In a brief filed on October 19, 2022, the IRS asked the U.S. Supreme Court to refuse to review the decision of the Sixth Circuit affirming, in a 2-1 split decision, that $45 million earned by appliance maker Whirlpool’s controlled foreign corporation (“CFC”) in Luxembourg was foreign base company sales income taxable under Subpart F of the Internal Revenue Code.
Whirlpool’s parent company maintains that income from its Luxembourg affiliate’s sales of appliances to its Mexican subsidiary cannot be taxed under Subpart F because it was generated by two foreign affiliates manufacturing different products. However, the IRS contends that the transactions fall within the I.R.C. §954(d) definition of foreign base company sales income (“FBCSI”) earned by a U.S. parent’s CFC and are therefore taxable under Subpart F.
Through its domestic and foreign subsidiaries, Whirlpool engages in the manufacture and distribution of major household appliances, including refrigerators and washing machines, in the United States and abroad. Whirlpool International Holdings, S.a.r.l. (“WIH”), is a wholly owned subsidiary of Whirlpool organized under the laws of Luxembourg. When it filed its petition, WIH had its principal place of business in Luxembourg. Before December 31, 2010, WIH was known as Maytag Corp. (Maytag) and was likewise engaged in the manufacture and distribution of household appliances.
During 2007-2009, Whirlpool restructured its Mexican manufacturing operations, driven largely by tax considerations. It organized a new entity in Luxembourg, which was a controlled foreign corporation (CFC) for Federal income tax purposes. Through a branch in Mexico, the Luxembourg CFC took over (at least nominally) the manufacturing operations previously conducted by a subsidiary of Whirlpool’s Mexican CFC. The Luxembourg CFC then sold the finished products to Whirlpool and its Mexican CFC, which distributed the products for sale to consumers. The Luxembourg CFC, which had one part-time employee, added no appreciable value to, but earned substantial income from, these sales transactions.
The Internal Revenue Service (“IRS”) determined that the sales income derived by the Luxembourg CFC constituted foreign base company sales income (FBCSI) under section 954(d) and was thus taxable to Whirlpool as subpart F income under section 951(a). The IRS accordingly increased Whirlpool’s taxable income for 2009 by $49,964,080, decreasing pro tanto its consolidated net operating loss (NOL) carryback deduction. The reduction in available NOL carry-backs generated a deficiency of $43,720 for Whirlpool for 2005 and a deficiency of $440,742 for Maytag for 2000.
The procedural history of this matter began with the U.S. Tax Court where, on May 5, 2020, Judge Lauber denied Whirlpool’s motion for summary judgment and granted the motion for summary judgment of the IRS. The Tax Court found that, whether or not the Luxembourg CFC is regarded as having manufactured the products, Whirlpool’s Mexican branch under section 954(d)(2) is treated as a subsidiary of the Luxembourg CFC, and the sales income the latter earned constitutes FBCSI taxable to Whirlpool as subpart F income. See 154 T.C. 142.
In an opinion issued on December 6, 2021, the Sixth Circuit affirmed the Tax Court’s opinion. See 19 F.4th 944.
Analysis of Subpart F
Subpart F income is defined to include (among other things) “foreign base company income.” Sec. 952(a)(2). As in effect for 2009, “foreign base company income” included “foreign personal holding company income,” e.g., dividends, interest, rents, and royalties. Sec. 954(a)(1), (c). It also included three types of foreign base company income, one of which is FBCSI. See sec. 954(a)(2), (3), (5). A taxpayer’s FBCSI is determined under section 954(d), reduced by deductions allowable under section 954(b)(5). See sec. 954(a)(2).
Gross income constitutes FBCSI if it meets the conditions set forth in section 954(d)(1) or (2). These provisions are aimed at personal property transactions involving related parties. They were intended to capture, and treat as subpart F income, “income from the purchase and sale of property, without any appreciable value being added to the product by the selling corporation.” S. Rept. No. 87– 1881, at 84, 1962-3 C.B. 707, 790; see 3 Joseph Isenbergh, International Taxation, para. 74.27, at 74,043 (4th ed. 2006) (“Foreign base company sales income—perhaps the quintessential form of Subpart F income— * * * is income that results from channeling sales of goods through a low-tax foreign entity that has no significant economic relation to the sales.”). Congress was concerned that such artificial separation of sales income from manufacturing income facilitated evasion both of U.S. and foreign tax.
