In a major win for taxpayers, 3M Company defeated the IRS in the agency’s attempt to tax income from a 3M subsidiary in Brazil (3M do Brasil Ltda.), getting back $5.2 million in refunds plus interest. The U.S. government claimed it can reach such income if the transactions are not “arms length” between the parent company and subsidiary under transfer pricing regulations promulgated by the Treasury. But 3M argued Brazilian law prohibited it from ever realizing the gain. NTUF’s Taxpayer Defense Center supported 3M with an amicus curiae (“friend of the court”) brief. We have also monitored the case’s progress.
Initially, a strongly divided (7-2-8) Tax Court said 3M owed the taxes on the Brazilian income. That’s a strange division of the Tax Court, described in a lengthy decision, so some explanation is needed. A seven-judge plurality of the Tax Court held that the regulations were a reasonable interpretation of a statute under what was known as Chevron deference. Two concurring judges thought the statute required the IRS to allocate the income to 3M as the parent of the Brazil subsidiary. The remaining eight Tax Court judges would have ruled for 3M.
But last year the Eighth Circuit reversed the Tax Court. Judge Stras, deciding for the unanimous three-judge panel, said “Statutes trump regulations,” and the IRS could not do via agency regulation what the statute prohibited, and no deference to the IRS existed under the recent landmark decision of Loper Bright Enterprises v. Raimondo. (NTUF’s Taxpayer Defense Center was also involved in the Loper Bright case, including an amicus brief before the U.S. Supreme Court.)
Judge Stras, a shortlister for the Supreme Court in years past, reasoned that the regulation was contrary to established Supreme Court guidance. In 1972, the U.S. Supreme Court held in Commissioner of Internal Revenue v. First Security Bank of Utah, N.A. that one limitation on the power to tax a foreign subsidiary is that the IRS could not reallocate income to a foreign source if earning that foreign source income was illegal or impossible to earn in that country. In other words, “to be taxed for income, a taxpayer must have complete dominion over it.” The Fifth Circuit and Sixth Circuit have followed this same rule. Yet, in 1994, the IRS wrote the opposite rule, disregarding this caselaw. Adopting what is now found at 26 C.F.R. § 1.482-1(h)(2), the IRS imposed an array of new criteria a taxpayer must meet to avoid the IRS imputing the income under 26 U.S.C. § 482. Notably, even when a foreign subsidiary could not legally make a payment to the parent company, the IRS will nonetheless impute the income on the parent company and tax it.
The government sought rehearing en banc, asking the whole Eighth Circuit to review the panel’s decision in favor of 3M—but that was denied. The government indicated that it was going to ask for the Supreme Court to weigh in, but ultimately let the deadline pass in late June. Now remanded back to the Tax Court, Judge Richard T. Morrison ruled that there was no deficiency in income tax for 3M, and ordered a refund of $5.2 million dollars back to the company (taxes paid, plus statutory interest).
That’s a major victory for 3M Company. But it may also play a heavy role in Coca-Cola’s similar case in the Eleventh Circuit, worth $20 billion in disputed taxes attributed to foreign subsidiaries of the soft drink giant. This gives the Eleventh Circuit the chance to side with the Fifth, Sixth, and Eighth Circuits in applying First Security to the IRS’s attempt to tax income a company cannot access due to international law. In doing so, it will join its sister circuits in curtailing the IRS power grab § 1.482-1(h)(2) and holding true to what Congress and the Supreme Court direct to protect taxpayers.
The case was 3M Company and Subsidiaries v. Commissioner of Internal Revenue, 8th Circuit No. 23-3772, Tax Court No. 5816-13.