Law Office of Charles W. Cope, PLLC | D.C. District Court Finds Denial of Treaty Benefits by IRS is Subject to Judicial Review
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  • D.C. District Court Finds Denial of Treaty Benefits by IRS is Subject to Judicial Review
    September 2015

    On September 18, 2015, the United States District Court for the District of Columbia issued a memorandum opinion in Starr International Company v. United States[1] holding that a decision by the U.S. competent authority to deny the benefits of the 1996 Switzerland-USA Income Tax Convention (the 1996 Treaty”) to the plaintiff, Starr International Company (“Starr”), was reviewable by the court. The decision overturns the position of the IRS announced last month in Rev. Proc. 2015-40 that the U.S. competent authority determines whether a taxpayer qualifies for such discretionary benefits in its “sole discretion.”[2] If this decision is upheld by the Court of Appeals for the District of Columbia, non-U.S. taxpayers who are denied treaty benefits by the U.S. competent authority under the discretionary relief provision found in the limitation on benefits article of most U.S. income tax treaties will be able to look to the courts for relief.  Thus, in many cases, the courts would become the ultimate arbiter as to whether relief is available to a resident of another country under a U.S. income tax treaty.
    Starr is the largest shareholder of the global insurance company AIG. For many years, Maurice Greenberg was AIG’s CEO, and Starr funded discretionary compensation plans for the executives of AIG.  Starr stopped funding AIG’s executive compensation plans after Mr. Greenberg was forced to resign in connection with an investigation by the New York Attorney General into accounting irregularities at AIG.[3]
    Starr was originally tax resident in Bermuda, but, in 2004, the company moved its corporate headquarters from Bermuda to Ireland. In 2005 Starr relocated its headquarters from Ireland to Switzerland in order to protect its assets from a lawsuit filed by AIG that argued Starr was contractually obligated to continue to fund the compensation plans.
    While tax resident in Ireland, Starr had qualified for the benefits of the U.S. income tax treaty with Ireland, which reduced the statutory U.S. withholding tax of 30 percent on the dividends that AIG paid to Starr. After the move to Switzerland, Starr wished to claim the benefits of the 1996 Treaty in order to claim a similar reduction in the U.S. withholding tax. In order to qualify for the benefits of the 1996 Treaty, Starr needed to satisfy one of the bright-line tests in the limitation on benefits article of the treaty.
    In 2007, concluding that it did not satisfy any of the tests specified in the treaty, Starr requested the U.S. competent authority to exercise its discretion to grant benefits under the 1996 Treaty.[4] As Starr was unable to substantiate that it was entitled to treaty benefits in the standard manner, AIG withheld U.S. tax at the rate of 30 percent on dividends paid to Starr in 2007 and 2008. While the U.S. competent authority was considering Starr’s request, Starr filed a 2007 tax return with the IRS that it identified as a “protective refund claim.” It did the same for 2008.
    In October 2010, the U.S. competent authority denied Starr’s request for benefits and did not pay a refund for 2007.[5] However, the IRS did issue a tax refund for the 2008 tax year.
    In 2014, Starr brought suit for refund under 26 U.S.C. § 7422[6] and 28 U.S.C. § 1346(a)(1)[7] claiming that the U.S. competent authority had abused his discretion in denying Starr the benefits of the 1996 Treaty. The IRS counterclaimed that Starr had fraudulently procured its refund for the 2008 tax year because it had failed to notify the IRS office with which it had filed the refund claim that its request for treaty relief with the U.S. competent authority was pending. The memorandum opinion deals only with Starr’s complaint and the IRS’s defenses.
    Analysis of the court
    In finding for Starr, the district court considered several questions. The first is whether the “committed-to-agency discretion” exception to judicial review can apply to a tax refund suit or is limited to a suit brought under the Administrative Procedure Act (the “APA”). If the exception is not limited to APA suits, the next issue is whether the 1996 Treaty precludes judicial review of the U.S. competent authority’s finding. The third question is whether the U.S. competent authority’s denial of treaty benefits may not be reviewed by the courts for lack of a meaningful legal standard. Finally, the final question is whether the political question doctrine precludes the court’s consideration of Starr’s request for relief.
    The Committed to Agency Discretion Exception
    The first issue is whether an agency action that is outside the scope of the APA is, nevertheless, subject to the exception for an issue that is committed to agency discretion. Starr argued that this exception should be limited to agency actions governed by the APA. The District Court finds, however, that there was case law supporting the view that even if the APA is not the source of the exception to judicial review, it provides a framework for reviewing a decision of an agency. Thus, the court proceeds to consider whether that exception should apply in this case.
