On October 22, the U.S. Court of Appeals for the Eighth Circuit heard oral arguments in 3M and Subsidiaries v. Commissioner of Internal Revenue, a case where the IRS retroactively changed its mind on how to enforce a statute. As we previously wrote, the dispute in the case is whether a 1994 IRS regulation on allocating corporate income between domestic and foreign related businesses follows the statute (26 U.S.C. Section 482) or disregards a series of earlier judicial decisions. 3M did not allocate “blocked income” from subsidiaries in countries that prohibit payment of dividends, like Brazil; the IRS argues that the “income” should be allocated to 3M. If the IRS did disregard past rulings, the question is whether they properly followed the Administrative Procedure Act in explaining why. Our brief in the case argues that the IRS failed to offer any explanation in its final rule, violating the Administrative Procedures Act.
At oral argument, Jonathan Bond represented 3M. First, Bond argued the IRS’s interpretation of Section 482 is incorrect and, if adopted by the Eighth Circuit, would create a split among various Courts of Appeal. The judges inquired to what extent the IRS’s interpretation of a law should be given deference given the U.S. Supreme Court’s recent decisions in Loper Bright Enterprises v. Raimondo, and Moore v. United States. Bond said that, in the context of controlling income, Moore expanded the definition, and under Loper Bright, the IRS’s interpretation of Section 482 is not the best interpretation, so the Court should not follow it. Second, Bond said courts cannot reconstruct an agency’s rule to reach a rationale.
The attorney for the Internal Revenue Service argued that one sentence of Section 482 grants the IRS the authority to impose the rule. One judge seemed to disagree, asking for clarification as to why one sentence of the statute should be read separately from the statute in its entirety. The IRS’s counsel suggested the second and third sentences of the statute represent a new standard set by Congress, superseding the first sentence. The IRS’s counsel further argued that 3M had full control over its earning and profit, and disagreed that Brazilian law had 3M dividends in mind when they prohibited dividend payments. Concerning the Administrative Procedure Act argument, the IRS’s counsel acknowledged the final rule’s explanatory section was short but argued the “reason for the regulation can be reasonably discerned from the preamble which is all the APA requires.”
The case was hotly debated, with judges asking pointed questions to each counsel. We will continue to monitor the case and update you with further developments.