The Supreme Court, Executive Deference, and International Taxes

The current Supreme Court, comprising seven justices appointed by Republican presidents, is “not a normal court,” according to President Biden.

Whether or not the court has “gone rogue,” as some claim, it certainly hasn’t been shy about shredding past precedent and making decisions with wide-ranging effects. On issues like reproductive rights, affirmative action and presidential immunity, the court’s conservative majority has created whole new frameworks from scratch and asserted judicial power in a way that has shocked many legal observers.

Weirdly, one area where the court shied away from flexing its muscle is international taxes. Those issues rarely make it to the Supreme Court anyways, but the Moore case gave the justices a chance to rework the underpinnings of the global tax system. Perhaps realizing it was a thicket they weren’t prepared to cut through, the court’s 7-2 decision declined, leaving the system intact–although some experts believe that both the decision and dissenting opinion leave hints that they may try to eviscerate any future wealth taxes. (See my interview with Missouri law professor David Gamage on the topic here.) Regardless, key international tax provisions like Subpart F are probably in the clear.

There may be other, subtler ways that the Supreme Court put current international tax practices on notice, however. One of the most-watched cases in the court’s 2023 term was Loper Bright Enterprises v. Raimondo, where the court issued a 6-2 decision which overturned “Chevron deference”--the principle that courts should generally concede to a federal agency’s interpretation of an ambiguous statute, established in the 1984 case Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc.

The Loper Bright decision was seen as a dramatic reining in of expansive power of the federal administrative state, something that never sat well with conservative jurists’ skepticism of overbearing government. In theory this would tilt the balance of power back towards Congress, but really it gives the courts much more of a say in determining the application of federal laws. It’s not necessarily true that courts would be less expansive in their interpretations than agencies, although given the right-leaning nature of many sitting judges that would be a good bet. The clearest practical effect of this is going to be many more lawsuits and legal proceedings that could potentially tie up agencies’ rollout of regulations and the implementation of new laws.

Could this affect international taxes, especially transfer pricing? Certainly, a lot of the key laws in the international part of the tax code have a lot of ambiguity.

Internal Revenue Code Section 482, the key statute that allows the government to make transfer pricing adjustments to intercompany transactions, is less than 200 words. Originally, it was only 91 words–one sentence allowing Treasury to “distribute, apportion, or allocate gross income, deductions, credits, or allowances” within an entity or corporate group to “prevent evasion of taxes or clearly to reflect the income.”

Believe it or not, 482 doesn’t actually include the arm’s-length standard, the global principle that internal prices should reflect what independent parties would have paid. That’s mostly laid out in case law and regulations, as well as tax treaties.

More recently, Congress added the “commensurate with income” principle to 482, applying to the transfer of intangible assets. That’s yet another ambiguous, potentially broad statute that the Internal Revenue Service has been reluctant to test.

Last month, I looked at the economic substance doctrine, another creation of the Supreme Court which was recently codified into law. The language Congress used to enact this provision is, well, a little baffling, and can legitimately be interpreted as either an expansion or constriction of the underlying principle. While the doctrine doesn’t only apply to international tax cases, when it is used it’s often to re-examine complex international tax structures which auditors suspect are only for the purpose of reducing overall taxes. The IRS has indicated that it's willing to be more aggressive about applying this principle in the future.

Since a 2011 decision affirming that the Administrative Procedure Act applied to tax regulations, the courts have been more willing to throw out IRS regulations–which in turn has made taxpayers much more eager to challenge them. In the months since the Loper Bright decision was released, many plaintiffs have referred to the opinion in ongoing litigation. (The government has too.)

Given all of this, it would seem that challenges to the international tax framework largely drawn up through Treasury regulation is inevitable, and have decent chances of succeeding.

“Loper Bright might usher in some fundamental changes in how taxpayers think about the entire US transfer-pricing regime,” DLA Piper said in an analysis of the decision. “It is conceivable that Loper Bright might invite taxpayer challenges about whether Congress has the authority to delegate the broad rulemaking authority that the IRS and Treasury have exercised with the regulations they have issued under Section 482.”

But, there are some reasons to doubt that a major overhaul is on its way, as well.

