Whirlpool Argues Income Wasn’t Foreign Base Company Sales Income

WHIRLPOOL FINANCIAL CORPORATION & CONSOLIDATED SUBSIDIARIES, ET AL,
Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

UNITED STATES TAX COURT

PETITIONERS' MOTION FOR PARTIAL SUMMARY JUDGMENT

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Judge Jacobs

PETITIONERS' TAX COURT RULE 121 MOTION FOR PARTIAL SUMMARY JUDGMENT UNDER SECTION 954(d)(1)

Pursuant to Tax Ct. R. 121, Petitioners move for partial summary judgment under section 954(d)(1) (the "Motion").¹ Petitioners respectfully ask that this Court hold as a matter of law that income earned by Whirlpool Overseas Manufacturing S.a.r.l. ("WOM")² in 2009 from its sale of refrigerators and washing machines ("washers") (collectively, the "Products") manufactured from raw materials, component parts, and supplies in its own manufacturing plants did not constitute foreign base company sales income ("FBCSI") under section 954(d)(1) of the Internal Revenue Code.³ A Brief in Support of the Motion ("Petitioners' Brief") setting forth in detail the facts and legal analysis establishing Petitioners' entitlement to partial summary judgment under section 954(d)(1) is attached.

(1) In 2009, WOM acted as a contract manufacturer in Mexico of refrigerators and washers for Maytag Sales, Inc. and Whirlpool Corporation ("Whirlpool US") and Whirlpool Mexico S. de R.L. de C.V. ("Whirlpool Mexico"). WOM conducted its activities through a maquiladora structure qualifying for Mexican tax and trade incentives. Under this structure, WOM's wholly-owned subsidiary, Whirlpool Internacional S. de R.L. de C.V. ("WIN"), an entity disregarded as separate from WOM for all US Federal income tax purposes under Treas. Reg. §§ 301.7701-2(a) and -3(a), provided manufacturing services to WOM. As WIN is disregarded, WIN's activities and assets are WOM's activities and assets. In 2009, WOM manufactured nearly one million refrigerators and over a half million washers in its own plants in Mexico using its own equipment and tooling. WOM built the refrigerators and washers from more than a half billion dollars worth of raw materials, component parts, and supplies purchased by WOM in its own name, using funds from its own bank accounts, with delivery of the raw materials, component parts, and supplies directly to WOM's manufacturing plants. WOM employed over 3,300 employees in its manufacturing operations, which it leased from two related Mexican affiliates. WOM sold the refrigerators and washers produced at its Mexican manufacturing plants to related parties, Whirlpool US and Whirlpool Mexico, in Mexico.

(2) This case arose out of an examination by Respondent of Whirlpool Corporation's taxable years ended December 31, 2008 and December 31, 2009. As a result of this examination, Respondent increased the taxable income of Whirlpool Corporation and its consolidated U.S. subsidiaries (the "Whirlpool Consolidated Group") for 2009 by the amount of $49,964,080 based on its assertion that such income should be treated as subpart F income under sections 951(a) and 954(d) of the Code. Respondent issued Notices of Deficiency to Petitioners on March 31, 2017 and March 29, 2017, with respect to this increase in Whirlpool Corporation's income. Each Notice of Deficiency described the grounds underlying the $49,964,080 income adjustment as follows:

Whirlpool Corporation & Subsidiaries has an additional subpart F inclusion under I.R.C. 951(a) and 954(d) in the amount of $49,964,080 for the tax year ending December 31, 2009 because the transactions between Whirlpool Overseas Manufacturing S.a.r.l., Whirlpool Internacional S. de R.L. de C.V., Whirlpool Mexico S.A. de C.V., Comercial Acros Whirlpool S.A. de C.V., Industrias Acros Whirlpool S.A. de C.V., and/or Whirlpool Corporation & Subsidiaries were, in form and/or in substance transactions giving rise to foreign base company sales income under I.R.C. 954(d). Whirlpool Corporation & Subsidiaries has also failed to establish that the form of the transactions is consistent with their substance.

(Petition for Whirlpool International Holdings, S.a.r.l. & Consolidated Subsidiaries, Ex. A, Form 886-A; Petition for Whirlpool Financial Corporation & Consolidated Subsidiaries, Ex. A, Form 886-A)

(3) For the reasons summarized below and explained more completely in Petitioners' Brief, this Court should hold that the income that WOM earned in 2009 from its sale of the Products did not constitute FBCSI under section 954(d)(1) of the Internal Revenue Code. Under Tax Ct. R. 121(b), "[s]ummary judgment is appropriate when there is a showing that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." Zaentz v. Commissioner, 90 T.C. 753, 754 (1988). As Respondent's own admissions and the materials attached to Petitioners' Brief demonstrate, no material facts are genuinely in dispute regarding this issue. Most importantly, Respondent has admitted that (i) the refrigerators and washers were produced at WOM's manufacturing plants through activities that Respondent admits constituted manufacturing, and (ii) WOM sold the refrigerators and washers to Whirlpool US and Whirlpool Mexico in Mexico.

(4) Under the plain language of section 954(d)(1), WOM's sales of refrigerators and washers to related parties in 2009 did not give rise to FBCSI because the property it sold was not the property purchased. The plain language of section 954(d)(1) states, in relevant part, that to derive FBCSI, a controlled foreign corporation ("CFC") must sell the same personal property that it purchases to related persons. The refrigerators and washers that WOM sold to Whirlpool US and Whirlpool Mexico in 2009 were different personal property than the raw materials, component parts, and supplies that WOM purchased. Therefore, the plain language of the statute establishes that WOM's purchase of raw materials, component parts, and supplies and WOM's sale of refrigerators and washers did not give rise to FBCSI under section 954(d)(1).

