As noted in an earlier post, 3M Co. v. Commissioner, T.C. Dkt. No. 5816-13, involves 3M’s challenge to the Internal Revenue Service’s (IRS’s) determination that Brazilian legal restrictions on the payment of royalties from a subsidiary in that country to its US parent should not be taken into account in determining the arm’s-length royalty between 3M and its subsidiary under Treas. Reg. § 1.482-1(h)(2). The case has been submitted fully stipulated under Tax Court Rule 122, and the parties’ simultaneous opening briefs were filed on March 21, 2016.

Citing First Sec. Bank of Utah and cases following it, 3M first argues that “[c]ase law consistently holds that the Commissioner cannot employ section 482 to allocate income that the taxpayer has not received and cannot receive because a law prevents its payment or receipt.” Under this line of authority the IRS’s proposed allocation of royalty income to 3M is precluded by Brazilian law. This result is not changed by Treas. Reg. § 1.482-1(h)(2) because that regulation is invalid.

The regulation is “procedurally invalid,” 3M argues, because Treasury and the IRS failed to satisfy the requirements of § 553 of the Administrative Procedure Act (APA) when they promulgated the regulation. They did not respond to significant comments criticizing the proposed regulation; nor did they articulate a satisfactory justification or explanation for the regulation. They thus did not engage in the “reasoned decisionmaking” required by the APA and case law such as State Farm and Altera when an agency issues regulations. (more…)