court for the District of Arizona, claiming that the Constitution barred the retroactive application of increased tax rates that were applied against each of them. Id. at 964-65. These claims were consolidated into a single case, and the District Court dismissed the complaints for failure to state a valid claim, finding the retroactive imposition of the increased estate and gift tax rates to be constitutionally valid. Id. at 965.

The Ninth Circuit held that the increase in rate was not the imposition of a “wholly new tax” within the meaning of the Lochner-Qra. cases. Id. at 966. The Court then turned to the main thrust of the issue, finding that Carlton supported the retroactive change which was “less extensive” than the retroactivity period of Carlton (and other cases decided before Carlton). Id. at 967. The Court also addressed the taxpayers' contention that their circumstances were distinguishable from Carlton because the measure there was “curative” whereas the increase in the estate and gift tax rates was not, and further that the consequences of the retroactive change were noxiously egregious. The Court dismissed both of these contentions. See id. at 967-68. The Court ultimately concluded that the change was a “rational means to legitimate purposes . . .” and upheld it. Id. at 967.

Finally, in NationsBank of Tex., N.A. v. United States, the Court of Appeals for the Federal Circuit also opined on the validity of section 13208 of OBRA '93. NationsBank of Tex., N.A. v. United States. 269 F.3d 1332 (Fed. Cir. 2001). NationsBank of Texas was executor of an estate, and paid additional tax from the estate as a result of the enactment of section 13208 of OBRA '93. Id. at 1334. It then sought a refund, which was denied, and following this sued for the refund in the Court of Federal Claims. Id. At the trial level, NationsBank raised seven claims, including that the change violated the Due Process Clause. Id. In its Court of Federal Claims due process argument, NationsBank of Texas argued that Carlton was limited to circumstances where there “was a mistake for Congress to cure with the retroactive [change],” and that barring this there was “no rational legislative purpose for the retroactive application of [section] 13208 [of OBRA '93].” See NationsBank of Tex., N.A. v. United States, 44 Fed. Cl. 661, 666 (Fed. Cl. 1999).

The Court of Federal Claims rejected this strained reading of Carlton and found a rational legislative purpose for the rate increase within the standards of Carlton. Id. In particular, it noted that Carlton's retroactivity period was “five months longer than the retroactive period established by [section] 13208 of OBRA '93.” Id.

Upon appeal, the Court of Appeals for the Federal Circuit agreed with the Court of Federal Claims, holding that the “modest” eight-month retroactive period was not “arbitrary and irrational,” and further, that Congress had acted “promptly” in enacting the change. 269 F.3d at 1337-38. In a related vein, the Court also concluded that given the “short and limited period” of legislative process that resulted in section 13208, there was no “taking” under the Fifth Amendment because the retroactive aspect of the change was not “so arbitrary and capricious as to amount to confiscation.” Id. at 1336 (citing Nichols v. Coolidge, 274 U.S. 531, 542-43 (1927)).

At the Federal Circuit Court of Appeals, one judge of the three-judge panel dissented from the opinion and judgment. Id. at 1338-1340. Judge Plager's dissent was unique in that he acknowledged that the “majority has the law on its side.” Id. at 1339. However, Judge Plager argued that the result was “simply unfair” and “should be unconstitutional.” Id. at 1338. The crux of his argument was that the limitation of the constitutional prohibition on ex post facto laws to only encompass criminal statutes was unsupported by “history” or “logic” — and should be consigned “to the historic dustbin where [it] belong[s].” Id. at 1339-1340. The Supreme Court declined to grant certiorari to address this (or any other issue). See 537 U.S. 813 (2002).

Retroactive Treasury Retaliations: Snan-Drane and Tate &Lyle

In two relevant post-Carfron cases, the action at issue was not directly a retroactive statutory change, but rather a retroactive Treasury Regulation. Both of these cases present a unique confluence of legal theories in that they both claim to rely to some degree on Carlton but simultaneously are grounded in a statutory provision that has since changed. In both cases, prior section 7805(b) was applicable and provided that “[t]he Secretary may prescribe the extent, if any, to which any ruling or regulation, relating to internal revenue laws, shall be applied without retroactive effect.” See Tate & Lyle v. Comm 'r, 87 F.3d 99, 107 (3d Cir. 1996); Snap-Drape v. Comm'r, 98 F.3d 194, 202 (5th Cir. 1996).

Currently, this Code section essentially provides the reverse, namely, that:

Except as otherwise provided in this subsection, no temporary, proposed, or final regulation relating to the internal revenue laws shall apply to any taxable period ending before the earliest of the following dates:

(A) The date on which such regulation is filed with the Federal Register.

(B) In the case of any final regulation, the date on which any proposed or temporary regulation to which such final regulation relates was filed with the Federal Register.

(C) The date on which any notice substantially describing the expected contents of any temporary, proposed, or final regulation is issued to the public.

Sec. 7805(b)(1). Another exception exists for “regulations filed or issued within 18 months of the date of the enactment of the statutory provision to which the regulation relates.” Sec. 7805(b)(2). These major changes to section 7805(b) were made by section 1101 of the Taxpayer Bill of Rights 2 ("TB2 Act"), Public Law 104-168 (104th Cong.). See 110 Stat. 1451, 1468. Per section 1101(b) of the TB2 Act, the changes were only applicable, however, with respect to “regulations which relate to statutory provisions enacted on or after the date of the enactment of [the TB2 Act].”

110 Stat. at 1469. The TB2 Act was enacted on July 30, 1996.

Neither Snap-Drape nor Tate & Lyle involve a Treasury Regulation relating to a statutory provision enacted on or after July 30, 1996, making prior section 7805(b) applicable. In Snap-Drape, the Treasury Regulation at issue addressed whether or not dividends paid to an ESOP that were deductible under the regular tax could be deducted in calculating earnings and profits ("E&P") for purposes of computing “adjusted current earnings” ("ACE") under the corporate alternative minimum tax ("Corporate AMT"). Snap-Drape, 98 F.3d at 196.

