USA Trends and Developments Contributed by: Sean Lyons, Nicholas Wilkins, Kevin Spencer and Kim Marie Boylan, White & Case LLP
Post-Loper Bright Challenges to Transfer Pricing Regulations: The 3M Case Less than two years since the Supreme Court issued its opinion in Loper Bright , federal courts have cited the decision more than 600 times; Loper Bright has had a real and immediate effect on disputes involving federal agency pronouncements. Litigants, including taxpayers, have been quick to use Loper Bright to challenge (or more effectively challenge) unfavourable federal agency rules and regulations. Already, a major case challenging transfer pricing regulations has been decided in the taxpayer’s favour. The trial court’s decision In 3M Co v Comm’r , 160 TC 50 (2023), the taxpayer challenged the validity of Treasury Regulation Sec - tion 1.482-1 (h)(2) in the US Tax Court. This regula - tion provides rules for determining when foreign legal restrictions on payments to related parties will be taken into account in a transfer pricing analysis. The regulation lists criteria, all of which must be met for the foreign legal restrictions on payments to be taken into account, and also describes a “deferred income method of accounting” that taxpayers must elect in order to defer recognition of amounts that should have been paid in the absence of the foreign legal restric - tions. At issue was the effect of Brazilian legal restrictions on paying royalties to foreign companies. In this case, the taxpayer’s Brazilian subsidiary was subject to a cap on the deduction for royalties paid to US affiliates for use of the affiliates’ intellectual property. The Brazilian subsidiary paid only what it could deduct (approxi - mately USD5 million), while the IRS asserted that an arm’s length royalty was much greater (approximately USD28 million). The IRS relied on Treasury Regulation Section 1.482-1 (h)(2) to argue that the Brazilian legal restrictions were not relevant to the transfer pricing analysis. The taxpayer argued that the regulation was invalid and its application impermissible for a variety of reasons. Because the US Tax Court decided 3M before the Supreme Court decided Loper Bright , the US Tax Court engaged in a Chevron analysis, concluding that the regulation’s interpretation and application of Sec - tion 482 of the Code was entitled to deference (Id at
255–88). Under Chevron step one, the US Tax Court concluded that the plain language of Section 482 was ambiguous as to the correct treatment of foreign legal restrictions on payments (Id at 275–76). The US Tax Court then turned to step two of the Chevron analysis, where it concluded that the criteria contained in Treas - ury Regulation Section 1.482-1 (h)(2) represented per - missible interpretations of Section 482 (Id at 279–88). Applying the regulation to the taxpayer’s facts, the US Tax Court held that the Brazilian legal restrictions at issue should not be taken into account in computing the Section 482 allocations (Id at 298). The parties’ appellate briefing On appeal, the parties’ initial briefing (which also occurred before the Supreme Court’s Loper Bright decision) was very typical of a challenge to a regu - lation under Chevron . Both parties argued that Sec - tion 482 of the Code unambiguously supported their respective positions. The taxpayer argued that – should Section 482 be determined to be ambiguous – Treasury Regulation Section 1.482-1 (h)(2)’s inter - pretation of the statute should be rejected as imper - missible, whereas the government naturally made the opposite argument. However, after briefing in the case had concluded, the US Supreme Court issued its Loper Bright decision. The US Circuit Court of Appeals for the Eighth Cir - cuit (the “Eighth Circuit”) invited the parties to submit supplemental briefing, with the taxpayer arguing that “Loper Bright eviscerates the Tax Court plurality’s sole rationale for upholding” Treasury Regulation Section 1.482-1 (h)(2) (Appellant’s Suppl Brief at 9, 3M Co v Comm’r , No 23-3772 (8th Cir 2 October 2024)). The taxpayer stated that “[t]he Tax Court plurality never suggested that the IRS’s position represents the best reading of Section 482” (Id) and urged the Eighth Circuit to adopt the taxpayer’s reading of the statute (Id at 9–10). The thrust of the taxpayer’s argument was that Supreme Court precedent predating Treas - ury Regulation Section 1.482-1 (h)(2), Comm’r v First Security Bank of Utah, NA , 405 US 394 (1972) (“First Security”), conclusively established that Section 482 may not be used to allocate income the payment of which is prohibited by law.
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