In 2006 3M Co entered into a licensing arrangement where certain intangibles were made available to its Brazilian subsidiary. Brazilian rules prescribe a one-percent cap on the royalties that a Brazilian licensee can remit to a foreign related party licensor, imposing a limitation on 3M’s Brazilian subsidiary to paying USD Mil 5.1 in trademark royalties to 3M Co in US, with regards to USD Mil 564 in Brazilian sales. In the IRS arm's length assessment, the royalty rate was six percent, and the assessee should have reported an additional USD Mil 27.8 of royalty income from the Brazilian subsidiary, notwithstanding the bar under Brazilian domestic law. The dispute arised with the US Blocked Income Regulation4, which was disputed with the U.S. Tax Court.
During submissions, 3M primarily relied on Commissioner v First Security Bank of Utah5 where the Supreme Court rejected the IRS’s section 482 adjustments due to legal restrictions blocking payments between related companies. 3M argued that the Supreme Court in First Security Bank held that section 482 was unambiguous in prohibiting the attribution of income to a taxpayer if receipt of the income is prohibited by law.
On the other hand, the Tax Court’s "narrow majority" rejected the assessee’s reliance on First Security Bank. It noted that the Supreme Court in First Security Bank did not examine Section 482 in a way to link the text of the statute to the principle that income cannot be attributed to a taxpayer who cannot legally receive it. The same majority highlighted that First Security Bank did not address if Section 482 “unambiguously precluded an allocation of income that could not be legally received.”