In Keysight Technologies, Inc. & Subsidiaries v. United States,¹ the US Court of Federal Claims held that Treasury lacked the authority to issue Treas. Reg. Section 1.951A-2(c)(5) (the disqualified basis regulation). This regulation disallows, for purposes of computing global intangible low-taxed income (GILTI), any deduction or loss attributable to "disqualified basis" arising from certain related-party transactions in the gap period before the effective date of IRC Section 951A. In reviewing Treasury's authority to issue the disqualified basis regulation, the court applied the standard articulated by the Supreme Court in Loper Bright Enterprises v. Raimondo (Loper Bright),² which requires courts to exercise independent judgment in interpreting statutes rather than defer to an agency's interpretation.

Facts

Keysight filed claims seeking refunds of amounts included as GILTI under IRC Section 951A for tax years 2020 through 2022. Keysight argued that it was entitled to compute its GILTI inclusion for each year by taking certain amortization deductions into account under IRC Section 197 with respect to the gross tested income of its controlled foreign corporations (CFCs).

Law

IRC Section 951A was enacted as part of the Tax Cuts and Jobs Act (TCJA) on December 22, 2017. In general, IRC Section 951A requires a US shareholder to include in income its GILTI with respect to its CFCs' earnings for the tax year.

The TCJA created a "gap period" for fiscal-year CFCs between the measurement date for the transition tax of IRC Section 965 and the first CFC tax year subject to IRC Section 951A. Specifically, IRC Section 965 imposed a "transition tax" on US shareholders of certain foreign corporations, including CFCs. Earnings and profits (E&P) subject to the transition tax were determined as of either November 2, 2017 or December 31, 2017, while E&P accruing afterwards was not subject to the transition tax. In contrast, GILTI first applied to CFCs for their tax years beginning after December 31, 2017. Accordingly, GILTI first applied to calendar-year CFCs for their tax years beginning on January 1, 2018 (immediately after the last IRC Section 965 measurement date) but did not apply to fiscal-year CFCs until their tax years began later in 2018 (even as late as tax years beginning on December 1, 2018).

During this gap period, income recognized by a CFC was not includible in the gross income of the CFC's US shareholders under IRC Section 951A or 965. Thus, a CFC could sell an asset to a related CFC, resulting in an increase in the tax basis in the asset acquired by the related CFC buyer with no US federal income tax cost. Then, after IRC Section 951A became effective, the CFC buyer could generally claim depreciation or amortization deductions attributable to that increased basis, thereby reducing its gross tested income and, in turn, its US shareholder's GILTI inclusion.

To address this, Treasury promulgated Treas. Reg. Section 1.951A-2(c)(5) to deny the benefit of "disqualified basis" (basis arising from related-party sales of certain assets during the gap period) in computing a CFC's tested income or tested loss. Specifically, the regulation treats deductions or losses attributable to disqualified basis as not "properly allocable" within the meaning of IRC Section 954(b)(5) to gross tested income (or subpart F income), and therefore unavailable to reduce tested income or other income subject to US tax.

Keysight challenged the validity of the regulation, arguing that a deduction under IRC Section 197 for amortizable basis in CFC-held intangible property should be allowed in computing its GILTI for the tax years in question. Because Keysight sought tax refunds, the case proceeded in the Court of Federal Claims under the court's refund jurisdiction.

Decision of the US Court of Federal Claims

The court found that Treasury lacked the authority to promulgate the disqualified basis regulation. In doing so, the court applied Loper Bright, in which the Supreme Court overturned the longstanding precedent of Chevron U.S.A. Inc v. Natural Resources Defense Council, Inc.³ as the standard for deference to agency decisions where a statute is ambiguous. The majority opinion in Loper Bright stated that, rather than deferring to agencies, courts "must exercise their independent judgment in deciding whether an agency has acted within its statutory authority."

The court first considered Treasury's reliance on its general authority under IRC Section 7805(a) to prescribe all "needful rules and regulations," holding that this general grant of authority, standing alone, is insufficient to support Treasury's issuance of the regulation. According to the court, finding that IRC Section 7805(a) broadly delegates sufficient authority for substantive regulations in all instances would render Loper Bright meaningless.

Next, the court rejected the government's arguments that IRC Section 7805(a)), in conjunction with former Section 951A(c)(2)(A)(ii), gave Treasury the authority to issue the disqualified basis regulation. Former IRC Section 951A(c)(2)(A)(ii) defined tested income of a CFC as "the excess … of deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5)[.]" The court rejected these arguments, finding no delegation of authority sufficient to support the disqualified basis regulations.

Separately, the court considered whether Treasury's interpretation of the phrase "properly allocable" was entitled to persuasive weight under Skidmore v. Swift & Co.⁴ Under Skidmore, an agency's interpretation may be considered persuasive, even if not controlling, depending on factors such as the thoroughness of the agency's consideration, the validity of its reasoning, and its consistency with earlier and later interpretations. The court found Treasury's interpretation of "properly allocable" unpersuasive. Specifically, the court explained that Treasury's interpretation was not sufficiently grounded in the statutory text and that "a clear thread of legislative intent" indicates that the phrase "properly allocable" is generally meant to require a factual relationship between a deduction and some related income. Thus, the court found Treasury's more expansive interpretation of the phrase "properly allocable" unpersuasive and declined to give the regulation weight under Skidmore.

Implications

The Keysight decision may be significant for taxpayers with deductions or losses attributable to disqualified basis. Affected taxpayers may wish to evaluate whether the decision could support protective or actual refund claims for open tax years, taking into account the applicable statutes of limitation and the procedural requirements for pursuing refund claims. In doing so, they should also keep in mind that the government may appeal the Court of Claims decision to the US Court of Appeals for the Federal Circuit.