3M, IRS Grilled Over Brazilian Law in Transfer Pricing Suit (1)

Eighth Circuit judges focused on 3M Co.‘s level of control over its Brazilian subsidiary during oral arguments Tuesday about 3M’s tax liability, with one judge appearing particularly skeptical of the IRS’s justification for its tax increase.

3M appealed the US Tax Court’s ruling that the IRS was permitted to allocate income from the company’s Brazilian subsidiary to the US parent for tax purposes in order to reflect what 3M’s income would be had the parent and subsidiary’s transactions been at arm’s length. The IRS’s $23.6 million allocation caused a $4.85 million tax liability for 3M, which the company disputes.

Judge David R. Stras, of the US Court of Appeals for the Eighth Circuit, debated with IRS counsel Francesca Ugolini over what options 3M had in avoiding the alleged deficiency while also remaining compliant with Brazilian law. Brazil protects its tax base by limiting royalty payments.

“I don’t see how reallocating blocked income prevents the evasion of taxes because 3M simply couldn’t have gotten the income,” Stras said. “They couldn’t have under Brazilian law.”

Ugolini disputed that 3M’s income was truly blocked by Brazilian law, arguing that the parent company could have caused 3M Brazil to pay dividends instead. Stras cut her argument off.

“Come on, dividends?” Stras said. “I would’ve counseled my client not to do that, knowing what I know now about the case and the code,” he said. Stras argued any characterization of 3M Brazil’s payments as dividends would have likely prompted the IRS to go after 3M for royalties anyway.

Level of Control

3M counsel Jonathan Bond, of Gibson & Dunn, pushed back on the IRS’s argument that 3M characterizing income as royalties rather than dividends validated a reallocation. 3M has no obligation as a taxpayer to maximize its taxable income, Bond told the court.

But Judge Jane Kelly responded skeptically to Bond, saying that his description “does speak to 3M’s control over its subsidiary.” In light of the US Supreme Court’s decision in Moore v. United States, complete control over income might not be strictly necessary for it to be taxable, she said.

“If the court focuses on whether 3M controls receipt of income from 3M Brazil, as a general matter, then they’re on the IRS’ playing field,” Leila D. Carney, a Caplin & Drysdale member practicing international tax litigation, said after hearing the arguments. Caplin & Drysdale doesn’t represent any parties in the case.

Carney said it was telling that, during oral arguments, the IRS leaned on the IRS’s statutory basis for the income allocation under IRC Section 482, rather than Treasury’s blocked income rule, which 3M says is invalid. That focus was likely motivated by the US Supreme Court’s decision in Loper Bright, which only came down after the Tax Court already ruled en banc for the government.

“Without Chevron deference, the Eighth Circuit has to grapple with how much respect to accord the form of the transaction, a form that was not controlled by the taxpayer but also was not an arm’s length transaction,” Carney said.

Judge Bobby E. Shepherd‘s questioning focused on creating a decision tree for the court to determine the degree to which the panel must address both the statute and Treasury’s blocked income rule.

“Judges have a tendency to look for the easy way out,” Shepherd said.

The case is 3M Co. v. Commissioner, 8th Cir., No. 23-3772, oral arguments 10/22/24.