Partnership Argues Tax Court Erred in Upholding Regs’ Validity

SIH PARTNERS LLLP,
EXPLORER CORPORATION, TAX MATTERS PARTNER
Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, 
Respondent-Appellee.

IN THE UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

ON APPEAL FROM THE UNITED STATES TAX COURT

OPENING BRIEF FOR PETITIONER-APPELLANT

Robert A. Long, Jr.
Robert E. Culbertson
Ivano M. Ventresca
COVINGTON & BURLING LLP
One CityCenter
850 Tenth Street NW
Washington, DC 20001-4956
(202) 662-6000
rlong@cov.com

Counsel for Petitioner-Appellant

CORPORATE DISCLOSURE STATEMENT

Pursuant to Federal Rule of Appellate Procedure 26.1 and Third Circuit L.A.R. 26.1, SIH Partners, LLLP, Explorer Partner Corp., Tax Matters Partner makes the following disclosure:

The following are parent corporations of SIH Partners, LLLP, Explorer Partner Corp., Tax Matters Partner: Colombus International Holdings, Inc.; Balboa International Holdings, Inc.; Coronado International Holdings, Inc.; Cortes International Holdings, Inc.; LaSalle International Holdings, Inc.; Explorer Partner Corp.

No publicly held companies hold 10% or more of the party's stock.

No publicly held corporation which is not a party to the proceeding before this Court has a financial interest in the outcome of the proceeding.

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TABLE OF CONTENTS

TABLE OF AUTHORITIES

INTRODUCTION

STATEMENT OF JURISDICTION

STATEMENT OF ISSUES

STATEMENT OF RELATED CASES

STATEMENT OF THE CASE

SUMMARY OF THE ARGUMENT

STANDARD OF REVIEW

ARGUMENT

CONCLUSION

ADDENDUM OF STATUTES AND REGULATIONS

TABLE OF AUTHORITIES

Cases

Anderson v. C.I.R., 698 F.3d 160 (3d Cir. 2012)

Arrowsmith v. Commissioner, 344 U.S. 6 (1952)

Avrahami v. Commissioner, Nos. 17594-13, 18274-13, 2017 WL 3610601 (T.C. Aug. 21, 2017)

Boulware v. United States, 552 U.S. 421 (2008)

Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984)

Commissioner v. Nat'l Alfalfa Dehydrating & Milling Co., 417 U.S 134 (1974)

Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958)

Dominion Resources, Inc. v. United States, 681 F.3d 1313 (Fed. Cir. 2012)

Dougherty v. Commissioner, 60 T.C. 917 (1973)

Dover Corp. v. Commissioner, 122 T.C. 324 (2004)

El v. Commissioner, 144 T.C. 140 (2015)

Encino Motorcars, LLC v. Navarro, 136 S. Ct. 2117 (2016)

Freedom Newspapers, Inc. v. Commissioner, 36 T.C.M. 1755 (1977)

Good Fortune Shipping SA v. Commissioner, 897 F.3d 256 (D.C. Cir. 2018)

Gregory v. Helvering, 293 U.S. 465 (1935)

Judulang v. Holder, 565 U.S. 42 (2011)

Luczaj & Associates v. Commissioner, Nos. 25541-14, 25542-14, 2017 WL 923522 (T.C. Mar. 8, 2017)

Ludwig v. Commissioner, 68 T.C. 979 (1977)

Maguire v. Commissioner, 313 U.S. 1 (1941)

Marx v. Gen. Revenue Corp., 568 U.S. 371 (2013)

Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011)

Melvin v. C.I.R., 88 T.C. 63 (1987), aff'd, 894 F.2d 1072 (9th Cir. 1990)

Merck & Co. v. United States, 652 F.3d 475 (3d Cir. 2011)

Michigan v. EPA, 135 S. Ct. 2699 (2015)

Motor Vehicle Mfrs. Assn. of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U.S. 29 (1983) 26, 40

Nat'l Parks Conservation Ass'n v. E.P.A., 803 F.3d 151 (3d Cir. 2015)

Neonatology Assocs., P.A. v. Commissioner, 299 F.3d 221 (3d Cir. 2002)

Northpoint Tech. Ltd. v. FCC, 412 F.3d 145 (D.C. Cir. 2005)

PPL Corp. v. C.I.R., 569 U.S. 329 (2013)

Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972)

Pub. Citizen v. Steed, 733 F.2d 93 (D.C. Cir. 1984)

Rauenhorst v. Commissioner 119 T.C. 157 (2002)

Rodriguez v. Commissioner, 137 T.C. 174 (2011), aff'd, 722 F.3d 306 (5th Cir. 2013)

Schank v. Commissioner, Nos. 16641-14, 16642-14, 2015 WL 8477305 (T.C. Dec. 9, 2015)

Si Men Cen v. Attorney General, 825 F.3d 177 (3d Cir. 2016)

Smith v. Commissioner, Dkt. No. 14900-15, 151 T.C. No. 5 (T.C. Sept. 18, 2018)

Torretti v. Main Line Hosps., Inc., 580 F.3d 168 (3d Cir.), amended, 586 F.3d 1011 (3d Cir. 2009)

United States v. Mead Corp., 533 U.S. 218 (2001)

United States v. Skelly Oil Co., 394 U.S. 678 (1969)

Util. Air Regulatory Grp. v. E.P.A., 134 S. Ct. 2427 (2014)

Woodall v. Fed. Bureau of Prisons, 432 F.3d 235 (3d Cir. 2005)

Statutes

5 U.S.C. § 706(2)(A)

26 U.S.C. § 1(h)(11)(C)

26 U.S.C. § 302(a)

26 U.S.C. § 304(a)

26 U.S.C. § 305(c)

26 U.S.C. § 316(a)

26 U.S.C. § 565

26 U.S.C. § 851(b)

26 U.S.C. § 882(a)

26 U.S.C. § 951

26 U.S.C. § 956

26 U.S.C. § 956(c)(1)

26 U.S.C. § 959

26 U.S.C. § 6213

26 U.S.C. § 6501(e)(1)(C)

26 U.S.C. § 7482(a)(1)

26 U.S.C. § 7806(b)

Pub. L. 103-66, 107 Stat. 312, § 13232(a)(1) (1993)

Pub. L. 115-97, 131 Stat. 2054 (Dec. 22, 2017)

Regulations

26 C.F.R. § 1.338-8(h)(4) 

26 C.F.R. § 1.385-3(c)(3)(i)(C)(3)(ii) 

26 C.F.R. § 1.865-2(d)(2) 

26 C.F.R. § 1.904-5(m)(4) 

26 C.F.R. § 1.1411-10(c), (g)

26 C.F.R. § 1.956-1(e)(2)

26 C.F.R. § 1.956-2(c)(1) 

26 C.F.R. § 1.956-2(c)(4)

Other Legislative Materials

H.R. Rep. 87-1447 (1962) 

H.R. Rep. 104-737 (1996) 

H.R. Rep. 108-94 (2003) 

H.R. Comm. on Ways and Means, Brief Summary of Provisions in H.R. 10650 the “Revenue Act of 1962” (1962)

Hearings on H.R. 10650 before the Senate Committee on Finance: Pt. 11 (1962) 

Revenue Act of 1962, H.R. 10650, 87th Cong., § 13(a)

S. Rep. 87-1881 (1962) 

Other Administrative Materials

28 Fed. Reg. 3,541, 3,541 (Apr. 11, 1963) 

29 Fed. Reg. 2,599, 2,599 (Feb. 20, 1964)

CCA 201653017 n.3 (Sept. 8, 2016) 

Dep't of the Treasury, “The Deferral of Income Earned Through U.S. Controlled Foreign Corporations: A Policy Study” (Dec. 2000) 

FSA 200216022 (Jan. 8, 2002)

GCM 36965 (Dec. 22, 1976)

Notice 88-108 

Notice 2004-70

Notice of Proposed Rulemaking, 80 Fed. Reg. 53,058, 53,061-68 (Sept. 2, 2015) 

P.L.R. 8746050 (Aug. 19, 1987) 

P.L.R. 8836037 (Jun. 14, 1988) 

P.L.R. 8922047 (Mar. 6, 1989) 

P.L.R. 9024026 (Mar. 15, 1990) 

P.L.R. 9024086 (Mar. 22, 1990) 

P.L.R. 9040045 (July 10, 1990) 

P.L.R. 9217039 (Jan. 28, 1992) 

P.L.R. 9507007 (Nov. 10, 1994) 

Rev. Rul. 71-373 (Jan. 1, 1971) 

Rev. Rul. 76-125 (Jan. 1, 1976) 

Rev. Rul. 76-192 (Jan. 1, 1976) 

Rev. Rul. 87-89 (Aug. 31, 1987) 

Rev. Rul. 89-12 (Jan. 23, 1989)

Rev. Rul. 89-73 (May 22, 1989)

Rev. Rul. 90-112 

T.A.M. 8042001 (Mar. 18, 1980) 

T.A.M. 8101012 (Oct. 7, 1980) 

T.D. 8916 (Jan. 3, 2001)

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INTRODUCTION

The IRS wants to have it both ways in this case. It seeks to treat a loan guarantee by a foreign corporation as a dividend, while simultaneously denying application of the lower tax rate that generally applies to dividends. Both positions cannot be correct — and in fact both are wrong.

In general, a shareholder of a corporation does not pay tax on the income of the corporation. Instead, the corporation pays tax on its own income and its shareholders are taxed on dividends they receive out of the corporation's earnings. These dividends typically were taxed at a reduced rate of 15 percent in the years at issue.

In subpart F of the Internal Revenue Code, Congress identified certain situations in which U.S. taxpayers could make use of a foreign corporation's earnings without formally declaring a dividend, and provided that in these situations U.S. shareholders should be taxed on the corporation's earnings in advance of a formal dividend.

Section 956, the section of subpart F that is relevant here, imposes tax on U.S. shareholders of a controlled foreign corporation (“CFC”) when the CFC makes specified investments in U.S. property that effectively repatriate the CFC's income and so are substantially equivalent to a dividend.¹ A quintessential example, directly addressed by section 956, is when a CFC makes a loan to a related U.S. person. In this situation, Congress determined that a loan is akin to a dividend and therefore required the CFC's U.S. shareholder to include the loan amount in its income, to the extent of the CFC's previously untaxed earnings.

Section 956(d) separately addresses loan guarantees. This separate treatment recognizes that the benefit a U.S. shareholder receives from a loan guarantee differs from the benefit the shareholder receives from a direct loan (addressed in section 956(c)). To deal with the unique aspects of loan guarantees, Congress assigned Treasury responsibility for drafting regulations to govern their treatment as investments in U.S. property. Treasury has failed to adequately carry out its responsibilities. Indeed, there are three reasons to reverse the Tax Court's decision.

First, there is no evidence that Treasury undertook the reasoned analysis necessary to determine when, and to what extent, a guarantee should be deemed a repatriation of a CFC's earnings. Instead, the regulations treat every CFC guarantor of a U.S. person's loan as investing the entire unpaid principal amount of that loan, and thus repatriating all of their earnings up to the full amount of the loan. This is essentially the same treatment that would apply under section 956(c) if the CFCs had loaned the funds directly. Treasury failed to address any of the characteristics of guarantees that led Congress to treat them differently from direct loans. The regulations take no account of whether the CFC's guarantee had any impact on the U.S. person's ability to receive the guaranteed loan, and apply without regard to whether the CFC is one of several guarantors of the loan. When there are multiple guarantors, as in this case, the guarantees can result in the repatriation of many times the amount of the loan. The regulations thus ignore the actual economic impact, if any, of the guarantee. Rather than providing a reasoned explanation for these rules as required by law, Treasury said only that they were issued “to conform” to section 956. The rules thus reflect a failure of reasoned decisionmaking, and do not support the imposition of tax.

Second, perhaps recognizing the shortcomings of Treasury's regulations and the absurdities they can produce, the IRS issued precedential guidance requiring that, in applying section 956, the facts and circumstances of each case must be reviewed to determine whether there has been a repatriation of CFC earnings. In this case, the IRS refused to follow its own precedent and incorrectly concluded that a repatriation of earnings occurred.

Third, the IRS compounded its mistake by imposing tax on the CFCs' earnings at the ordinary income rate (35 percent), rather than the qualified dividend income (“QDI”) rate (15 percent). Three years after the guarantees, and before the IRS ever questioned the taxation of the CFCs' earnings, the CFCs distributed their earnings, and tax was paid at the QDI rate of 15 percent. The IRS argues that taxation of those earnings should have been accelerated under section 956 as if they were dividends while also arguing that the earnings should be taxed at the higher ordinary rate because, when they were deemed to be repatriated by virtue of the guarantees under the section 956(d) regulations, they were not actually dividends. But this argument ignores the fact that income inclusions under section 956 are dividends by their very nature. Accelerating income recognition does not change the character of that income.

In short, the government cannot have it both ways. It cannot treat CFC guarantees as substantially the equivalent of a dividend for purposes of inclusion in current income while also arguing that the same guarantees are not substantially equivalent to a dividend for purposes of the applicable tax rate.

The Tax Court erroneously concluded that, because Congress did not expressly state in a statute that earnings made taxable under section 956 “are dividends for general purposes of the Code,” J.A. 55 (emphasis in original), Congress must not have intended to tax them as dividends. This conclusion disregards the structure and history of section 956, ignores Supreme Court precedent, is contradicted by the IRS' own guidance, and violates the purpose of the QDI rules.

The Tax Court's decision should be reversed.

STATEMENT OF JURISDICTION

The Tax Court had jurisdiction under 26 U.S.C. § 6213. It entered its final order on January 18, 2018. J.A. 3. Appellant filed a timely notice of appeal on April 16, 2018. J.A. 1-2. This Court has jurisdiction under 26 U.S.C. § 7482(a)(1).

STATEMENT OF ISSUES

STATEMENT OF RELATED CASES

Appellant is aware of one related case, SIH Partners, LLLP, Explorer Partner Corp., Tax Matters Partner v. Commissioner of Internal Revenue, No. 026531-16 (Tax Ct. filed Dec. 12, 2016).

STATEMENT OF THE CASE

A. Statutory Framework

A CFC is not subject to U.S. income tax on foreign income unless it engages in a U.S. trade or business. See 26 U.S.C. § 882(a). However, U.S. shareholders are taxed on dividends they receive from a CFC. Congress enacted subpart F of the Code to limit the ability of U.S. shareholders to avoid U.S. tax by (i) causing CFCs to earn certain “mobile” income that would otherwise be earned by the U.S. shareholders or (ii) making use of CFC earnings without formally declaring a dividend. 26 U.S.C. §§ 951(a)(1)(A), 951(a)(1)(B), 956.

The provision at issue here, section 956, addresses the second situation. Under section 956, U.S. shareholders must pay U.S. tax when a CFC, instead of formally declaring a dividend, invests its earnings in specified “United States property.”² If those earnings are later formally distributed as dividends, no further U.S. tax is due. Thus, section 956 effectively accelerates U.S. tax (i.e., ends a deferral of tax) on CFC earnings by treating those earnings as if they were distributed to the CFC's U.S. shareholders.

Congress determined that CFC investments in U.S. property should trigger tax to a CFC's U.S. shareholder because they are “substantially the equivalent of a dividend.” J.A. 21 (Tax Ct. 18) (quoting S. Rep. 87-1881 at 88 (1962)). Absent section 956, if a CFC invested its income in U.S. property, “the income would be effectively repatriated in a manner that would escape current tax.” Dep't of the Treasury, “The Deferral of Income Earned Through U.S. Controlled Foreign Corporations: A Policy Study” at xv (Dec. 2000), available at https://www.treasury.gov/resource-center/tax-policy/Documents/Report-SubpartF-2000.pdf. To counteract this, under section 956 “the U.S. shareholder must include in income an amount calculated by reference to the amount invested in the U.S. property.” Id.

With limited exceptions not relevant here, section 956 applies a categorical rule whenever a CFC invests in “tangible property located in the United States,” “stock of a domestic corporation,” “an obligation of a United States person,” and certain types of intellectual property. 26 U.S.C. § 956(c)(1). When a CFC makes such an investment, its U.S. shareholders must include a specified amount of the CFC's previously untaxed earnings in their income.

The amount of the CFC's earnings that a U.S. shareholder must include in its income as a result of a CFC's investment in U.S. property is generally measured by the CFC's “basis” in the property, i.e., the amount the CFC has invested in that property. Specifically, a U.S. shareholder must include in income the CFC's basis in the property up to the amount of the CFC's previously untaxed earnings. Id. § 956(a)(1).

A guarantee of a U.S. person's loan is not an asset of the CFC — it is a contingent liability. However, in some circumstances a guarantee may enable a U.S. shareholder to obtain a loan that it could not otherwise obtain, and thus can be viewed as an indirect repatriation of funds. See, e.g., Ludwig v. Commissioner, 68 T.C. 979, 990 (1977) (“[T]he controlling stockholders could derive nearly identical benefits by borrowing funds from another source and having the loan guaranteed by the [CFC] or secured by a pledge of such corporation's assets. Such use of the credit or assets of the [CFC] indirectly effects a repatriation of available earnings.”).

Rather than listing pledges and guarantees among the investments in property that automatically trigger U.S. tax according to a set statutory formula, Congress addressed pledges and guarantees in a separate subsection of section 956 and assigned Treasury responsibility for promulgating rules to govern their treatment. Specifically, section 956(d) provides: “[A] controlled foreign corporation shall, under regulations prescribed by the Secretary, be considered as holding an obligation of a United States person if such controlled foreign corporation is a pledgor or guarantor of such obligation.” (emphasis added).³ Because guarantees do not otherwise constitute investments in U.S. property, and a CFC guarantor does not have an adjusted basis in its guarantee or the guaranteed loan, absent valid regulations no CFC guarantee would trigger taxation under section 956. See J.A. 19 (Tax Ct. 16) (no dispute that section 956(d) is not self-executing).

B. Regulatory Framework

In response to section 956(d), the Treasury Department promulgated regulations (the “section 956(d) regulations”) governing the treatment of pledges and guarantees. As relevant here, those regulations address two issues: (1) When is a CFC that provides a pledge or guarantee of a U.S. person's obligation considered to hold an obligation of a U.S. person, and thus to have made an investment in U.S. property? and (2) How much of the guaranteed obligation should be viewed as an investment by the CFC in U.S. property that triggers taxation of the CFC's earnings? Section 1.956-2(c)(1) answers the first question by adopting a categorical rule that any CFC pledge or guarantee causes the CFC to hold “an obligation of a U.S. person.” 26 C.F.R. § 1.956-2(c)(1). Section 1.956-1(e)(2) answers the second question by adopting a categorical rule that “the amount taken into account with respect to any pledge or guarantee . . . shall be the unpaid principal amount . . . of the obligation with respect to which the controlled foreign corporation is a pledgor or guarantor.” Id. § 1.956-1(e)(2).