(5) The legislative history of section 954(d)(1) confirms that WOM did not derive FBCSI in 2009. "Since the definition [of FBCSI] covers only transactions involving both a purchase and a sale, it does not apply to income of a controlled foreign corporation from the sale of a product it manufactures." H.R. Rep. No. 87-1447, at A94 (1962); see also S. Rep. No. 87-1881, at 245 (1962). Moreover, "sale of the final product would not be foreign base company sales income if the corporation substantially transforms the parts or materials, so that, in effect, the final product is not the property purchased." H.R. Rep. No. 87-1447, at A94 (1962); S. Rep. No. 87-1881, at 245 (1962). Further, "[m]anufacturing and construction activities (and production, processing, or assembly activities which are substantial in nature) would generally involve substantial transformation of purchased parts or materials." H.R. Rep. No. 87-1447, at A94-A95 (1962); S. Rep. No. 87-1881, at 245 (1962).

(6) Treas. Reg. § 1.954-3, as in effect in 2009, confirms that Congress's intent in drafting the flush language in section 954(d)(1) was to distinguish between those situations in which a CFC sold the same property that the CFC purchased, and those in which the CFC sold property that was different from the property that the CFC purchased. These regulations do not impose requirements as to who must perform the requisite activities. Indeed, there is no statutory basis for imposing such requirements.

(7) Respondent objects to the granting of this Motion.

* * *

WHEREFORE, Petitioners pray that this Court hold as a matter of law that income earned by WOM in 2009 from its sale of the Products manufactured from raw materials, component parts, and supplies in its own manufacturing plants did not constitute FBCSI under section 954(d)(1) of the Internal Revenue Code.

Dated: February 4, 2019

Respectfully submitted,

Mark A. Oates
T.C. No. OM0113

BAKER & MCKENZIE LLP
300 East Randolph Street,
Suite 5000
Chicago, IL 60601
(312) 861-7594
Mark.Oates@bakermckenzie.com
Attorneys for Petitioners

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BRIEF IN SUPPORT OF PETITIONERS' TAX COURT RULE 121 MOTION FOR PARTIAL SUMMARY JUDGMENT UNDER SECTION 954(d)(1)

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TABLE OF CONTENTS

OVERVIEW

STATEMENT OF FACTS

ARGUMENT

CONCLUSION

TABLE OF AUTHORITIES

CASES:

Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986)

Anheuser-Busch Brewing Ass'n v. United States, 207 U.S. 556 (1908)

Ashland Oil, Inc. v. Commissioner, 95 T.C. 348 (1990)

Bausch & Lomb v. Commissioner, T.C. Memo 1996-57

Burlington N. R.R. Co. v. Okla. Tax Comm'n, 481 U.S. 454 (1987)

Chrysler Corp. v. Commissioner, 436 F.3d 644 (6th Cir. 2006)

Conn. Nat'l Bank v. Germain, 503 U.S. 249 (1992)

EEOC v. Horizon/CMS Healthcare Corp., 220 F.3d 1184 (10th Cir. 2000)

Estate of Chenoweth v. Commissioner, 88 T.C. 1577 (1987)

Exxon Mobil Corp, v. Allapattah Servs., Inc., 545 U.S. 546 (2005)

Fed. Deposit Ins. Corp, v. Meyer, 510 U.S. 471 (1994)

Grant Creek Waters Works, Ltd. v. Commissioner, 91 T.C. 322 (1988)

International Business Machines Corp. v. United States, 38 Fed. Cl. 661 (1997)

J.B.D.L. Corp. v. Wyeth-Ayerst Labs., Inc., 485 F.3d 880 (6th Cir. 2007)

Lamie v. United States Tr., 540 U.S. 526 (2004)

Lyons v. Bd. of Educ. of Charleston, 523 F.2d 340 (8th Cir. 1975)

Moore v. Philip Morris Co., 8 F.3d 335 (6th Cir. 1993)

National Starch & Chemical Corp. v. Commissioner, T.C. Memo 1986-512

Old Colony R.R. Co. v. Commissioner, 284 U.S. 552 (1932)

Smith v. United States, 508 U.S. 223 (1993)

Vetco, Inc. v. Commissioner, 95 T.C. 579 (1990)

Zaentz v. Commissioner, 90 T.C. 753 (1988)

STATUTES

26 U.S.C. § 954(d)(1)

26 U.S.C. § 954(d)(2)

REGULATIONS:

Treas. Reg. § 1.954-3

Treas. Reg. § 1.954-3(a)(1)

Treas. Reg. § 1.954-3(l)(1)(iii)

Treas. Reg. § 1.954-3(a)(4)

Treas. Reg. § 1.954-3(a)(4)(i)

Treas. Reg. § 1.954-3(a)(4)(ii)

Treas. Reg. § 1.954-3(a)(4)(iii)

Treas. Reg. § 301.7701-2(a)

Treas. Reg. § 301.7701-3(a)

Treasury Decision 6734 (May 15, 1964)

Treasury Decision 7555 (July 28, 1978)

Treasury Decision 7893 (May 19, 1983)

Treasury Decision 7894 (May 19, 1983)

Treasury Decision 9008 (July 23, 2002)

LEGISLATIVE HISTORY:

H.R. Rep. No. 87-1447 (1962)

S. Rep. No. 87-1881 (1962)

ADMINISTRATIVE GUIDANCE:

Rev. Rul. 75-7, 1975-1 C.B. 244

Rev. Rul. 97-48, 1997-2 C.B. 89

COURT RULES:

Tax Ct. R. 121

MISCELLANEOUS:

Gregg D. Lemein, "Contract Manufacturing: Rev. Rul. 97-48 Revokes Rev. Rul. 75-7," TAXES — THE TAX MAGAZINE (Jan. 1998)