In this case, the business owners had sold 80 percent of their shares to a newly-formed ESOP, which obtained the funds to acquire the shares by obtaining a bank loan. Id. In 1990, the taxpayer corporation paid dividends to its shareholders, including the ESOP, which in turn used the dividends to pay down the bank loan. As a result, the taxpayer was entitled to a deduction of the amount pursuant to section 404(k). Id. at 196-197. When it came time for the taxpayer to compute its Corporate AMT on its 1990 federal income tax return, it did not make any adjustment for the section 404(k) deduction. Id. at 197. On May 3, 1990, the Treasury Department published a proposed Treasury Regulation that proposed disallowing a deduction for section 404(k) dividends in determining E&P for purposes of computing ACE under the Corporate AMT. Id. This Treasury Regulation was finalized on March 15, 1991, and indicated that it was retroactively effective for taxable years beginning after December 31, 1989. Id.

In the Omnibus Budget Reconciliation Act of 1989 ("OBRA '89"), a number of changes were made to the alternative minimum tax, including a provision (i.e., OBRA '89 section 7611(g)(3)) that provided that “[n]ot later than March 15, 1991” the Treasury Secretary “shall” prescribe final regulations that provide guidance “as to which items of income are included in [ACE] under section 56(g)(4)(B)(i) of the Internal Revenue Code of 1986 and which items of deduction are disallowed under section 56(g)(4)(C) of such Code.” 103 Stat. 2106, 2373.

Notwithstanding the applicable Treasury Regulation, the taxpayer did not adjust its ACE calculation for tax year 1990. Upon audit, the IRS recomputed the taxpayer's alternative minimum taxable income for tax year 1990, increasing it and asserting a related deficiency. 98 F.3d at 197. The taxpayer timely challenged the determination in the Tax Court, objecting to both the validity of the Treasury Regulation and its retroactive application. Id. The Tax Court held that the regulation was valid and also that the retroactive application of the regulation was valid. Id.

The Fifth Circuit Court of Appeals affirmed the Tax Court. It found that the regulation was itself a valid exercise of regulatory authority. Id. at 199-202. It also found that its 14-month retroactive application was valid. Id. at 202. In principal part, the Fifth Circuit held on this point on the broad authority granted to the Treasury Secretary by prior section 7805(b) to determine the extent to which a Treasury Regulation was to be made retroactive, concluding that the Secretary did not abuse his discretion in not making the change prospective-only. Id. at 202-204. In addition, the Court also found some support in Carlton, finding in a cursory analysis that the Secretary's choice to make the regulation retroactive was neither arbitrary nor irrational, noting that at some unspecified point retroactivity would be impermissible. Id. at 203-04.

Tate & Lyle involved a different set of issues, but similarly implicated both prior section 7805(b) and Carlton. Section 267 generally operates to limit certain related-party deductions. As is relevant to this case, section 267(a)(2) (as amended by section 174(c) of the Deficit Reduction Act of 1984) provides for matching of interest income and deductions in the case of related parties where the payor is on an accrual method of accounting and the payee is on a cash method, effective for taxable years beginning after December 31,1983. See 98 Stat. 494, 708. An additional provision of section 267 — section 267(a)(3), which was added by the Tax Reform Act of 1986 — provides that “[t]he Secretary shall” proscribe regulations that “apply the matching principle of [section 267(a)(2)] in cases in which the person to whom the payment is to be made is not a United States person.” See 100 Stat. 2085,2914. The enactment of section 267(a)(3) was made retroactive to taxable years beginning after December 31, 1983 to match the effective date of section 267(a)(2). Id. at 103.

In response to the enactment of section 267(a)(3), the Treasury Secretary issued final Treasury Regulations on December 31, 1992 that provided in relevant part that “[a]n amount that is owed to a related foreign person and that is otherwise deductible under Chapter 1 thus may not be deducted by the taxpayer until such amount is paid to the related foreign person. . . .” Id.; see also Treas. Reg. sec. 1.267(a)-3(b)(1). Another provision of this Treasury Regulation specifically provides that “[i]nterest that is not effectively connected income of the related foreign person is an amount covered by paragraph [1.267(a)-3(b)] of this section, regardless of whether the related foreign person is exempt from United States taxation on the amount owed pursuant to a treaty obligation of the United States. 87 F.3d at 103-04; see also Treas. Reg. sec. 1.267(a)-3(c)(2). In short, as a result of this regulation “a taxpayer who owes interest to a related foreign person, where the related foreign payee is exempt from taxation on the interest received from U.S. sources not effectively connected with a U.S. trade or business of the foreign payee due to a tax treaty, may not deduct the interest owed to the related foreign person until the taxpayer actually pays the interest to the related foreign person.” Id. at 104. The Treasury Secretary made Treasury Regulation section 1.267(a)-3(c)(3) retroactively effective to interest deductions allowable in tax years beginning after December 31, 1983. Id.

Tate & Lyle, Inc. made payments to related, foreign affiliates that were impacted by Treasury Regulation section 1.267(a)-3(c)(3) by virtue of their being exempt under the United States/United Kingdom income tax treaty. Id. at 101. Tate & Lyle challenged the rule in the Tax Court and won, with the Tax Court holding that Treasury Regulation section 1.267(a)-3 was invalid, with some Tax Court judges finding that such a rule would violate the Due Process Clause even if the regulation was found to be valid. Id. at 102.

