WASHINGTON, Sept 29 (Reuters) - A federal court in Texas on Friday ruled that the Obama administration acted unlawfully last year when its Treasury Department cracked down on U.S. companies that try to reduce their U.S. taxes by rebasing abroad, in a process known as inversion.
The U.S. Chamber of Commerce and the Texas Association of Business had filed a lawsuit in Texas federal court that said a regulation from the Treasury Department in April 2016 exceeded what the law allows the department to do.
They argued the Internal Revenue Service rule used was "arbitrary and capricious" because it was instated without notice and opportunity for comment in violation of standards required for rulemaking.
The U.S. District Court for Western Texas in Austin agreed, saying the IRS rule was a substantive or legislative regulation that required a notice and comment period before it was instated.
The U.S. Treasury, the U.S. Chamber of Commerce and Texas Association of Business could not be immediately reached for comment.
The lawsuit was the first to challenge a rule on inversion. The deals are legal, but have drawn criticism from some politicians who say U.S. companies that do them are avoiding their tax obligations. A wave of inversions largely ended after Treasury moved against the deals.
The IRS rule had been aimed at transactions involving non-U.S. companies, such as Ireland-based drugmaker Allergan Plc (AGN.N) that have grown through a series of acquisitions.
It had helped scuttle what had been a planned $160 billion combination of Allergan and U.S. drugmaker Pfizer Inc (PFE.N) in what would have been the largest inversion ever.
Dozens of U.S. companies have done inversions since 1983, when the first such deal was completed. Treasury has periodically moved to curb the flow of deals because inversions erode the U.S. corporate income tax base.
Treasury unveiled a package of rules in 2016 meant to further discourage the deals, which typically involve a U.S. multinational buying a smaller company in a foreign country with lower corporate taxes and then rebasing there, if only on paper.
Inverting U.S. companies usually leave their core U.S. operations at home, transferring only their legal tax domicile to the home country of the acquired company. Recent popular destinations for the deals are Ireland, Britain and Canada. (Reporting by Chris Sanders)