U.S. competent authority’s denial of discretionary treaty benefits is subject to judicial review

Tax Hot Topics: Denial of discretionary treaty benefits The U.S. District Court for the District of Columbia on Sept. 18 rejected the government’s claim that federal courts do not have judicial oversight regarding the U.S. competent authority’s (USCA’s) exercise of discretion over treaty benefits. In so ruling, the court in Starr Int’l Co. v. U.S., No. 1:14-cv-01593 (D.D.C. 2015) allowed the case to move forward so that the court may determine whether the USCA abused its discretion by denying the taxpayer treaty benefits involving the U.S.-Swiss tax treaty. Taxpayers considering whether to request the USCA’s assistance should carefully monitor the status of this case.

In 2004, Starr was the largest single holder of stock in AIG, Inc. and moved its headquarters from Bermuda to Ireland, where, under the 1997 U.S.-Ireland tax treaty, the withholding rate on dividends was lower than the rate in Bermuda. Starr thereafter relocated its headquarters to Switzerland. Under the U.S.-Swiss tax treaty, a Swiss company receiving dividends from a U.S. company is automatically entitled to halve its withholdings under certain enumerated circumstances. In 2007, Starr acknowledged that it was not entitled to treaty benefits under one of the U.S.-Swiss treaty’s enumerated circumstances, but it requested a discretionary ruling by the USCA and the Swiss competent authority, as provided by the treaty.  

Almost three years went by without a response from the USCA; so, in 2010, Starr filed a protective refund claim with the IRS for approximately $38 million. In October 2010, the USCA denied Starr's request under the treaty to reduce Starr's 2007 withholding tax on the AIG dividends. However, Starr later received a treaty-based refund for its 2008 taxes, which, according to Starr, involved the same material facts as its 2007 claim.

Starr brought suit in September 2014, claiming that the IRS erroneously denied its request for benefits under the treaty. Starr contended that the government abused its discretion because (1) Starr was not treaty shopping when it relocated to Switzerland; (2) the USCA failed to consult with the Swiss competent authority before denying Starr's request; and (3) the government had no basis for allowing a 2008 refund while denying its 2007 request based on the same facts. The government responded that the USCA's decision rests entirely within the agency’s discretion, and that the federal courts lack jurisdiction to review that decision.

The district court rejected the government’s arguments. The case now advances to the trial stage in the district court to hear evidence to determine whether the USCA abused its discretion.

This case could have a significant impact on the USCA process. The initial ruling at this stage is somewhat surprising, considering earlier precedent. See, for example, Yamaha Motor Corp. v. U.S., 779 F. Supp. 610 (D.D.C. 1991). Then again, the case could be viewed as “trending” in the direction of other recent cases, where the IRS’s discretion in USCA matters, advance price agreements and Section 482 regulations has been called into question. See the IRS’s ongoing litigation in Eaton Corp. v. Commissioner, No. 5576-12, and the decision in Altera Corp. v. Commissioner, 145 T.C. 3 (2015).

Ultimately, Starr may provide useful perimeters regarding the USCA’s discretion – factors that may impact the way certain matters (such as taxpayer-initiated adjustments) are viewed relative to the IRS’s recently updated guidance on USCA requests in Rev. Proc 2015-40.  

David Bowen
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Douglas Wood
+1 704 632 6837

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