Deference Provided to Regulations When There’s a Drafting Error

The recently enacted tax reform legislation, Pub. L. No. 115-97 (the Tax Act), created two new foreign tax credit limitation baskets – one for foreign branch income (new section 904(d)(1)(B)) and one for any amount includible in gross income under section 951A (i.e., GILTI) (new section 904(d)(1)(C)). However the Tax Act failed to amend section 904(d)(2)(H)(i) to reflect these changes to section 904(d)(1). Section 904(d)(2)(H)(i) has historically treated foreign taxes on amounts that do not constitute income under US principles as imposed on income described in the general category income basket by cross-referencing “paragraph (1)(B).” Congress did not change the cross-reference in section 904(d)(2)(H)(i) to properly cross-reference “paragraph (1)(D)” (which is now the “general category income” basket). As a result of this oversight, section 904(d)(2)(H)(i) currently instructs the taxpayer to treat foreign taxes imposed on amounts that do not constitute income under US principles as imposed on income described in the foreign branch income basket.

The legislative history and relevant Treasury regulations suggest that the failure to amend this Code section was inadvertent, and the current cross-reference is a result of a drafting error. However, it is unclear at this time when or if Congress or the Treasury will address this error through either a technical correction or regulations. In the meantime, taxpayers are left wondering how to proceed. As discussed in detail below, the answer that we believe is most supported by case law is to apply section 904(d)(2)(H)(i) as if its language and cross-reference had been properly amended.

Creditability of Foreign Taxes with No Associated Income for US Federal Income Tax Purposes

Section 901 allows taxpayers to credit foreign income taxes paid against US tax, subject to the limitations of section 904. In general, section 904 limits the amount of foreign tax credit to the amount of potential US tax on the taxpayer’s aggregated foreign source income within separate limitation categories. Neither section 901 nor section 904 requires that a taxpayer receive US income associated with foreign taxes in order to claim a foreign tax credit. That is, even where a foreign tax is imposed on income of a foreign taxpayer that would not constitute taxable income in the United States, a foreign tax credit is allowed, subject to the section 904 limitation.

The regulations under section 904 support this interpretation. Treas. Reg. § 1.904-6(a)(1)(iv) provides, in relevant part:

If, under the law of a foreign country or possession of the United States, a tax is imposed on an item of income that does not constitute income under United States tax principles, that tax shall be treated as imposed with respect to general limitation income.

This “base difference rule” under Treas. Reg. § 1.904-6(a)(1)(iv) was codified in 2004 to section 904(d)(2)(H)(i). Section 904(d)(2)(H)(i) provides that “In the case of taxable years beginning after December 31, 2006, tax imposed under the law of a foreign country or possession of the United States on an amount which does not constitute income under United States tax principles shall be treated as imposed on income described in paragraph (1)(B).”

When Section 904(d)(21)(H)(i) was enacted, Section 904(d)(1)(B) historically was the general income basket. Section 14201 (GILTI) and section 14302 (establishment of foreign branch income category for purposes of section 904) of the Tax Act each amended section 904(d)(1) by redesignating subparagraphs (A) and (B) as subparagraphs (C) and (D) and inserting as (A) “any amount includible in gross income under section 951A (other than passive income)” and inserting as (B) “foreign branch income.” Therefore, section 904(d)(2)(H) now cross-references to the “foreign branch income” basket. As discussed below, section 904(d)(2)(H) is now in direct conflict with Treas. Reg. § 1.904-6(a)(1)(iv), which makes clear that “If, under the law of a foreign country or possession of the United States, a tax is imposed on an item of income that does not constitute income under United States tax principles, that tax shall be treated as imposed with respect to general limitation income.” (Emphasis added).

Statutory Interpretation

There are a number of statutory interpretation canons that may be applied to determine whether taxpayers may rely on Treas. Reg. § 1.904-6(a)(1)(iv) that now conflicts with section 904(d)(2)(H)(i) or if taxpayers should read section 904(d)(2)(H)(i) as we believe it was intended to be amended.

