Case Overview
3M Company and Subsidiaries v. Commissioner addresses whether the IRS may use Internal Revenue Code §482 to impute (“allocate”) royalty income that a U.S. parent could not legally receive because of foreign law restrictions on payments by a foreign subsidiary. The dispute turned on Treas. Reg. §1.482-1(h)(2) (the “foreign legal restrictions” or “blocked-income” rule), which limits when the IRS will take foreign restrictions into account in applying the arm’s-length standard.
The U.S. Tax Court upheld the regulation and sustained the IRS’s allocation in a sharply divided reviewed decision. After Loper Bright ended Chevron deference, the Eighth Circuit reversed, holding that §482 itself cannot reach income the taxpayer was legally prohibited from receiving.
Key Facts
- Tax year: 2006.
- Notice of deficiency: $4,847,004 income tax deficiency; IRS increased income by $23,651,332 under §482. (Tax Court)
- Structure/intangibles: 3M Company owned key trademarks; other IP (patents and nonpatented technology) was held by a wholly owned U.S. affiliate within the consolidated group; the Brazilian operating company was a wholly owned Brazilian subsidiary.
- Actual payments: The Brazilian subsidiary paid $5,104,756 in trademark royalties to 3M Company under trademark licenses; it paid no patent royalties/technology-transfer payments.
- Stipulated economics: The parties agreed the IRS’s proposed allocation reflected an arm’s-length outcome; the dispute was principally about legal constraints and the regulation’s validity/application.
The Dispute
3M argued that Brazilian law and Brazilian administrative practice effectively capped what its Brazilian subsidiary could legally remit as royalties to a controlling foreign company, so §482 could not allocate more “income” than 3M could legally receive. The IRS relied on Treas. Reg. §1.482-1(h)(2), which generally disregards foreign legal restrictions unless the taxpayer satisfies a multi-factor test (including, among other requirements, that the restriction is publicly promulgated, generally applicable in comparable circumstances (including to uncontrolled parties), and not realistically avoidable through other payment forms, plus exhaustion/no-circumvention concepts).
3M attacked the regulation under Chevron and the APA/State Farm, citing Commissioner v. First Security Bank of Utah, 405 U.S. 394 (1972), and other “blocked income” precedents as limiting §482 where income cannot legally be paid or received.
Holding and Reasoning
Tax Court (Feb. 9, 2023) — IRS wins (judgment sustained)
- Vote/structure: Reviewed decision with a 9–8 judgment for the IRS; the Eighth Circuit later described the reasoning as a seven-judge plurality plus two concurrences to reach the judgment.
- Regulation upheld: The Tax Court rejected 3M’s challenges and upheld Treas. Reg. §1.482-1(h)(2) against the statutory (Chevron) and APA/State Farm attacks.
- Application to Brazil: Applying the regulation’s prerequisites, the court concluded the Brazilian “legal restrictions” did not qualify to be taken into account. A key interpretive point was that “publicly promulgated” in the regulation requires the restriction to be in writing, and the court found the relevant Brazilian restrictions/policies failed that (and other) regulatory requirements. The IRS’s §482 increase therefore stood.
Eighth Circuit (Oct. 1, 2025) — taxpayer wins (reversed and remanded)
- No Chevron deference: Applying Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024), the court adopted the “best reading” of §482 without deferring to the regulation.
- Statutory limit (dominion/control): Relying on First Security Bank and “blocked income” authorities (including Procter & Gamble), the court held §482 cannot allocate “income” the taxpayer could not legally receive—because the taxpayer lacks “complete dominion” over it.
- Commensurate-with-income sentence: The court rejected the IRS’s argument that §482’s “commensurate with income” sentence for intangibles changes the threshold meaning of “income.” It treated that sentence as addressing how to measure allocable income for intangibles, not as authorizing allocations of amounts barred by law.
- Dividends-as-substitute rejected: The IRS argued the subsidiary could have paid additional dividends instead of royalties. The court rejected this, emphasizing that dividends and royalties differ in legal and tax character and that §482 does not require structuring around foreign-law payment limits.
- Disposition: The Eighth Circuit reversed and remanded for the Tax Court to redetermine 3M’s 2006 tax consistent with its interpretation of §482.
Takeaways for Practitioners
- Separate “arm’s-length” from “legally payable”: Even when an arm’s-length royalty is agreed, foreign-law constraints may still drive the U.S. tax result—especially after Loper Bright.
- Build a restriction record: Preserve primary legal sources and evidence of enforcement risk (e.g., recordation requirements, remittance approvals, penalties), and document whether restrictions apply to uncontrolled parties.
- Don’t assume substitutes solve it: Courts may treat “alternative payments” (e.g., dividends) as non-comparable to royalties, depending on statutory framing and the facts.
- Forum matters: The Eighth Circuit decision is binding in that circuit; elsewhere, it is persuasive and may interact with other pending §482 litigation addressing foreign legal restrictions.
Related Content
For practical implementation, see our Transfer Pricing Documentation Guide and refresher on the Arm's Length Principle.
Frequently Asked Questions
Q1: What is “blocked income” in a §482 transfer pricing context?
A: It refers to amounts the IRS imputes under §482 that the taxpayer argues it could not legally receive (or the payer could not legally remit) because of foreign law restrictions (e.g., royalty caps, remittance controls).
Q2: What did the Tax Court do with Treas. Reg. §1.482-1(h)(2)?
A: It upheld the regulation and applied its multi-factor test, concluding the Brazilian restrictions did not satisfy the prerequisites (including the “publicly promulgated” requirement, which the court interpreted to mean “in writing”), so the IRS could disregard the restrictions for §482 purposes.
Q3: What did the Eighth Circuit hold after Loper Bright?
A: It held §482 cannot allocate royalty income that 3M could not legally receive under foreign law, because “income” for §482 purposes requires taxpayer dominion/control, and a regulation cannot override that statutory boundary.
Q4: Did the Eighth Circuit decide the APA challenge to the blocked-income regulation?
A: No. The reversal rested on statutory interpretation of §482 (post-Loper Bright), not on procedural invalidity under the APA.
Q5: Does §482’s “commensurate with income” rule for intangibles override blocked-income limits?
A: The Eighth Circuit said no: it viewed the “commensurate with income” sentence as a valuation/measurement rule for allocable intangible income, not as authority to allocate amounts that are legally blocked from payment or receipt.
