3M Transfer Pricing Case Shows Ripple Effect of Chevron’s Demise

The end of Chevron deference will affect how courts analyze tax regulations, particularly transfer pricing regulations. We’re seeing this play out in 3M Co. v. Commissioner, which was argued before a federal appeals court this week, as well as in Abbott Laboratories v. Commissioner, a case challenging part of the cost-sharing regulations in US Tax Court.

With these two cases, a potentially messy picture emerges: Different standards of review could apply in different courts, and the same regulation could be valid in one circuit and invalid in another. That result would hold unless and until the US Supreme Court decides to offer further guidance. This possibility was made clear by Tuesday’s oral arguments in 3M.

Given this uncertainty, taxpayers facing the issues being litigated in 3M and Abbott Laboratories should consider filing protective refund claims while these and other cases work their way through the judicial system.

In 3M, the taxpayer is challenging the so-called blocked income regulation in Reg. 1.482-1(h). The Tax Court narrowly upheld the regulation, in large part relying on Chevron deference, prompting 3M to appeal to the US Court of Appeals for the Eighth Circuit. Meanwhile, Abbott Laboratories is challenging the rules for allocating stock-based compensation under Reg. 1.482-7(d)(1), an issue previously litigated in Altera v. Commissioner—another case that relied on Chevron.

The Supreme Court’s June ruling in Loper Bright v. Raimondo overturned the 40-year-old Chevron doctrine that required lower courts to defer to agencies’ reasonable interpretations of unclear statutes. The justices didn’t establish a standard of review for post-Chevron regulatory challenges like these. So lower courts must create their own framework, including in the pending multimillion-dollar transfer pricing disputes.

Two lines of inquiry are likely to emerge: First, does the regulation embody a policy choice or factual determination? If so, courts also are likely to defer to the agency’s regulation as long as it reflects reasoned decision-making.

Otherwise, if the regulation is interpreting the statute, courts may move to a second question: Does the Treasury have discretionary authority to interpret the statute through regulations? If so, the agency’s interpretation may still be entitled to deference. If not, the court would interpret the statute without deference to the regulation and could hold the regulation invalid. As reflected in 3M‘s oral arguments, courts will also need to address the order in which to address these two questions.

Under Section 482 of the tax code, these questions don’t have clear answers. Courts will have to grapple with whether the blocked income regulation and the stock-based compensation rules are factual determinations or policy decisions. There is a strong argument that creating the arm’s-length standard (which appears nowhere in the statute), and then providing rules for specific situations, represent policy choices.

In its supplemental brief in 3M, the government implies that the blocked income regulation incorporates a factual or policy choice, though it doesn’t spend much time elaborating.

If a court concludes that the regulation represents a policy choice or factual determination, it would analyze the regulation under the Administrative Procedure Act’s reasoned decision-making standard. At least several Tax Court judges concluded the blocked income regulation didn’t meet this standard as described in Judge Emin Toro’s dissent in 3M.

If the court concludes that the regulations are instead legal interpretations, the question becomes whether Congress granted the Treasury the legal authority to interpret the statute. Although Section 7805(a) allows the Treasury secretary to “prescribe all needful rules and regulations for the enforcement of this title,” it seems unlikely that such a general provision would entitle an agency deference to interpret Section 482 or other tax code provisions.

Unlike other tax code provisions, Section 482 doesn’t expressly delegate authority to the Treasury secretary to interpret the provision through regulations. However, Section 482 says the Treasury secretary “may distribute, apportion or allocate gross income, deductions, credits or allowances” if if the secretary determines it is necessary to prevent tax evasion “or clearly reflect the income” of related entities.

A court could interpret this provision as embodying the power to draft rules that apply to all taxpayers—that is, through regulations—in addition to making determinations on a case-by-case basis. This is how the government interpreted its authority in its briefs in 3M. By contrast, 3M argued that Loper Bright undermines the core reasoning of the Tax Court, and that Section 482 contains no express delegation.

Given Tuesday’s oral arguments in 3M, there will be judicial precedent applying Loper Bright to the Section 482 regulations soon—at least relatively speaking.

However, the Tax Court makes decisions based on circuit precedent applicable to that taxpayer. So the Eighth Circuit’s decision in 3M will become binding precedent only for other taxpayers in the Eighth Circuit. Other circuits could develop their own different frameworks in post-Chevron world, which the Tax Court would need to apply to other taxpayers.

Moreover, the Tax Court may come to different conclusions in Abbott Laboratories. And indeed, that case would be appealed to the Seventh Circuit and that decision would again only be binding on other taxpayers in the Seventh Circuit.

The result: Taxpayers in some circuits could be required to include stock-based compensation in their cost-share calculations under the upheld Reg. 1.482-7(d)(1)(iii), for example, while taxpayers in other circuits would not. Similarly, taxpayers in some circuits could be required to include blocked income as income, while taxpayers in other circuits would not.

Now we wait for these interpretive questions to play out in the Tax Court, district courts, and circuit courts as the statutes of limitations for open years begin to close. As statutes of limitations for open years begin to close, taxpayers may wish to consider filing protective refund claims regarding the outcome of pending court cases to protect the ability to later file for refunds if the regulations are held invalid.

The cases are 3M v. Commissioner, 8th Cir., No. 23-03772, oral argument 10/22/24 and Abbott Laboratories v. Commissioner, T.C., No. 15235-24, complaint filed 9/19/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Lauren Ann Ross is special counsel at Covington & Burling, focusing on tax controversy matters and transfer pricing issues.

Adam Spiegel is an associate at Covington & Burling in Washington, D.C., and a member of the tax practice group.

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