The section 956(d) regulations thus treat every CFC that guarantees a loan to its U.S. shareholder as if the CFC itself had loaned all the borrowed funds to the U.S. shareholder. They impose this result without regard to whether, or to what extent, a CFC guarantee actually enabled the U.S. shareholder to borrow funds that it would otherwise not have received but for the benefit of such guarantee. For example, the regulations do not consider factors such as whether the CFC guarantor had enough assets to support the entire amount of the loan, or whether the CFC was the sole guarantor or one of many parties guaranteeing the loan. Under the regulations, every CFC guarantor, except for those subject to a conduit financing exception that is not applicable here, is treated as making the entire amount of the guaranteed loan, up to the amount of its previously untaxed earnings. Where multiple CFC guarantors are involved, the regulations treat each guarantor as making the full amount of the loan — for example, ten CFC guarantors would result in ten times the loan amount being treated as invested in U.S. property (with the inclusion capped by the CFCs' unrepatriated earnings). The only explanation Treasury provided for all of its section 956 regulations (including many having nothing to do with pledges or guarantees) was a single sentence stating that they were issued to “conform” to section 956. 29 Fed. Reg. 2,599, 2,599 (Feb. 20, 1964).

After the regulations were promulgated, Treasury and the IRS recognized that the rules can produce strange results, particularly as applied to multiple guarantors. See Notice of Proposed Rulemaking, 80 Fed. Reg. 53,058, 53,061-68 (Sept. 2, 2015) (“[I]n cases in which there are, with respect to a single obligation, multiple pledgors or guarantors that are CFCs . . ., the aggregate amount of United States property treated as held by CFCs may exceed the unpaid principal amount of the obligation.”); FSA 200216022 (Jan. 8, 2002) (recognizing that a literal application of section 1.956-2(c)(1) “could produce strange results”), available at https://www.irs.gov/pub/irs-wd/0216022.pdf. Yet the IRS has failed to fix these problems.

C. The Facts of This Case

This appeal involves the IRS's application of its section 956(d) regulations to the earnings of two CFCs: Susquehanna Europe Holdings Limited (“SEHL”)⁴ and Susquehanna Trading Services, Inc. (“STS,” and, together with SEHL, “the CFCs”). The CFCs are owned by appellant SIH, which is commonly controlled with Susquehanna International Group, LLP (“SIG”) and its affiliates (the “SIG group”). J.A. 8-10 (Tax Ct. 5-7).

In 2007, Merrill Lynch loaned $1.485 billion to SIG. J.A. 11-12 (Tax Ct. 8-9). In connection with the loans, numerous SIG affiliates, including the two CFCs at issue here, entered into an Amended and Restated Guarantee and Security Agreement with Merrill Lynch (“ARGSA”) and several ancillary agreements. J.A. 12 (Tax Ct. 9). Through these agreements, the SIG affiliates guaranteed the loans, and some non-CFC guarantors pledged their assets in support of the loans. Id. At the time the loans were issued, SIG and the non-CFC guarantors had over $2.7 billion in liquid net assets on deposit with Merrill Lynch, nearly twice the amount of the loans. J.A. 72-74 (Harley Decl. ¶¶ 7-10). By contrast, the combined net assets of both CFC guarantors were approximately $240 million, less than ten percent of the non-CFC guarantors' combined liquid net assets on deposit with Merrill Lynch. Id.

SIH presented uncontroverted testimony that Merrill Lynch requested that the two CFCs serve as guarantors not to provide collateral support for the loans but rather to ensure that Merrill Lynch could still obtain access to the assets of SIG and its U.S. affiliates if SIG transferred assets to the CFCs. See J.A. 65-67 (Greenberg Decl. ¶¶ 9-13). The terms of the ARGSA reflect this purpose, as each guarantor had a right to contribution from the other guarantors that was calculated by reference to the funds that each guarantor had received from other SIG affiliates. J.A. 76, 100 (Harley Decl. ¶ 18; Stipulation ¶ 61).

SIG repaid the loans by December 2011. J.A. 13 (Tax Ct. 10). No SIG affiliate was required to pay any amount under the guarantee. Id.

Prior to the repayment of the loans, SEHL distributed earnings to SIH of $250 million (in 2010) and $25 million (in 2011), and in 2010 STS distributed earnings to SIH of approximately $74 million. J.A. 108 (Stipulation ¶¶ 80, 82, 85). Because the CFCs qualified for benefits under U.S. income tax treaties in those years, those distributed earnings were reported as QDI and taxed at the 15-percent rate. It is these same earnings that the IRS, under the section 956(d) regulations, claims should have been taxed in earlier taxable years, and at a higher rate.

D. Procedural History

The IRS determined that the CFC earnings distributed in 2010 and 2011 should have been taxed in 2007 and 2008 under the section 956(d) regulations, because the CFCs had served as co-guarantors of SIG's borrowing from Merrill Lynch. J.A. 4 (Tax Ct. 1). Having concluded that the CFCs' earnings were taxable to their U.S. shareholder as if distributed as a dividend, the IRS further determined that these earnings were not an actual dividend and thus should have been taxed at the ordinary income tax rate of 35 percent, rather than the QDI rate of 15 percent then applicable to dividends received from certain CFCs.⁵ J.A. 51 (Tax Ct. 48).

SIH petitioned the Tax Court for review, arguing that (1) the CFCs' earnings were not subject to accelerated taxation in 2007 and 2008, but that (2) if they were, the QDI rate should apply.⁶ J.A. 5-7, 58 (Dkt. 1, Tax. Ct. 2-4). SIH and the IRS subsequently filed cross-motions for summary judgment. J.A. 6 (Tax Ct. 3).

SIH argued that the section 956(d) regulations are arbitrary and capricious, and thus could not support the asserted tax deficiency. J.A. 19 (Tax Ct. 16). Alternatively, SIH contended that the IRS was required by its own administrative practice to examine whether there had been a repatriation in substance. J.A. 7 (Tax Ct. 4). SIH further argued that, even if SIH had been required to include some amount in income in 2007 and 2008, any income from SEHL's earnings should have been taxed at the QDI rate, rather than the ordinary income rate, because any such tax was imposed on CFC earnings that were deemed to have been distributed to SIH by virtue of the guarantees, which would be qualified dividend income. J.A. 51-56 (Tax Ct. 48-53).

The Tax Court granted the IRS’s motion for summary judgment and denied SIH’s motion. J.A. 3 (Order). The Tax Court upheld the validity of the section 956(d) regulations, and affirmed the IRS’s determination that the QDI rate did not apply. J.A. 45-46. The Tax Court also held that, given the language of the regulations, the proffered facts and circumstances demonstrating that the CFC guarantees did not constitute a repatriation in substance were irrelevant. J.A. 47-51.

SIH filed a timely appeal.

SUMMARY OF THE ARGUMENT

1. The section 956(d) regulations are invalid. Section 956 taxes U.S. shareholders on CFC earnings that are repatriated to the United States through investments in U.S. property, including direct loans from a CFC to its U.S. shareholder. In section 956(d), Congress provided that pledges and guarantees would be considered investments in U.S. property “under regulations prescribed by the Secretary.”

Treasury's section 956(d) regulations treat every CFC guarantor of a U.S. person's loan as though it has made the full amount of the guaranteed loan. These broad-brush rules do not reflect a reasonable policy choice made in light of the statutory purpose. Moreover, Treasury failed to give any explanation for its policy choice or even any indication that it considered important aspects of the issues.

By treating each CFC guarantor as lending the entire guaranteed loan, the section 956(d) regulations ignore both congressional intent and economic reality. Although some CFC guarantees may repatriate CFC earnings by making possible a U.S. person's receipt of a loan that otherwise would not be obtainable on the same terms, that is not true of all guarantees. And it certainly is not true that all guarantees repatriate the full amount of the underlying loan. The actual value of a given guarantee, and thus its repatriating effect, depends on real-world factors such as the terms of the obligation and guarantee, the creditworthiness of the obligor and the guarantor, and whether there are multiple guarantors. The section 956(d) regulations, without reasoned explanation, ignore all these issues and instead treat all guarantees exactly like direct loans. If that were Congress' intent, it could simply have left guarantees in the section 956(c) list, and not provided a separate grant of regulatory authority.

The section 956(d) regulations are particularly arbitrary as applied to a CFC guarantor that is one of several guarantors of a loan, as is the case here. Treasury gave no indication that it considered the issues raised by multiple guarantors when it promulgated the section 956(d) regulations. By treating every CFC guarantor of a single loan as having made an investment equal to the full amount of the loan, the regulations can easily treat CFC guarantors as having repatriated far more earnings than would have been deemed repatriated if they had jointly loaned the money themselves. That is contrary to both congressional intent and common sense, as well as to the approach Treasury took in regulations applying section 956 to partnerships.

The IRS has recognized that its rules lead to strange results. And despite the categorical language of the rules, the IRS for decades followed binding guidance that required it to examine the facts and circumstances of each case to determine whether, in substance, there had been a repatriation of the CFC's earnings. See, e.g., Rev. Rul. 89-73 (May 22, 1989). Having abandoned a wooden approach to the application of the section 956 regulations decades ago, the IRS belatedly seeks to adopt such an approach here.

