How the Keysight Decision Will Impact Future Tax Litigation Cases

Recently, the U.S. Court of Federal Claims decided Keysight Technologies, Inc. v. United States, No. 25-137. Keysight held that the Treasury Department exceeded its statutory authority when it issued a regulation governing the Global Intangible Low-Taxed Income (“GILTI”) tax regime. Keysight Technologies interpreted the United States Supreme Court decision in Loper Bright Enterprise v. Raimondo, 603 US 369 (2024).

Recently, in Relentless Inc. v. U.S. Department of Commerce and Loper Bright Enterprise v. Raimondo, the Supreme Court overruled more than four decades of deference to federal agencies known as the Chevron doctrine. Under the Chevron doctrine, federal courts were often required to defer to “permissible” agency interpretation of the statutes those agencies administer-even when a reviewing court reads the statute differently. The Supreme Court held in Loper Bright that the Administrative Procedure Act (“APA”) requires courts to exercise their independent judgment in deciding whether an agency has acted within its statutory authority, and courts may not defer to an agency interpretation of the law simply because a statute is ambiguous. This article discusses the impact that Loper Bright will have on tax litigation cases involving the Internal Revenue Service (“IRS”).

The Application of the APA to Federal Agencies

Congress in 1946 enacted the APA “as a check upon administrators whose zeal might otherwise have carried them to excess not contemplated in legislation creating their offices.” The APA prescribes procedures for federal agency action and delineated the basic contours of judicial review of such action. And it codifies for agency cases the unremarkable, yet elemental proposition reflected by judicial practice dating back to Marbury v. Madison, 5 U.S. 137 (1803): that courts decide legal questions by applying their own judgment. The APA specifies that courts, not federal agencies, such as the IRS, will decide “all relevant questions of law” arising on review of agency action, even those involving administrative law. See 5 U.S.C. 706. It prescribes no deferential standard for courts to employ in answering those legal questions despite mandating deferential judicial review of agency policy-making and factfinding. See 5 U.S.C. Sections 706(2)(A), (E).

Courts exercising independent judgment in determining the meaning of statutory provisions, consistent with the APA may seek aid from the interpretation of those responsible for implementing particular statutes. When the best reading of a statute is that it delegates discretionary authority to an agency, the role of the reviewing court under the APA is to independently interpret the statute and effectuate the will of Congress subject to constitutional limits. According to the holding of the Supreme Court in Loper Bright, the deference that Chevron requires of courts reviewing agency action cannot be squared with the APA.

Chevron v. NRDC

Chevron, U.S.A. Inc. v. NRDC, 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984) was decided in 1984 by a bare quorum of six Justices. Chevron set forth a deferential judicial approach to federal agency interpretation of law, one which we shall examine in detail. Chevron began as a challenge to EPA rules defining the phrase “stationary source” in the “new source review” program established by the 1977 amendments to the Clean Air Act. See 42 U.S.C.A. Section 7409. The 1977 amendments imposed more stringent air quality requirements on states that had not yet reduced pollution to levels below certain ambient standards in what the statute called nonattainment areas. These provisions required permits “for the construction and operation of new or modified stationary sources” of air pollution. See 42 U.S.C.A. Section 7502. A state could issue a permit for construction of a new or modified major source in a nonattainment area only if the proposed source met these stringent requirements. The EPA initially interpreted “stationary source” to include all individual pieces of pollution-emitting equipment within a plant. The EPA, however, conducted a subsequent rulemaking proceeding, the end result of which was to repeal these earlier rules and to replace them with the so-called “bubble” approach. Under the “bubble” approach, EPA defined a major stationary source as the entire plant rather than the individual facilities within the plant.

On appeal, the D.C. Circuit Court of Appeals overturned the EPA’s new interpretation of “stationary source.” The court found that Congress had no specific intent concerning the term “stationary source,” particularly as it applied to the bubble concept. Nevertheless, the court reversed the agency based on its own interpretation of that term in light of the overall purposes of the amended Clean Air Act.