James P. Fuller et al., "Rev. Rul. 97-48 and the Revocation of Rev. Rul. 75-7," 15 Tax Notes Int'l 1783 (Dec. 1, 1997)

Webster's Third New International Dictionary of the English Language Unabridged (3rd ed. 1963)

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This Brief is filed in support of Petitioners' Motion for Partial Summary Judgment Under Section 954(d)(1) (the "Motion"). In the Motion, Petitioners pray that this Court hold as a matter of law that income earned by Whirlpool Overseas Manufacturing S.a.r.l. ("WOM")¹ in 2009 from its sale of refrigerators and washing machines ("washers") (collectively, the "Products") manufactured from raw materials, component parts, and supplies in its own manufacturing plants did not constitute foreign base company sales income ("FBCSI") under section 954(d)(1) of the Internal Revenue Code. As no genuine questions of material fact exist, partial summary judgment is appropriate.²

OVERVIEW

This Motion presents the question of whether section 954(d)(1) means what its words say: a controlled foreign corporation ("CFC") that purchases and sells personal property to a related party has FBCSI under section 954(d)(1) only if the personal property sold by the CFC is the same personal property purchased by the CFC. In this case, there is no genuine issue of material fact as to what WOM (the CFC at issue) purchased and sold. WOM purchased a plethora of raw materials, component parts, and supplies, including rolls of steel, railroad cars of plastic resin, flat sheets of plastic, chemicals, paint, tubing, screws, bolts, and various other sundry items. Moreover, as Respondent has admitted, from these raw materials, component parts, and supplies, refrigerators and washers were manufactured at WOM's Ramos and Horizon Manufacturing Plants in Mexico. As further admitted by Respondent, WOM sold these refrigerators and washers to Whirlpool US and Whirlpool Mexico, S.A. de C.V. ("Whirlpool Mexico”). Thus, the personal property purchased by WOM (raw materials, component parts, and supplies) was not the same personal property sold by WOM (refrigerators and washers). Accordingly, WOM's sales of the refrigerators and washers could not and did not give rise to FBCSI under section 954(d)(1).

Although there is no genuine question of material fact as to whether WOM sold refrigerators and washers manufactured from raw materials, component parts, and supplies purchased by WOM, Respondent nonetheless contends that WOM should be deemed to have incurred FBCSI under section 954(d)(1) because WOM used leased employees in WOM's Ramos and Horizon Manufacturing Plants rather than directly employing the manufacturing personnel.

Section 954(d)(1), however, imposes no requirement that a CFC manufacture its products using directly hired employees rather than using leased employees. Rather, section 954(d)(1) requires only that the property sold in essence not be the property purchased in order to escape treatment as FBCSI; that is, the plain language of section 954(d)(1) treats income as FBCSI only if the personal property sold is the same as the personal property purchased. While the statute requires the property sold to be different than the property purchased to avoid FBCSI, the statute does not prohibit the CFC from using leased employees in the manufacture of the CFC's products at the CFC's own manufacturing plants. Indeed, the statute does not even require that the CFC manufacture or otherwise transform raw materials, component parts, and supplies into finished products: the CFC would not have FBCSI even if the CFC used a different entity (related or unrelated) to manufacture the CFC's finished products from the CFC's raw materials, component parts, and supplies. In short, section 954(d)(1) is concerned with whether a CFC purchases and resells the same personal property, not whether the CFC itself is the physical instrumentality of producing finished products from the raw materials, component parts or supplies purchased.

STATEMENT OF FACTS

WOM is an entity formed under Luxembourg law and, in 2009 and later years, was an indirectly held, wholly-owned subsidiary of Whirlpool Corporation.³ In 2009, WOM's manufacturing operations and other substantial activities were performed in Mexico, with only nominal, administrative activities performed in Luxembourg by a single, part-time employee.⁴

In 2009, WOM conducted its Mexican operations both through the operations of Whirlpool Internacional, S. de R.L. de C.V. ("WIN"), WOM's wholly-owned Mexican subsidiary, which was disregarded as separate from WOM for US federal income tax purposes,⁵ and through a permanent establishment of WOM in Mexico.⁶

In 2009, WOM manufactured refrigerators and washers in Mexico under the Mexican government's "maquiladora” manufacturing incentives program, pursuant to which Mexico elected to tax only a portion of the manufacturing profit in Mexico and then at a significantly reduced tax rate.⁷ In order to qualify for maquiladora treatment, among other requirements, WOM (the foreign principal) was required to produce its refrigerators and washers in Mexico using equipment and tooling owned by WOM, from raw materials and component parts owned by WOM, but using a separate Mexican subsidiary to perform manufacturing services for WOM using Mexican manufacturing personnel.⁸

In order to comply with the latter maquiladora requirement, WOM used WIN, its "check-the-box" Mexican subsidiary,⁹ as the separate Mexican entity providing the manufacturing services. WIN, in turn, leased its employees from two related Mexican affiliates, Industrias Acros Whirlpool, S.A. de C.V. ("IAW") and Comercial Acros Whirlpool, S.A. de C.V. ("CAW”). As was common practice in many Mexican maquiladora operations due to Mexican legal requirements and like Whirlpool's Mexican operations generally, WIN (and therefore WOM) leased its employees from a separate entity (IAW or CAW) rather than directly hiring the employees.¹⁰ WIN's employees reported up to the Plant Managers of the Ramos and Horizon Manufacturing Plants, who in turn reported to Eduardo Elizondo, a member of WIN's Board of Directors and Whirlpool's head of manufacturing in Mexico.¹¹ WIN's profits were taxed by Mexico at the preferential 17% tax rate applicable to maquiladoras.

