3M Co. & Subsidiaries v. Comm'r of Internal Revenue

Decision Date09 February 2023
Docket Number5816-13
Parties3M COMPANY AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtUnited States Tax Court

160 T.C.No. 3

3M COMPANY AND SUBSIDIARIES, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 5816-13

United States Tax Court

February 9, 2023


P is the common parent company of the P consolidated group. As among the members of the P consolidated group (and among P's foreign affiliates), ownership of trademarks had been centralized in P. Other intellectual property, including patents and nonpatented technology, was owned by S, a second-tier wholly owned U.S. subsidiary of P. S is a member of the P consolidated group.

B is a wholly owned Brazilian subsidiary of S. During 2006, B used in its business operations the trademarks owned by P. B's use of these trademarks was governed by three trademark licenses that P and B had executed in 1998. Each license concerned a separate set of trademarks. In accordance with the licenses, B paid a royalty to P equal to 1% of its sales of the trademarked products. Some products sold by B were subject to trademarks covered by more than one of the three trademark licenses. For such products, B and P calculated the trademark royalties using a stacking principle under which, for example, if a particular product used trademarks covered by all three trademark licenses, the royalties were 3% of the sales of the product. Computing the royalties using this stacking principle, B paid P trademark royalties in 2006.

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B also used in its business operations patents and nonpatented technology owned by S. B paid no patent royalties and made no technology-transfer payments to S. No patent license and no technology-transfer agreement was in effect between S and B.

On its 2006 consolidated federal income-tax return, the P consolidated group reported as income the trademark royalties that B paid to P in 2006.

In the notice of deficiency, R determined that the income of the P consolidated group should be increased under I.R.C. sec. 482 to account for B's use of the intellectual property of P and S. The increase in income determined in the notice of deficiency represents an arm's-length rate of compensation for the intellectual property used by B.

P's position is that the I.R.C. sec. 482 allocation should correspond to the maximum amount that B could have paid for the intellectual property in question under the laws of Brazil, less related expenses.

R's I.R.C. sec. 482 adjustment does not take into account the effect of the Brazilian legal restrictions. A 1994 regulation, 26 C.F.R. sec. 1.482-1(h)(2) (2006), sets forth the requirements that must be met before R "will take into account the effect of a foreign legal restriction" under I.R.C. sec. 482. T.D. 8552, 59 Fed.Reg. 34971 (July 8, 1994). The Brazilian legal restrictions do not meet the requirements.

P contends that some of the requirements are invalid because they fail either the Chevron step 2 test or the part of the State Farm test that requires the agency to adequately respond to comments. See Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 844 (1984); Motor Vehicle Mfrs. Ass'n of the U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983); Altera Corp. & Subs. v. Commissioner, 145 T.C. 91, 120, 130 (2015), rev'd, 926 F.3d 1061 (9th 2019). P also contends that the entire regulation addressing foreign legal restrictions, 26 C.F.R. sec. 1.482-1(h)(2) (2006), is invalid under the part of

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the State Farm test that requires the agency to give a satisfactory explanation for the regulation and the part of the State Farm test that requires the agency to respond to comments. Furthermore, P contends that the entire regulation is invalid under Chevron step 1 because Commissioner v. First Security Bank of Utah, N.A., 405 U.S. 394 (1972), and its progenitor and progeny held that under predecessors to I.R.C. sec. 482 R cannot make an allocation of income to a taxpayer who did not receive income and could not legally receive the income.

Held: The requirement of 26 C.F.R. sec. 1.482-1(h)(2)(i) (2006) that "a foreign legal restriction will be taken into account only to the extent that it is shown that the restriction affected an uncontrolled taxpayer under comparable circumstances" is not invalid under Chevron step 2.

Held, further, the requirement that foreign legal restrictions be taken into account under I.R.C. sec. 482 only if they are publicly promulgated, 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006), means that the foreign legal restrictions must be in writing.

Held, further, the Brazilian legal restrictions at issue do not meet the requirement in 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006) that foreign legal restrictions be taken into account under I.R.C. sec. 482 only if they are publicly promulgated.

Held, further, the requirement that foreign legal restrictions be taken into account under I.R.C. sec. 482 only if they are publicly promulgated, 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006), is not invalid under Chevron step 2.

Held, further, the requirement that foreign legal restrictions be taken into account under I.R.C. sec. 482 only if they are "generally applicable to all similarly situated persons (both controlled and uncontrolled)", 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006), is not invalid under Chevron step 2.

Held, further, the 1994 regulation, 26 C.F.R. sec. 1.482-1(h)(2) (2006), is valid under Chevron step 1.

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Held, further, the 1994 regulation, 26 C.F.R. sec. 1.482-1(h)(2) (2006), is not invalid under P's State Farm theory.

Walter A. Pickhardt and Michael J. Kaupa, for petitioner.

Justin L. Campolieta and William R. Peck, for respondent.

CONTENTS

FINDINGS OF FACT .................................................................. 10

1. 3M do Brasil Ltda. (or 3M Brazil); its 1952 agreement with 3M Company .................................................. 11

2. The 1982 trademark licensing agreement ....................... 12

3. The 1983 licensing agreement .......................................... 12

4. The 1997 proposed licensing agreement .......................... 13

5. Termination of the 1982 trademark licensing agreement and the 1983 licensing agreement; execution of the 1998 trademark licenses; stipulations related to Brazilian law ...................................................................................... 18

6. Texts of certain Brazilian legal documents referred to in the stipulations related to Brazilian law .......................... 35

7. 1999 assignment agreement; corporate restructuring .... 42

8. Business operations during the 2006 tax year ................. 43

a. 3M Global ................................................................ 43

b. 3M Brazil ................................................................ 44

c. Intellectual property; services ................................ 45

d. Payments by 3M Brazil .......................................... 47

9. Tax reporting ..................................................................... 48

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10. The notice of deficiency ..................................................... 48

11. Closing agreement ............................................................. 51

12. The petition ....................................................................... 51

13. The stipulation that the rate of compensation under the standard licensing agreement is an appropriate arm's-length rate under section 482 ........................................... 53

14. The stipulation that the section 482 adjustment must be reduced by $4,117,370 in unreimbursed research-and-development expenses incurred by 3M Brazil .......... 53

15. The stipulation that under Brazilian law, the maximum amount that 3M Brazil could have paid to 3M IPC as patent royalties or technology-transfer payments in 2006 was $4,283,153 after reduction for the $5,104,756 in trademark royalties paid by 3M Brazil to 3M Company in 2006 ............................................................... 53

16. The stipulation that if the Court holds that the section 482 adjustment must take into account the Brazilian legal restrictions, then the minimum section 482 adjustment should be $165,783 ........................................ 56

17. Respondent's position ........................................................ 56

18. Petitioner's position ........................................................... 58

19. Other stipulations ............................................................. 65

OPINION ...................................................................................... 65

I. Procedural matters ............................................................ 65

II. Review of the authorities under U.S. law relevant to the arguments by the parties ............................................ 67

A. The Revenue Act of 1921 ........................................ 70

B. The Revenue Act of 1924 ........................................ 72

C. The Revenue Act of 1926 ........................................ 72

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D. The Revenue Act of 1928 ........................................ 73

E. The Revenue Act of 1932 ........................................ 74

F. The Revenue Act of 1934 ........................................ 75

G. Regulations 86 ........................................................ 75

H. The Federal Register Act and the publication of the first issue of the Federal Register ................... 79

I. The Revenue Act of 1936 ........................................ 83

J. Regulations 94 ........................................................ 83

K. The 1937 amendment to the Federal Register Act ........................................................................... 83

L. The first edition of the Code of Federal Regulations ............................................................. 84

M. The Revenue Act of 1938 ........................................ 86

N. Regulations 101...

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