The Third Circuit Court of Appeals reversed, finding that the regulation was valid and also that it did not violate due process. Id. at 101. It first found that the regulation was a valid exercise of regulatory authority (and in the process concluded that the regulation was “not arbitrary, capricious or manifestly contrary to [the statute]).” Id. at 105; see also id. at 102-106. It also found that the retroactive application of the regulation did not violate due process. In doing so, it explicitly distinguished Carlton because “Carlton involved the retroactive application of a statute, and here we are dealing with the retroactive application of a regulation.” Id. at 107. It then turned to former section 7805(b) and concluded that “[c]learly Congress has determined that treasury regulations are presumed to apply retroactively. The extent to which newly promulgated regulations shall not apply retroactively is a matter of discretion left to the Secretary.” Id. It then determined that it was not an abuse of the Treasury Secretary's discretion to issue Treasury Regulation section 1.267(a)-3(c)(3) nine years and one month retroactively. Id. at 108.

Retroactivity as a Taxpayer Sword/Shield: Neal and Buerer

In two relevant cases, the taxpayers actually wanted the statute to be applied retroactively (or more retroactively), reversing the general trend of taxpayers being aggrieved by the retroactive application. Buerer v. United States involved a circumstance where a taxpayer argued that the nearly three-month retroactive application of a Taxpayer Relief Act of 1997 legislative change to the section 121 exclusion of gain from the sale of a taxpayer's primary residence and the repeal of the section 1034 rollover provision did not go far enough and was thereby a violation of the taxpayer's due process rights. Buerer v. United States, 141 F. Supp. 2d 611, 612 (W.D.N.C. 2001).

Prior to the enactment of the Taxpayer Relief Act of 1997 change to section 121 and repeal of section 1034, the Code provided for the exclusion of gain from the sale of a taxpayer's principal residence by a taxpayer who had attained 55 years of age and met a variety of other requirements. Sec. 121 (Supp. II 1996). In addition, prior section 1034 provided that a taxpayer who sold a principal residence and within two years thereafter acquired a new principal residence could roll over the gain from the first residence into the newly-purchased residence, effectively allowing the taxpayer to defer all gain provided that the cost of the new residence exceeded that of the old residence. Sec. 1034(a) (Supp. II 1996).

Section 312(b) of the Taxpayer Relief Act of 1997 repealed section 1034, and section 312(a) of that act significantly modified section 121 to provide a more general exclusion of gain from the sale of a primary residence without any reference to the age of the selling taxpayer. See 111 Stat. 787, 837-839. Section 312(d) of the Taxpayer Relief Act of 1997 generally made the changes described above effective to sales and exchanges occurring after May 6, 1997, but provided an election for taxpayers to not apply the changes to sales occurring before the date of enactment. Ill Stat. at 841.

The taxpayer had sold her home on April 25, 1997 and did not purchase a new, more expensive home within two years of that date. 141 F. Supp at 612. The taxpayer sued for a refund of the additional taxes she paid in the District Court for the Western District of North Carolina, claiming the changes made by the Taxpayer Relief Act of 1997 in relevant part violated the Due Process Clause. Id.

The District Court concluded that taxpayer's due process had not been violated, citing to Carlton. Id. at 613. The Court concluded that Congress' choice to limit the nearly three-months retroactive effect of section 312 of the Taxpayer Relief Act of 1997 was an “eminently reasonable means of furthering [Congress'] legitimate goals.” Id. at 614. The taxpayer had argued that Congress could have extended the retroactivity period even further to January 1, 1997 as the '“statute was in the process of enactment from the first of the year'. . . .” Id. The Court determined that this was not a bar to sustaining the changes, as the taxpayer was on notice of the potential changes, and while notice was not dispositive of the constitutionality of the changes, could have delayed the sale of her home. Id.

Neal v. United States is a unique case where the United States was arguing (mostly indirectly) against the congressionally appointed retroactive effect of a repeal of a tax statute. Neal v. United States, No. 97-1093 (W.D. Pa. 1998), 98-2 USTC 86,519, 86,520. Neal involved a taxpayer who released her contingent reversionary interests in a trust in 1989 in order to trigger federal gift tax liability and avoid greater gift tax later through the application of section 2036(c), but upon the subsequent retroactive repeal nunc pro tunc of section 2036(c) rescinded her releases under her equitable rights pursuant to Pennsylvania law based upon a unilateral mistake of law as to the validity of section 2036(c). Id.

Section 10402(a) of OBRA '87 added section 2036(c) to the Code, and section 3031 of the Technical and Miscellaneous Revenue Act of 1988 ("TAMRA") modified section 2036(c). Section 2036 broadly requires the value of the estate to be increased by the value of transferred property in which the transferor has retained certain interests, including the “enjoyment of' the transferred property. Sec. 2036(a). Simplified greatly, 2036(c) generally applied with respect to certain transfers by a person owning a substantial interest in an enterprise of property interests with respect to such person's interest in the enterprise (a so-called “disproportionate transfer”). It provided that where the transferor retained an interest in the income or rights in the enterprise, the retention of such interest would be treated as the retention of the “enjoyment of' the transferred property. Sec. 2036(c) (1989).

The IRS construed section 2036(c) in a Notice, promulgating a variety of rules with respect to gift taxes. See Notice 89-99, 1989-2 C.B. 422. On November 5,1990, Congress repealed section 2036(c) in its entirety in section 11601(a) of the Omnibus Budget Reconciliation Act of 1990 ("OBRA '90"). See 104 Stat. 1388-490. Section 11601(b) of OBRA '90 made this repeal effective to the original effective date of the enactment of section 2036(c) {i.e., with respect to property transferred after December 17, 1987). See 104 Stat. 1388-491. Congress intended the repeal of section 2036(c) to be nunc pro tunc, meaning that it was to be done with retroactive effect but with the same effect “as if regularly done.” See 98-2 USTC at 86,525 n.2.