The Tax Court erroneously concluded that the regulations are both valid and should be applied literally, finding that, because CFC guarantees “clearly benefit the U.S. shareholder,” it was reasonable for Treasury to “choose a broad baseline rule for pledges and guarantees” J.A. 42, 45. But neither the IRS nor the Tax Court explained how this broad baseline rule is consistent with the statutory purpose, and Treasury provided no reasoned explanation for the rule it adopted.

Because the section 956(d) regulations are contrary to congressional intent, at odds with economic reality, and were promulgated without a reasoned explanation, they do not provide a valid basis for imposing additional tax on SIH.

2. If the Court concludes that the section 956(d) regulations are valid, it should at a minimum vacate and remand to the Tax Court for proceedings consistent with precedential IRS guidance that examines the facts and circumstances of each case to determine whether, in substance, there was a repatriation of CFC earnings. Such an analysis would show that there was no repatriation in substance here, because the CFC guarantees merely prevented the expatriation of SIG's U.S. assets, rather than the repatriation of CFC earnings.

3. Having argued that the CFCs' earnings should be taxed on an accelerated basis because they made an investment in U.S. property that is substantially equivalent to a dividend, the IRS reverses course and argues that the earnings should not be taxed as a dividend, but rather as ordinary income. The IRS cannot have it both ways: it cannot accelerate tax on the ground that the guarantees are substantially equivalent to a dividend while simultaneously arguing that they are not substantially equivalent to a dividend for purposes of the applicable rate.

The IRS argues that section 956 accelerated the year in which SIH is taxed on the CFCs' earnings, from the year in which the earnings were actually distributed to an earlier year in which the earnings are deemed to have been repatriated through an investment in U.S. property as a result of the loan guarantee. The IRS position is that CFC earnings that were in fact distributed in 2010 and 2011 and taxed at a rate of 15 percent, should be deemed distributed in 2007 and 2008 and taxed at a rate of 35 percent. But the acceleration of income does not change its character.

If, contrary to SIH's analysis, this Court determines that the section 956(d) regulations are valid and require that SIH be taxed in 2007 and 2008 on the CFCs' earnings, it should hold that any income derived from SEHL's earnings was taxable at the QDI rate, rather than at the ordinary income rate.

The Tax Court erred in adopting the IRS's contrary analysis, which relies on a purported distinction between amounts that are treated “as” dividends versus those treated “as if” they were dividends. The court concluded that, because Congress did not expressly state in the statute that earnings made taxable under section 956 “are dividends for general purposes of the Code,” J.A. 55 (emphasis in original), Congress did not intend to tax them as dividends. This conclusion is not only contrary to the purpose of section 956, its legislative history, and general tax principles, but ignores numerous instances in which the IRS has done exactly what the Tax Court said was prohibited by its crabbed reading of the statute — that is, in numerous regulations and rulings the IRS has treated section 956 repatriations as dividends. That precedent supports treating section 956 inclusions as qualified dividend income, and should be followed here.

STANDARD OF REVIEW

This Court reviews the Tax Court's legal conclusions de novo and its factual findings for clear error. See Anderson v. C.I.R., 698 F.3d 160, 164 (3d Cir. 2012). Agency action is unlawful if it is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 U.S.C. § 706(2)(A).

ARGUMENT

I. TREASURY'S SECTION 956(D) REGULATIONS ARE UNREASONABLE AND ARBITRARY

The undisputed purpose of section 956 is to tax transactions that repatriate CFC earnings to the United States. In section 956(d), Congress provided that pledges and guarantees would be considered investments in U.S. property “under regulations prescribed by the Secretary.” Treasury's regulations under section 956(d) address two questions: (1) when does a CFC guarantee constitute an investment in U.S. property for purposes of section 956? and (2) how much of the CFC's earnings should be taxed based on such guarantees? Treasury's mechanical answers to those questions are unreasonable and arbitrary because they impose tax without regard to whether, and to what extent, the CFC has in fact repatriated earnings by entering into a guarantee.

A. Treasury Regulations Must Be Reasonable, Non-Arbitrary, and Reasonably Explained

This Court reviews Treasury's regulations under the familiar Chevron framework. See Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 842-43 (1984); Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44, 48 (2011). Where, as here, the statute leaves gaps for the agency to fill, the question is “whether the agency's answer is based on a permissible construction of the statute” — that is, whether it represents a “reasonable policy choice for the agency to make” in light of the statute and its purpose. Chevron, 467 U.S. at 843-45. The agency's construction is permissible if, but only if, the agency “operate[s] within the bounds of reasonable interpretation.” Util. Air Regulatory Grp. v. E.P.A., 134 S. Ct. 2427, 2442 (2014); see also Mayo, 562 U.S. at 58.

In “reviewing the reasonableness of a regulation,” courts “may consider the plain language of the statute, its origin, and purpose,” and must ensure that the regulation “harmonize[s] with the statute” and is “reasonable in light of the legislature's revealed design.” See Si Men Cen v. Attorney General, 825 F.3d 177, 186-87 (3d Cir. 2016). A regulation receives no deference if it is arbitrary, capricious, or “contrary to clear congressional intent,” Torretti v. Main Line Hosps., Inc., 580 F.3d 168, 174 (3d Cir.), amended, 586 F.3d 1011 (3d Cir. 2009). In addition, a regulation that lacks a reasoned explanation is arbitrary and thus unlawful. See Encino Motorcars, LLC v. Navarro, 136 S. Ct. 2117, 2125 (2016) (“[W]here the agency has failed to provide [a reasoned explanation], its action is arbitrary and capricious and so cannot carry the force of law.”).

As the Supreme Court has explained, analysis under the “arbitrary [or] capricious” standard, 5 U.S.C. § 706(2)(A); Motor Vehicle Mfrs. Assn. of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U.S. 29, 43 (1983), is the “same” as in Chevron step two because, for both, courts “ask whether an agency interpretation is 'arbitrary or capricious in substance,'” Judulang v. Holder, 565 U.S. 42, 52 n.7 (2011) (quoting Mayo, 562 U.S. at 48). See also Michigan v. EPA, 135 S. Ct. 2699, 2706-07 (2015); Good Fortune Shipping SA v. Commissioner, 897 F.3d 256, 263 (D.C. Cir. 2018) (“[IRS] must . . . engage in reasoned analysis sufficient to command our deference under Chevron.” (internal quotation marks omitted)).

For the reasons that follow, the regulations under section 956(d) are unreasonable and arbitrary, inadequately explained, and reflect a failure of reasoned decision making.

B. The Regulations Are Inconsistent with the Purpose and Structure of Section 956

1. Section 956 Taxes Investments in Property That Are “Substantially The Equivalent Of A Dividend”

The purpose of section 956 is undisputed. As the Tax Court recognized, Congress acted “'to prevent the repatriation of income to the United States in a manner which does not subject it to U.S. taxation.'” J.A. 21 (quoting H.R. Rep. 87-1447 at 52 (1962)). Congress recognized that “untaxed CFC earnings invested in United States property” “'generally'” provide a benefit to U.S. shareholders “'which is substantially the equivalent of a dividend being paid to them.'” Id. (quoting S. Rep. 87-1881 at 88). The IRS has long recognized the purpose of section 956 is “to prevent the repatriation of income to the United States in a manner which does not subject it to U.S. taxation.” Rev. Rul. 89-73.

To achieve its purpose, Congress carefully considered both the types of CFC investments in U.S. property that trigger a repatriation of earnings and the amount of earnings repatriated by such transactions. In section 956(c), Congress listed specific types of U.S. property that trigger a repatriation. And in section 956(a), Congress provided that the amount of a CFC's investment in such U.S. property, and thus the amount of earnings considered repatriated, is generally the CFC's adjusted basis in the property — i.e., the amount the CFC has actually invested. Under these provisions, when a CFC directly loans money to related U.S. persons, Congress considers the amount of the loan to have been repatriated.

Congress also recognized that a CFC's guarantee of a third-party loan may serve to repatriate earnings indirectly by enabling a U.S. shareholder to receive funds that the U.S. shareholder would not have otherwise been able to receive on the same terms. But loan guarantees differ from direct loans in important ways: a guarantee is not an investment in property, and a guarantor has no tax basis in a guarantee. Moreover, guarantees arise in a wide range of circumstances and do not necessarily make additional funds available to a U.S. shareholder.

Congress clearly recognized that guarantees present special issues. Although the House version of what became section 956 included pledges and guarantees in the list of CFC transactions that automatically trigger U.S. tax, see Revenue Act of 1962, H.R. 10650, 87th Cong., § 13(a), the statute as enacted removed pledges and guarantees from that list.⁷ Instead, Congress separately addressed pledges and guarantees in section 956(d), which provides that “under regulations prescribed by the Secretary,” a CFC “shall be considered as holding an obligation of a United States person if such [CFC] is a pledgor or guarantor of such obligation.” It is undisputed that section 956(d) is not self-executing, as it applies only “under regulations.” J.A. 19 (Tax Ct. 16).

Congress's decisions to (i) limit section 956(c) categorical inclusions to the amount of a CFC's actual investments in U.S. property, and (ii) accord separate treatment to guarantees and pledges “under regulations,” reflect the fundamental principle that taxation should reflect economic reality. See, e.g., Gregory v. Helvering, 293 U.S. 465, 470 (1935) (in tax statutes, Congress does not intend to “exalt artifice above reality”); Merck & Co. v. United States, 652 F.3d 475, 483 (3d Cir. 2011) (noting “tax code's general insistence on the controlling effect of economic reality”). That is, the statute seeks to tax U.S. shareholders on an amount of CFC earnings equal to the CFC's actual investments in U.S. property, nothing more.

