FedEx FTC Victory: Section 965 Reg Held

In FedEx, 1 the U.S. District Court for the Western District of Tennessee invalidated reg. section 1.965-5(c)(1)(ii) and granted FedEx a tax refund of $89 million for improperly denied foreign tax credits. FedEx did not dispute that if the regulation were valid, it would not be entitled to a refund. The opinion is very well written and an important precedent for regulations being invalidated when they contradict the statute. The court also rejected the IRS's argument that policy should control whether a regulation is valid.

Under the transition tax rule in section 965(b), before including the accumulated overseas earnings of profitable subsidiaries in income, U.S. corporations are allowed to offset those earnings with the losses of their unprofitable foreign subsidiaries, which the court called offset earnings.

FedEx argued that it is entitled to FTCs on the offset earnings under sections 959, 960, and 965. The IRS argued that the statutes forbid these FTCs and that, even if the statutory language were ambiguous, reg. section 1.965-5(c)(1)(ii) fills the gap by prohibiting a credit.

Section 959 permits funds to be distributed to the United States shareholder without additional tax if those funds have already been included in income under section 951. Offset earnings, however, were never included in income. Section 965(b)(4)(A) addresses this situation, stating that:

For purposes of applying section 959 in any taxable year beginning with the taxable year described in subsection (a), with respect to any United States shareholder of a deferred foreign income corporation, an amount equal to such shareholder's reduction under [section 965(b)(1)] which is allocated to such deferred foreign income corporation under this subsection shall be treated as an amount which was included in the gross income of such United States shareholder under section 951(a).

Section 959 excludes from income earnings that have already been included under section 951, and section 965(b)(4)(A) extends that exclusion to offset earnings by directing that offset earnings be treated as if they were previously included by section 951. The parties agreed that, under sections 959 and 965(b)(4)(A), offset earnings are not included in income when repatriated. They disagreed, however, about how section 965(b)(4)(A) affects FedEx's claim to FTCs.

Before the Tax Cuts and Jobs Act, when a U.S. corporation had to include its foreign subsidiary's earnings in income under subpart F and section 951, section 960(a)(1) provided a credit for foreign taxes, and when the parent repatriated those funds, section 960(a)(2) denied a second, redundant credit. Section 960(a)(3) granted a credit for any additional foreign taxes that had been imposed after the section 951 inclusion and for which no credit had previously been granted.

FedEx argued that section 960(a)(3) provides an FTC for foreign taxes paid on offset earnings because the offset earnings are never included in income under section 951 and FedEx never received a credit under section 960(a)(1).

FedEx argued that section 960(a)(3) unambiguously provides a credit because:

  • the distributed offset earnings were excluded from income under section 959;
  • those offset earnings are treated as dividends for which a credit is given under sections 901 and 902; and
  • the foreign taxes associated with the offset earnings were not previously deemed paid by section 960(a)(1).

FedEx argued that the government cannot deny that credit by using a regulation to rewrite the statutory text.

The government argued that although offset earnings are never actually included in income under section 951, they are deemed to have been included in income and therefore must be treated that way. The government argued that FedEx's associated foreign taxes were deemed to have been paid already under section 960(a)(1), and that section 960(a)(2) states that foreign taxes previously deemed paid under section 960(a)(1) will not be credited again. Because offset earnings are treated as included in income under section 951, the government argued that they cannot produce a credit under section 960.

FedEx responded that the government ignores crucial limiting language; section 965(b)(4)(A) treats offset earnings as included in income "for purposes of applying section 959." Thus, offset earnings are treated as previously included in income under section 959, which shields those earnings from inclusion in income when they are distributed. Offset earnings are not treated as included in income when applying section 960, which controls the grant of tax credits.

The court agreed with FedEx and stated that the government's argument contradicts the ordinary and common meaning of the statute's command that offset earnings be treated as included in income for purposes of applying section 959. As courts have recognized, "for purposes of" is limiting language that confines its subject matter to some purposes but not others. The phrase, "for purposes of applying section 959," singles out one particular section for different treatment and thereby demonstrates that the section 965(b)(4)(A) language should not apply to the remainder of the tax code.

The court held that section 965(b)(4)(A) is unambiguous and applies to section 959, but not to other sections. The government's attempt to stretch section 965(b)(4)(A) by making it apply to both section 959 and section 960 contravenes the plain and ordinary meaning of the statute.

