A Tennessee district court granted CIC Services, LLC (CIC) and Ryan, LLC’s (together, the plaintiffs) request for a preliminary injunction against the IRS enforcement of Notice 2016-66. The plaintiffs, two managers of captive insurance companies, argued, among other things, that the notice violated the Administrative Procedure Act (APA) in that it failed to follow the rule making requirement that there be a notice-and-comment period. The case was previously dismissed by the district court for lack of subject matter jurisdiction, but the Supreme Court ruled the court did have jurisdiction. When reviewing a case for preliminary injunctions, a court must consider the (1) the movant's likelihood of success on the merits; (2) whether the movant will suffer irreparable injury without an injunction; (3) whether granting the injunction would cause substantial harm to others; and (4) whether the public interest would be served by granting the injunction.
On Nov. 1, 2016, the IRS issued Notice 2016-66 (the notice), modified by Notice 2017-08, designating micro-captive insurance transactions as transactions of interest for purposes of Reg. section 1.6011-4. The notice requires that taxpayers who enter into micro-captive transactions, and material advisers who advise on micro-captive transactions, file disclosure statements with the IRS Office of Tax Shelter Analysis.
In their complaint, CIC and Ryan alleged that as captive insurance managers they are subject to Notice 2016-66’s disclosure requirements as material advisors and that complying with such requirements would force them to incur significant costs. CIC and Ryan argued that the notice is a “legislative-type rule” that does not comply with the notification and comment requirements under the APA, and that the notice is arbitrary and capricious. Further, plaintiffs allege that the notice does not comply with the requirements of the Congressional Review of Agency Rulemaking Act because it was not submitted to Congress or the Comptroller General. As such, CIC and Ryan requested that the court enjoin the IRS from enforcing the notice’s disclosure requirements while the merits of their claim that the notice is invalid are litigated.
Preliminary injunction review
Under the APA, there is a distinction between legislative rules, which are subject to the APA notice-and-comment requirements, and interpretive rules, which are not. There is no clear line between what is considered a legislative rule and what is an interpretive rule. Generally, legislative rules create new law, impose new rights or duties, or otherwise effect a substantive change in existing law or policy. Interpretive rules are issued by an agency to advise the public of what the administrative agency thinks a statute means. Legislative rules have the force and effect of law, while interpretive rules do not.
A federal agency must follow a three-step process for promulgating a legislative rule: (1) an agency must issue a general notice of proposed rulemaking, usually by publication in the Federal Register, (2) if notice is required, then the agency must give interested parties an opportunity to participate in the rule making process through submission of written data, views or arguments (comments), and (3) when the agency promulgates the final rule, it must include in the rule's text a concise general statement of its basis and purpose.
The district court found that CIC demonstrated that it is likely to succeed on its claim that Notice 2016-66 constitutes a legislative rule, and that it is invalid because the Secretary failed to comply with the required notice-and-comment procedures under the APA. The court determined that the ‘transaction of interest’ language in Reg. section 1.6011-4(b) was circular in nature and thus created a ‘catch-all’ which could grant the IRS unlimited discretion to label any transaction a transaction of interest. Ultimately, the court determined that classifying a transaction a transaction of interest through an agency-issued notice, like Notice 2016-66, would constitute a legislative rule because it expands the footprint of the Reg. section 1.6011-4(b) by creating new rights and duties regarding reporting requirements. Therefore, the notice likely should have been subject to the APA’s notice-and-comment requirements.
The court weighed the remaining factors for determining if a preliminary injunction should be granted and found that the plaintiffs should be granted a preliminary injunction against enforcement of Notice 2016-66.
This is a significant win for taxpayers looking to fight the reporting requirements of Notice 2016-66 and other notices prescribing transactions of interest. Although this injunction related solely to CIC and Ryan, it is persuasive authority for other courts asked to rule on challenges to such notices based upon the APA. Taxpayers should consult with their tax advisors to determine if this case could have an impact on them.