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April 09, 2024 The Tax Lawyer

Blocked Income & 3M Company & Subsidiaries v. Commissioner - Round One - The Chevron Step One Argument

Vol. 77, No. 2 - Winter 2024

Philip G. Cohen


More than six years after the case was tried, the Tax Court issued its voluminous, reviewed decision in 3M Company & Subsidiaries v. Commissioner, in which it concluded, by a razor-thin 9-8 margin, that the Service had the authority, under Regulation section 1.482-1(h)(2), to reallocate foreign income that was allegedly restricted under Brazilian law. In reaching that conclusion, the Tax Court upheld both the substantive and procedural validity of that regulation, which was issued in 1994 and is often referred to the “blocked income” regulation. The various opinions in the case, totaling 346 pages, consist of a 274-page opinion of the Tax Court, to which six other judges joined, two concurring opinions, and three separate dissenting opinions.

Not surprisingly, the 3M Company’s contentious opinions have raised a host of thought-provoking questions. In this author’s opinion, the taxpayer in 3M Company should have prevailed on its argument that Regulation section 1.482-1(h)(2) is substantively invalid under the Chevron step one test. This Article explains the reasoning for that conclusion and leaves to others to comment on the additional challenges—primarily focused on various Administrative Procedure Act (APA) challenges to the promulgation of that regulation—that the taxpayer made in that case.

I base this conclusion on the Supreme Court’s 1972 decision in First Security Bank of Utah. Irrespective of the correctness of that decision—and there are a fair amount of critics in this regard—the Supreme Court’s decision there clearly held that section 482 does not permit the Service to allocate income to someone who is prohibited by law from receiving it.

While not entirely free from doubt, there is a strong argument that the Court’s decision in First Security Bank was based on the statute and did not rely on a regulation in reaching its decision. In the absence of a statutory change, lower courts are bound to follow it, and the Treasury Department should not be permitted to usurp that authority through regulations or otherwise.

While sound tax policy mandates that the Service should vigorously enforce arms-length transfer pricing between related parties, including the robust use of the commensurate-with-income amendment to section 482 to address abuses in this area, there are no compelling reasons, from a judicial standpoint at least, to limit the holding of First Security Bank to domestic—as opposed to foreign—legal restrictions. This was the conclusion of the courts in Procter & Gamble, Exxon and Texaco. The Tax Court in 3M Company should have followed that precedent absent a statutory amendment that limited the scope of First Security Bank. Although an argument could be made that the Chevron step one test was satisfied in 3M Company, either because the First Security Bank holding was based on regulations no longer in effect or because the fact-pattern in that case was so different from 3M Company that the former decision should not be deemed binding, the more persuasive view is to the contrary. Furthermore, there is a convincing case that the plain text of the commensurate-with-income amendment to section 482 did not constrain the First Security Bank holding, and there is no evidence in the legislative history that this was the Congressional intention.


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