Arbitrary Debt-Equity Regs Should Be Withdrawn, Attorney Says

I am writing to express my view that the proposed regulations under section 385 are arbitrary and capricious because they address a concern that Congress did not intend for Treasury to address under this section.¹

Section 385 delegates to Treasury the authority to issue regulations that would guide the determination of whether an instrument is a debt instrument or an equity instrument. This delegation is plainly intended to provide Treasury with the authority to issue rules that would aid in the determination of whether a purported debt (or equity) instrument is what it purports to be.² Other Code sections address concerns regarding corporate inversions and earnings stripping.³

The Administrative Procedure Act (APA) requires a court to "hold unlawful and set aside agency action, findings, and conclusions" that the court finds to be "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law."⁴ As the Supreme Court explained,

Additionally, the Supreme Court has recently reaffirmed that it is appropriate to hesitate before concluding that Congress has delegated to an agency the authority to address issues of "deep 'economic and political significance.'"⁹ The proposed rules are estimated to raise $843 million in additional annual revenue through, at least, 2026.¹⁰ This is revenue that Congress could have used to offset additional spending or facilitate tax reform and is plainly of "deep 'economic and political significance.'"¹¹ Accordingly, any doubt as to whether the proposed regulations are within the intended scope of Treasury's delegated authority should be resolved in the negative.

As the proposed regulations have retroactive effect, I respectfully request that Treasury promptly withdraw the proposed regulations.

²See S. Rep. No. 91-552, at 138 (1969) ("In view of the uncertainties and difficulties which the distinction between debt and equity has produced in numerous situations . . . the committee further believes that it would be desirable to provide rules for distinguishing debt from equity in the variety of contexts in which this problem can arise. The differing circumstances which characterize these situations, however, would make it difficult for the committee to provide comprehensive and specific statutory rules of universal and equal applicability. In view of this, the committee believes it is appropriate to specifically authorize the Secretary of the Treasury to prescribe the appropriate rules for distinguishing debt from equity in these different situations.").

³See, e.g., I.R.C. §§ 163(j), 7874.

⁴ 5 U.S.C. § 706(2)(A); see also Dominion Res., Inc. v. United States, 681 F.3d 1313 (Fed. Cir. 2012) (applying arbitrary and capricious review to Treasury Regulations); Altera v. Commissioner, 145 T.C. No. 3 (2015).

⁵Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29, 43 (1983) (emphasis added).

⁶See Prop. Treas. Reg. §§ 1.385-3, -4.

⁷See U.S. Dept. of the Treas., Press Center, Treasury Announces Additional Action to Curb Inversions, Address Earnings Stripping, https://www.treasury.gov/press-center/press-releases/Pages/j10405.aspx (quoting Treasury Secretary Jacob J. Lew: "Today, we are announcing additional actions to further rein in inversions and reduce the ability of companies to avoid taxes through earnings stripping."). Even these concerns do not fully explain the scope of the proposed regulations because, as others have noted, these rules will also sweep up many ordinary business transactions.

⁸See State Farm, 463 U.S. at 43. Taking Treasury's apparent view to its absurd, logical conclusion, Treasury could, in theory, issue regulations that treat all intercompany debt as equity.

⁹King v. Burwell, 135 S. Ct. 2480, 2489 (2015) (quoting Utility Air Regulatory Group v. EPA, 134 S. Ct. 2427, 2444 (2014) (quoting FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 160 (2000))); see also Loving v. I.R.S., 742 F.3d 1013, 1021 (D.C. Cir. 2014) ("The Supreme Court has stated that courts should not lightly presume congressional intent to implicitly delegate decisions of major economic or political significance to agencies.") (citing Brown & Williamson, 529 U.S. at 160).

¹⁰See Regulatory Impact Analysis, IRS-2016-0014-0001.

¹¹King, 135 S. Ct. at 2489 (quoting Utility Air Regulatory Group, 134 S. Ct. at 2444 (quoting Brown & Williamson, 529 U.S. at 160)).