The government argued that section 965(b)(4)(A) applies to section 960(a)(3) because section 960(a)(3) mentions (or, in the government's argument, applies) section 959. The court found this argument unpersuasive. Had Congress intended section 965(b)(4)(A) to apply "for purposes of applying sections 959 and 960," it could have said so.

Also, the apposition of "applying" with "section 959," as well as the absence of any other specifically named part of the tax code, suggests that section 959 — and no other section — is the "limited purpose" or "particular subject matter" to which section 965(b)(4)(A) applies, the court said.

The government's argument would also create too many unintended consequences. The tax code contains many phrases such as "for purposes of" and "for purposes of applying." If a statute says "for purposes of section X, Y is true," under the government's approach, Y would be taken as true not only in section X, but also in any other part of the statutory scheme that mentions or invokes section X.

The court held that the government's theory of the case is not a plausible reading of the pertinent statutes. 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).

The government argued that considerations of policy weigh against FedEx's interpretation of the statute because offset earnings are untaxed in the United States. Giving FTCs on those earnings "is not the mitigation of double tax; it is the elimination of any tax." The court said that although there is considerable weight to the government's arguments, the court cannot consider extratextual indicators of congressional intent, such as legislative history or general considerations of policy.

Amici Urge Section 965 Reg Review

While the U.S. District Court was invalidating a regulation under section 965, the statute itself was being challenged in the Supreme Court. Amicus briefs filed March 27 by the U.S. Chamber of Commerce, the Cato Institute, and other prominent advocacy groups and think tanks urged the Court to grant certiorari in Moore, 2 in which the U.S. Court of Appeals for the Ninth Circuit rejected the taxpayers' challenge to the transition tax.3

The petition filed by Charles and Kathleen Moore asks the Court to determine whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states. The Moores argue that section 965, which taxed U.S. shareholders on the unrepatriated earnings of foreign corporations, is not an income tax because it taxed unrealized amounts.

The Cato Institute brief notes that the Court has recognized "the rule that income is not taxable until realized."4

"To be subject to an income tax, a taxpayer must have income," the Cato brief asserts. "If a tax on unrealized investment holdings like [section 965] can be treated as an 'income' tax, then anything can be treated as an income tax. And if anything can be treated as an income tax, then the Sixteenth Amendment's limitation to 'income' taxes is meaningless."

Similarly, the U.S. Chamber of Commerce argues that the realization requirement provides a limiting principle that defines the term "income tax."

"Income has a plain and longstanding meaning: for something to be 'income,' it must, in some way, 'come in,'" the chamber brief asserted before quoting the landmark case of Macomber. 5 The Macomber Court wrote that the "characteristic and distinguishing attribute of income" is "a gain . . . coming in, being 'derived,' that is received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal."6 (Emphasis in original.) The Macomber Court held that Congress lacks the power to tax "accumulated profits [of a corporation] . . . as income of the stockholder" without apportionment among the states.7

The various amicus briefs discuss what "realization" has come to mean. The Manhattan Institute and professors Erik M. Jensen and James W. Ely emphasize dominion and control over gains, as described in First Security Bank. 8 The Cato Institute distinguishes the tax imposed on subpart F income as applying to a base that is both constructively realized and limited to current-year income of the controlled foreign corporation, unlike the accumulated unrealized earnings taxed by section 965. The Buckeye Institute quotes from Judge Patrick J. Bumatay's dissent from the Ninth Circuit's order denying an en banc rehearing: "While there may be . . . cases that test the outer limits of what constitutes a realized gain, the term 'income' still retains realization as a definitional requirement."


1. FedEx Corp. v. United States, No. 2:20-cv-02794 (W.D. Tenn. 2023).

2. Moore v. United States, 36 F.4th 930 (9th Cir. 2022).

3. See Larissa Neumann and Julia Ushakova-Stein, "U.S. Tax Review: Transition Tax, Final FTC Regs, and Priority Guidance Recommendations," Tax Notes Int'l, July 4, 2022, p. 23.

4. Helvering v. Horst, 311 U.S. 112, 116 (1940).

5. Eisner v. Macomber, 252 U.S. 189 (1920).

6. Id. at 207.

7. Id. at 219.

8. Commissioner v. First Security Bank of Utah, 405 U.S. 394

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Originally published by Tax Notes International.

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