The lawsuit, filed on behalf of the Memphis-headquartered company and its subsidiaries, took aim at Section 965 transition tax rules, which were made final at the beginning of 2019. Specifically, it took aim at a subsection that “purports to eliminate a foreign tax credit granted by Congress for taxes that FedEx and its foreign affiliates actually paid,” according to the complaint.
The company said invalidating the provision would enable it to access the $89 million refund through tax credits that are unavailable under the final rules.
This isn’t the first lawsuit to challenge the transition tax rules. In Silver v. IRS, a U.S. citizen with an accounting and law firm based in Israel has argued that the way the rules were issued failed to comply with multiple procedural requirements.
The transition tax, created in the 2017 tax law, applied to the untaxed foreign earnings of U.S. shareholders of certain foreign corporations, treating the earnings as if they were brought back to the U.S.
FedEx argued that the final rules prevented it from claiming foreign tax credits for foreign taxes that were paid on a controlled foreign corporation’s offset earnings—meaning the net amount of earnings computed by offsetting positive earnings and profits by negative earnings and profits. It said the IRS and Treasury replaced Congress’s “clear legislative text” in the 2017 tax law with their “preferred policy choice” when issuing the final rules.
FedEx said it overpaid taxes for tax years spanning June 1, 2017, to May 31, 2019, because the rules requiring those taxes are arbitrary and capricious under the Administrative Procedure Act, a law that establishes agency requirements for certain regulations. It reasoned that the rules expose the company to a greater tax on its future transactions and don’t treat the company as well as similarly situated taxpayers simply because of the company’s foreign operations structure.
FedEx also alleged the IRS and Treasury violated the APA’s requirement to provide notice and respond to comments on proposed rules, writing that they didn’t give “meaningful consideration to alternative views from interested parties.”
The company also said the rules were wrongly made applicable to transactions that occurred before the code section’s enactment and more than a year before the final rules’ publication in the Federal Register.
In a statement emailed to Bloomberg Tax, John Scruggs of FedEx said the company pays all its taxes and that the challenged rules contradict provisions of the 2017 tax law and the tax code.
The Treasury and Justice departments didn’t respond to requests for comment.
Tie to Supreme Court Case
FedEx said it had to treat the rules as valid, pay the taxes, and then sue for a refund because the U.S. Court of Appeals for the Sixth Circuit—the appeals court with jurisdiction over Tennessee federal district courts—has interpreted a law known as the Anti-Injunction Act in a way that prohibits bringing the lawsuit sooner. The company cited a Sixth Circuit decision in CIC Services, LLC v. IRS, on which the U.S. Supreme Court will hold oral arguments on Dec. 1.
The Supreme Court has been asked to rule on the scope of the Anti-Injunction Act, which the Sixth Circuit interpreted as prohibiting Tennessee firm CIC Services from bringing its lawsuit challenging an IRS reporting requirement before violating the requirement and paying a penalty.
But if CIC Services is ultimately penalized by the IRS, or the Supreme Court finds it doesn’t need to be penalized in order to bring its suit, it will be able to get a court to rule on its core allegation: that the IRS failed to abide by requirements under the Administrative Procedure Act when it created the reporting requirement.
The outcome on that issue could have implications for the fate of FedEx’s lawsuit, said Robert Russell, counsel at Kostelanetz & Fink LLP in Washington.
“There’s certainly an argument to be made on the rulemaking process under 965, but importantly, how much deference the government is given is part of the APA discussion, which is a much bigger discussion than 965,” he said.
The case is FedEx Corp. v. United States, W.D. Tenn., No. 2:20-cv-02794, complaint filed 11/2/20.
—With assistance from Siri Bulusu.