Captive

CIC Services v. Internal Revenue Service is one of the rare tax cases to come before the Supreme Court. While apparently technical, the case has great implications for jurisdiction, administrative law and the tax system overall. The stakes in the case, which will be argued on Tuesday, are about how the government implements a tax code that affects numerous policy spheres outside of mere revenue-raising and how it can fight tax shelters. At the heart of the case are two competing laws. First is the Anti-Injunction Act, which states that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.” The AIA, along with the tax exception to the Declaratory Judgment Act, typically means that taxpayers wishing to challenge a determination of federal tax must either receive a notice of deficiency and sue in the U.S. Tax Court, or exhaust administrative remedies and sue for a refund in either federal district court or the U.S. Court of Federal Claims. But the AIA has started to clash with the Administrative Procedure Act. In its 2011 decision in Mayo Foundation for Medical Education and Research v. United States, the court determined that tax is not separate from the rest of administrative law, and it then evaluated a Treasury Department regulation under the deferential standard of review outlined in Chevron USA v. Natural Resources Defense Council. In pushing against tax exceptionalism in administrative action, the court in Mayo held that the actions of the IRS also fell under the standards outlined in the APA. Under the APA, there is a presumption of pre-enforcement review of agency actions – meaning that individuals or businesses affected by an agency action can normally challenge the action in court before it is enforced against them. This case presents this very clash. CIC Services is a Tennessee company that advises other companies on the practice of “captive insurance” – an arrangement in which a parent company creates a subsidiary insurance company for the purpose of insuring the risk of its owners. CIC sued the IRS seeking an injunction under the APA against a 2016 guidance, known as Notice 2016-66, that made certain micro-captive insurance transactions “reportable transactions.” Under the tax code and Treasury regulations, the IRS can issue notices identifying certain transactions that the agency suspects may be used for tax shelters as reportable transactions. If a transaction is reportable, parties involved in it and their material advisers must provide certain information to the IRS, including the advisers’ client lists. Failure to adhere to these requirements results in penalties under the Internal Revenue Code. Importantly, these penalties, which are found in 26 U.S.C. Chapter 68, Subchapter B, are treated as taxes and have traditionally been viewed as taxes for the purposes of the AIA. Additionally, if the failure to report was criminally willful, criminal sanctions may also arise. CIC argued that it suffered harm from the reporting requirements and that Notice 2016-66 was issued in violation of the APA, because the agency did not hold a public notice-and-comment period before issuing the guidance and because the guidance was arbitrary and capricious — the standard under the APA for when courts must set aside agency actions. But the district court dismissed the case, ruling that the suit was barred by the AIA. CIC appealed to the U.S. Court of Appeals for the 6th Circuit, which affirmed. In its briefing at the Supreme Court, CIC has three major arguments: (1) a textual argument regarding the AIA, (2) a purpose-based argument regarding both the APA and the AIA, and (3) constitutional concerns with the AIA as interpreted by the lower courts. The thrust of CIC’s textual argument is that the text of the AIA does not cover the suit at hand. CIC relies on Direct Marking Association v. Brohl, which addressed the Tax Injunction Act, the AIA sister’s statue for state taxes. The TIA says that federal courts “shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.” At issue in Direct Marketing was a Colorado requirement that out-of-state retailers report sales to Colorado residents so the state could collect sales and use taxes. Failure to do so would result in a penalty. The Supreme Court held that the TIA did not limit federal courts’ jurisdiction over the Colorado reporting requirement because the requirement was prior to and separate from “assessment, levy or collection.” The court also narrowly interpreted the TIA’s use of the word “restrain.” CIC argues that because the TIA is a related statute and relies on federal tax law principles for its interpretation, the AIA should be similarly construed. The IRS requirement is but a reporting requirement prior to assessment or collection, and “restrain” should be interpreted narrowly, so that CIC’s pre-enforcement suit is not barred by the AIA. CIC makes two additional textual arguments. First, the company insists it is not seeking to “enjoin” any tax, even though the penalty for noncompliance with Notice 2016-66 is considered a tax for the purpose of the AIA. The main point is that, because CIC has not yet violated any law, there is no act of assessment to restrain. Any future penalty assessed by the IRS would be merely discretionary and would apply only after the action. Second, CIC points out that it did not bring suit for the purpose of restraining the assessment or collection of the tax. Rather the suit merely challenges the validity of Notice 2016-66. Regarding the purpose of the APA and the