First and foremost, statutory interpretation begins with the “plain language” of the statute. If the statutory language is unambiguous, no further inquiry is necessary and the statute is enforced according to its terms. Hardt v. Reliance Standard Life Ins. Co., 560 U. S. 242, 251 (2010). The courts generally will not look to the legislative history to help interpret the statute if it is unambiguous, and they will not apply the agency’s interpretation of the statute (here, Treasury Regulations) if the agency’s interpretation is in conflict with the unambiguous language. Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc., 467 U. S. 837 (1984); U. S. v. Vogel Fertilizer Co., 455 US 16, 26 (1982).

If the statute is ambiguous, then the courts continue on to a second step. In analyzing the statute itself, they may look to the legislative history to determine Congressional intent. U. S. v. Vogel Fertilizer Co., 455 US 16, 26 (1982). In analyzing an agency’s interpretation of the statute, the court will determine if the agency’s interpretation is reasonable. Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc., 467 U. S. 837 (1984).

Plain Language

Under the first step, determining whether the language of a statute is ambiguous requires the court to examine “the language itself, the specific context in which the language is used, and the broader context of the statute as a whole.” Robinson v. Shell Oil Co., 519 US 337, 341 (1997). On its face the “plain language” of section 904(d)(2)(H)(i) states foreign income taxes imposed on income that is not income for US tax purposes “shall be treated as imposed on income described in paragraph (1)(B).” As a result of other amendments made by the Tax Act “paragraph (1)(B)” is now foreign branch income.

Under this first step, the courts have explicitly noted that a statute is not ambiguous just because it contains on obvious scrivener’s or drafting error. In re Price, 370 F.3d 362, 369 (3d Cir. 2004) (superseded by legislation) (“Ambiguity does not arise merely because a particular provision can, in isolation, be read in several ways or because a statute contains an obvious scrivener’s error.”) (citing Lamie v. United States Trustee, 540 US 526 (2004)). In the event of an obvious drafting error, the US Tax Court and the US Court of Federal Claims have simply applied the law as if the error had not been made. See Adkison v. Commissioner, 129 TC 97 (2007), aff’d 592 F3d 1050 (9th Cir. 2010) (Tax Court assumed the failure to make an obvious conforming adjustment was inadvertent and applied the law as if the amendment had been made.); see also Fed. Natl. Mortgage Ass. v. US 56 Fed. Cl. 228 (2003), rev’d on other grounds 379 F.3d 1303 (Fed. Cir. 2004); see also King, et al. v. Burwell, et al., 135 S. Ct. 2480, 2505 (2015) (Scalia Dissent) (“Only when it is patently obvious to a reasonable reader that a drafting mistake has occurred may a court correct the mistake. The occurrence of a misprint may be apparent from the face of the law, as it is where the Affordable Care Act ‘creates three separate Section 1563s.’”). An example of a misprint apparent from the face of the Tax Act is under new section 951A(d) which includes two separate section 951A(d)(3)s.

Drafting errors raise an interesting problem: If an obvious scrivener’s error does not make the statute ambiguous, and courts generally do not look beyond the statute when it is unambiguous, how do you determine if the statute actually contains a scrivener’s error? Like most issues involving statutory interpretation, the courts (and even specific judges within the courts) are split on the issue. A number of courts look at the legislative history to determine if there is an error in the drafting of the statute. However, there are just as many courts that end the inquiry after reading the plain language of the statute and determining that it is clear as written, instruct the litigant to petition Congress to fix the legislation.

In US v. Ron Pair Enterprises, Inc., the Supreme Court explained that when the plain language expresses congressional intent then “reference to legislative history and to pre-Code practice is hardly necessary.” 489 US 235 (1989). Nevertheless, in that case, after the Supreme Court had determined that the plain language expressed congressional intent, it also analyzed the legislative history and bankruptcy practice prior to the enactment of the new statute. Id. at 242 (“The plain meaning of legislation should be conclusive, except in the ‘rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.’ Griffin v. Oceanic Contractors, Inc., 458 US 564, 571, 102 S.Ct. 3245, 3250, 73 L.Ed.2d 973 (1982). In such cases, the intention of the drafters, rather than the strict language, controls.”); see also Lamie v. U.S. Trustee, 540 US 526, 539 (2004) (“Though we find it unnecessary to rely on the legislative history behind the 1994 enactment of § 330(a)(1), we find it instructive that the history creates more confusion than clarity about the congressional intent. History and policy considerations lend support both to petitioner’s interpretation and to the holding we reach based on the plain language of the statute.”).