WOM's permanent establishment in Mexico arose from WOM's ownership of the equipment, tooling, raw materials, component parts, supplies, and inventory used in its Mexican manufacturing operations, as well as its use of fixed places of business at the Ramos and Horizon Manufacturing Plants and the sale in Mexico of the refrigerators and washers it produced.¹² As a further part of the Mexican maquiladora incentives, Mexico did not tax WOM's profits arising from its Mexican permanent establishment.¹³

In 2009, WOM acted as a contract manufacturer of refrigerators and washers for Whirlpool US and Whirlpool Mexico.¹⁴ Under its contract manufacturing agreements with Whirlpool US and Whirlpool Mexico, Whirlpool US and Whirlpool Mexico dictated the specifications, quality parameters, materials, quantities and dates when products were to be built by WOM. WOM built the products on a "turn-key" basis, that is, WOM acquired its own raw materials, component parts, and supplies required for manufacture of the refrigerators and washers and sold completed refrigerators and washers to Whirlpool US and Whirlpool Mexico. WOM transferred title for the refrigerators and washers to Whirlpool US and Whirlpool Mexico at the end of the assembly lines at the Ramos and Horizon Manufacturing Plants as the Products were moved from those plants to the neighboring Factory Distribution Centers ("FDCs"). Under the contract manufacturing agreements, WOM sold the refrigerators and washers to Whirlpool US and Whirlpool Mexico at a price equal to WOM's costs of manufacture plus a markup.¹⁵

The majority of WOM's operations and sales related to refrigerators, accounting for 62.4% of its revenue.¹⁶ WOM produced refrigerators at its Ramos Manufacturing Plant in Ramos Arizpe, Coahuila, Mexico, which is located about 90 minutes outside Monterrey, Mexico. The Ramos Manufacturing Plant contained nearly a million square feet (956,647 square feet) of space in 2009, housing over $88 million of WOM's manufacturing equipment and tooling.¹⁷ In 2009, WOM employed 2,583 leased employees at the Ramos Manufacturing Plant, with the Plant running three shifts per day, six days per week, with the seventh day (Sunday) used for necessary maintenance. The Ramos Manufacturing Plant's round-the-clock operations manufactured nearly one million refrigerators in 2009, with WOM selling 920,328 refrigerators to Whirlpool US and 46,521 refrigerators to Whirlpool Mexico.¹⁸

WOM's refrigerators were manufactured at the Ramos Manufacturing Plant from hundreds of items of raw materials, component parts, and supplies.¹⁹ WOM's refrigerator manufacturing process started from rolls of steel delivered on trucks. Rolls of steel for the outer cabinets and doors were first delivered to WOM's Horizon Manufacturing Plant where the rolls of steel were cut to length and palletized for further processing at the Ramos Manufacturing Plant.²⁰ Other rolls of steel intended for the manufacture of various other component parts were delivered directly to the Ramos Manufacturing Plant for cutting. Once the steel was cut to length, the flat steel was stamped, punched and pressed in a series of manufacturing steps to create cabinets, ice-side doors, refrigerator-side doors,²¹ brackets, rails, mounts, and other steel components for use in the manufacture of the refrigerators. These manufacturing steps just to make the cabinets involved the largest pieces of manufacturing equipment at Ramos, with the equipment used comprising automated lines that were over 230 feet long.²²

Liners and other plastic parts were also fabricated by WOM for the refrigerators. In 2009, WOM purchased millions of flat sheets of plastic extruded from plastic resin.²³ WOM used a "thermoforming” process to mold each of the four liners required for each refrigerator from a flat sheet of plastic: 1) the liner for the inside of the side-by-side refrigerator section; 2) the liner for the inside of the freezer section; 3) the liner for the refrigerator door; and 4) the liner for the freezer door. "Thermoforming" is a manufacturing process in which a plastic sheet is heated to a pliable forming temperature, formed to a specific shape in a mold, and trimmed to create a usable product. Thermoforming at the Ramos Manufacturing Plant was accomplished using WOM's automated thermoforming machines, each of which was approximately two stories tall and over 90 feet long. The sheet was loaded onto a conveyor which first transported the sheet through an oven that heated the sheet to the point where it could be stretched and molded. Once the flat sheet of plastic reached the requisite temperature, the conveyor moved the sheet to the stamping/molding operation in which the flat sheet was transformed into the required shape for one of the four liner types.²⁴ After sufficient cooling, the thermoforming machine then ejected the liner from the mold and the conveyor transported the now-formed liner to the next station in the thermoforming machine where the liner was trimmed to size and shape. After trimming, the conveyor moved the liner to the end of the thermoforming machine where an employee de-burred the liner, while checking for defects and ensuring that all required holes and perforations through the liner were complete and proper.²⁵

The liners ultimately served as the inner wall of the refrigerator, freezer and door sections. WOM's employees injected insulating foam into the cavity between the liners and the exterior metal using large automated injection equipment that formed a manufacturing line two stories high and over 200 feet long. The insulating foam was created from the combination of several chemicals. Before the insulating foam could be injected, however, tubes, wires, coils and other items first needed to be installed into the cavity, and the liners secured to the frame on the two pre-foam assembly lines.²⁶

At the Ramos Manufacturing Plant, the refrigerators were assembled on four main assembly lines that stretched the length of the plant (6 football fields long), plus two door assembly lines where the freezer and refrigerator doors were separately produced, with the finished doors then being merged onto the main assembly lines for installation on the refrigerators.²⁷

