United States: FedEx v. United States

Tax News and Developments May 2023

In brief

On 31 March 2023, the United States District Court for the Western District of Tennessee granted FedEx’s motion for partial summary judgment and invalidated Treas. Reg. § 1.965-5(c)(1)(ii), which purported to disallow credits for foreign taxes paid or accrued associated with Offset Earnings, as described below. Order, FedEx Corp. & Subs. v. United States, 20-cv-2794 (W.D. Tenn. 31 March 2023). The court invalidated the foregoing regulation (“Final Rule”) as contrary to statute under Chevron Step One and further held that the government’s interpretation of the relevant statutory text was unreasonable under Chevron Step Two.


In more detail

Prior to the 2017 Tax Cuts and Jobs Act (TCJA), Pub. L. No. 115-97, 131 Stat. 2054 (22 Dec. 2017), the US employed a “worldwide” system of taxation that taxed all income earned by US citizens and corporations whether it was generated domestically or abroad. In 2017, Congress passed the TCJA which replaced the “worldwide” system of taxation with a “territorial” system of taxation. To facilitate the change in tax law, Congress imposed a one-time “transition tax” under section 965 on deferred foreign earnings. In determining the transition tax, Congress recognized that many multinational corporations had foreign subsidiaries that lost money for years. Thus, under section 965(b), Congress allowed multinational corporations to offset or net the earnings of historically profitable foreign corporations with the losses of historically loss-making controlled foreign corporations. The court defined the portion of earnings from profitable foreign corporations that are offset by losses from other foreign corporations as “Offset Earnings”. The net amount of deferred earnings (the section 965(a) inclusion) was included in income under section 951. The Offset Earnings were treated as included in income only “[f]or purposes of applying section 959”. Under section 965(b)(1), Offset Earnings are never actually included in income under section 951.

The Department of Treasury promulgated Treas. Reg. § 1.965-5(c)(1)(ii) (“Final Rule”), which provides in pertinent part that “[n]o credit is allowed under section 960(a)(3) or any other section for foreign income taxes that would have been deemed paid under section 960(a)(1) with respect to the portion of a section 965(a) earnings amount that is reduced under § 1.965-1(b)(2) or § 1.965-8(b) [i.e., for foreign taxes on Offset Earnings]”.

FedEx initiated a refund suit and challenged the validity of the Final Rule, which required the court to interpret the statute under the two-step Chevron framework. Chevron U.S.A. Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). Under Chevron, the court first asks whether Congress has directly spoken to the precise question at issue ("Chevron Step One"). If a court — using all of the ordinary tools of statutory construction to interpret the statute and without providing any deference to the agency’s views — determines that the statute is unambiguous under Chevron Step One, the inquiry must end and the statute controls. If a statute is ambiguous, the court proceeds to Chevron Step Two, which asks whether the agency’s regulation is a permissible interpretation of the statute. In FedEx, the court focused its Chevron Step One analysis on the limiting language in section 965(b)(4)(A). The court stated that the ordinary and common meaning of section 965(b)(4)(A) was to command that Offset Earnings be treated as included in income only “[f]or purposes of applying section 959”. Had Congress intended section 965(b)(4)(A) to apply more broadly, it could have done so.

The court considered the government’s “dual and self-contradictory” argument with respect to Offset Earnings and section 960. According to the government, because Offset Earnings were deemed included in income, the foreign taxes paid on Offset Earnings were deemed to have already been paid under section 960(a)(1), such that section 960(a)(2) disallowed a second credit. But, as the court noted, the government did not previously provide a credit for foreign taxes paid on Offset Earnings under section 960(a)(1). That is because Offset Earnings were included in income only “[f]or purposes of applying section 959” and were not actually included in income under section 951 by reason of section 965(b)(1), so section 960(a)(1) did not provide a credit. Because section 959 classified Offset Earnings as previously taxed earnings and profits, foreign taxes paid or accrued on those earnings were creditable under section 960(a)(3) when distributed back to the United States. According to the court:

FedEx’s account is simpler and more convincing: its Offset Earnings, when distributed, were “excluded from gross income under section 959(a),” and the foreign taxes paid on Offset Earnings were never previously “deemed paid . . . under” section 960(a)(1). 26 U.S.C. § 960(a)(3) (2016). Under these straightforward and unambiguous statutory terms, FedEx is entitled to foreign tax credits on its Offset Earnings under section 960(a)(3).

The court acknowledged the government’s policy arguments but made clear that because the statute was unambiguous, it could not “consider extra-textual indicators of congressional intent, such as legislative history or general considerations of policy, at Chevron step one”. Further, the court noted that Congress may well have intended to grant foreign tax credits on Offset Earnings given Congress’s policy of encouraging the repatriation of foreign earnings.

In sum, the court held that Final Rule was invalid under Chevron Step One as the Final Rule contradicted the unambiguous statute. The court also stated that even if the statutory text was ambiguous, the regulation was still invalid under Chevron Step Two because the government’s interpretation of the statute was unreasonable.

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