2. The Regulations Implementing Section 956(d) Are Unreasonable

The section 956(d) regulations are inconsistent with the structure and purpose of section 956, as well as economic reality, because they impose shareholder-level tax without regard to whether and to what extent CFC earnings have been repatriated. The regulations treat every CFC that guarantees a U.S. person's loan as if it had made the full amount of the underlying loan directly to the U.S. shareholder. This effectively reinstates the rejected House version of the legislation, ignoring Congress's decision to remove guarantees from the list of items treated categorically as investments in U.S. property. If Congress had intended to apply a categorical rule to guarantees, it could simply have left guarantees in the section 956(c) list, and not provided the separate grant of regulatory authority.

The regulations ignore the features of guarantees that led Congress to grant Treasury regulatory authority in the first place. Although some CFC guarantees may effectively repatriate CFC earnings by making additional funds available to a U.S. person, that is not true of all guarantees. And even among CFC guarantees that have some repatriating effect, very few can plausibly be seen as repatriating the full amount of a guaranteed loan. U.S. tax law generally provides that guarantees may be recharacterized as a direct loan only when a lender looks primarily to the guarantor, and not the borrower, for expected repayment. See, e.g., Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972) (addressing when a guarantee can be recharacterized as a direct loan). Yet the section 956(d) regulations recharacterize every CFC guarantee as a direct loan, by treating every CFC guarantor as though it invested the full loan amount in U.S. property.

The section 956(d) regulations are particularly unreasonable when applied, as they were in this case, to multiple guarantors. When a loan is guaranteed by multiple parties, no one guarantor can plausibly be viewed as making the entire amount of the loan available to the U.S. shareholder. Yet under the section 956(d) regulations, each CFC guarantor is treated as making the full amount of the loan, and as repatriating funds up to the limit of its untaxed earnings, regardless of the guarantees' economic effect. Thus, when more than one CFC guarantees a given loan, the regulations deem the guarantors to have made multiple loans, and may tax the U.S. shareholder on multiples of the entire amount of the actual loan. For example, if all 39 guarantors in this case had been CFCs, a single $1.485 billion loan could have resulted in more than $57.9 billion of deemed loans from the CFCs. This absurd result demonstrates the irrationality of treating CFC guarantors as investing in the full amount of a loan regardless of the actual effects of the guarantee.

3. IRS Practice Shows that the Regulations Are Unreasonable

The IRS's own administrative practice confirms the unreasonableness of its regulations. For decades the IRS repeatedly declined to apply its section 956 regulations in accordance with their rigid language. The IRS formalized this approach in binding IRS guidance stating that, in applying section 956, “[t]he facts and circumstances of each case must be reviewed to determine if, in substance, there has been a repatriation of the earnings of the controlled foreign corporation.” Rev. Rul. 89-73 (emphasis added). Unlike the categorical language of the section 956(d) regulations, this case-by-case analysis reflects the bedrock principle that “tax classifications . . . turn on the objective economic realities of a transaction rather than . . . the particular form the parties employed.” Boulware v. United States, 552 U.S. 421, 429 (2008). See also PPL Corp. v. C.I.R., 569 U.S. 329, 340 (2013) (rejecting IRS's categorical, form-driven interpretation of a tax provision as contrary to “the black-letter principle that 'tax law deals in economic realities'” (citation omitted)).

The IRS argued below that only the government, and not taxpayers, can benefit from this facts-and-circumstances analysis in Revenue Ruling 89-73. But the IRS's other rulings are to the contrary.⁸ In a 1980 Technical Advice Memorandum involving a U.S. parent's pledge of CFC stock to secure its obligations under a guarantee, the IRS concluded — despite the categorical language of the section 956(d) regulations — that, “[v]iewing the substance of the transaction,” there was “no evidence of a controlled foreign corporation's earnings being directly or indirectly repatriated to the U.S.” T.A.M. 8042001 (Mar. 18, 1980). As the IRS explained, “a proper interpretation of the statute is reached when one focuses not on the highly technical meaning of the terms 'pledge' and 'guarantor' as used in commercial transactions, but instead on the purpose of section [956(d)] of the Code” — which is “to prevent a United States shareholder from being able to repatriate directly or indirectly the controlled foreign corporation's earnings without the United States shareholder being taxed on such earnings as a dividend.” Id.; see also T.A.M. 8101012 (Oct. 7, 1980) (U.S. parent's obligation as guarantor of CFC's bank borrowing held not an “obligation” of a U.S. person within the meaning of section 956, consistent with the reality that the guarantee of such obligation worked no repatriation of CFC earnings).⁹

Conversely, the IRS has found a repatriation in substance in circumstances where the literal terms of section 956 and its regulations do not apply.¹⁰ In conducting this facts-and-circumstances analysis, the IRS historically has not adopted an all-or-nothing approach to repatriation, but instead has assessed the amount that the CFC repatriated in a given transaction. For example, in Revenue Ruling 90-112 the IRS applied section 956 to a CFC that invested in U.S. property through a partnership, and concluded, under “the general principle that section 956 is concerned with the substance of a transaction and not merely its form,” that the CFC at issue only repatriated the amount proportional to its partnership interest and not the full amount of the underlying investment.

Indeed, the IRS has directly acknowledged some of the problems with its section 956(d) regulations, but has failed to fix them. See 80 Fed. Reg. 53058 (noting that in the case of multiple guarantors “the aggregate amount of United States property treated as held by CFCs may exceed the unpaid principal amount of the obligation,” and soliciting comments regarding potential solutions to the anomaly); FSA 200216022 (recognizing that a literal application of guarantee regulations “could produce strange results”); cf. Good Fortune, 897 F.3d at 263 (finding the IRS's regulations “all the more inexplicable” because the IRS recognized, after promulgating the regulations at issue, that one of their main premises was incorrect).

The Tax Court acknowledged the arguments “concerning economic reality” and “strange results,” but dismissed them with an observation that “'[r]egulation, like legislation, often requires drawing lines.'” J.A. 44 (citation omitted). Congress authorized Treasury to draw lines to implement section 956(d), but that authorization does not extend to lines that are “unmoored from the purposes and concerns” of the statute. Judulang, 565 U.S. at 64. For example, Treasury could have drawn a line that treats all CFC guarantees as investments in U.S. property but measures the amount of the investment as the value of the guarantee. As another example, Treasury itself has suggested that the investment in U.S. property mechanically deemed to occur by virtue of CFC guarantees under the section 956(d) regulations could at least be allocated among multiple CFC guarantors, 80 Fed. Reg. at 53,062, which is similar to what Treasury has done in the context of CFC investments made through partnerships, see supra p. 35. Under that regulation, if the 39 guarantors of the Merrill Lynch loan had joined together to directly make the loan, the CFCs would be considered to have invested in only their pro rata share of the loan. Yet the section 956(d) regulations would treat the CFCs, as guarantors, the same as if they had each made the entire amount of the loan. In the section 956(d) regulations, Treasury drew lines that cannot be squared with the purpose of section 956, and it has declined to correct the anomalies created by its rules. See Woodall v. Fed. Bureau of Prisons, 432 F.3d 235, 249 (3d Cir. 2005) (holding that regulations are “not reasonable in light of the legislature's revealed design” (citation omitted)).

C. Treasury Did Not Provide a Reasoned Explanation for the Regulations

“When an administrative agency sets policy, it must provide a reasoned explanation for its action.” Judulang, 565 U.S. at 45. A regulation that lacks a reasoned explanation “is itself unlawful and receives no Chevron deference.” Encino, 135 S. Ct. at 2126. Thus, “a 'reasonable' explanation of how an agency's interpretation serves the statute's objectives is the stuff of which a 'permissible' construction is made.” Northpoint Tech. Ltd. v. FCC, 412 F.3d 145, 151 (D.C. Cir. 2005).

Treasury provided no reasoned explanation for its guarantee regulations. Instead, it said only that all of the section 956 regulations were issued to “to conform” to section 956. 29 Fed. Reg. at 2,599; 28 Fed. Reg. 3,541, 3,541 (Apr. 11, 1963). When an agency makes a policy choice, a conclusory statement that the agency's choice “conforms” to the statute is no explanation at all. Such a statement says nothing about why the chosen approach conforms to the statute, let alone why it is preferable to other approaches. As this Court has noted, “conclusory remarks . . . do not equip . . . a court to review the [agency's] reasoning.” Nat'l Parks Conservation Ass'n v. E.P.A., 803 F.3d 151, 166 (3d Cir. 2015). Such an explanation “could be used to justify any [determination] at all,” which “demonstrates its arbitrariness.” Id.

Even on its own terms, Treasury's statement cannot withstand scrutiny. Rather than merely “conforming” to the statute, the section 956(d) regulations reflect Treasury's recognition that policy choices needed to be made. For example, they create an exception for guarantees related to “conduit financing arrangements.” See 26 C.F.R. § 1.956-2(c)(4). If Treasury's categorical rules actually were necessary to “conform” to the statute, such extra-statutory rules would be impermissible.