Following the enactment of section 2036(c) but prior to the nunc pro tunc repeal of section 2036(c), and based on the IRS's interpretation of this section as provided in Notice 89-99, the taxpayer's advisors believed that she would owe greater gift taxes in the future if she did not release her reversionary interests in a grantor retained interest trust ("GRIT"). Id. at 86,520. She did so in 1989, thereby completing at the time a taxable gift. Id. Following the nunc pro tunc repeal of section 2036(c), however, the taxpayer exercised her equitable right under Pennsylvania state law to rescind her prior release of her contingent reversionary interests in the GRIT. Id.

In Neal, the District Court for the Western District of Pennsylvania had to determine whether in 1989 the taxpayer had made a completed gift by releasing her contingent reversionary interests in the GRIT, and thereby ceased her “dominion and control” over the GRIT within the meaning of section 2511 and Treasury Regulation section 25.2511-2, or whether her subsequent rescission of such release prevented the gift from having occurred. Id. at 86,522. This required the Court to determine whether Pennsylvania state law recognized her rescission of her prior release, which in turn required the Court to determine the effect of Congress' retroactive nunc pro tunc repeal of section 2036(c). Id.

In the Pennsylvania courts, the taxpayer was found to have effectively rescinded her release. Id. The IRS, however, argued that this rescission was not effective for federal tax purposes in part because there was no mistake of law in 1989 within the meaning of Pennsylvania law because the federal law in question (i.e., section 2036(c)) was valid and operable. Id. at 86,522-86,523. This required the Court to examine whether or not the retroactive repeal of section 2036(c) was valid, and the IRS was required to implicitly argue that the retroactive application in this context was improper. Id. at 86,524. The Court determined, with brief analysis, that the facts in question implicated Carlton — and met the standard for retroactivity expressed therein. Id. In significant part, the Court appears to have relied heavily on the fact that Congress explicitly sought to repeal section 2036(c) nunc pro tunc. See, e.g., id. at 86,523-86,524 (“There is no need to search for contextual clues or sift through legislative history for Congress' implicit intent here, for as the parties have stipulated, Congress has made its intent express and unambiguous — its repeal of section 2036(c) is retroactive, and nunc pro tunc.”).

The Court thereby determined that the taxpayer had made a mistake of law in 1989 within the meaning of Pennsylvania law, and thereby that her rescission of her release was within her equitable rights under Pennsylvania law — thereby making her gift incomplete for federal gift tax purposes. Id. at 86,526. It thereby concluded that she was entitled to a refund of the gift tax paid. Id.

Additional. Unclassified Cases

Furlong v. Comm 'r. Broadly-speaking, the issue in Furlong v. Comm 'r was whether, in the context of the rules of section 72(p)(1)(A), the effective date of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") was impermissible under the Due Process Clause. Furlong v. Comm 'r, 36 F.3d 25, 26 (7th Cir. 1994).

Factually-speaking, the taxpayer in this case was the sole shareholder of an Illinois corporation and on August 25,1982 borrowed $99,000 from his pension plan. Id. Section 72(p)(1)(A) was added to the Code by section 236(a) of TEFRA. Pub. L. 97-248, 96 Stat. 324, 509. The provision generally provides that where a taxpayer receives a loan from a qualified plan such amount is treated as if it was a distribution under the plan. Id. Though TEFRA was enacted on September 3,1982, section 236(c) of TEFRA provided that the addition of section 72(p)(1)(A) was generally effective with respect to loans, assignments, and pledges made after August 13,1982. 96 Stat. at 510-11.

The taxpayer in this instance did not include the $99,000 of loan proceeds as income on his 1982 joint federal income tax return. 36 F.3d at 26. In May 1990, the IRS issued the taxpayer a notice of deficiency that in relevant part included the loan proceeds as income to the taxpayer. Id.

The taxpayer timely filed a Tax Court petition contesting this deficiency. Id.; see also Furlong v. Comm 'r, T.C. Memo. 1993-191. In principal part, the taxpayer argued that his Due Process Clause rights were violated by the less-than-one-month retroactive imposition of section 72(p)(1)(A). Id. The Tax Court denied the challenge in an opinion issued April 29,1993. See T.C. Memo. 1993-191. The Tax Court determined that the taxpayer's Due Process Clause rights were not violated because the retroactive enactment of section 72(p)(1)(A) was not arbitrary or capricious in that it was not “harsh and oppressive.”

More specifically, the Tax Court first determined that the imposition of section 72(p)(1)(A) was not a “wholly new tax” within the meaning of the Lochner-ora Supreme Court cases, distinguishing these. Id. The Tax Court also concluded that the particular change in question was “reasonably foreseeable” and that therefore there was no Due Process Clause violation. Id.

Having lost in the Tax Court, the taxpayer timely appealed to the Seventh Circuit Court of Appeals. See Furlong, 36 F.3d at 26. In the period between when the Tax Court rendered judgment and the Seventh Circuit issued its opinion, the Supreme Court decided Carlton. Id. In reviewing the Tax Court's decision, the Seventh Circuit first examined whether or not the enactment of section 72(p)(1)(A) was that of a “wholly new tax,” determining that it was not. Id. at 27-28. It then reviewed whether or not the one-month retroactive enactment of this provision was a legitimate legislative purpose furthered by rational means, concluding that it was. Id. at 28-29.

Jamieson v. Comm 'r. The broad issue in Jamieson v. Comm 'r was the application of the alternative minimum foreign tax credit of section 59(a). T.C. Memo. 1995-550. Secondarily, and as is relevant to the analysis of this Opinion, an issue was the applicability (and validity) of the amendments to section 7852(d) to implement the so-called “later-in-time” rule of tax treaty interpretation that was enacted on November 10, 1988 by section 1012(aa) of TAMRA, and which was retroactively effective to taxable years beginning on or after January 1,1987. Id. at n.4; see also 102 Stat. 3342, 3351-52.

