Today we welcome back Professor Andy Grewal, the Orville L. and Ermina D. Dykstra Professor in Income Tax Law at the University of Iowa College of Law. In this post, which originally appeared in the blog Notice & Comment, Professor Grewal discusses the Sixth Circuit decision in Whirlpool v Commissioner, Whirlpool’s petition for certiorari and the issue of phantom regulations. Following Andy’s original post, Whirlpool filed a reply to the government’s brief in opposition. And last week the Supreme Court announced that the case has been distributed for consideration at its upcoming conference on November 18, 2022. Les
As discussed in a prior post, the Sixth Circuit in Whirlpool v. Commissioner, 19 F.4th 944 (6th Cir. 2021), embraced phantom regulations. The court concluded that a statute that contemplated rules applying “under regulations” could operate regardless of whether regulations had been issued under the statute. Though in Whirlpool the Treasury had issued regulations relevant to the dispute, the court ignored them and decided the case based on its own beliefs of what the regulations should say (i.e., the court applied phantom regulations).
Whirlpool involves a complex statutory regime relating to U.S. corporations and their foreign business activities. However, one only needs to understand the basics to appreciate the significant administrative law issue raised by the case. A provision in the tax code, Section 954(d)(2), contemplates that a U.S. company may conduct foreign operations directly (i.e., through a branch) rather than through a separate subsidiary. The statute further contemplates that using a branch rather than a subsidiary may generate tax benefits for the U.S. company. If a U.S. company’s arrangements reveal these elements—that is, if the U.S. company (1) uses a branch and (2) would get tax benefits from using that branch—then, “under regulations prescribed by the Secretary,” the branch will be treated like a subsidiary. This means the U.S. company would lose out on its tax benefits.
Section 954(d)(2)’s structure seems quite clear: If two conditions are met then, “under regulations,” claimed tax benefits may be denied. In Whirlpool, the Solicitor General maintains that the statute does not require regulations to operate. That is, to the Solicitor General, the statute exhibits a “self-executing nature.” Brief at 14. Though the Solicitor General acknowledges “Congress does sometimes ‘expressly condition’ the operation of a statute on agency regulations,” she claims that Congress has not done so under Section 954(d)(2). One must wonder what words the Solicitor General would have wanted Congress to use here. Section 954(d)(2) covers complex material but any English speaker can understand its structure. If two conditions are met, regulations will prescribe a result. If someone were told that she faced consequences “under the law,” she would quite naturally assume that the law must be examined to determine those consequences.
To varying degrees, the Solicitor General, the Sixth Circuit, and the Tax Court claim that Section 954(d)(2)’s “literal” language independently mandates the denial of tax benefits. See Brief at 13-14. But by “literal” language, they mean Section 954(d)(2)’s language, shorn of its reference to regulations. They do not use “literal” literally.
The allegedly literal approach to Section 954(d)(2) becomes even more confounding when one sees how the government interprets “under regulations” in other contexts. In IRS Chief Counsel Adv. 201009013, the taxpayer attempted to claim tax benefits under Section 336(e). Section 336(e), like Section 954(d)(2), states that tax consequences will proceed “[u]nder regulations prescribed by the Secretary.” But unlike Section 954(d)(2), Section 336(e) prescribes favorable tax consequences. In this context, IRS Chief Counsel personnel found that the statute could not apply until regulations were issued, and that the taxpayer’s claim should fail. See also Regulations Enabling Elections for Certain Transactions Under Section 336(e), T.D. 9619, 78 Fed. Reg. 28467 (May 15, 2013) (regulations “permit” taxpayers to invoke Section 336(e) only as of the specified effective date). The government somehow believes that the phrase “under regulations” must be observed in Section 336(e) but ignored in Section 954(d)(2).
If the Supreme Court granted certiorari in Whirlpool, it likely would not bless the government’s opportunistic approach to statutory interpretation. Instead, the Supreme Court would remand the case to the Sixth Circuit. That court simply ignored the regulations issued under Section 954(d)(2). The Supreme Court would likely direct the Sixth Circuit to examine whether and how the regulations affected Whirlpool’s claimed tax benefits. Section 954(d)(2) alone could not dictate the result.
Possibly sensing a remand, and to discourage further review, the Solicitor General claims that the Sixth Circuit made a “statute-specific holding.” Brief at 16. That claim is true, in the sense that courts always reach holdings specific to the statutes in front of them. But there is nothing terribly unique about a statute that contemplates results “under regulations” prescribed by an agency. Statutes in that form pervade the United States Code. In that sense, Whirlpool is hardly “specific.” Instead, it raises tensions with the various Supreme Court and circuit court decisions that say references to regulations mean precisely what they say. See Grewal, Substance Over Form? Phantom Regulations and the Internal Revenue Code, 7 Houston Bus. & Tax J. 42 (2006). As always, whether the Court will grant certiorari remains unpredictable. The Solicitor General’s brief does a perhaps admirable job in opposing certiorari. It takes a relatively straightforward question presented and makes it appear wildly impenetrable, which discourages review. However, even if the Court does not now grant certiorari, issues over phantom regulations demand eventual clarification. As the last four decades have shown, the lower courts’ inconsistent and haphazard approach to them has yielded substantial confusion over numerous major areas of federal tax law.