Section 245A Anti-Abuse Regulation Invalid

In Siemens Medical Solutions USA Inc. v. Commissioner, the Tax Court held that the Treasury’s extraordinary disposition rules cannot limit the 100% DRD under Section 245A. The case rejects Treasury’s argument that it has authority to close a transition-period gap for certain fiscal-year taxpayers and reflects judicial scrutiny of agency rulemaking after Loper Bright Enterprises v. Raimondo.

Background

The Tax Cuts and Jobs Act of 2017 (TCJA) transitioned the U.S. international tax system toward a partial participation exemption for corporate foreign earnings through several interrelated provisions with different effective dates.

Section 245A generally allows a 100% DRD for the foreign-sourced portion of a dividend received by a domestic corporation from a specified 10%-owned foreign corporation. Congress made the deduction available for distributions after Dec. 31, 2017. Section 965 imposed a one-time mandatory repatriation tax on accumulated untaxed foreign earnings measured by reference to Nov. 2, 2017, or Dec. 31, 2017. Section 951A introduced the global intangible low-taxed income (GILTI) regime, which generally applies to taxable years of controlled foreign corporations (CFCs) beginning after Dec. 31, 2017.

Due to the mismatch in effective dates, a fiscal-year CFC could earn income after the Section 965 measurement dates but before the GILTI regime became effective, while a later distribution of those untaxed earnings could qualify for the Section 245A deduction. To address this transition-period gap, Treasury issued Temporary Treasury Regulation Section 1.245A-5T in June 2019, including the extraordinary disposition rules to limit the Section 245A DRD during that period. The rules applied to dispositions of certain property by a specified 10%-owned foreign corporation during its disqualified period while it was a CFC if the disposition was to a related party and outside the ordinary course of business. When earnings generated by such dispositions were later distributed, the rules generally disallowed 50% of the Section 245A deduction attributable to the extraordinary disposition amount.

In Siemens, a Dutch CFC that was 67.78% owned by Siemens’ U.S. consolidated group completed an internal restructuring during its fiscal-year ending Sept. 30, 2018. The CFC sold two foreign affiliates to related group members, generating approximately 819 million euros of additional earnings and profits. In March 2019, the CFC made a pro rata distribution, of which approximately $670.6 million was a foreign-source dividend received by Siemens’ U.S. consolidated group. Siemens claimed a full Section 245A deduction and disclosed on Form 8275-R, “Regulation Disclosure Statement,” its position that the extraordinary disposition rules were invalid. The IRS issued a notice of deficiency and disallowed approximately $315 million of the deduction. The company filed a petition in Tax Court challenging the validity of the regulations.

Highlights of the decision

The government argued that the extraordinary disposition rules were valid because they addressed mismatched effective dates that created an unintended tax-free period during which the Section 245A DRD would be allowed. The court disagreed, finding that the resulting gap is a consequence of Congress’ legislative choice rather than an ambiguity Treasury could resolve through regulation. It further concluded that the rules’ narrow focus on related-party transactions of fiscal-year CFCs outside the ordinary course of business did not change the analysis because those limitations are inconsistent with a plain reading of Section 245A.

The court also rejected the government’s reliance on Sections 245A(g) and 7805(a) for authority. Section 245A(g) authorizes Treasury to prescribe regulations that are “necessary or appropriate” to carry out Section 245A. Section 7805(a) more generally authorizes Treasury to prescribe “all needful rules and regulations” for enforcement of the IRC. The court explained that these provisions authorize Treasury to implement the statute but not to impose substantive limitations that Congress did not enact. Although Section 245A(g) provides a specific delegation of regulatory authority, the court noted that it does not authorize Treasury to create an exception to the 100% deduction based on transaction-based criteria absent from the statute. Similarly, Section 7805(a)’s general rulemaking authority does not permit Treasury to impose limitations on the Section 245A deduction that Congress did not include in the statute. Citing Loper Bright, the court emphasized that courts must independently interpret statutes and determine the boundaries of delegated authority. Because the extraordinary disposition rules were inconsistent with Section 245A’s clear statutory language, the court concluded that the regulation was neither necessary nor appropriate and fell outside Treasury’s delegated authority.

Crowe observation

Although Siemens directly considered temporary regulations under Temporary Regulation Section 1.245A-5T, it has implications for the final rule in Treasury Regulation Section 1.245A-5, which contains a comparable limitation.

Together with the recent Court of Federal Claims decision in Keysight Technologies Inc. & Subsidiaries v. United States, Siemens continues a streak of taxpayer wins challenging the validity of regulations in a post-Loper Bright world.

Looking ahead

The government can appeal the decision, and future appellate review or administrative actions concerning Treasury Regulation Section 1.245A-5 could affect the result. Taxpayers whose Section 245A deductions were reduced under the extraordinary disposition rules should consult their tax advisers to review affected distributions and evaluate next steps.