Notwithstanding the lack of any explanation for Treasury's policy choices in the section 956(d) regulations, the Tax Court was persuaded that “[t]he agency's path 'may reasonably be discerned'” because the “proposed and final rules concerning CFC pledges and guaranties sought to implement the clear wording of the statute and to equate the treatment of these transactions with the treatment of items of United States property under the statute.” J.A. 33. But as explained above, and as the Tax Court itself acknowledged, the statutory language does not require Treasury to treat all CFC guarantees as investments in U.S. property equal to the full value of the loan. Congress assigned Treasury responsibility for making policy choices, and the reasons for Treasury's choice cannot be discerned from its one-sentence “explanation.”

Treasury's conclusory statement gives no indication that it even considered the issues presented by the fact that not all guarantees effect a repatriation of earnings or the presence of multiple guarantors, let alone why it resolved them as it did. See State Farm, 463 U.S. at 43 (agency regulation is “arbitrary and capricious if the agency has . . . entirely failed to consider an important aspect of the problem”); Dominion Resources, Inc. v. United States, 681 F.3d 1313, 1318 (Fed. Cir. 2012) (holding Treasury regulation “violates the State Farm requirement that Treasury provide a reasoned explanation for adopting a regulation”); Pub. Citizen v. Steed, 733 F.2d 93, 99 (D.C. Cir. 1984) (“[W]e will demand that the [agency] consider reasonably obvious alternative[s] . . . and explain its reasons for rejecting alternatives in sufficient detail to permit judicial review.”).

The D.C. Circuit recently held that a categorical tax regulation supported by a single-sentence explanation was unreasonable. See Good Fortune, 897 F.3d 256. Treasury, in construing a statutory provision concerning the types of stock ownership that permit a foreign shipping corporation to qualify for a tax exemption, adopted a blanket regulation excluding bearer shares as a permissible form of stock ownership, based on a one-sentence explanation that invoked “the difficulty of reliably demonstrating the true ownership of bearer shares.” Id. at 260 (quoting 68 Fed. Reg. 51,394, 51,399). The court held that this “single, undeveloped statement” was inadequate. Id. at 262.

Treasury's one-sentence “explanation” for its section 956(d) regulations is even more unreasonable than the inadequate one-sentence explanation in Good Fortune. In Good Fortune, Treasury at least addressed the issue and stated, in a conclusory fashion, why it adopted a categorical rule — it simply failed to adequately explain why it adopted the particular rule it chose. Here, Treasury did not even state why it adopted a categorical rule. Indeed, Treasury's statement was not even tied specifically to section 956(d), as it applied to every provision of section 956 addressed in the rulemaking. By “cho[osing] to paint with such a broad brush,” the IRS “failed adequately to justify its categorical rule.” Id. at 266 (internal quotation marks omitted).

D. The Facts of this Case Highlight the Unreasonableness of the Regulations

This case exemplifies the problems with section 956(d) regulations. After entering into the guarantees, SEHL and STS distributed earnings of nearly $350 million to SIH. All these distributions were subject to U.S. taxation, and all taxes were paid at the dividend rate. Nevertheless, Treasury invoked the section 956(d) regulations to accelerate taxation of those earnings and more than double the tax rate. But applying those regulations here highlights their unreasonableness.

First, by joining with 37 other affiliates to guarantee SIG's loans in 2007, SEHL and STS did not cause SIG to obtain a loan it would not have otherwise obtained on the same terms, and thus did not provide a benefit to their shareholders that was “substantially the equivalent of a dividend being paid to them.” J.A. 21 (Tax Ct. 18). SIG and its U.S. affiliates had far more assets in the United States than were needed to obtain the loans, with or without the CFC guarantors. J.A. 66-67 (Greenberg Decl. ¶ 13). Merrill Lynch requested that SIG's foreign affiliates serve as guarantors to prevent the potential expatriation of funds from the United States. These transactions were not a repatriation, and are far removed from the type of tax avoidance schemes that prompted Congress to enact subpart F.

Second, it is particularly unrealistic for the IRS to assert that, by serving as two of 39 guarantors on SIG's loans, the CFCs each invested $1.485 billion in U.S. property. The Tax Court concluded that this anomaly is excusable given that “[t]he amounts determined under section 956 are capped by the statute at the CFCs' applicable earnings for the tax years in issue,” and that, in this case, those amounts “do not exceed the value of the underlying obligations.” J.A. 49. This explanation misses the point. The fact that the CFCs' earnings happen to be less than their purported investments in U.S. property is a fortuity that does not cure the basic problem with the section 956(d) regulations, which is that they treat each CFC guarantor as having invested an amount in U.S. property that is divorced from the amount of any actual repatriation of earnings provided to U.S. shareholders by a guarantee.

* * * *

In sum, Treasury's guarantee regulations are inconsistent with the purpose of section 956, detached from economic reality, and virtually unexplained. Accordingly, they cannot support the imposition of additional tax on SIH.

II. EVEN IF THE REGULATIONS WERE VALID, THE IRS'S OWN PRECEDENTIAL GUIDANCE WOULD REQUIRE A REVIEW OF THE FACTS

As noted in Part I above, the IRS's own guidance states that “[t]he facts and circumstances of each case must be reviewed to determine if, in substance, there has been a repatriation of the earnings of the controlled foreign corporation.” Rev. Rul. 89-73 (emphasis added). This statement in a revenue ruling is a binding “concession” by the IRS, see Rauenhorst v. Commissioner, 119 T.C. 157, 171-73 (2002) (describing revenue rulings “as concessions by the Commissioner”); Dover Corp. v. Commissioner, 122 T.C. 324 (2004) (applying Rauenhorst). Accordingly, even if this Court determines (despite the analysis in Part I) that the section 956(d) regulations can stand, it should vacate and remand with instructions to employ the standard required by the IRS's own precedent.

The facts and circumstances of this case show that there was no repatriation in substance. SIG's U.S. affiliates had sufficient assets on deposit with Merrill Lynch to fully collateralize the entire amount of the borrowing. See J.A. 66-67 (Greenberg Decl. ¶ 13). The guarantees thus did not enable SIG to borrow a greater amount than it otherwise could have borrowed. Id. Instead, the guarantees prevented SIG from restricting Merrill Lynch's access to SIG's U.S. assets, which SIG otherwise could have accomplished by transferring those assets to the CFCs absent the guarantees.

The IRS never analyzed these facts to determine whether there was a repatriation in substance. Nor did it explain why it was departing from its longstanding approach requiring that the facts and circumstances of each case must be reviewed. This “[u]nexplained inconsistency” is itself a “reason for holding [its new] interpretation to be an arbitrary and capricious change from agency practice.” Encino, 136 S. Ct. at 2125-26; see also id. (“When an agency changes its existing position, it . . . must at least 'display awareness that it is changing position'” and “'show that there are good reasons for the new policy.'” (quoting FCC v. Fox Television Stations, Inc., 556 U.S. 502, 515 (2009)).

The Tax Court, for its part, did not address Revenue Ruling 89-73 or the other IRS authorities calling for an analysis of the facts of each case. Instead, the Tax Court simply observed that SIG could have avoided the entire problem by refusing to provide Merrill Lynch with the CFC guarantees. J.A. 50. But the issue is not whether SIG could have undertaken a different transaction, it is whether the transaction SIG undertook resulted in a repatriation, and therefore is properly subject to tax under section 956.¹¹

Accordingly, if the Court determines that the guarantee regulations are valid, it should remand this case with instructions to undertake the analysis required by the IRS's binding guidance.

III. SECTION 956 INCLUSIONS SHOULD BE TAXED AS DIVIDENDS

The IRS compounds its error by arguing that any inclusions arising under section 956 must be taxed at the ordinary rate of 35 percent rather than the 15-percent rate applicable to qualified dividends. A conclusion that the section 956(d) regulations are valid and require SIH to be taxed on a deemed repatriation of the CFC's earnings would logically foreclose the IRS position that the 35-percent rate applies to such earnings. That is so because:

• Congress enacted section 956 to tax U.S. shareholders on transactions that are substantially the equivalent of a dividend.

• Transactions that do not effectively “dividend” value from a CFC to a U.S. shareholder fall outside section 956.

• Thus, if the Court determines that the guarantee regulations are valid and apply here, it follows that the CFCs' guarantees were substantially the equivalent of a dividend.

Put simply, the government cannot claim that CFC guarantees are substantially the equivalent of a dividend for purposes of inclusion in current income while also arguing that the same guarantees are not substantially equivalent to a dividend for purposes of the applicable rate.

The IRS position also leads to irrational results. It is undisputed that:

• If SEHL had paid a formal dividend to its U.S. shareholders during the years in question in lieu of guaranteeing the loan, the QDI rate would have applied.

• If SEHL had paid a formal dividend and had made the loan guarantee in the same year, the QDI rate would have applied.

• If SEHL had paid a formal dividend and then made the loan guarantee in a subsequent year, the QDI rate would have applied with respect to any earnings distributed in the formal dividend.

Each of those scenarios produces economic results identical to the transactions in this case. But the IRS nevertheless argues that the exact same transactions result in tax at more than double the QDI rate simply because the taxpayer undertook them in the wrong order: the guarantee preceded the formal dividend.

That arbitrary result is not supported by the statute for several reasons. First, the QDI rules apply to constructive dividends. Second, section 956 and the structure of subpart F demonstrate that section 956 inclusions are dividends. Third, multiple IRS authorities, ignored by the IRS and the Tax Court, treat section 956 inclusions as dividends. Fourth, not treating section 956 inclusions as dividends creates timing anomalies that are contrary to Supreme Court precedent. Accordingly, any additional amounts that SIH was required to include in income in 2007 and 2008 under section 956 based on SEHL's guarantee should receive QDI treatment.¹²

A. The QDI Rules Apply to Constructive Dividends

The QDI provisions in section 1(h)(11) apply to “dividends.” Because Congress did not adopt a special definition of “dividends” for purposes of section 1(h)(11), the Code's general definition of “dividends” for income tax purposes applies. See 26 U.S.C. § 316(a) (defining “dividends” as “any distribution of property made by a corporation to its shareholders . . . out of its earnings and profits of the taxable year. . . .”).