In Jamieson, the taxpayers resided in Canada (and principally earned Canadian-source income). T.C. Memo 1995-550. The taxpayers claimed an alternative minimum foreign tax credit under section 59(a)(1) without applying the limitation provided by section 59(a)(2), which was enacted by the Tax Reform Act of 1986. Id. The IRS determined that this was improper, and issued a notice of deficiency. Id. The taxpayers timely petitioned the Tax Court, arguing that the Convention Between the United States of America and Canada With Respect to Taxes on Income and on Capital ("U.S./Canada Tax Treaty") strictly prohibited double-taxation and thereby had overridden the limitation of section 59(a)(2). Id.

In ruling for the IRS, the Tax Court determined that section 59(a)(2) applied.

Id. The Tax Court held that TAMRA section 1012(aa) also applied and that, under the later-in-time rule, section 59(a)(2) governed because the enactment of section 59(a)(2) post-dated the entry into force of the U.S./Canada Tax Treaty. Id. As part of this ruling, the Tax Court further determined with no analysis that the 23-month retroactivity period of TAMRA section 1012(aa) “is a modest one and does not violate petitioner's right of due process,” citing Tate & Lyle and Carlton. Id. at n.4.

Montana Rail Link v. United States. This case involved an amendment to the Railroad Retirement Act ("RRTA") that was made by OBRA '89. Montana Rail Link v. United States, 76 F.3d 991, 992 (9th Cir. 1996). For railroad employers, the RRTA operates in place of the Social Security Act. Id.; see also secs. 3201-3241. In 1983, the Social Security Act was amended to in relevant part provide that employer contributions to 401(k) plans were treated as part of the contribution base for Social Security tax purposes. 76 F.3d at 993. As discussed below, a commensurate change to the RRTA was not made until OBRA '89, however. Id.

This change to the RRTA was generally made on a prospective basis. Id.-, see also Pub. L. 101-239 sec. 10206(c)(2)(A)(i), 103 Stat. 2106, 2475. However, section 10206(c)(2)(A)(ii) of the OBRA '89 change to the RRTA also provided that the modifications would be applied retroactively to remuneration already paid where “the employer treated [it] as compensation when paid.” 103 Stat. at 2475. As the Court noted, the legislative history to OBRA '89 specified that the potential retroactivity was required with respect to amounts paid prior to 1990 because the amounts would have already been credited [to employees] for some benefit purposes” and also because “it is likely that some employees would already have begun receiving benefits based on the crediting of such amounts.” See 76 F.3d at 993.

Originally, the taxpayer had treated its 401(k) contributions to employees as taxable compensation for purposes of the RRTA excise and withholding taxes. Id. at 993. After meeting with Railroad Retirement Board staff in November 1988, however,

the taxpayer concluded that it did not need to treat these amounts as “compensation” for purposes of the RRTA. Id. It stopped doing so, and went so far as to reimburse employees for amounts withheld from 1987 and 1988 that it now believed to have been incorrectly withheld. Id.

The taxpayer modified its 1989 withholding and excise tax payment as well, and in 1991 sought a refund for applicable taxes paid in 1987 and 1988. Id. The IRS disallowed the refund claim and the taxpayer timely filed suit. Id. at 993-994. The District Court for the District of Montana ruled in favor of the IRS, holding that based upon Carlton the taxpayer had no Due Process Clause claim. See Montana Rail Link v. United States, 873 F. Supp. 1415,1422 (D. Mont. 1994). With respect to the retroactivity period, the District Court held that Congress had acted promptly, that Carlton did not establish a strict definition of what a “modest period of retroactivity” meant, and that Carlton was also distinguishable because the change there “clarified a recently enacted law whereas Section 10206 changes an existing law.” Id. at 1421.

The Ninth Circuit affirmed the District Court. 76 F.3d at 992-993, 995. With respect to the retroactivity period of the OBRA '89 change to the RRTA, the Ninth Circuit noted that it only impacted employers who had already acted in accordance with the retroactive change, and that to not apply a retroactivity period that was commensurate with this treatment would have itself been “arbitrary and irrational.” Id. at 994. As the Court noted, in the case of employees whose employers had already treated 401 (k) contributions as wages to now limit the application of the rule change “would have severely hurt [any such] workers who had retired expecting that they would receive a level of benefits based in part on tax payments made from 1983 through 1987.” Id.

Sutherland v. Comm 'r. This case involved an unmarried, cohabitating couple who filed separate single-filer tax returns in 1997 and both claimed the earned income tax credit ("EITC") with respect to different children in their combined household.

See T.C. Memo. 2001-8. Specifically, one taxpayer claimed the EITC with respect to two of her three children, and the other taxpayer claimed the EITC with respect to the third child. Id. The second taxpayer's modified adjusted gross income was higher than the first taxpayer's. Id.

Section 32(c)(1)(C) specifies a so-called “tie-breaker rule” for purposes of the EITC where two or more persons would otherwise be an “eligible individual” with respect to the same “qualifying child” for purposes of claiming the EITC, providing that in this case the individual with the highest modified adjusted gross income for the applicable tax year is the one that would be eligible for the credit.

In 1990, Congress had modified the rules of section 32(c) to provide that a “qualifying child” for purposes of the EITC was one that satisfied a “relationship test,” a “residency test,” an “age test,” and an “identification test.” Id.',see also Pub. L. 101-508 sec. 11111(a), 104 Stat. 1388, 1388-410 - 1388-412. Under the “identification test,” a taxpayer had to “include on his or her income tax return the name, age, and taxpayer identification number of each qualifying child with respect to whom he or she claimed the [EITC].” T.C. Memo. 2001-8.

