‘Killer B’ Final Rules Show IRS Wants to Keep Flexing Its Muscle

The final regulations for certain “Killer B” transactions are the latest step the IRS is taking to assert its ability to regulate transactions it deems abusive. They’re also consistent with its pattern of targeting tax benefits it believes are unintended.

Triangular B reorganizations involve a subsidiary’s use of its parent’s stock to acquire the stock of another company under Section 368(a)(1)(B) of the tax code. In a Killer B transaction, the subsidiary buys that parent’s stock, which is tax-free for the parent to issue under Section 1032.

The IRS has sought to recharacterize that purchase as a Section 301 dividend to increase tax liabilities. Tax professionals have long argued that this was an overreach, and that the deemed dividend mechanism goes beyond the statutory mechanism of turning off corporate status.

While the final rules address the treatment of parent stock and securities in triangular reorganizations involving foreign corporations, the bigger point is that the IRS may be putting taxpayers on notice that its rules should be broadly construed, including by retroactively designating transactions as abusive, which is generally prohibited by Section 7805(b).

When the IRS publishes a notice identifying abusive practices, companies tend to avoid those practices in the interest of corporate governance. This is particularly true for the large public corporations that were engaging in the transactions at issue, even if the transaction fell within the letter of the law.

The new rules won’t change much for multinational companies that have been following the rules in the form of IRS notices that were issued on the topic in 2014 and 2016, followed by proposed regulations in October.

But the stakes are high for multinational corporations that don’t heed the IRS’s warnings. If a company chooses to get involved with a triangular reorganization deemed abusive by the regulations, they’re risking the consequences of being audited by the IRS.

The IRS has adopted a broad interpretation of Section 367. Some commenters have argued in favor of a more narrow interpretation—that Section 1032 transactions aren’t subject to Section 367. However, the Treasury and the IRS declined to construe Section 367 narrowly and promulgated an anti-abuse rule that it believes to pull transactions that may be related to a reorganization through an example some believe extends beyond the rule itself.

It’s unclear whether the government was confidently standing behind Auer deference—perhaps in conflict with the policy behind the US Supreme Court’s recent determination that Chevron deference is no longer appropriate. Auer deference applies to how agencies interpret their own unclear regulation, while Chevron deference required courts to defer to agencies’ reasonable interpretations of unclear laws and ambiguous statutes.

Judges have been empowered by the decision in Loper Bright Enterprises v. Raimondo to broadly apply principles of taxpayer deference. As a result, this potential attempt to stake out and bolster Auer’s agency deference—applicable when interpreting its own rules—may not be met kindly by taxpayers, particularly those who relied on Treasury’s March 2019 policy statement that the IRS won’t argue beyond its own rules.

The Supreme Court’s July 1 decision in Corner Post Inc. v. Board of Governors clarifies that taxpayers harmed by a regulation have six years following the injury to bring an Administrative Procedure Act claim that ultimately could lead to the regulation being found invalid. It’s unlikely that a regulatory example can justify a broad interpretation of the rule.

If a taxpayer was injured by an expansive reading of the rules in the regulations, it wouldn’t be the first time that a taxpayer could argue that the IRS was stretching Section 367 further than Congress intended.

The IRS decided to keep example three in the final regulation because, as included in the preamble, it demonstrates how the same rule from the 2011 Final Regulations applies to different scenarios. Purportedly, the adjustments described in these examples align with what would happen under those regulations since they involve transfers made “in connection with” a reorganization.

But not everyone agrees the examples proposed in 2023 don’t retroactively expand the reach of the 2011 anti-abuse rule. It wasn’t until Notice 2014-32 that a broader interpretation emerged based on this language: “the IRS and the Treasury Department are concerned that some taxpayers may be interpreting the anti-abuse rule too narrowly, including with respect to what constitutes a funding for purposes of invoking the anti-abuse rule.”

If the rule is as broad as the IRS posits, it’s not clear what adjustments the IRS might attempt by arguing a transaction has some connection to a reorganization for which Section 367 might be relevant.

The new rules demonstrate how the APA still affects how federal administrative agencies may propose and establish regulations. By posting the Killer B guidance last fall and allowing public participation in the rule-making process in the form of comments, the IRS allowed for feedback and engagement on the topic.

As articulated in the APA, for any federal agency to have the effect of law, the agency must comply with APA procedures. However, as part of APA requirements, the IRS had to explain in its preamble to the regulations why it wasn’t adopting comments by practitioners, aiming for these new regulations to have the effect of law.

Their point that their own rule is broad enough to capture new transactions not previously contemplated requires an expansive interpretation of the rule and Auer deference for such an interpretation, which could conflict with the Treasury’s policy statement that the IRS won’t argue that subregulatory guidance (the prior notices) have the force and effect of law.

The cases are Loper Bright Enterprises v. Raimondo, U.S., 22-451, 6/28/24 and Corner Post Inc. v. Board of Governors, U.S., 22-1008, 7/1/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Ben Willis is a corporate tax practitioner and director with Baker Tilly’s Washington Tax Council.

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