Section 954(d)(1) generally provides that, when a CFC earns income in connection with the purchase or sale of personal property in certain transactions involving a “related person,” that income will be FBCSI if the property is (A) manufactured outside the country in which the CFC is organized and (B) sold for consumption or use outside that country. Section 954(d)(2), captioned “Certain branch income,” prevents a U.S. shareholder from escaping section 954(d)(1) by having its CFC conduct activity through a branch (as opposed to a subsidiary) outside the CFC’s home country. Where the carrying on of activities through a branch “has substantially the same effect” as if the branch were a wholly owned subsidiary, then, “under regulations prescribed by the Secretary,” the branch will be treated as a subsidiary of the CFC for purposes of determining FBCSI. Sec. 954(d)(2).
In its petition for certiorari, Whirlpool framed the issue as follows:
Whether the divided Sixth Circuit properly held—in conflict with precedent of this Court and settled administrative-law principles—that a statute that is conditioned on regulations delineating its reach may be enforced without regard to those regulations?
Numerous statutes are expressly conditioned on the promulgation of regulations that delineate when or how a particular statutory provision applies. In Section 954(d)(2) of the Internal Revenue Code, Congress declared that certain income earned abroad by foreign corporations is subject to U.S. taxation; but Congress explicitly conditioned § 954(d)(2)’s execution on “regulations prescribed by the Secretary [of the Treasury]” delineating the income subject to taxation. 26 U.S.C. § 954(d)(2).
According to Whirlpool, regulations implementing § 954(d)(2) that have been in place for over 50 years yield a result in this case that the income would not be taxable. Indeed, the dissent in the divided Sixth Circuit recognized that the income would not be taxable under the regulations.
Moreover, according to Whirlpool, the Sixth Circuit’s decision conflicts with precedent of the U.S. Supreme Court on whether a statute conditioned on the promulgation of regulations may be enforced without regard to such regulations. Dunlap v. United States, for example, involved a statute that allowed manufacturers “to use alcohol in the arts, or in any medicinal or other like compound . . . under regulations to be prescribed by the Secretary of the Treasury” and provided that manufacturers “shall be entitled” to a refund of stamp taxes paid on such alcohol. 173 U.S. 65, 70 (1899) (emphasis added) (citation omitted). The Secretary never issued the regulations called for by Congress, however, and a manufacturer sought a stamp-tax refund under the statute alone. Id. at 71, 74. The Court held that the statute could not be enforced in the absence of regulations. Dunlap also recognized that a court may not impose its own view of what a statute requires when the statute is to be effectuated “under regulations” prescribed by an agency.
Whirlpool further argued that the Court’s longstanding precedents also underscore the effect of regulations issued pursuant to a statute to be effectuated “under regulations.” In Campbell v. United States, for example, a statute authorized a “drawback” of duties paid on imported materials when incorporated into manufactured goods, “to be ascertained under such regulations as shall be prescribed by the Secretary of the Treasury.” 107 U.S. 407, 407 (1883). The Secretary issued regulations implementing the statute, and a manufacturer who sought a drawback of import duties complied with them in full. Id. at 409. Despite the manufacturer’s compliance with the regulations, the Secretary and his agents “wholly refused” to take any action on the manufacturer’s drawback request. Id. The Court held that this was improper.
Whirlpool also urges that the Sixth Circuit’s decision also contravenes fundamental principles of administrative law. Under this argument, Whirlpool urged that it is well-settled that regulations, including those that clarify or narrow the scope of statutory liability, bind the agency, unless they are found to be invalid by a court or are properly withdrawn. See, e.g., United States v. Caceres, 440 U.S. 741, 751 n.14 (1979); United States ex rel. Accardi v. Shaughnessy, 347 U.S. 260, 266-67 (1954); Columbia Broad. Sys. v. United States, 316 U.S. 407, 420-21 (1942). Likewise, when an agency decides a matter based on a particular regulation, a reviewing court must review the matter on the same basis—not on some other basis that the agency might be able to give. See, e.g., Securities & Exch. Comm’n v. Chenery Corp., 318 U.S. 80, 87 (1943) (“The grounds upon which an administrative order must be judged are those upon which the record discloses that its action was based.”).
The IRS, of course, urges in its response brief that the Sixth Circuit correctly decided the issue, relying solely on the relevant statute. This was proper, according to the IRS brief, because the situation unambiguously resulted in subpart F income, thereby obviating the need to resort to regulations that simply interpret the statute.
We will anxiously await the result of this case.