The four main refrigerator assembly lines started with the cabinet sides and tops (stamped, punched, and pressed from the rolls of steel prior to the beginning of the main assembly lines), which were joined, to form a tall upside down U on a base. As this initial structure passed down the assembly line, the refrigerators incrementally began to take shape. Hundreds of employees worked on the main assembly lines each shift, performing hundreds of different assembly tasks involving hundreds of parts, processes, and quality checks, including screwing, bolting, gluing, wiring, bending, welding, soldering, adjusting, and other assembly operations, as well as inspecting and testing all of the refrigerators manufactured on the assembly lines.²⁸ At the end of the assembly lines, the refrigerators were packaged for shipment, serial numbers were scanned into the computer systems, and the refrigerators were sold by WOM to Whirlpool US and Whirlpool Mexico as the refrigerators left the Ramos Manufacturing Plant and moved on a conveyor system into the FDC in the building next door.²⁹

Respondent has admitted that the activities performed at the Ramos Manufacturing Plant constituted the manufacture of refrigerators.³⁰

WOM produced washers at its Horizon Manufacturing Plant in Apodaca, Nuevo Leon, Mexico, which is located in the Monterrey, Mexico metropolitan area. The Horizon Manufacturing Plant contained nearly 414,000 square feet of space in 2009, housing over $58 million of WOM's manufacturing equipment and tooling.³¹ In 2009, WOM employed 802 leased employees at the Horizon Manufacturing Plant, with the Plant running three shifts per day, six days per week, with the seventh day (Sunday) used for necessary maintenance. In 2009, the Horizon Manufacturing Plant manufactured nearly 550,000 washers, with WOM selling 544,721 washers to Whirlpool US and 4,236 washers to Whirlpool Mexico.³²

WOM's washers were manufactured at the Horizon Manufacturing Plant from hundreds of items of raw materials, component parts, and supplies.³³ WOM's washer manufacturing process started from rolls of steel delivered on trucks to the Horizon Manufacturing Plant. The rolls of steel were used to fabricate the washer enclosures (cabinets), the washer drums, and various steel component parts such as brackets and supports. Once the rolls of steel were cut to length, the flat steel was stamped, punched, pressed and formed in a series of manufacturing steps to create the washer enclosures, washer drums, brackets, supports and other steel components for use in the manufacture of the washers. After fabrication, the washer enclosures and other parts requiring painting were then placed into an automated, continuous paint line running the length of the plant along one wall that cleaned, primed, painted and baked the parts to produce the range of colors available to Whirlpool's washer customers across its many washer brands.³⁴

Metal parts for the washer drum assemblies were taken to separate drum assembly lines for fabrication of the drums. After fabrication of the drum assemblies, the drum lines merged with the two main assembly lines.³⁵

In 2009, WOM's washers were front-load, horizontal axis washing machines. The drum assemblies were formed from flat stainless steel cut from rolls that were stamped in a series of manufacturing steps resulting in a cutting, punching/perforating, and bending process. The steel was first cut to the proper dimensions, then punched to create the perforations allowing water to flow through the drums. The flat sheets were then stamped or pressed to create an opposite bend on each end of the sheet. Finally, the sheets were formed into a cylinder by rolling the steel and locking the rolled cylinder together by coupling the opposite bends in the steel together. Supports and an end cap were then added to provide support and rigidity. A spindle mechanism was added to provide the support and the axis around which the drum would spin. "Fins” were added to the inside of the metal drum assemblies to catch and agitate the clothing as the metal drum assembly spun inside the washers during the wash process. In 2009, Horizon Manufacturing Plant personnel fabricated approximately 550,000 metal drum assemblies.³⁶

The drum was ultimately placed in a plastic tub to hold the water in the washer. The plastic tub was fabricated in two parts by WOM's personnel at the Horizon Manufacturing Plant through a plastic injection molding process. WOM had six plastic injection molding machines at the Horizon Manufacturing Plant, three each for the front and back portions of the plastic tub. The plastic tubs were fabricated from plastic resin pellets purchased by WOM. WOM purchased plastic resin by the railroad car, which arrived at the plant on railroad sidings. The resin pellets were literally sucked out of the railroad cars by vacuum hoses and were placed in large holding tanks akin to water towers for storage until used in the injection molding process. The resin pellets were fed into the injection molding machines by vacuum lines. The injection molding machines then melted the resin pellets and injected the liquid plastic into injection molds unique for the front and back portions of each model of tub. After injection, the mold was allowed to cool before the injection molding machine separated the mold and extracted the portion of the plastic tub from the mold. Horizon Manufacturing Plant personnel then deburred the plastic and ensured that the tubs were properly formed. The plastic tubs were then moved to the drum assembly line where the drum assemblies were completed. During 2009, the personnel at WOM's Horizon Manufacturing Plant fabricated approximately 1.1 million tub halves needed to produce the drum assemblies for WOM's washers.³⁷

WOM's washers were built on two main assembly lines that ran the length of the Horizon Manufacturing Plant, plus two drum assembly lines where the washer drum and tub assemblies were fabricated, with the finished drum and tub assemblies then being merged into the main assembly lines for installation in the washers.³⁸

The two main washer assembly lines³⁹ started with the welding together of the cabinet sides and tops (stamped, punched, pressed, and painted from rolls of steel prior to the beginning of the main assembly lines). As this initial structure passed down the assembly line, the washers incrementally began to take shape.⁴⁰ Hundreds of employees worked on the main and drum assembly lines each shift, performing hundreds of different assembly tasks involving hundreds of parts, processes, and quality checks, including screwing, bolting, gluing, wiring, bending, welding, soldering, adjusting, and other assembly operations, as well as inspecting, testing, and draining all of the washers manufactured on the assembly lines.⁴¹ At the end of the assembly lines, the washers were packaged for shipment, serial numbers were scanned into the computer systems, and the washers were sold by WOM to Whirlpool US and Whirlpool Mexico as the washers left the Horizon Manufacturing Plant and moved on a conveyor system into the FDC in the building next door.⁴²

Respondent has admitted that the activities performed at the Horizon Manufacturing Plant constituted the manufacture of washers.⁴³