Many other courts have also looked to congressional intent to determine whether there had been a drafting error. See Adkison v. Commissioner, 129 TC 97 (2007) (“By all appearances, Congress simply overlooked the reference to section 6013(e) contained in section 6230(a)(3)(A) and failed to make a conforming amendment to that section. In any event, both provisions reflect congressional intent that the spouse of a partner may initiate a claim for relief from joint and several liability…”); Fed. Natl. Mortgage Ass. v. US 56 Fed. Cl. 228 (2003), rev’d on other grounds 379 F.3d 1303 (Fed. Cir. 2004) (“There is no reason, however, to believe that the omission was anything but inadvertent. The legislative history reveals no discussion about the missing proviso between the final conference report and the enactment of section 6621(d), and the clause was reinserted without fanfare a few months later, via technical correction.”); Fitzpatrick v. Morgan Southern, Inc., 261 F.Supp.2d 978 (W.D. TN 2003) (“Examination of whether 49 USC. § 14704 contains an error requires a discussion of the legislative history and circumstances surrounding the passage of the statute.”); In re American Home Mortg., Inc. 379 B.R. 503 (2008); but see In re Jr. Hale Contracting Co, Inc. 465 B.R. 218 (2011) (The Bankruptcy Court acknowledged a drafting error and then applied the statute as drafted. “That leads to what the Court concedes is an anomalous result in this instance: an interpretation and application of the statute that honors its literal (and reasonable) wording while almost certainly running contrary to what Congress actually intended when it was rewriting the statute.”).

The legislative history to section 904(d)(2)(H) clearly provides that “Creditable foreign taxes that are imposed on amounts that do not constitute income under US tax principles are treated as imposed on general limitation income.” See House Committee Report, American Jobs Creation Act of 2004, PL 108-357, 10/22/2004. Additionally, the section of the Conference Committee Report addressing the provision requiring foreign branch income to be allocated to a specific foreign tax credit basket makes no reference to the special base difference rule under section 902(d)(2)(H). H.R. Rep. No. 115-466, at 503 (Conf. Rep.). Further evidence of the drafting error is provided by what the legislative history omitted. There is no reference to requiring creditable foreign taxes imposed on amounts that do not constitute income for US purposes to be recategorized to the foreign branch income basket.

Based on the legislative history of section 904(d)(2)(H), we believe that the failure of section 904(d)(2)(H)(i) to cross-reference “paragraph (1)(D)” (the “general category income” basket) rather than “paragraph (1)(B)” (“foreign branch income”) was the result of an inadvertent drafting error.

Treasury Regulations

Generally, when a regulation conflicts with a subsequently enacted Code section the statute controls. Farrell v. U.S., 313 F.3d 1214 (9th Cir. 2002); see also see also Scofield v. Lewis, 251 F.2d 128, 132 (5th Cir. 1958) (“A Regulation, valid when promulgated, becomes invalid upon the enactment of a statute in conflict with the Regulation.”). If the courts find that the subsequent statute is ambiguous, then the courts may apply the Chevron analysis in order to determine if the agency’s interpretation of the statute is reasonable.

Under the analysis discussed above, an obvious drafting error does not make a statute ambiguous for purposes of reaching step-two of the Chevron analysis. Because we believe that section 904(d)(2)(H)(i) is to be read as if it references “paragraph (1)(D),” Treas. Reg. § 1.904-6(a)(1)(iv) is not in conflict with the statute and thus the typical rule from Farrell does not apply. Treas. Reg. § 1.904-6(a)(1)(iv) applies and “the tax shall be treated as imposed with respect to general limitation income.”

Conclusion

Section 904(d)(2)(H)(i) contains an inadvertent drafting error. In order to determine that this Code section is unambiguous, but contains a drafting error the courts may look to the legislative history of section 904. That legislative history makes clear that section 904(d)(2)(H)(i) was meant to reference the general category income basket no matter where it actually winds up in the Code. Treas. Reg. § 1.904-6(a)(1)(iv) is not in conflict with how section 904(d)(2)(H)(i) should have been amended and therefore lends support that foreign taxes imposed on an amount that does not constitute income for US purposes belong in the general limitation category basket.