On August 26, 2024, the Tax Court issued its first major opinion applying the U.S. Supreme Court's decision in Loper Bright v. Raimondo to the interpretation of a tax regulation. In Varian Medical Systems Inc. v. Commissioner, the Tax Court unanimously held that the plain language of the effective date provisions of the Tax Cuts and Jobs Act (TCJA) entitled a fiscal year (FY) taxpayer to a section 245A dividends received deduction (DRD) for section 78 dividends the taxpayer was deemed to receive during a one-time "gap period." As a result, regulations that the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) promulgated to prevent this outcome for fiscal year taxpayers had no legal effect. 

The Varian opinion sends a clear message that the Tax Court will vigorously apply the Supreme Court's mandate in Loper Bright to "exercise [its] independent judgment in deciding whether an agency has acted within its statutory authority[.]" The Varian decision may influence the outcome of similar challenges to TCJA regulations that purport to rewrite effective dates in analogous circumstances, including the extraordinary disposition rules under Treasury Regulation § 1.245A-5 and the global intangible low-taxed income (GILTI) disqualified basis rules under Treas. Reg. § 1.951A-2. FY taxpayers (and calendar year taxpayers with FY subsidiaries) for which the relevant statute of limitation has not elapsed should evaluate the merits of submitting an affirmative claim consistent with the Tax Court's decision in Varian, taking into account any offsetting foreign tax credit (FTC) detriment that follows from the court's decision. 

The central legal challenge in Varian involves a simple mismatch in TCJA effective dates. Section 78 was enacted in 1962 and generally treated any deemed paid foreign taxes as a dividend to a U.S. shareholder. When Congress enacted section 245A, it amended the Code to prohibit the application of the section 245A DRD to section 78 deemed dividends. However, that amendment applied only to tax years of foreign corporations that began after December 31, 2017. Under the plain language of the relevant statutes, section 245A allowed a deduction for section 78 dividends deemed received by FY taxpayers between January 1, 2018, and the end of their 2018 fiscal year. In 2019, the IRS promulgated regulations that purported to overturn this result. See Treas. Reg. § 1.78-1.

The Tax Court, leaning on Loper Bright, held that the statutory text was clear, and the regulation did not impact Varian's eligibility for the DRD. Under Loper Bright, while "careful attention" is due to Treasury's position, courts must exercise independent judgment in determining whether Treasury acted within its statutory authority. Here, regulations that changed the effective date for the section 78 amendment fell "outside the boundaries of any authority" delegated to Treasury under section 245A(g). Although Loper Bright directs courts to "respect" delegations of rulemaking authority, the delegation in section 245A(g) is limited to "guidance as may be necessary or appropriate" to implement section 245A and this grant of authority could not be construed as permitting regulations that contradict "unambiguous" statutory text. The IRS's alternative argument that the regulation interpreted the "ambiguous interaction" between sections 78 and 245A also failed to persuade the court. 

The IRS did not rely solely on the regulation to defend its assessment of Varian. The IRS also observed that the effective date provision for section 245A referred only to "distributions" after December 31, 2017, and then asserted that a section 78 dividend is not a "distribution." The Tax Court rejected this argument. Reading section 245A to require an actual "distribution" was too narrow, inconsistent with the term's historically broad definition, and would preclude other deemed dividends from qualifying for the DRD, even though Congress had explicitly provided for such amounts to qualify. The court also rejected policy arguments raised by the IRS. 

While the taxpayer prevailed on its eligibility for the 245A DRD, the Tax Court agreed with the IRS that section 245A(d) required Varian to reduce its FTCs by the amount that its deemed paid foreign taxes were attributable to the foreign earnings reflected in its section 78 dividend. The Tax Court endorsed the formula offered by the IRS in its brief. Under that formula, whether applying the section 245A DRD in this context yields a net benefit depends on the effective rate of foreign tax.

The Varian decision may not be officially reduced to judgment for some time. The opinion addresses motions for partial summary judgment, and unrelated issues remain to be adjudicated. Ultimately, computations of Varian's tax liability will be required in light of the ruling on disallowance of FTCs. Nevertheless, the opinion is expected to immediately shape pending and future tax disputes, especially parallel cases challenging Treasury Regulation § 1.78-1, including Kyocera (District of South Carolina) and Sysco (Tax Court), for which the Tax Court has ordered supplemental briefing. If Varian is a harbinger of how courts will approach challenges to Treasury regulations, there are a number TCJA regulations for which the end may be near.

For more information, please contact:

Kevin L. Kenworthy, kkenworthy@milchev.com, 202-626-5848

Jeffrey M. Tebbs, jtebbs@milchev.com, 202-626-1480

Jaclyn Roeing, jroeing@milchev.com, 202-626-5929

Omar M. Hussein, ohussein@milchev.com, 202-626-1578

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