In total, between the Ramos and Horizon Manufacturing Plants, WOM employed 3,385 personnel leased from IAW and CAW. WOM's employees reported up to the Plant Managers at the Ramos and Horizon Manufacturing Plants, who in turn reported directly to Mr. Elizondo, one of the Directors on WOM's Board and the head of Whirlpool's manufacturing in Mexico. WOM's manufacturing personnel worked in WOM's two plants comprising over 1.37 million square feet of space filled with $146 million worth of WOM's manufacturing equipment and tooling. WOM's manufacturing personnel worked around the clock and in 2009 manufactured nearly a million refrigerators and over a half-million washers. WOM's total cost of producing these Products was well over $700 million, including materials costs and non-material conversion costs.⁴⁴

WOM's personnel in Mexico purchased the raw materials, component parts, and supplies for WOM, entering into contracts in WOM's name, and paying with WOM's funds from WOM's bank accounts.⁴⁵ WOM's raw materials, component parts, and supplies were delivered directly by the vendors to WOM's Ramos and Horizon Manufacturing Plants.⁴⁶ The raw materials, component parts, and supplies required to manufacture WOM's refrigerators and washers are illustrated by the raw materials, component parts, and supplies purchased by WOM to build its top selling refrigerator (SKU ED5VHEXVQ01) and top selling washer (SKU WFW8300SW05).⁴⁷ From WOM's steel, plastic resin and sheets, chemicals, screws, bolts, springs, rods, bearings and other sundry items, WOM manufactured refrigerators and washers at the Ramos and Horizon Manufacturing Plants.⁴⁸

Respondent has also admitted that WOM sold the refrigerators and washers to Whirlpool US and Whirlpool Mexico.⁴⁹

The personal property purchased by WOM (the raw materials, component parts, and supplies) were not the same personal property sold by WOM (refrigerators and washers).

ARGUMENT

I. PARTIAL SUMMARY JUDGMENT UNDER SECTION 954(d)(1) IS APPROPRIATE BECAUSE THE PERSONAL PROPERTY WOM PURCHASED IS NOT THE PERSONAL PROPERTY WOM SOLD AND NO GENUINE QUESTIONS OF MATERIAL FACT EXIST.

In complex litigation, such as the present case, a motion for partial summary judgment serves the salutary purpose of allowing the court to streamline issues for trial and to promote settlement. Lyons v. Bd. of Educ. of Charleston, 523 F.2d 340, 347 (8th Cir. 1975); Grant Creek Water Works, Ltd, v. Commissioner, 91 T.C. 322, 325 (1988); Estate of Chenoweth v. Commissioner, 88 T.C. 1577, 1578-79 (1987). The Court should grant summary judgment with respect to an issue in controversy when there are no genuine issues of material fact in dispute and the moving party is entitled to judgment as a matter of law. Tax Ct. R. 121; Moore v. Philip Morris Co., 8 F.3d 335, 339 (8th Cir. 1993); Zaentz v. Commissioner, 90 T.C. 753, 754 (1988). A "material" fact is a fact that might affect the outcome of the legal issues in dispute. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986) ("Only disputes over facts that might affect the outcome of the suit under the governing law will properly preclude the entry of summary judgment."); J.B.D.L. Corp, v. Wyeth-Ayerst Labs., Inc., 485 F.3d 880, 887 (6th Cir. 2007); EEOC v. Horizon/CMS Healthcare Corp., 220 F.3d 1184, 1190 (10th Cir. 2000); International Business Machines Corp, v. United States, 38 Fed. Cl. 661, 665 (1997); National Starch & Chemical Corp, v. Commissioner, T.C. Memo 1986-512. The sole legal issue in dispute in this Motion is whether the personal property sold by WOM is the same personal property purchased by WOM. As shown in Part II below, there is no dispute surrounding the material facts establishing that the personal property WOM sold (refrigerators and washers) was not the same personal property that WOM purchased (raw materials, component parts, and supplies). For the reasons discussed below, Petitioners are entitled to partial summary judgment as a matter of law that WOM's income from its sales of refrigerators and washers in 2009 did not constitute FBCSI.

II. WOM DID NOT DERIVE FBCSI IN 2009 UNDER SECTION 954(d)(1) BECAUSE THE PROPERTY THAT IT SOLD TO RELATED PARTIES WAS NOT THE SAME PROPERTY THAT IT PURCHASED.

In 2009, WOM purchased hundreds of separate raw materials, component parts, and supplies from unrelated suppliers with respect to each refrigerator and washer that it sold to related parties in 2009. Through the operations of its Horizon and Ramos Manufacturing Plants in Mexico, WOM manufactured these raw materials, component parts, and supplies into refrigerators and washers, which it sold to related parties. The refrigerators and washers that WOM sold in 2009 were not the same property that it purchased and, thus, do not give rise to FBCSI under section 954(d)(1). The plain language of section 954(d)(1), the corresponding legislative history, and the applicable regulations all establish, as a matter of law, that WOM's sales of refrigerators and washers manufactured from raw materials, component parts, and supplies did not give rise to FBCSI under section 954(d)(1).

A. UNDER THE PLAIN LANGUAGE OF SECTION 954(d) (1), WOM'S SALES OF REFRIGERATORS AND WASHERS TO RELATED PARTIES IN 2009 DID NOT GIVE RISE TO FBCSI BECAUSE THE PROPERTY IT SOLD WAS NOT THE PROPERTY PURCHASED.

