US business groups file lawsuit challenging tax inversion regulations

Two US business groups today filed a lawsuit in Federal court challenging the validity of US tax regulations aimed at stopping “serial” corporate inversions.

The court action, brought by the US Chamber of Commerce and the Texas Association of Business, accuses the government of exceeding its authority and circumventing the Administrative Procedures Act when issuing the temporary regulations last April.

“Treasury and the IRS ignored the clear limits of a statute, and simply rewrote the law unilaterally. This is not the way government is supposed to work in America,” said US. Chamber President and CEO Thomas J. Donohue.

The regulations tighten rules designed to prevent companies from moving their tax and legal residence offshore to avoid US tax while continuing to maintain operations in the US.

They are widely believed to have been enacted to prevent a pending merger between Pfizer and Allergan, which would have been the biggest inversion in US history terms of transaction value. In fact, the day after the regulations were issued, Pfizer and Allergan announced their intention to abandon their merger.

Under the regulations, foreign parent stock attributable to assets acquired from a US company within three years would be disregarded for purposes of calculating the 60 percent and 80 percent thresholds of section 7874.

This means that, after a merger, it would be more likely that the combined business would be subject to US taxation under section 7874 rules that apply when the shareholders of the former US company own at least 80 percent of the combined company or, alternatively, the combined business would face a loss of tax benefits under section 7874 rules that apply when the former shareholders own at least 60 percent of the combined firm.

According to the business groups, though, Treasury’s only authority to affect the statutory percentages through regulations is a limited power to disregard transactions that are part of a plan to avoid the numerical thresholds of Section 7874.

The government lacks authority to issue the temporary regulations at issue, the plaintiffs argue, because the regulations apply even if the previous acquisitions were not part of a plan to avoid the framework of Section 7874.

The groups also claim that Treasury failed to give a reasoned explanation for its action, and the regulations are thus arbitrary and capricious and must be set aside.

Further, they argue that, by issuing the regulations in temporary form and making them effectively immediately, the government has violated the notice and comment requirement of the Administrative Procedures Act.

Lily Fu Claffee, chief legal officer of the US Chamber of Commerce, said that the government offered no justification for avoiding their legal obligations under the Administrative Procedure Act.

“The IRS should not act as if they are above the basic rules that govern all federal agencies,” she said.

The lawsuit was filed in the US District Court of the Western District of Texas.

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