On July 22,1998, Congress modified the rules of section 32(c) in section 6021(b) of the Internal Revenue Service Restructuring and Reform Act of 1998 ("RRA 1998") to make the identification of a qualifying child necessary for purposes of claiming the credit but not an actual element of the definition of a “qualifying child.” Id., see also Pub. L. 105-206 sec. 6021(b)(3), 112 Stat. 685, 824. The RRA 1998 change to section 32(c) was made retroactively effective to the enactment of the 1990 changes to section 32(c). 112 Stat. 824.

Upon the basis of the RRA 1998 changes to section 32(c) and the application of the tie-breaker rules, the IRS disallowed the first taxpayer's EITC claim, but noted that the second taxpayer could claim the EITC with respect to these two children. Id. The first taxpayer timely petitioned the Tax Court for a redetermination, arguing that the disallowance was improper and violated the taxpayer's Due Process Clause rights. Id.

The Tax Court examined the RRA 1998 changes to section 32(c), but only “the retroactive application of the 1998 amendment to petitioner's 1997 tax year. . . .” Id. It concluded that the applicable retroactivity period was modest, that the changes did not violate the taxpayer's due process rights, and upheld the IRS's denial of the taxpayer's EITC claim. Id. In measuring the retroactivity period, the Court concluded that the applicable period was the period between the enactment of the RRA 1998 changes (i.e, July 22,1998) and the taxpayer's “1997 tax year,” which was a period of “approximately” one year. Id. Depending on how the Court measured, this period could be anywhere from just under seven months (i.e., the period between July 22, 1998 and December 31, 1997) to just over 18 months (i.e., the period between July 22, 1998 and January 1, 1997).

Kitt v. United States. This case centered on whether or not the 10 percent additional tax of section 72(t) applied to an amount that was rolled-over from a traditional IRA to a Roth IRA and immediately withdrawn. Kitt v. United States, 288 F.3d 1355,1358 (Fed. Cir. 2002) (pet. for reh'g).

As enacted in the Employee Retirement Security Act, early withdrawals from an IRA are generally (except in certain specified circumstances) treated as “unqualified withdrawals” and are subject to a 10 percent additional tax. Id. at 1356; see also sec. 72(t). When Congress enacted rules creating Roth IRAs in 1997 as part of the Taxpayer Relief Act of 1997, it also adopted a special rule for withdrawals that provided a different (and more limited) basis for calculating the amount of a withdrawal that was subject to the section 72(t) additional tax. 288 F.3d at 1356-1357; see also sec. 408A(d)(1)(B) (Supp. Ill 1997) (repealed 1998). In addition, another provision adopted at the same time allowed for rollovers from “traditional” IRAs to Roth IRAs, and treated any amount rolled-over as a direct contribution to the Roth IRA. Id. at 1357; see also sec. 408A(d)(3)(B) (Supp. Ill 1997) (amended 1998). Between the special unqualified withdrawal rules and the rollover provision, the upshot was that taxpayers who rolled over an amount from a traditional IRA to a Roth IRA and immediately withdrew the rolled-over amounts would not be subject to the section 72(t) penalty. Id.

The Taxpayer Relief Act of 1997 was enacted on August 5,1997, and made applicable to taxable years beginning after December 31, 1997. See 111 Stat. 787, 788, 829. Congress quickly realized its mistake, however. As part of RRA 1998, enacted on July 22, 1998, new rules were adopted that prevented the result described above. 288 F.3d at 1357-58; see also sec. 408A(d)(3)(F)(i). These changes were effective retroactively to the effective date of the Taxpayer Relief Act of 1997. See 112 Stat. at 826.

In relevant part, the taxpayers in Kitt argued that the retroactive application of the changes to section 408A made by the RRA 1998 were an unconstitutional violation of the Due Process Clause. After paying the section 72(t) penalty, they filed a claim for a refund in the Court of Federal Claims. See Kitt v. United States, 47 Fed. Cl. 821, 824 (Fed. Cl. 2000). In relevant part, the Court of Federal Claims found for the IRS, holding that the “one-year period of retroactivity” was “modest” and that under Carlton the retroactivity did not violate the Due Process Clause. 47 Fed. Cl. at 825.

The Federal Circuit Court of Appeals agreed, noting not only that Congress had “acted promptly and established only a modest period of retroactivity” but also that “the retroactive period of this legislation was substantially shorter than the retroactive period upheld in Carlton-, here only seven months, as against fourteen months in Carlton." See 277 F.3d 1330, 1335 (Fed. Cir. 2002) (internal citations omitted); see also 288F.3datl358 (Op. on Reh'g). Thus, the Federal Circuit Court of Appeals brushed aside any argument that the taxpayers' due process rights had been violated.

Analysis

As briefly described above, a determination of whether or not the Proposal would violate the Due Process Clause as-applied to a negatively affected taxpayer turns upon the rules articulated in Carlton. As described below, the potentially-relevant post-Carlton caselaw adds no additional legal standards and on a factual basis such cases are either clearly distinguishable or clearly within the factual contours of Carlton.

As the controlling authority, Carlton stands for the proposition that the Due Process Clause standard for retroactive tax laws to accord with the Constitution is that the retroactive change has a “legitimate legislative purpose furthered by rational means.” 512 U.S. at 30-31. In so holding, the Supreme Court in Carlton clarified not only that the “due process standard” for such laws to be the same regardless of the “formulation” by which it was expressed (e.g., not “harsh and oppressive” versus not “arbitrary and irrational”) but also that the due process standard must be met by both the retroactive and prospective aspects of the law. Id.