The Supreme Court reversed the Court of Appeals, and in doing so, appears to have narrowed the range of legal issues in which courts are expected to have the final say. The Supreme Court disagreed with the D.C. Circuit’s willingness to substitute its legal interpretation for that of the federal agency when the statute in question was ambiguous and was being applied to a policy approach to pollution on which Congress provided no express direction. The Supreme Court set forth a two step approach to the review of questions of law:

“If Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency’s answer is based on a permissible construction of the statute.” See Chevron, 467 U.S. at 843, 104 S.Ct. at 2782.

To uphold the agency’s interpretation, the court need not conclude “that the agency construction was the only one it permissibly could have adopted, or even the reading the court would have reached if the question had arisen in a judicial proceeding.” It need only conclude that the agency’s interpretation was a “permissible” one. Buttressing the Chevron court’s deferential approach to agency interpretations was the fact that certain agencies are connected to an electorally accountable branch of government- the executive. Justice Stevens thus spoke in terms of presidential deference:

“Judges are not experts in the field, and are not part of either political branch of the Government. Courts must, in some cases, reconcile competing political interests, but not on the basis of the judges’ personal policy preference. In contrast, an agency to which Congress has delegated policy-making responsibilities may, within the limits of that delegation, properly rely upon the incumbent administration’s views of wise policy to inform its judgments. While agencies are not directly accountable to the people, the Chief Executive is, and it is entirely appropriate for this political branch of the Government to make much policy choices- resolving the competing interest which Congress itself either inadvertently did not resolve, or intentionally left to be resolved by the agency charged with the competing interest which Congress left to be resolved by the agency charged with the administration of the statute in light of everyday realities.” See Chevron, 467 U.S. at 865-66, 104 S.Ct. at 2793.

Chevron’s two step approach to judicial review has clearly changed the “mood” of reviewing courts when dealing with questions of statutory interpretation and to some extent it has changed the law of judicial review of agency interpretation as well. By asking first whether Congress spoke “precisely” to the statutory issue in question, and second, whether or not Congress’ intent was “unambiguously clear” on that issue, the Supreme Court has narrowed the category of issues involving the kinds of questions of law that a court is willing to examine closely, and has expanded the number of agency decisions to which it will defer. If a reviewing court is satisfied that there is no clear congressional intent respecting the precise question at issue, a reasonableness test applies to the agency’s interpretation of the statute involved. As the Chevron court noted, “the court may not substitute its own construction for a reasonable interpretation” by the agency. This is the case, even if the court would have reached a different conclusion in a judicial setting. Reasonableness review usually involves “the agency’s textual analysis (broadly defined, including where appropriate resort to legislative history) and the compatibility of the inquiry with the congressional purpose informing the measure.

Loper Bright Decision

In Loper Bright, the Supreme Court overruled Chevron. Under Chevron’s first step, the Court asked whether Congress spoke to the issue at hand. If yes, the Court followed Congress’ wishes. If the statute was silent or ambiguous, under the second step, the Court asked whether the regulation was a “permissible construction” of the statute. Under Chevron, the Court was not to enforce its own view, but instead was supposed to defer to the expertise of the agency that had issued the regulation as long as the regulation was reasonable- commonly referred to as Chevron deference. Now, under Loper Bright, courts are required to “exercise their independent judgment in deciding whether an agency has acted within its statutory authority.” Under Loper Bright, questions of statutory interpretation should be answered by judges and not federal agencies.

The Impact of Loper Bright on Tax Litigation Cases

As discussed above, under Loper Bright, statutory interpretation should be left to the courts and not federal agencies. The Supreme Court in Loper-Bright identified one exception to this general rule. According to the Supreme Court, when Congress expressly delegates authority to a federal agency, the court’s role is simply to “effectuate the will of Congress.” The Department of Treasury and one of its divisions, the IRS are the federal administrative agencies responsible for overseeing the tax laws promulgated and enacted by Congress. Internal Revenue Code Section 7805 authorizes the Department of Treasury and the IRS to issue regulations to provide guidance in applying new legislation and to address uncertainty that arises with existing Internal Revenue Code provisions. Such regulations are intended to interpret and provide directions on complying with the tax law enacted by Congress. Treasury Regulations are referred to as either legislative or interpretative:

Legislative regulations establish substantive law and are issued pursuant to specific grant of authority from Congress. Normally, when such authority is granted, the statute provides that “the Secretary shall provide such regulations as may be necessary or appropriate to carry out the provisions of this section.” Before the Treasury can issue regulations, the APA requires that certain rulemaking procedures be conducted, such as giving public notice and a period during which the public can comment on the regulation. Interpretative regulations do not establish substantive law. Instead, they clarify previously enacted law. These regulations are issued under the general authority of Section 7805(a) of the Internal Revenue Code, which empowers the Treasury Secretary to “prescribe all needful rules and regulations” to enforce the Internal Revenue Code.