One aspect that makes international tax unique is how much of it is based on treaties. Tax treaties–technically, treaties for the prevention of double taxation–go back decades, even nearly a century, and many of them spell out the arm’s-length standard as well as other basic transfer pricing principles.

As with all areas of law it’s complicated, but treaties that are ratified by the Senate are generally seen as having the force of legislation. So in that sense, the arm’s-length standard is part of the U.S. legal code.

There’s also the subtle but important difference between statutes that are broad on purpose, and statutes that appear to be unintentionally ambiguous, and which agencies take the initiative to fill in the gap. The court has recognized limits on how much Congress can delegate to the executive branch, but it’s a different question than what agencies can do when there’s a genuine question about what a given passage means. Some of the key international tax provisions, especially 482, could be seen as unambiguously broad in the powers granted to Treasury, if somewhat ambiguous in how they might be applied.

And in practice, this may be a kettle of worms that the Supreme Court doesn’t want to be part of. This could end up playing out like Moore–the court takes up a case, sparking lots of speculation, only to be followed with a status quo-confirming decision. Much as they like to see themselves as impartial jurists issuing decisions from above, the justices aren’t removed from the outside world, or the potential consequences of a framework-shattering decision. They live in reality, like the rest of us.

DISCLAIMER: These views are the author's own, and do not reflect those of any employer or client. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

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This Friday, I talk to Jason Yen, current EY principal and former associate international tax counsel as the U.S. Treasury Department's Office of Tax Policy. Yen was a U.S. delegate to the OECD during the recent Two-Pillar project, and was also involved in the 2015 OECD project on Base Erosion and Profit Shifting.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• I probably haven’t been writing about the United Nations tax proceedings as much as I should be. It’s sometimes so easy to get wrapped up in the Organization for Economic Cooperation and Development’s Two-Pillar process, I forget that there’s another important multilateral tax negotiation, happening on my side of the Atlantic no less. It’s just hard to dive in with this without following the daily debates, and even with my newly unemployed status I haven’t found the time. But it’s coming up in conversations with international tax folks more and more, so expect to see some coverage of it in the future. On Sunday, the chair of the ad-hoc tax committee released a revised draft of the “Terms of Reference” for negotiations on a framework convention. It’s hard to know what to make of it without understanding some of the diplomatic nuances, but what strikes me is how broad the scope is, including not just international coordination and anti-avoidance measures but environmental sustainability and equity. (Though references to the "effective taxation" of wealthy individuals have been replaced with addressing "tax evasion and avoidance" by wealthy individuals–a big change.) There’s a lot of potential for mission creep and lack of focus here, although the large scope could draw more countries into the process.
• I haven’t been posting regular updates on countries’ implementation of Pillar Two, because if I did I doubt there’d be room for much else. But given Canada’s importance, both to the U.S. and the world, this seemed worth noting–in its annual budget consultation, released Monday, the Canadian government unveiled new legislation to implement parts of the framework, including the transitional under-taxed profits rule. This includes amendments to prior legislation such as the definition of a “reverse hybrid entity,” part of the OECD’s recent anti-abuse guidance which has raised some objections from taxpayers for being too broad. Translating the OECD guidelines into national statutory text has proven to be especially difficult for some jurisdictions, so many eyes will be pouring over these documents to spot any big disconnects.
• As one of its non-Pillars projects, the OECD has been releasing reports on the pricing of minerals, to help resource-rich but cash-poor jurisdictions in transfer pricing of these potentially valuable assets. Even basic commodities can sometimes be trickier to price than you’d think, but many minerals are seeing their value skyrocket as part of the global decarbonization effort. The OECD latest paper, released Monday, covers lithium, a “critical mineral” that is involved in battery production. “Critical minerals” have been the buzzword in D.C. for the past two years, since the Inflation Reduction Act poured billions of dollars into incentives for renewable energy, including electric vehicles that need special batteries to function. So this analysis could be especially useful to some mining jurisdictions hoping to get into this new global trend.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

Fireball, appearing in Pep Comics #12 in 1941. After surviving a chemical fire set by an arsonist called the Bug, firefighter Ted Tyler found himself able to control and absorb flames. He decided to become an anti-arsonist crimefighter, who is also able to leap great distances and melt bullets.

Contact the author at amparkerdc@gmail.com.