3M Co. v. Commissioner
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2020’s Key Tax Controversy Developments

In the face of the pandemic and all the challenges that came with 2020, tax controversy marched on. In this article, we explore several important cases, including one of the most closely watched Supreme Court cases, CIC Services LLC v. Internal Revenue Service, which raises important questions regarding the scope of the Anti-Injunction Act and impacts the ability of taxpayers to engage in preenforcement challenges to regulations.

We also look into the latest updates in the transfer pricing area, changes to the Compliance Assurance Process, what to expect during the audit of a campaign issue and more.

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3M Company, IRS File Opening Briefs in “Blocked Income” Case

As noted in an earlier post, 3M Co. v. Commissioner, T.C. Dkt. No. 5816-13, involves 3M’s challenge to the Internal Revenue Service’s (IRS’s) determination that Brazilian legal restrictions on the payment of royalties from a subsidiary in that country to its US parent should not be taken into account in determining the arm’s-length royalty between 3M and its subsidiary under Treas. Reg. § 1.482-1(h)(2). The case has been submitted fully stipulated under Tax Court Rule 122, and the parties’ simultaneous opening briefs were filed on March 21, 2016.

Citing First Sec. Bank of Utah and cases following it, 3M first argues that “[c]ase law consistently holds that the Commissioner cannot employ section 482 to allocate income that the taxpayer has not received and cannot receive because a law prevents its payment or receipt.” Under this line of authority the IRS’s proposed allocation of royalty income to 3M is precluded by Brazilian law. This result is not changed by Treas. Reg. § 1.482-1(h)(2) because that regulation is invalid.

The regulation is “procedurally invalid,” 3M argues, because Treasury and the IRS failed to satisfy the requirements of § 553 of the Administrative Procedure Act (APA) when they promulgated the regulation. They did not respond to significant comments criticizing the proposed regulation; nor did they articulate a satisfactory justification or explanation for the regulation. They thus did not engage in the “reasoned decisionmaking” required by the APA and case law such as State Farm and Altera when an agency issues regulations. (more…)

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IRS and Taxpayers Continue Fight over Regulations Intended to Overrule Judicial Precedent

In March 2013, 3M filed a petition with the US Tax Court challenging the Internal Revenue Service’s (IRS) determination that additional royalty income should be allocated to 3M’s US headquarters from its Brazilian subsidiary.  See 3M Co. v. Commissioner, T.C. Dkt. No. 5186-13.  Specifically, the IRS determined that Brazilian legal restrictions on the payment of royalties to the US parent should not be taken into account in determining the arm’s-length price between 3M and the subsidiary under Treas. Reg. § 1.482-1(h)(2).  3M’s position will require the Tax Court to revisit its earlier, pre-regulations holdings on the subject and to decide whether the Supreme Court of the United States has already resolved the issue.

The parties recently submitted the case fully stipulated under Tax Court Rule 122, with simultaneous opening briefs due on March 21, 2016.  The parties will then have the opportunity to submit reply briefs responding to each other’s arguments.

More than 40 years ago, the Supreme Court in Commissioner v. First Sec. Bank of Utah, 405 U.S. 394 (1972), rejected the IRS’s attempt to apply section 482 where federal law prohibited the taxpayer from receiving the income the IRS was seeking to allocate to it.  Subsequent Tax Court and appellate court decisions applied the Supreme Court’s holding to restrictions under foreign and state law.  In 1994, the IRS promulgated current Treas. Reg. § 1.482-1(h)(2), which provides, in part, that “a foreign legal restriction will be taken into account only to the extent that it is shown that the restriction affected an uncontrolled taxpayer under comparable circumstances for a comparable period of time.”  Although the regulation also contains a deferred income election that permits the deferred recognition of restricted income, subject to a matching deferral of deductions, it may be difficult in most situations to meet these requirements.

Whether 3M succeeds may depend on how the Tax Court applies the recent Supreme Court decision in U.S. v. Home Concrete & Supply LLC, 132 S.Ct. 1836 (2012).  There, the Supreme Court held that its prior interpretation of a statute meant that “there is no longer any different construction that is consistent with [the prior opinion] and available for adoption by the agency.”  This is an important case for all taxpayers, not just those dealing with the blocked income issue, and the Tax Court’s determination may have a broad impact on future challenges to tax regulations.

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