Post Loper Bright, the Department of Treasury and the IRS have argued that Section 7805 makes it clear that Congress wants it to be the primary interpreter of the Internal Revenue Code and the tax law in general. And, even under Loper Bright, Congress can, in effect, designate a federal agency as a primary interpreter of an area law involved. This does not, however, mean that the agency’s power in this regard is unlimited. It can be overturned, but only if the Secretary exceeded his statutory authority or if the regulation is ‘arbitrary, capricious, or an abuse of discretion, or otherwise not in accordance with the law.” See, e.g., Massachusetts v. Secretary of HHS, 749 F.2d 89 (1st Cir.1984), cert. Denied 472 U.S. 1017, 105 S.Ct. 3478, 87 L.Ed.2d 613 (1985).

The Plaintiff in Keysight Technologies argued that “it is entitled to an amortization deduction under Section 197 of the Internal Revenue Code when computing its GILTI inclusion under Section 951A.” Keysight Technologies further argued that had Treasury Regulation Section 1.951A-2(c)(5) had never been promulgated, Keysight Technologies would have been permitted to utilize a Section 197 amortization deduction when computing its GILTI inclusion. As a result Keysight Technologies challenged the validity of Treasury Regulation Section 1.951A-2(c)(5). Keysight Technologies took the position that Treasury Regulation Section 1.951A-2(c)(5) “contradicts the promulgated statute; exceeds the Treasury’s authority; and is not a logical outgrowth of the proposed rule in violation of the APA.

The Court of Claims stated in its opinion that “when Chevron fell, so too did the presumption that statutory ambiguity favoring government agencies. According to the Court of Claims, under this new reality, “Loper Bright unambiguously reassigned interpretive authority to the courts.” Consequently, courts now have the final word on statutory meaning and that “agency interpretations of statutes are not entitled to deference.” More importantly, “the general grant of authority in Section 7805(a) standing alone, is insufficient to supply the requisite authority to the” IRS or Department of Treasury. “

Under the Court of Claims interpretation of Loper Bright in Keysight Technologies, the IRS and the Department of Treasury will no longer be the primary interpreter of tax law under Section 7805.

The Ordinary Meaning of Statutory Terms and Loper Bright

In addition, there was a dispute in Keysight Technologies involving the term “properly allocable.” The core of the dispute was whether the government could redefine the term “properly allocable” in order to deny deductions that were related to the GILTI regime. The government argued that because the term “properly allocable” is not defined in the Internal Revenue Code, the Department of Treasury is authorized to elect to determine its definition. Keysight Technologies is not the only case in which the Department of Treasury has attempted to redefine statutory terms to save the government’s position in litigation. According to the Court of Claims, permitting the Treasury Department to read ambiguity into the Internal Revenue Code and have unfettered discretion of the definition of key terms is “precisely the kind of agency overreach Loper Bright was designed to foreclose”

Conclusion

For many years, the Treasury Department and the IRS had general rulemaking authority under Internal Revenue Code Section 7805 to prescribe “all needful rules and regulations.” Section 7805 provided the Treasury Department and the IRS blanket authority to interpret the tax law and draft regulations as the Treasury Department and the IRS saw fit. The Treasury Department and the IRS also believed that Section 7805 provided them with some kind of Loper Bright exception. Recent court decisions have put an end to this old framework. As a result, taxpayers will likely revisit and challenge Treasury Regulations more frequently.

Anthony Diosdi is one of several international tax attorneys at Diosdi & Liu, LLP. As an international tax attorney, Anthony Diosdi provides international tax advice to closely held entities and publicly traded corporations. Anthony Diosdi also represents closely held entities and publicly traded corporations in IRS examinations. Diosdi & Liu, LLP has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.