    Whether the 1997 Treaty Precludes Judicial Review
    Citing the Supreme Court, the District Court finds that “an action is committed to agency discretion if the applicable provision of law ‘is drawn so that a court would have no meaningful standard against which to judge the agency’s exercise of discretion.’ Heckler v. Chaney, 470 U.S. 821, 830 (1985).” The District Court then finds that the IRS did not show clear and convincing evidence of an intent to limit judicial review.
    Although the language of the discretionary relief provision of the 1996 Treaty is “broadly permissive” and leaves the court “little to latch onto,” the court finds that the U.S. Treasury’s Technical Explanation to the 1996 Treaty (the “Technical Explanation”) provides a sufficient standard to apply in order for a court to review the determination of the U.S. competent authority. The court views the Technical Explanation as clarifying the applicable legal standard and notes that because the Technical Explanation was available when the Senate considered whether to approve the 1996 Treaty, the Senate was put on notice as to how the Treasury would exercise its authority when discretionary relief was sought.[8] The district court goes on to state that the 1996 Treaty “enables courts to review the IRS’s actions against a coherent legal benchmark: the ‘principal purpose test.’”[9]
    Whether There Exist Manageable Standards for Review
    The court begins its analysis by observing that even if the statutory text provides no “judicially manageable standards” an agency, by supplying a list of factors to guide its determinations, may provide a standard for judicial review. The court also notes that the Court of Appeals for the D.C. Circuit is willing to consider documents generated by the agency well after the passage of the statute. 
    The IRS argued that the standard in the Technical Explanation was not sufficiently specific to allow judicial review. The District Court finds, however, that “the Court is not so daunted by the prospect of reviewing the IRS’s determinations” under the principal purpose test of the Technical Explanation and notes that courts have reviewed Treasury regulations that utilize a principal-purpose standard.[10]
    Whether the Case is Non-Justiciable under the Political Question Doctrine
    The final issue considered by the District Court is whether the political-question doctrine bars judicial review in this instance. The court concludes that the doctrine does not.
    Initially, the district court notes that the courts have the authority to construe treaties. The District Court then refers to a Supreme Court decision, Zivotofski v. Clinton 132 S. Ct. 1421 (2012), for the relevant legal standard: “a political question exists ‘where there is a textually demonstrable constitutional commitment of the issue to a coordinate political department; or a lack of judicially discoverable and manageable standards for resolving it.’” The court finds that whether Starr should be denied treaty benefits is not committed “to the Executive’s unfettered discretion. [citations omitted].” Also, there is a sufficiently manageable standard for judicial review in this case.
    The next step in this litigation is for the court to consider whether Starr should be granted treaty benefits under the principal purpose test described in the Technical Explanation.  After that opinion is issued, the losing party is likely to appeal to the D.C. Circuit.
    This decision is significant as more taxpayers now will be willing to request treaty benefits from the U.S. competent authority because they will have recourse to the courts should the U.S. competent authority deny those benefits. Moreover, as the standards for judicial review and the granting of treaty benefits are developed by the courts, tax advisors likely will be willing to opine on whether a court would find for the taxpayer should the IRS denied treaty benefits. Based on the government’s position set out in the recently issued Rev. Proc 2015-40, the IRS is likely to continue to resist these development.
    [1] Case No. 14-cv-01593 (September 18, 2015).
    [2] See Rev. Proc. 2015-40, section 3.06(2)(b): “The U.S. competent authority in its sole discretion may grant benefits under the discretionary provision of an LOB article in a U.S. income tax treaty.”
    [3] See Hank Greenberg Still in the Ring at 90, Battling A.I.G. Charges, NY Times, April 30, 2015.
    [4] Paragraph 6 of article 22 provides “A person that is not entitled to the benefits of this Convention pursuant to the provisions of the preceding paragraphs may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.”
    [5] In reaching its decision, the U.S. competent authority did not consult the Swiss competent authority.
    [6] This section of the Internal Revenue Code is entitled: Civil Action for Refund
    [7] This section provides: The district courts shall have original jurisdiction, concurrent with the United States Court of Federal Claims, of: (1) Any civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws;
    [8] The IRS recently has issued additional guidance as to the factors it considers when deciding to exercise its discretion to provide treaty benefits.  See Rev. Proc.
    [9] The IRS had rejected Starr’s request for treaty benefits because it could not conclude that obtaining treaty benefits was not at least one of the principal purposes for Starr moving to Switzerland.
    [10] Rev. Proc. 2015-40 sets out the standard that the IRS applies today in some detail.