AIA, CIC argues that if a penalty is styled as a tax under Subchapter 68B, then the APA is essentially vitiated for most IRS regulations because pre-enforcement review will be generally unavailable. That means that the only way to challenge an IRS reporting requirement would be to first violate the requirement – which in turn undermines the purpose of the AIA to have taxpayers comply with the tax laws. Finally, CIC argues that a broad interpretation of the AIA raises constitutional concerns. The only way to get into court to challenge Notice 2016-66 is to violate the law. If that is done willfully, then there are criminal sanctions. The government provides three arguments as to why the AIA should bar the suit: (1) a textual argument that examines the AIA in the broader statutory context of the tax code, (2) an argument that defanging Notice 2016-66 would essentially stop the assessment and collection of a tax, and (3) a rejection of CIC’s arguments regarding the purpose of the APA and its constitutional concerns. The government argues that the text of the AIA and its statutory context show that CIC’s suit is one seeking to restrain the assessment or collection of a tax. Overall, one must read the AIA in context with the tax code. While the AIA prohibits pre-enforcement injunctive relief, Congress has explicitly provided the refund suit mechanism as a way to challenge IRS actions. In context, then, the AIA serves as a channeling mechanism to the refund litigation scheme. Additionally, Congress is quite explicit as to when it wants to provide an exception to the AIA, and it did not do so here. Furthermore, the government maintains that this case must be about restraining the assessment of taxes. The court has repeatedly held that the penalties in Subchapter 68B are taxes because they are keyed to either the apparent tax savings from a tax-evading transaction or the likely income of a material adviser providing a client with these types of transactions. The government then rejects CIC’s textual arguments. It distinguishes the penalty for failure to report in Direct Marketing from the penalty at issue here. To do so, the government cites a concurring opinion from Justice Ruth Bader Ginsburg in Direct Marketing as well as a 2015 opinion from the U.S. Court of Appeals for the District of Columbia Circuit in Florida Bankers Association v. Department of the Treasury. In Florida Bankers, banks sued to enjoin another reporting requirement backed up by Subchapter 68B penalties. A split panel of the D.C. Circuit found the fact that the penalties were taxes was significant: Enjoining the reporting requirement in Florida Bankers would essentially stop the collection of the taxes. The government’s main point is that here, too, enjoining Notice 2016-66 would enjoin the collection of penalties that are, in fact, taxes. The government notes that Florida Bankers made clear that merely challenging the regulatory aspects of a tax does not allow it to evade the AIA. Finally, the government rejects CIC’s APA and constitutional avoidance arguments. The APA explicitly allows for an override of pre-enforcement review by other statutes precluding judicial review — and the AIA is one such statute. Furthermore, the APA does not authorize a review where there is another adequate remedy in court, and the refund suit procedures are that remedy. On the constitutional avoidance front, the government notes that if one has a good-faith belief that the IRS promulgated Notice 2016-66 improperly, then one can disclose the belief and avoid criminal sanction. Besides the parties’ arguments, two amicus briefs are worth noting because they provide important policy context. Arguing in favor of CIC is Professor Kristin Hickman. She suggests that the IRS and the Treasury Department can no longer be treated as exceptional from general administrative law doctrine. In light of Mayo, tax exceptionalism should end. Indeed, ending tax exceptionalism is especially important since the IRS and Treasury have historically not followed notice-and-comment rulemaking procedures. Furthermore, Hickman says the imperative to narrow the AIA is even more important now because the tax system today regulates vast areas of life. The tax laws are no longer merely revenue raising, but rather affect policy spheres from health care to housing. A brief in support of the government from former government officials, many of whom are now tax professors, provides, in sharper focus, the reason that Notice 2016-66 exists: It came about because of statutes and regulations designed to combat tax shelters. Reportable transactions are transactions used to create tax shelters and issuing subregulatory notices is the main way that the IRS identifies these transactions. Allowing broad pre-enforcement challenges to such notices would kneecap efforts by Congress and the IRS to fight these shelters. The brief also notes that, in particular, micro-captive transactions (which Notice 2016-66 targets) are the source of a great deal of abusive tax planning. Finally, there is an interesting personnel point regarding both Direct Marketing and Florida Bankers, the two most prominent cases in the briefs. Direct Marketing, written by Justice Clarence Thomas, was unanimous. It reversed a decision by a unanimous panel of the U.S. Court of Appeals for the 10th Circuit. Then-Judge Neil Gorsuch was on that panel. Florida Bankers, on the other hand, was an opinion by a divided panel of the D.C. Circuit. Then-Judge Brett Kavanaugh authored that opinion.