It is well established that “dividends” include not only formally declared distributions, but also “disguised” and “constructive” dividends. As a leading treatise explains, “[t]he hallmark of a constructive distribution is value passing from a corporation to, or a specific economic benefit conferred by a corporation on, its shareholder without receiving equivalent value in return.” Bittker & Eustice: Federal Income Taxation of Corporations & Shareholders, ¶ 8.06 (2018). Thus, “[a] shareholder, even if the corporation has dispensed with the formalities of declaration, may be charged with a disguised or constructive dividend if the corporation confers a direct benefit on him from available earnings and profits without expectation of repayment.” Neonatology Assocs., P.A. v. Commissioner, 299 F.3d 221, 231-32 (3d Cir. 2002). For example, where shareholders use corporate property — like the company car — for a personal purpose, there is a benefit, and thus a constructive dividend. Melvin v. C.I.R., 88 T.C. 63, 79 (1987), aff'd, 894 F.2d 1072 (9th Cir. 1990). These results follow not from particular Code provisions that define disguised or constructive dividends, but rather from the principle that “tax classifications like 'dividend' . . . turn on 'the objective economic realities of a transaction rather than . . . the particular form the parties employed.'” Boulware, 552 U.S. at 429.

Because disguised or constructive dividends are, in economic reality, dividends, they are taxed as dividends. Both the IRS and the courts have recognized that constructive dividends are eligible to be taxed at the QDI rate. See Luczaj & Associates v. Commissioner, Nos. 25541-14, 25542-14, 2017 WL 923522, at *8 n.3 (T.C. Mar. 8, 2017) (noting apparent IRS concession that “constructive dividends constitute 'qualified dividends' within the meaning of section 1(h)(11)”); Avrahami v. Commissioner, Nos. 17594-13, 18274-13, 2017 WL 3610601, at *32, 34 (T.C. Aug. 21, 2017) (constructive dividend failed to qualify as QDI only because not paid by treaty-eligible CFC); Schank v. Commissioner, Nos. 16641-14, 16642-14, 2015 WL 8477305, at *8 (T.C. Dec. 9, 2015) (stating petitioners could potentially benefit from QDI rate under constructive dividend theory). Cf. Smith v. Commissioner, Dkt. No. 14900-15, 151 T.C. No. 5, at 53 n.12 (T.C. Sept. 18, 2018) (not reaching the issue because it was not addressed by the parties).¹³

Taxing constructive dividends at the QDI rate furthers the purpose of the QDI rules. Because corporations pay tax on their earnings, the shareholder-level tax that is imposed when corporate earnings are distributed results in double taxation. Congress enacted the QDI provisions in section 1(h)(11) to reduce the double taxation of corporate earnings, with the goal of spurring economic activity by encouraging distribution of earnings to shareholders. See H.R. Rep. 108-94 at 31 (2003) (“[T]he Committee finds that present law, by taxing dividend income at a higher rate . . ., encourages corporations to retain earnings rather than to distribute them as taxable dividends.”). The purpose of section 1(h)(11), which expressly applies to CFCs, is thus furthered by applying the QDI rate to constructive dividends as well as formal dividends, since both promote economic activity through shareholder access to corporate earnings.

B. Section 956 and the Structure of Subpart F Confirm that Section 956 Inclusions Are Taxable as Dividends

1. Section 956 Inclusions Are Statutory Constructive Dividends

The rationale of section 956 is that “earnings brought back to the United States are taxed to the shareholders [under section 956] on the grounds that this is substantially the equivalent of a dividend being paid to them.” S. Rep. 87-1881 at 88; see also H.R. Rep. 87-1447 at 52 (provisions “deny tax deferral where funds are brought back and invested in the United States in a manner which does not otherwise subject them to U.S. taxation”). In short, section 956 adopts a “statutory constructive dividend doctrine.” Dougherty v. Commissioner, 60 T.C. 917, 930 (1973); see also Bittker & Eustice, supra, ¶ 15.62[4][a] (section 956 inclusions are “deemed” or “constructive” dividends).

Indeed, the Code itself refers to section 956 inclusions (and other section 951(a) inclusions) as “[c]onstructive dividends” in the title of 26 U.S.C. § 6501(e)(1)(C). Notably, Congress amended this Code section in 2004, one year after it enacted the QDI rules, without changing the provision's title, confirming its understanding that section 956 inclusions are constructive dividends.¹⁴

2. The Structure of Subpart F Demonstrates That Congress Intended Section 956 Inclusions to be Treated as Dividends

The structure of subpart F confirms that section 956 inclusions are properly taxed as dividends. As explained above, subpart F applies to two broad categories of undistributed CFC earnings: (1) subpart F income, which is immediately taxable to U.S. shareholders under section 951(a)(1)(A); and (2) income not otherwise subject to subpart F (and thus normally taxable at the shareholder level only when formally distributed as dividends) that was invested in U.S. property, which was taxable under section 951(a)(1)(B), in the amount determined by section 956. The Staff of the Committee on Ways and Means described these two categories of income as follows:

The amounts on which the U.S. person is taxed may be classified as: (1) subpart F income, and (2) profits considered as being distributed. . . . The amount treated as having been distributed is the profit accumulated after 1962 to the extent that it is invested in certain prohibited types of property which include . . . most assets situated in the United States.

H.R. Comm. on Ways and Means, Brief Summary of Provisions in H.R. 10650 the “Revenue Act of 1962”, at 9 (1962) (emphasis added), available at https://www.finance.senate.gov/imo/media/doc/87PrtRevwm.pdf.

In the case of non-subpart F income, section 956 determines when deferral of U.S. taxation should end based on Congress's judgment that certain investments in U.S. property are functionally equivalent to dividends that repatriate earnings to the United States. Like formal dividends, section 956 deemed dividends permit a U.S. shareholder to access otherwise-deferred CFC earnings. In both situations, the U.S. shareholder obtains the use of the CFC's earnings, and therefore Congress treated both situations as repatriation events justifying taxation.

Moreover, once a CFC's earnings are taxed under section 956, they are not taxed again when they are formally distributed as dividends. 26 U.S.C. § 959. Instead, section 956 accelerates the tax on dividends that otherwise would have attached to those earnings. Thus, the structure and purpose of section 956 — taxing disguised distributions of otherwise-deferred foreign earnings — confirms the dividend equivalence of section 956 inclusions.

In short, section 956 addresses the timing of U.S. taxation. It applies to business earnings of a CFC that have been properly deferred from U.S. taxation, ending that deferral when earnings are made available to a U.S. shareholder, just as deferral would end if those earnings were paid out as a formal dividend. Nothing about this timing provision suggests altering the character of the income recognized by denying dividend treatment.

In reaching a contrary result, the Tax Court looked to whether there was an actual distribution of CFC earnings, and found none. J.A. 54-55 (citing Rodriguez v. Commissioner, 137 T.C. 174 (2011), aff'd, 722 F.3d 306, 309-10 (5th Cir. 2013)). But a narrow focus on actual distributions disregards the constructive dividend doctrine and the structure and purpose of section 956. See Neonatology, 299 F.3d at 231-32. The Tax Court thus failed to give sufficient weight to decades of constructive dividend authorities, including those recognizing that constructive dividends qualify under the QDI rules.

C. The IRS Regularly Treats Section 956 Inclusions as Dividends Even When No Statute Expressly Provides for Such Treatment

Directly contradicting its position here, the IRS has repeatedly issued interpretive guidance that treats section 956 inclusions as dividends for purposes of multiple Code provisions, even when no statute expressly requires such treatment. For example, four tax regulations require that section 956 inclusions be treated as dividends for purposes of four different substantive rules that turn on the payment or receipt of a dividend:

1. 26 C.F.R. § 1.338-8(h)(4) (“treating any reference to a dividend” as including “[a]n amount included in income under section 951(a)(1)(B)”).

2. Id. § 1.385-3(c)(3)(i)(C)(3)(ii) (“the term dividend includes inclusions with respect to stock (for example, inclusions under sections 951(a) and 1293)”).

3. Id. § 1.865-2(d)(2) (defining “dividend recapture amount” to encompass “an inclusion described in section 951(a)(1)(B)”).

4. Id. § 1.904-5(m)(4) (dividend “includ[es] an amount included in gross income under section 951(a)(1)(B)”).

A fifth regulation permits taxpayers to elect such treatment. Id. § 1.1411-10(c), (g). Thus, five regulations require or permit dividend treatment of section 956 inclusions in the absence of a statutory provision expressly providing for such treatment.

Similarly, twenty IRS letter rulings treat subpart F inclusions, including section 956 inclusions, as dividends for purposes of the rules that tax the “unrelated business taxable income” (“UBTI”) of tax-exempt organizations.¹⁵ Indeed, Congress has tacitly endorsed the IRS treatment of subpart F income as a dividend for UBTI purposes. See H.R. Rep. 104-737 at 294 (1996) (citing with approval IRS rulings treating subpart F inclusions as dividends, and criticizing one ruling that adopted a different analysis).

