Insights from the 3M Court Ruling
A recent ruling by the Eighth Circuit Court of Appeals in 3M Company v. Commissioner may significantly influence how the IRS applies Section 482 to cross‑border transfer pricing adjustments.
The case was an appeal of the US Tax Court’s decision in an audit matter between the IRS and 3M Company (3M). In the audit, the IRS adjusted the 2006 royalty income from 3M’s Brazilian affiliate. Although Brazilian law caps royalty payments to foreign affiliates, the IRS nevertheless increased 3M’s income by more than USD 23 million.
The US Tax Court sided with the IRS; the Eighth Circuit, however, sided with 3M. Ruling that the IRS had to take the foreign regulations into account when making the adjustments. Therefore, the adjustments shouldn’t have been made.
The Background
To understand the significance of this court ruling, we need to understand the facts of the case.
3M is a multinational conglomerate operating in the industry, worker safety, and consumer goods fields. A core component of its business lies in the IP it holds, including patents, trademarks, trade names, and copyrights, of well-known brands such as Scotch and Post-it.
The IP is licensed to 3M’s affiliates, allowing them to use it in exchange for a royalty payment. In 2006, the IP was licensed to most of the affiliates using a standard licensing agreement. The agreement included a royalty payment of 6% of the net sales and an additional 1% for the marketing intangibles.
However, 3M Brazil operated under a different agreement that set the royalty payment to just 1% of the net sales. The reason for the lower rate was the Brazilian local laws, which cap the allowed royalty payment to a foreign affiliate at the amount that is deductible for tax purposes.
The IRS claimed that there was an underpayment of royalties between 3M and 3M Brazil. Using IRC §482, it relocated more than USD 23 million to 3M, resulting in an additional tax payment of USD 4.5 million.
These facts set the stage for a dispute over when foreign restrictions should be taken into account when applying Section 482.
The Arguments
3M argued that Brazilian regulations capped the royalty payment for IP usage to a foreign related party. As a result, the company claimed it was unable to set a higher royalty rate. 3M further contended that, when applying IRC Section 482, such foreign legal restrictions must be taken into account.
The IRS rejected 3M’s position and applied Section 482 of the IRC without regard to the Brazilian restrictions, asserting that those limitations did not satisfy the criteria necessary to be considered under U.S. tax law.
The US Tax Court Decision
The US tax court agreed with the IRS, stating that the Brazilian restrictions don’t meet the requirements to be recognized for IRC section 482 purposes. The court agreed that 3M’s income should be increased.
3M appealed this decision to the United States Court of Appeals for the Eighth Circuit.
The Eighth Circuit Decision
The Eighth Circuit ruled in favor of 3M. In its ruling, the court relied on the Loper Bright decisions, which state that the court needs to find the best reading of the statue. This is in contrast to the Chevron deference doctrine, according to which the court should consult governmental agencies when the law is unclear.
Applying this principle, the court held that the IRS must consider foreign legal restrictions when applying Section 482 and therefore lacked authority to make the adjustment in question.
Relying on precedents about blocked income that were set in older cases (including First Security Bank of Utah and Procter & Gamble). The Eighth Circuit held that an income can be subject to Section 482 relocation if the taxpayer has “dominion or control” over it. Meaning the taxpayer must have the ability to allocate income among the affiliates. In cases where this isn’t possible due to legal restrictions, the IRS can’t relocate the income.
In the 3M case, the income was blocked by the Brazilian regulations, making it impossible for 3M to have higher royalties. Relocating this income by the IRS wouldn’t achieve the purpose of clearly reflecting 3M’s income.
Key Takeaways
The key takeaway from this court case is the shift in the court’s approach. From using the Chevron Deference and consulting the IRS, they now use the Loper Bright mandate, looking for the best reading of the law.
This ruling introduces uncertainty for multinational taxpayers regarding the scope of the IRS’s authority in TP adjustments. On the one hand, at the beginning of 2025, the IRS issued GLAM 2025-001, which widens its powers. GLAM 2025-001 allows the use of past profit data when making TP adjustments, rather than relying only on ex-ante information. On the other hand, this court ruling limits those powers by requiring consideration of foreign legal restrictions. This divergence creates uncertainty for taxpayers navigating cross‑border compliance.
Because the ruling is recent, its full impact will become clear only over time. In the meantime, taxpayers should keep records and documentation about their transfer pricing policy. A well-documented TP policy is much easier to defend in case of an audit.
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