US court invalidates “serial inversion” tax regulation that ended Pfizer-Allergen merger

by Amanda Varma & Brigid Kelly

A US district court has ruled that the IRS’s temporary ‘serial inversion’ regulations are invalid, concluding that immediately effective temporary regulations are subject to the notice-and-comment requirements of the Administrative Procedure Act (APA) and that the government violated those rules when promulgating the regulations.

The September 29 ruling of the US District Court for the Western District of Texas concerns Temp. Treas. Reg. § 1.7874-8T, which targets inversion transactions in which the foreign acquiring corporation had previously acquired US companies.

The temporary regulations, issued April 2016, are widely believed to have targeted the proposed merger of New York-based Pfizer Inc. and Dublin-based Allergan, where Pfizer would have been combined under Allergan. The day after the regulations were issued, Pfizer and Allergan terminated their proposed deal.

Challenged regulation

The temporary regulations included various rules aimed at limiting inversions.  The regulation challenged in the case, Temp. Treas. Reg. § 1.7874-8T, disregards certain stock of a foreign acquiring corporation that is attributable to prior acquisitions of US entities for purposes of computing the extent to which former shareholders of the US corporation own stock in the foreign acquiring corporation. The percentage of stock owned by former shareholders of the US corporation is relevant to determining whether certain negative tax consequences arise under section 7874.

The text of the temporary regulations, which took immediate effect, also served as the text of simultaneously issued proposed regulations subject to the notice-and-comment requirement under the APA.

Case background

In August 2016, the US Chamber of Commerce and the Texas Association of Business filed a lawsuit alleging, under the APA, that Temp. Treas. Reg. § 1.7874-8T exceeded the agencies’ statutory jurisdiction and that the promulgation of the rule was arbitrary and capricious and done without notice and opportunity for comment in violation of the APA.

The plaintiffs ultimately moved for summary judgment on their claims. The IRS then moved to dismiss the case, asserting that the plaintiffs lacked standing to challenge the rule and that the suit was barred by the Anti-Injunction Act.


The district court determined that the plaintiffs had associational standing based on the fact that at least one of their members, Allergan, would have standing to sue in its own right.

The district court stated that “although . . . facially neutral” in terms of its “general application,” the plaintiffs had shown that Treasury, in promulgating the temporary regulation at issue, had specifically targeted the proposed Pfizer-Allergan merger.  The court further stated that “[i]t is enough that Allergan identified a specific transaction that was thwarted” and “asserted that it would actively pursue other inversions if this court were to set aside the challenged [regulation].”

Anti-Injunction Act

The district court also sided with the plaintiffs in holding that their claims were not barred by the Anti-Injunction Act, which prohibits suits to “restrain[] the assessment or collection of any tax.”

According to the district court, the plaintiffs did not seek to restrain the assessment or collection of a tax, but “challenge the validity of the Rule so that a reasoned decision can be made about whether to engage in a potential future transaction that would subject them to taxation.”

In addition, the district court stated that the challenged regulation “is not a tax, but a regulation determining who is subject to taxation under provisions of the [Code].”

APA & temporary regulations

According to the court, the fact that the regulations were temporary “does not excuse the Agencies from the notice-and-comment procedure required by the APA.”

The court rejected the government’s argument that section 7805(e) permits Treasury and the IRS to issue temporary regulations without notice and comment.

The district court also determined that the rule in question constituted a substantive, or legislative, regulation.

The IRS contended that the regulation was an interpretive regulation, which advises the public of the agency’s construction of the statutes it administers and is not subject to notice and comment.  According to the court, the regulation made “substantive modifications to the application of the statute.”  Consequently, the court concluded that the regulation was subject to the APA’s notice-and-comment requirement.

However, the court rejected the plaintiffs’ claim that the regulation lacked statutory authority, stating that Treasury and the IRS had “broad authority” under the statute.

The court also rejected the argument that the regulation was arbitrary and capricious under the APA, determining that Treasury and the IRS had provided a “thorough explanation and basis” for the regulations in the preamble and did not rely on factors that Congress did not intend for them to consider or fail to consider an important aspect of the issue before them.

Potential implications

The ultimate significance of the district court decision will depend on whether the government appeals and, if it does, what the Fifth Circuit concludes on appeal.

It is possible that the Fifth Circuit would not even reach the APA issue if it disagrees with the district court’s decision regarding either standing or the Anti-Injunction Act.

In the near term, it seems unlikely that, leaving aside any broader regulatory reform efforts being undertaken by the new administration, Treasury and the IRS will change their approach with respect to the issuance of temporary regulations on the basis of one district court decision.

However, given recent successful APA challenges (in this case and the Altera Tax Court case), taxpayers and practitioners are likely to continue to look for opportunities to argue that unfavorable regulations are invalid.

At this point, the impact of the district court decision on inversion transactions is also likely limited.

A would-be inverter that otherwise might be impacted by Temp. Treas. Reg. § 1.7874-8T would still need to grapple with the possibility that another court would reach a different result with respect to the validity of the temporary regulations.

In addition, other anti-inversion regulations, including ones impacting certain post-inversion planning, were not addressed in the case and, in many cases, continue to have a significant impact on the attractiveness of an inversion.  US companies may also be taking a “wait and see” approach with respect to inversions in light of fundamental tax reform.

Amanda Varma

Amanda Varma advises clients on US federal income tax matters, with particular focus on international tax planning and controversies.

Her practice includes counseling domestic and foreign businesses with respect to cross-border acquisitions, business restructurings, and financings, tax treaty matters, deferral and foreign tax credit issues, transfer pricing, and withholding and reporting issues.

She also regularly advises clients on special issues arising in international tax controversies, including competent authority and information exchange. Ms. Varma also represents clients in connection with regulatory and legislative tax policy matters.

Amanda Varma

Brigid Kelly

Brigid Kelly advises clients on a wide range of federal income taxation issues with a particular focus on international tax. She has experience working on tax legislative, transactional, and controversy matters and has represented both domestic and foreign clients.

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