Carlton also indicated how courts should identify when such standard was met with respect to any particular retroactive tax law. Id. at 30. In order to “meet[ ] the requirements of due process” here (as anywhere else), Carlton holds that Congress must “[f]irst” have a “purpose in enacting the amendment [that is] neither illegitimate nor arbitrary. . . .” and “[s]econd” that Congress must have “acted promptly and established only a modest period of retroactivity.” 512 U.S. at 32-33.

These “first” and “second” principles are emblematic of the needed clarity that Carlton provides to the murky formulations and benchmarks by which other prior courts had evaluated retroactive tax legislation. Carlton said as much in its indirect³¹ evaluation of some other “factors” long considered highly important by various courts, including the extent to which the taxpayer had relied on the original law and the extent to which the taxpayer had sufficient notice of the change in law. With respect to the former, Carlton noted that detrimental reliance was “insufficient to establish a constitutional violation,” and with respect to the latter observed that the lack of notice was not “dispositive.” 512 U.S. at 33-34. The implication of this juxtaposition clearly is that what was identified by the Carlton Court is dispositive on the matter.

Justice O'Connor's concurring opinion provides useful additional guidance with respect to this Due Process Clause evaluation process. As she noted, legislators nearly always have a “rational” purpose for enacting retroactive tax laws because doing so “is rationally related to the legitimate governmental purpose of raising revenue.” Id. at 37 (O'Connor, J. concurring). Notwithstanding, she also observed that “the Court has never intimated that Congress possesses unlimited power to 'readjust rights and burdens . . . and upset otherwise settled expectations.'” (citing to her concurrence in Pension Benefit Guaranty Corporation) and indicated that “[t]he governmental interest in revising the tax laws must at some point give way to the taxpayer's interest in finality and repose.” Id. at 37-38.

In her view, the key to reconciling these seemingly disparate edicts is found in focusing on the length of the retroactivity period. Id. at 38-39. As described above, she indicated that in “every case” in which the Supreme Court had upheld a retroactive tax law against a Due Process Clause challenge “the law applied retroactively for only a relatively short period prior to enactment.” Id. at 38. Based upon the examples she provided, she further observed that “[a] period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in [her] view, serious constitutional questions.” Id.

Applying the Carlton standard described above to the circumstances behind the Proposal quickly demonstrates how greatly the two diverge — and this divergence grows by the day. For example, in Carlton the period of time between enactment of the statutory change and the announcement by the IRS that it would not apply the statute as drafted was approximately three months. Here, the period is indefinite as the IRS and Treasury have made no such pronouncement (and based upon their most recent guidance never intend to make such a pronouncement). In Carlton, only four months elapsed between the enactment of the original provision and the date that three of the four Chairmen and Ranking Members of the tax-writing Committees had introduced bills to address the statute's problematic language. Here, the period is indefinite in that only a single³² Chairman or Ranking Member of a tax writing Committee has endorsed the Proposal. Most importantly, in Carlton the period of time between the enactment of the original provision and the changed provision was merely 14 months. Here, the period is indefinite (and will in any case be longer than two years).

There are a number of other facts that distinguish the circumstances surrounding the Proposal and the facts of Carlton. One significant fact is that the change identified (and enacted) in Carlton flowed directly from Congress' clear intent. See 512 U.S. at 31-32 (discussing Congress' intent in the original provision and with respect to the change). As described in detail above, however, it is not at all clear from the legislative history that the Proposal fits Congress' stated intent any better than the originally-enacted provision. In fact, given that the clearest indicator of Congress' intent — i.e., the legislative text — makes it plain that Congress fully intended to repeal section 958(b)(4), one can strongly argue that the Proposal does exactly the opposite of what Congress intended.³³

Moreover, the Proposal contains a number of relevant design elements that are completely novel — e.g., an entirely new Code section that introduces the completely new legal concept of a “foreign-controlled foreign corporation” — and which are not reflected in any aspect of the legislative history. The very concept of a foreign-controlled foreign corporation is devoid of any basis in the text and legislative history of the TCJA. Further, creating this new category of foreign corporation and incorporating it into a highly complex international tax regime, one that in relevant part currently only distinguishes between CFCs and non-CFCs would have far-reaching implications and give rise to a series of new, unanswered questions that were not considered in the adoption of the TCJA.³⁴ In contrast, the “curative” measure enacted in Carlton simply refined one aspect of the original legislative change to mirror Congress' clearly expressed (and original) intent.

Given the differences described above, it is clear that the circumstances surrounding the Proposal suffer from a number of significant defects from the standpoint of a Carfron-based, as-applied Due Process Clause challenge analysis, which cause the Proposal to resoundingly violate Carlton's “second principle” (and perhaps violate the first). As will be shown below, none of the relevant additional post-Carlton guidance remedies these defects. Thus, one cannot but conclude that were a future court to evaluate whether or not the Proposal violates the Due Process Clause as-applied to a negatively-affected taxpayer, that court should find that it does violate due process.

The potentially precedential post-Carlton caselaw summarized above is either highly distinguishable or clearly within the guidelines articulated by Carlton. Of the twelve relevant decisions we reviewed in the prior section of this Opinion, none lead to a different result than a court would reach relying solely on the standards articulated in Carlton, with six cases expressing no new legal doctrines while being highly distinguishable on the facts, and the remaining six cases expressing no new legal doctrines while simultaneously falling within the factual contours of Carlton (and clearly outside of the facts surrounding the Proposal). These conclusions are explained below in greater detail.

