GILTI Disqualified Basis Regulations Invalid

In Keysight Technologies Inc. & Subsidiaries v. United States, the Court of Federal Claims held that Treasury Regulation Section 1.951A-2(c)(5) is invalid. The case addresses the U.S. Department of the Treasury’s attempt to limit an advantage for certain fiscal-year taxpayers when computing reductions in GILTI. The decision signals closer scrutiny of agency authority for regulations post-Loper Bright Enterprises v. Raimondo.

Background

Section 951A, enacted by the Tax Cuts and Jobs Act of 2017, requires U.S. shareholders of controlled foreign corporations (CFCs) to include their share of a CFC’s net tested income in current year taxable income as GILTI. Tested income generally is determined by starting with the CFC’s gross income, excluding specified categories, and subtracting properly allocable deductions from the income. Specifically, as relevant to the regulation at issue, Section 951A(c)(2)(A)(ii) defined tested income as the excess (if any) of the CFC’s gross income over the deductions (including taxes) properly allocable to such gross income under rules similar to the rules of Section 954(b)(5) (or to which such deductions would be allocable if there were such gross income).

The dispute in Keysight arose from a timing mismatch built into the transition to GILTI. Some taxpayers with fiscal-year CFCs could obtain an advantage by claiming deductions associated with basis created during a transition period Treasury viewed as outside the intended reach of the new regime. Treasury responded by issuing Treasury Regulation Section 1.951A-2(c)(5), which generally treats basis created during this gap period as disqualified basis and prevents depreciation, amortization, and other deductions attributable to disqualified basis from reducing gross tested income. Keysight claims that, absent the regulation, it was entitled to Section 197 amortization deductions related to subsidiaries for 2020 through 2022.

In Loper Bright, the Supreme Court overruled the longstanding Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. deference doctrine and reaffirmed that courts bear the ultimate responsibility for interpreting statutes. Against that backdrop, Keysight argued that Treasury Regulation Section 1.951A-2(c)(5) is invalid because the regulation exceeded the Treasury’s authority and is contrary to statute.

Highlights of the decision

The court explicitly rejected the government’s reliance on Section 7805(a) as an all-purpose source of authority for regulations. In the court’s view, a general grant of authority to prescribe needful rules and regulations under Section 7805(a) does not give Treasury authority to issue regulations absent specific authority under the statute.

Crowe observation

The case could have consequences beyond the regulation at issue, especially as tax regulation preambles rely more heavily on Section 7805(a) as a source of authority.

The court examined whether there is authority under the statute and concluded that Section 951A(c) provides no statutory basis, either express or implied, for the challenged regulation. It emphasized that Congress expressly granted Treasury regulatory authority in other portions of Section 951A tied to specific subsections and conditions (for instance, the anti-abuse provision in Section 951A(d) relating to qualified business asset investment) but did not include a comparable delegation of authority with respect to the tested income provisions at issue here.

The government also relied on Section 951A’s reference to rules similar to Section 954(b)(5) for authority. Under the government’s argument, Section 954(b)(5) includes explicit language authorizing the secretary of the Treasury to issue regulations defining “properly allocable,” and that authority was incorporated by reference into Section 951A. The court disagreed, finding that Section 954’s regulatory authority is applicable, by its own terms, only to that section.

Treasury further argued that the regulation was needed to stop certain fiscal-year taxpayers from exploiting a transition mismatch. Although the court acknowledged Treasury’s concern that fiscal-year filers could benefit in a way that calendar-year filers could not, it disagreed that the statute provided authority for anti-abuse regulations that override the statutory structure Congress enacted or that benefiting when complying with the statute should be treated as abusive.

The court also was unpersuaded that the regulation was consistent with the statute. Relying heavily on its analysis of authority, the court found Treasury’s interpretation of “properly allocable” unpersuasive, concluding that the regulation lacked sufficient support in statutory text, historical usage, and allocation principles previously applied by Treasury.

Together with the recent Tax Court decision in Siemens Medical Solutions USA Inc. v. Commissioner, Keysight continues a streak of taxpayer wins challenging the validity of regulations in a post-Loper Bright world.

Looking ahead

Since the decision can be appealed, it does not settle the issue regarding validity of the regulations. Nevertheless, taxpayers affected by Treasury Regulation Section 1.951A-2(c)(5) should work closely with their tax advisers to evaluate whether open years support opportunities for refund claims, amended returns, or protective claims. More broadly, the decision also might prompt taxpayers to revisit other regulations that rely on limited or disputed grants of statutory authority, particularly as courts continue to define the contours of agency rulemaking authority in the post-Loper Bright environment.