United States: Taxpayer Challenges Validity of IRS Transfer Pricing Regulation

In a petition recently filed in the U.S. Tax Court, a taxpayer has challenged the Internal Revenue Service (IRS) regulation that provides that the IRS can reallocate income between affiliates even when foreign law prohibits making the payment or receipt in question.  The dispute is important for several reasons outlined in this newsletter.  Taxpayers may want to examine their positions on prior tax returns.


On March 3, 2013, the 3M Company filed a petition in the U.S. Tax Court challenging the validity of an Internal Revenue Service (IRS) transfer pricing regulation stating that the IRS can reallocate income between related parties even if foreign legal restrictions prohibit the payment or receipt (Treas. Reg. §1.482-1).  An exception to this precludes an IRS reallocation if the foreign restrictions are generally applicable to all similarly situated persons, whether controlled or uncontrolled.  The IRS adopted this regulatory approach in 1994, shortly after losing, in 1992, Procter & Gamble Co. (961 F.2d 1255 (6th Cir. 1992), affirming 95 TC 323 (1990)) and, in 1993, Exxon Corp. (TC Memo 1993 – 616 (1993)).  

Procter & Gamble established to the satisfaction of the Tax Court and the U.S. Court of Appeals for the Sixth Circuit that the IRS could not use Internal Revenue Code (Code) section 482 to reallocate income, because Spanish law, not control over an affiliate, created the alleged distortion of income by prohibiting the payment of the amount in question (961 F.2d at 1258).  In reaching their conclusions, the Sixth Circuit and the Tax Court relied in part on an earlier Supreme Court of the United States decision, Commissioner v. First Security Bank, that held that the IRS cannot use section 482 to reallocate income between related parties when federal law precludes the payment of the amount at issue.  (See Procter & Gamble Co., 961 F.2d at 1258 (citing Comm. v. First Security Bank, 405 U.S. 394 (1972)).)   

The 3M case, which appears to be the first docketed case challenging the validity of the 1994 regulations (though there may be other controversial and potentially vulnerable parts of Treas. Reg. §1.482-1 that could be challenged), arises in the context of Brazilian industrial property law requirements that in 2006 prevented the payment of certain royalties by a Brazilian subsidiary of 3M.  Although the taxpayer's petition is silent on this, the Brazilian rules may not have applied similarly to both controlled and uncontrolled persons, as the IRS regulation requires.  The IRS Form 886-A (Explanation of Adjustments) issued to 3M alleges "it has not been established that the Brazilian legal restrictions affected an uncontrolled taxpayer under comparable circumstances for a comparable period of time ...".

The foreign legal requirement regulation was controversial when the IRS first proposed it in 1993 and then finally adopted it in 1994.  It remains a cause for concern for taxpayers subject to different types of foreign legal restrictions.  The regulation, if it is valid, would narrow, if not override, the successful argument in First Security Bank of Utah and Procter & Gamble Co. that when U.S. or foreign law prevents a payment that causes an alleged distortion of income, as opposed to the taxpayer using its own control to create a distortion of income, then one of the Code's threshold principles for the use of section 482 to reallocate income has not been satisfied.

It is worth noting that the language of Code section 482 is, in relevant part, the same today as it was during the tax years at issue in First Security Bank of Utah, Procter & Gamble Co. and Exxon Corp., which go back to 1955.  Thus, the prior  statutory interpretations and basic holdings of the courts appear to be equally valid under the Code in the year at issue in the 3M controversy (2006) and today.

Of course, the 1994 IRS regulation introduces a new issue because it adds the prerequisite that the foreign legal restriction preventing payment must apply similarly to controlled and uncontrolled parties.  As 3M has challenged the validity of the foreign legal requirement part of the 1994 IRS regulation, this brings into play how much deference the Tax Court should give to the regulation. 

As indicated, the "control" requirement of the statute that the Supreme Court interpreted in 1972 for tax years 1955 through 1959 in First Security Bank and that the Sixth Circuit interpreted in 1992 for tax years 1978 and 1979 in Procter & Gamble Co., is the same as it is in 2006, the tax year at issue in the 3M petition.  Consequently, 3M could be asking the Tax Court whether the IRS can interpret the same statutory requirement differently from the Supreme Court (and the Sixth Circuit) by issuing a regulation after losing the issue several times in the courts. 

In these circumstances, does the 1994 regulation have to give way to the prior judicial interpretations of the same statutory provision?  One would hope that is the result under the most recent Supreme Court views on the level of deference that the courts must give to an IRS regulation.  (See Mayo Foundation for Medical Ed. & Research v. United States, 131 S. Ct. 704 (2011) and United States v. Home Concrete & Supply, LLC et al., 132 S. Ct. 1836 (2012).)  In Home Concrete & Supply, the Supreme Court held that the IRS could not by regulation overrule the Supreme Court's prior interpretation of the same statute.

In our view, [the prior Supreme Court decision] has already interpreted the statute, and there is no longer any different construction that is consistent with [the prior Supreme Court decision] and available for adoption by the agency.  (132 S. Ct. at 1843)

In closing, the 3M controversy could lead to interesting jurisprudence not only on the substantive question of when legal requirements preclude IRS reallocations, but on the amount of deference to be given to an IRS regulation that conflicts with how the statute has been long interpreted by the courts.  Should the 3M case be decided by the Tax Court, rather than settled, the Tax Court may have to wrestle with whether it can uphold the Supreme Court's section 482 principles in First Security while complying with the recent Supreme Court standards on regulatory deference.  This should be possible, as illustrated by Home Concrete & Supply

In the meantime, taxpayers may want to take another look at their tax return positions in cases where foreign legal restrictions that applied to them may have run afoul of the narrowed standard of the 1994 regulations, but could satisfy the principles established in the prior court cases.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions