Business Groups Sue U.S. Government Over Tax-Inversion Rules

The U.S. government is being sued over its rules limiting tax-motivated inversion transactions in a case that stems from Pfizer’s scuttled merger plans with Allergan.

The U.S. Chamber of Commerce and a Texas business group sued the federal government, alleging the Treasury Department’s rules limiting tax-motivated inversion transactions violate the law.

The lawsuit filed Thursday charges the government rewrote the Internal Revenue Code itself after Congress wouldn’t go along with President Barack Obama’s proposed legislative changes to limit inversions.

“This is not the way government is supposed to work in America,” Thomas Donohue, the chamber’s president and chief executive officer, said. “Instead of breaking the rules to punish companies engaged in lawful transactions, Washington should just do its job and comprehensively reform the tax code.”

The case in the U.S. District Court for the Western District of Texas stems from regulations the government issued April 4 that led Pfizer Inc. and Allergan PLC to cancel a planned merger that would have located the combined companies in Ireland.

That was the government’s third administrative action against inversions, transactions in which companies can get addresses in low-tax countries, often by merging with a smaller firm based in a lower-tax jurisdiction.

Those April 4 rules attacked “serial inverters,” companies such as Allergan that had grown to their current size through other inversions. The rules would disregard three previous years of those deals when calculating the size of the two companies, and that matters because the tax rules are tied to the relative size of companies that merge and take a non-U.S. address.

“This action was based on strong policy interests and clear legal authority,” a Treasury spokeswoman said in a statement. “We will continue to defend these regulations, which will help slow the erosion of our corporate tax base.”

The lawsuit points to statements in 2014 by Treasury Secretary Jack Lew in which he emphasized the limits to administrative action and said the government would be doing more if it could.The suit also says “it was widely understood” that Treasury had written the rule to stop the Pfizer-Allergan merger. Treasury officials have said repeatedly they didn’t target any particular deal.

Normally, lawsuits over tax regulations occur after a company has filed a tax return and been audited. In this case, the chamber and the Texas Association of Business are asserting the rules violated the Administrative Procedure Act, which governs federal rule-making. They say the government didn’t provide adequate reasons for the rules and failed to explain why it made the rules effective immediately.

“But for this Rule, Allergan would actively explore merger opportunities with large U.S. pharmaceutical companies, and Pfizer would actively explore merger opportunities with foreign pharmaceutical companies that have recently acquired U.S. corporations or may acquire such corporations,” the lawsuit says.

The case was likely filed in Texas for two reasons, said Patrick Smith, a lawyer at Ivins, Phillips & Barker in Washington. A 2015 precedent in the District of Columbia Circuit Court of Appeals made it harder to bring challenges to stop tax regulations before they are applied to specific taxpayers. Additionally, Texas is in the Fifth U.S. Circuit Court of Appeals, which has shown a willingness to invalidate regulations and other administrative actions.

Even if the government loses in the Fifth Circuit, the conflict with the D.C. Circuit precedent would give the administration an opening to take the case to the Supreme Court, said Mr. Smith, who isn’t involved in the case. The government will also likely challenge the plaintiffs’ standing to sue.

“On the merits, the challengers have a very strong case,” Mr. Smith said. “Don’t expect any decision on the merits for quite some time.”

Both companies are members of the U.S. Chamber of Commerce, according to the lawsuit.

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