Snap-Drape and Tate & Lyle are inapposite for two significant reasons. First, both involve the application of former section 7805(b) which explicitly provided a presumption that Treasury Regulations were to be retroactive except to the extent that the Treasury Secretary identified that they were not retroactive. Clearly, no such circumstances exist with respect to the Proposal. Second, both involve Treasury Regulations, which are developed and promulgated in an entirely different “process” than federal tax legislation, and subject to different rules and limitations (e.g., the Administrative Procedure Act, Congressional Review Act). Indeed, in its holding in Tate & Lyle the Third Circuit Court of Appeals specifically distinguished Carlton in announcing a special sub-rule for the review of Treasury Regulations subject to former section 7805(b):

Based on the Supreme Court's holding in Carlton, the Tax Court found the six year [sic] period in this case excessive, and thus, violative of the Due Process Clause. We find, however, that Carlton is distinguishable: Carlton involved the retroactive application of a statute, and here we are dealing with the retroactive application of a regulation.

The retroactivity of treasury regulations is governed by I.R.C. § 7805(b), which states:

The Secretary may prescribe the extent, if any, to which any ruling or regulation, relating to the internal revenue laws, shall be applied without retroactive effect.

Clearly Congress has determined that treasury regulations are presumed to apply retroactively. The extent to which newly promulgated regulations shall not apply retroactively is a matter of discretion left to the Secretary.

Tate & Lyle, 87 F.3d at 107 (internal citations omitted) (emphases added). Thus, neither of these two cases adds anything to one's understanding of how the standards articulated in Carlton would apply to the Proposal.

The two cases involving circumstances where taxpayers were not per se challenging the existence of retroactivity with respect to a legislative change — Neal and Buerer — are also inapposite to the circumstances surrounding the Proposal. In Buerer, the taxpayer was not challenging the existence of retroactivity with respect to the legislative change, but rather Congress' determination that the legislative change should only be three months retroactive (the taxpayer wanting a longer retroactivity period). Thus, the facts in Buerer differ quite significantly from those surrounding the Proposal (i.e., where a negatively-affected taxpayer would be challenging any retroactive application of the statutory change as-applied to it).

Neal is highly-distinguishable for two reasons. First, like Buerer the taxpayer was not per se challenging the retroactivity of a change in law. In fact, in Neal the taxpayer was not challenging retroactivity at all — it was the government that was indirectly (and collaterally) challenging retroactivity. Setting aside the fact that this feature distinguishes Neal from the facts surrounding the Proposal, it is interesting to observe that the collateral nature of the government's challenge to the retroactivity of the nunc pro tunc repeal of section 2036(c) strongly suggests that the District Court's views on this point are merely dicta. In other words, it is by no means clear that had the District Court concluded the retroactive nunc pro tunc repeal of section 2036(c) violated the Due Process Clause, it would not have respected the Pennsylvania court's binding determination that the taxpayer had made a mistake of law that allowed her to rescind her release under the equitable principles of Pennsylvania law, thereby revoking her otherwise irrevocable gift for federal gift tax purposes. In any case, this fact makes the case highly-distinguishable.

A second distinguishable aspect of Neal is that the District Court made clear that its views on retroactivity were directly tied to the nunc pro tunc repeal that both parties had stipulated to the existence of. See 98-2 USTC at 86,522. The facts surrounding the Proposal completely lack any such contour, providing another ground to distinguish the case.

Two more cases are likewise highly-distinguishable. National Taxpayers Union did not truly³⁵ involve a Due Process Clause challenge to the estate and gift tax rate increases, but turned on whether or not the NTU had pre-deficiency standing to challenge the increases (it did not). Montana Rail Link involved a circumstance where retroactivity only applied if the taxpayer had already treated the item in the same manner as the retroactive clarification required. Neither of these circumstances exists with respect to the Proposal.

In terms of other potential precedents, this leaves six cases: two memorandum opinions³⁶ of the U.S. Tax Court {Sutherland and Jamieson), two opinions of the Federal Circuit Court of Appeals {Kitt and NationsBank), and one opinion each of the Seventh {Furlong) and Ninth {Quarty) Circuit Courts of Appeals. Assuming for the sake of argument that the reasoning of each court could hold analytical value, it is still quite clear that the cases do not add anything to the Car/fon-based analysis described above because all of them involved circumstances where, under the standards of Carlton, the tax law change was made “promptly” and with a “relatively brief period of retroactivity.”

In Furlong, the retroactive change was made less than one month after the original change. In Kitt, the retroactive change was made seven months after the original. In NationsBank and Quarty, the retroactive change came eight months after the original. In Sutherland, the change came either seven months or 18 months after the original (depending on how one views what the court meant by the taxpayer's “1997 tax year”). Finally, Jamieson (which had the most cursory Due Process Clause analysis of any of these six cases) saw the change enacted 23 months after the original. Thus, even assuming that all of these precedents are well-reasoned and carry equal weight none of them identified a permissible retroactivity period that significantly exceeded the period that existed in Carlton. In any case, the factual circumstances surrounding the Proposal already exceed those of any of these additional potential precedents.

Conclusion

Based upon the facts and authorities identified and analyzed above, were we asked to opine upon the matter we would be of the opinion that were the Proposal to be enacted on or after January 23, 2020 it should be found to violate the Due Process Clause as-applied to a negatively-affected taxpayer. Given the holding of the controlling case in this area, the certainty of our opinion would to some degree increase with the further passage of time. We would express no opinion, however, as to what degree our certainty will increase. Further, we would express no opinion with respect to any facts, transactions, or issues not specifically identified herein.

It is important to note that given that the Due Process Clause challenge that is being evaluated in this Opinion is limited to an as-applied challenge brought by a negatively-affected taxpayer, it would seem that Congress could easily prevent the possibility of (or render moot) any such challenge by either enacting any changes to section 958(b) on a prospective-only basis, or enacting such changes prospectively but allowing taxpayers to choose to apply them on a retroactive basis.

If you have any questions, please contact me at ken.kies@fpgdc.com or 202-772-2482.

Very truly yours,

Kenneth J. Kies
Federal Policy Group
Washington, DC