The IRS has explained why it requires dividend treatment of subpart F inclusions in the absence of a statutory rule:

Subpart F income is taxed in largely the same manner as a dividend. The mere fact that the timing of income recognition is accelerated under the Subpart F provisions . . . does not result in treating the Subpart F inclusion any differently than distribution of an actual dividend in the absence of these rules, unless specifically provided elsewhere in the Code.

P.L.R. 9024026 (Mar. 15, 1990). See also T.D. 8916 (Jan. 3, 2001) (explaining that “like an actual dividend,” 956 inclusions are “treated as paid pro rata out of all of the CFC's earnings and profits”). Moreover, the IRS routinely refers to section 956 inclusions as deemed dividends. See, e.g., GCM 36965 (Dec. 22, 1976) (stating that “under Code § 951 U.S. shareholders are deemed to have received dividends from controlled foreign corporations attributable . . . to the increase in earnings invested in U.S. property, as defined in Code § 956”); P.L.R. 9217039 (Jan. 28, 1992) (stating that “amounts included under section 951(a)(1)(A) and (B) are treated as deemed dividend payments”).

The IRS's longstanding treatment of section 956 inclusions as dividends for a variety of analogous Code purposes should be followed here.

D. The Tax Court Placed Undue Reliance on Statutory Provisions Expressly Providing for Dividend Treatment in Certain Circumstances

The Tax Court recognized that “section 951 in operation treats a CFC's investment in United States property 'as if it were a dividend.'” J.A. 55. It nevertheless held that, because no Code provision expressly provides that section 956 inclusions are treated as dividends for QDI purposes, Congress intended them to be taxed at ordinary income tax rates. The Tax Court relied on Rodriguez, which similarly concluded that “when Congress decides to treat certain inclusions as dividends, it explicitly states as much, and Congress has not so designated the inclusions at issue here.” 722 F.3d at 311. This conclusion is incorrect, for several reasons.

First, neither the Tax Court in this case nor the courts in Rodriguez considered the multiple IRS regulations and rulings that treat section 956 inclusions as dividends in the absence of a specific statutory provision to that effect. If the reasoning of those courts is correct, all of those regulations and rulings are invalid.

Second, neither the Tax Court in this case nor the Rodriguez courts recognized that the established rules governing constructive dividends, as well as the structure and history of subpart F, support treating section 956 inclusions as dividends even without a specific statutory provision to that effect. See supra pp. 52-55.

Third, it is not correct that statutory provisions designating certain section 951 inclusions as dividends for specified purposes would become meaningless “surplusage” unless all other section 951 inclusions are taxed as ordinary income. Rodriguez, 722 F.3d at 311. In Rodriguez, the Tax Court pointed to six Code sections (26 U.S.C. §§ 54A(g), 302(a), 304(a), 305(c), 551(b), and 1248) as showing that Congress knows how to provide for dividend treatment when that is what it intends. See Rodriguez, 137 T.C. at 178-79. But the court read far too much into those provisions. Many are rules that change the characterization of a transaction, or the character of a taxpayer's income. For example, under section 1248 a shareholder's gain on the sale of stock is treated as dividend income, even though it does not involve a distribution of a company's earnings and profits, actual, constructive, or deemed. Other cited provisions involve similar transformations. See 26 U.S.C. §§ 302(a), 304(a), 305(c) (deeming certain transactions with respect to corporate stock to be distributions).

By contrast, in section 956, Congress addressed a timing issue, accelerating the taxation of otherwise-deferred earnings when shareholders accessed those earnings through an investment in U.S. property. Regardless of when that income is recognized by the U.S. shareholder, it is dividend income by its very nature. For that reason, the IRS authorities addressing other provisions that simply apply to “dividends” have routinely treated section 956 inclusions as dividends notwithstanding the absence of a statutory rule requiring such treatment.

Similarly, the Rodriguez courts misread the significance of four Code provisions that address the dividend treatment of subpart F inclusions.¹⁶ All four provisions clarify the treatment of section 951(a)(1)(A) inclusions, which as noted above are not covered by the dividend-equivalence rationale of section 956. Three of the provisions extend dividend treatment to such inclusions and one confirms non-dividend treatment, for purposes of particular specialized Code rules. These specialized rules should not be read to reject the general dividend equivalence of section 956 inclusions. One of the cited provisions does not address section 956 inclusions at all, and thus has limited relevance. 26 U.S. § 851(b). If anything, the absence of a specific reference to section 956 inclusions in a rule extending dividend treatment to section 951(a)(1)(A) inclusions suggests that Congress understood it did not need to expressly mention section 956 inclusions to confirm that they are subject to dividend treatment.

Two of the other cited provisions broadly apply dividend treatment to section 951(a)(1) inclusions, and thus extend such treatment to section 951(a)(1)(A) inclusions for specified purposes, while also confirming that treatment of section 956 inclusions. Id. §§ 959(a)(1), 960(a)(1). This type of broad cross-reference should not be read to contradict the general dividend equivalence of section 956 inclusions. The fourth provision simply confirms, in the foreign tax credit limitation context, that section 951(a)(1)(A) inclusions are not dividends while section 956 inclusions are. Id. § 904(d)(3)(G).

In sum, these specialized rules either confirm or do not address the general dividend equivalence of section 956 inclusions. They should not be read as prohibiting the dividend treatment of such amounts, as otherwise established by the structure and history of section 956.

Over and above these points, the “canon against surplusage is not an absolute rule,” because “[r]edundancies across statutes are not unusual events in drafting.” Marx v. Gen. Revenue Corp., 568 U.S. 371, 385 (2013). Here, the strong reasons for according dividend treatment to section 956 inclusions — including the constructive dividend doctrine, the purpose, structure, and history of section 956, and the numerous IRS regulations and rulings treating section 956 inclusions as dividends — all support the conclusion that the QDI rate applies.

Finally, there is a particularly strong reason to apply dividend treatment with respect to section 956 inclusions related to guarantees of loans to U.S. persons. The Rodriguez courts considered only investments in tangible U.S. property that did not result in any distribution to the U.S. shareholders. But here, the U.S. shareholders received cash, in the form of loans from Merrill Lynch. The IRS position treats the cash received by SIG as actually coming from CFC earnings. Thus, under the IRS position, that distribution of cash from corporate earnings is a dividend.

E. Failing to Treat Section 956 Inclusions as Dividends Leads to Timing-Based Anomalies Contrary to Supreme Court Precedent

Taxing section 956 inclusions as if they are ordinary income, rather than dividend income, also produces arbitrary results. The applicable tax rate is more than doubled, based not on any substantive distinction, but solely on the timing and manner of repatriating CFC income. This result violates Supreme Court precedent addressing the timing of income recognition.

First, the Supreme Court has held that merely accelerating the recognition of income should not alter the character of the income to the taxpayer. See, e.g., Commissioner v. P.G. Lake, Inc., 356 U.S. 260, 265 (1958) (holding that a taxpayer's sale of an oil payment right was taxable as ordinary income because the “lump sum consideration seems essentially a substitute for what would otherwise be received at a future time as ordinary income”). When a treaty-eligible CFC distributes its earnings to an individual shareholder, the dividend unquestionably is taxed at the QDI rate. When section 956 requires a shareholder-level income inclusion with respect to the earnings of the CFC, that inclusion merely accelerates the taxation of those earnings. This acceleration is “essentially a substitute for what would otherwise be received at a future time” as dividends, id., and thus should not alter the character the income would have if it had been received in due course.

Second, the Supreme Court has likewise instructed that when closely related events occur in different taxable years, the tax treatment of those events must take into account the treatment that would apply if all the relevant events occurred in the same taxable year — that is, the tax characterization of the related events must be consistent across the years, under a “relation back” principle. See Arrowsmith v. Commissioner, 344 U.S. 6, 8-9 (1952); United States v. Skelly Oil Co., 394 U.S. 678 (1969). Courts have applied this doctrine “in favor of both the taxpayer and the Government in a myriad of factual settings.” Freedom Newspapers, Inc. v. Commissioner, 36 T.C.M. 1755 (1977).

Here, SEHL distributed its earnings and profits in 2010, after having entered into the guarantee at issue long before there was any suggestion from the IRS that the guarantee could have triggered a section 956 inclusion. When SEHL distributed its earnings and profits in 2010, all taxes due were paid at the QDI rate. Now, solely because SEHL is deemed to have distributed those same earnings in 2007 and 2008, the IRS contends that the shareholders should have paid taxes earlier and at more than double the dividend rate. By contrast, as discussed above, it is undisputed that if SEHL had provided the guarantees and paid a formal dividend of an equivalent amount in the same year, the QDI rate would apply to the CFC's earnings thus repatriated. Under the Arrowsmith doctrine, merely separating the two events into different taxable years should not generate the dramatically different tax result the IRS seeks.

There is no indication in statutory text or legislative history that Congress intended to override tax doctrines that require consistent tax treatment of income regardless of whether it is accelerated or otherwise spread across multiple tax years. And there certainly is no indication that Congress intended to impose the anomalous and arbitrary result that the IRS seeks to impose here.

CONCLUSION

The judgment of the Tax Court should be reversed.

Respectfully submitted,

Robert A. Long, Jr.
D.C. Bar No. 415021

Robert A. Long, Jr.
Robert E. Culbertson
Ivano M. Ventresca
COVINGTON & BURLING LLP
One CityCenter
850 Tenth Street NW Washington, DC 20001-4956
(202) 662-6000
rlong@cov.com