The plain language of section 954(d)(1) makes clear, in relevant part, that to derive FBCSI, a CFC must purchase the same personal property that it sells to related persons. The refrigerators and washers that WOM sold to Whirlpool US and Whirlpool Mexico in 2009 were different personal property than the raw materials, component parts, and supplies that WOM purchased. Therefore, WOM's purchase of raw materials, component parts, and supplies and WOM's sale of refrigerators and washers did not give rise to FBCSI under section 954(d)(1). Section 954(d)(1) provides in pertinent part:

[T]he term "foreign base company sales income" means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with . . . the purchase of personal property from any person and its sale to a related person[.]

(Emphasis added.)

This Motion thus turns on the meaning of "its" within the language "the purchase of personal property from any person and its sale to a related person."⁵⁰

Words in a statute are given their common, ordinary meanings unless Congress makes clear in the statute that they should have a different, unique meaning. Fed. Deposit Ins. Corp, v. Meyer, 510 U.S. 471, 476 (1994); Smith v. United States, 508 U.S. 223, 228 (1993); Old Colony R.R. Co. v. Commissioner, 284 U.S. 552, 560-61 (1932). Thus, all of the words in section 954(d)(1) must be given their common, ordinary meanings, except for those terms that are expressly defined in the statute. There is no statutory definition of the term "its," so the term should be construed in accordance with its ordinary meaning.

Webster's Third New International Dictionary defines "its" as "of or relating to it or itself as object of an action: experienced by it as object <this proposal and ~ final enactment into law>[.]" "It" is defined in relevant part as "that one — used as neuter pronoun of the third person singular that is the subject or direct object or indirect object of a verb or the object of a preposition and used in reference to (1) a lifeless thing <took a quick look at the house and noticed ~ was very old>[.]" "Itself" is defined as "that identical one.” Webster's Third New International Dictionary of the English Language Unabridged (3d ed. 1963).

When section 954(d)(1) refers to "the purchase of personal property from any person and its sale to a related person," (emphasis added) the phrase "its sale" necessarily refers to the sale by the CFC of the same personal property that the CFC purchased. As this is the only common sense reading of this phrase, there is no need to look to other sources to define this term. Conn. Nat'l Bank v. Germain, 503 U.S. 249, 254 (1992) ("When the words of a statute are unambiguous, then, this first canon is also the last: 'judicial inquiry is complete.'" (quoting Rubin v. United States, 449 U.S. 424, 430 (1981))); Chrysler Corp, v. Commissioner, 436 F.3d 644, 654 (6th Cir. 2006) ("[T]he language of the statute is the starting point for interpretation, and it should also be the ending point if the plain meaning of the language is clear." (quoting United States v. Choice, 201 F.3d 837, 840 (6th Cir. 2000))); see also Lamie v. United States Tr., 540 U.S. 526, 538 (2004) ("There is a basic difference between filling a gap left by Congress' silence and rewriting rules that Congress has affirmatively and specifically enacted." (quoting Mobil Oil Corp, v. Higginbotham, 436 U.S. 618, 625 (1978))).

The language of section 954(d)(1) is concerned with the quantum of change between the personal property purchased and the personal property sold. Section 954(d)(1) is not concerned with who brings about the quantum of change. The only relevant question is whether the property sold was the same as the property purchased. If the property sold was different from the property purchased, then the sale of such property does not give rise to FBCSI.

The refrigerators and washers that WOM sold to related parties in 2009 bore no resemblance to the raw materials, component parts, and supplies that WOM purchased. Accordingly, WOM's sale of refrigerators and washers in 2009 did not constitute a sale to related parties of the same property that it purchased, and these sales did not give rise to FBCSI under the plain language of section 954(d)(1).

B. THE LEGISLATIVE HISTORY OF SECTION 954(d)(1) CONFIRMS THAT WOM DID NOT DERIVE FBCSI IN 2009 FROM THE SALE OF REFRIGERATORS AND WASHERS TO RELATED PARTIES.

Because the plain meaning of section 954(d)(1) is clear, it is not necessary for a court to resort to the legislative history or other extrinsic aids to determine the intent of Congress. See, e.g., Exxon Mobil Corp, v. Allapattah Servs., Inc., 545 U.S. 546, 568 (2005) ("[T]he authoritative statement is the statutory text, not the legislative history or any other extrinsic material. Extrinsic materials have a role in statutory interpretation only to the extent they shed a reliable light on the enacting Legislature's understanding of otherwise ambiguous terms."); Burlington N. R.R. Co. v. Okla. Tax Comm'n, 481 U.S. 454, 461 (1987) ("Legislative history can be a legitimate guide to a statutory purpose obscured by ambiguity, but in the absence of a clearly expressed legislative intention to the contrary, the language of the statute itself must ordinarily be regarded as conclusive." (internal quotations omitted)). Nonetheless, the legislative history of section 954(d)(1) confirms the plain meaning of the flush language in this provision.

Congress confirmed that the relevant question under section 954(d)(1) was whether "in effect, the final product is not the property purchased." The House Ways and Means Committee in its technical explanation of section 954(d)(1) reported:

Since the definition covers only transactions involving both a purchase and a sale, it does not apply to income of a controlled foreign corporation from the sale of a product which it manufactures. In a case in which a controlled foreign corporation purchases parts or materials which it then transforms or incorporates into a final product, income from the sale of the final product would not be foreign base company sales income if the corporation substantially transforms the parts or materials, so that, in effect, the final product is not the property purchased. Manufacturing and construction activities (and production, processing, or assembling activities which are substantial in nature) would generally involve substantial transformation of purchased parts or materials.

H.R. Rep. No. 87-1447, at A94-A95 (1962)(emphases added).

The Senate Finance Committee explained section 954(d)(1) in virtually identical language:

The definition does not apply to income of a controlled foreign corporation from the sale of a product which it manufactures. In a case in which a controlled foreign corporation purchases parts or materials which it then transforms or incorporates into a final product, income from the sale of the final product would not be foreign base company sales income if the corporation substantially transforms the parts or materials, so that, in effect, the final product is not the property purchased. Manufacturing and construction activities (and production, processing, or assembling activities which are substantial in nature) would generally involve substantial transformation of purchased parts or materials.

