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In a split decision, the 6th U.S. Circuit Court of Appeals affirmed a lower court’s dismissal of a lawsuit challenging an Internal Revenue Service notice highlighting potential problems with microcaptives and imposing reporting requirements.
In November 2016, the IRS published a notice that identified certain microcaptive transactions as transactions of interest that have "a potential for tax avoidance or evasion," but noting the IRS lacked sufficient information to distinguish between lawful and unlawful transactions, according to the decision in CIC Servs. LLC. V. Internal Revenue Service, published by the Cincinnati-based appeals court on Wednesday. By deeming these transactions to be reportable transactions, the notice imposed requirements and potential penalties on taxpayers engaging in them and on material advisers aiding in them.
In March 2017, Knoxville, Tennessee-based CIC Services, a material adviser to taxpayers engaging in microcaptive transactions, filed a complaint in the U.S. District Court for the Eastern District of Tennessee in Knoxville alleging that the notice was promulgated in violation of the Administrative Procedure Act and the Congressional Review Act and seeking a preliminary injunction. Specifically, the company alleged that the notice was a legislative rule that required notice-and-comment rulemaking, was arbitrary and capricious and required submission for congressional review before it could go into effect.
In April 2017, the district court denied the motion for a preliminary injunction, reasoning that it would not be in the public interest and that plaintiff was unlikely to succeed on the merits, according to the appellate decision. The IRS then moved for dismissal of the lawsuit by asserting it was barred by the Anti-Injunction Act, which prevents federal courts from staying state court proceedings except in limited situations, and the tax exception to the Declaratory Judgment Act, which divests federal district courts of jurisdiction over lawsuits "for the purpose of restraining the assessment or collection of any tax."
In November 2017, the district court granted the dismissal motion and the case was appealed to the 6th circuit, which affirmed the dismissal on Wednesday.
“The broader legal context in which this case has been brought is not lost on this Court,” the two judges affirming the decision stated, citing the IRS’s history of not complying with APA procedures and the company’s contention that the notice was an “obvious violation” of the APA. “But that does not in and of itself give federal district courts subject matter jurisdiction over suits seeking to enjoin the assessment or collection of taxes. Absent further instruction from Congress or the Supreme Court, such suits are barred by the AIA.”
But the dissenting judge disagreed that the Anti-Injunction Act barred the appellate court from reviewing CIC's pre-enforcement challenge of an IRS reporting requirement as that statute sought to ward off undue judicial interference with the process of tax collection, the judge said.
“But the reporting requirement here generates no revenue for the Government,” the judge stated. “And the point of the penalty is to incentivize compliance with the requirement — not to incentivize its own assessment and collection. So it is not at all clear to me that barring CIC's suit serves the purpose of the Anti-Injunction Act. Indeed, the opposite appears true.”
Captives electing to follow Section 831(b) of the U.S. Tax Code have increasingly come under IRS scrutiny, with major cases challenging IRS determinations going against these companies.
“The details of these transactions and their tax implications for those that engage in them are not relevant to this appeal,” the 6th circuit said in a footnote.
A company spokesperson could not be immediately reached for comment while an IRS spokeswoman declined to comment on pending litigation.
A U.S. Tax Court judge handed a victory to the Internal Revenue Service on Monday in a closely watched case involving an 831(b) captive insurer.