S. Rep. No. 87-1881, at 245 (1962)(emphases added).

Congress thus intended that FBCSI include income only from transactions that involve the purchase and sale of property that has not been changed or transformed in any significant manner. Congress anticipated that this test would be met if the parts or materials that are purchased are transformed or incorporated into a final product. Further, as reflected in the language of the House and Senate reports, Congress considered "production, processing or assembling activities which are substantial in nature,” as well as "manufacturing", "to generally involve substantial transformation of purchased parts or materials.” H.R. Rep. No. 87-1447, at A94-A95 (1962); S. Rep. No. 87-1881, at 245 (1962).

Although Congress illustrated the fundamental principle reflected in the statutory language by reference to a CFC that "manufactures" or "transforms" purchased property into a final product, the only decisive test, as reflected in the language and structure of section 954(d)(1), is whether, in effect, the final product is the same as the property purchased. If it is not, then no FBCSI arises.

Long before the adoption of section 954(d)(1), the determination of whether a product had been "manufactured” was considered by the U.S. Supreme Court. In 1908, in Anheuser-Busch Brewing Ass'n v. United States, 207 U.S. 556, 562 (1908), the Supreme Court ruled:

Manufacture implies a change, but every change is not manufacture, and yet every change in an article is the result of treatment, labor and manipulation. But something more is necessary, as set forth and illustrated in Hartranft v. Wiegmann, 121 U.S. 609. There must be transformation; a new and different article must emerge, "having a distinctive name, character or use."

In this case, WOM's production of refrigerators and washers meets this longstanding definition of "manufacture:" the rolls of steel, plastic pellets and sheets, and the plethora of other raw materials, components and supplies lose their separate status and acquire a distinctive name, character or use, that is, refrigerators and washers.

Here, Respondent has admitted that the refrigerators and washers were manufactured at the Ramos and Horizon Manufacturing Plants. (Respondent's Admissions at ¶¶ 76, 77, 78.) It is undisputed that the property sold (refrigerators and washers) is not the same as the property purchased (raw materials, component parts, and supplies). The fact that WOM manufactured these Products in its own manufacturing plants using leased employees instead of directly hired employees is of no consequence to the statutory analysis under the plain language of section 954(d)(1).

C. TREAS. REG. § 1.954-3 CONFIRMS THE PLAIN READING OF SECTION 954(d)(1) AND FURTHER DEMONSTRATES THAT WOM'S SALES OF REFRIGERATORS AND WASHERS TO RELATED PARTIES IN 2009 DID NOT GIVE RISE TO FBCSI.

As established above, the plain meaning of section 954(d)(1) is clear, so it is not necessary to resort to Treasury Regulations for guidance concerning the interpretation of its language. However, the Treasury Regulations that were in effect in 2009 confirm that Congress's intent in drafting the flush language in section 954(d)(1) was to distinguish between those situations in which a CFC sold the same property that the CFC purchased, and those in which the CFC sold property that was different from the property that the CFC purchased.

The applicable regulations in effect in 2009 were issued on May 15, 1964, shortly after section 954(d) went into effect. Minor modifications were made to these regulations in 1978, 1983, and 2002, but these revisions did not materially impact the structure or language of regulations under section 954(d)(1).⁵¹ These regulations closely mirror the language of section 954(d)(1) and are consistent with congressional intent in enacting this provision. In particular, these regulations focus on activities that would be sufficient to transform personal property purchased by a CFC so that, in effect, the property sold was not the property purchased. These regulations do not impose requirements as to who must perform the requisite activities. Indeed, there is no statutory basis for imposing such requirements.

1. TREAS. REG. § 1.954-3(a)(1) AND ITS EXAMPLES CONFIRM THAT WOM DERIVED NO FBCSI IN 2009 BECAUSE THE REFRIGERATORS AND WASHERS THAT IT SOLD TO RELATED PARTIES WERE NOT THE SAME PROPERTY THAT WOM PURCHASED.

Treasury Regulation § 1.954-3(a)(1) outlines the general rules for the application of section 954(d). This provision repeats the language in section 954(d)(1), providing, in relevant part, that:

Foreign base company sales income of a controlled foreign corporation shall, except as provided in subparagraphs (2), (3), and (4) of this paragraph, consist of gross income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with (a) the purchase of personal property from a related person and its sale to any person, . . . [or] (c) the purchase of personal property from any person and its sale to a related person[.]"

(Emphases added.) As with the statutory language of section 954(d)(1), this language confirms that FBCSI includes income derived from "the purchase of personal property from a related person and its sale to any person" as well as "the purchase of personal property from any person and its sale to a related person."

Lest there be any doubt, Examples 1 and 2 in Treas. Reg. § 1.954-3(a)(1)(iii) make plain the meaning of "its" and the requirement that FBCSI attaches only if the property sold is the same as the property purchased. Example 1 concludes that a CFC's income is FBCSI when the CFC purchases property from a related party and sells that property to an unrelated party "in the form in which purchased." Treas. Reg. § 1.954-3(a)(1)(iii) (example 1) (emphasis added). Likewise, Example 2 concludes that the CFC also has FBCSI when it purchases property from an unrelated person and sells to a related party that property "in the form in which purchased." Treas. Reg. § 1.954-3(a)(1)(iii) (example 2) (emphasis added). In both examples, the language "in the form in which purchased" illustrates the statutory language "the purchase of personal property . . . and its sale." Compare Treas. Reg. § 1.954-3(a)(1)(iii) (example 1) and (example 2) with Section 954(d)(1). The regulatory language "in the form in which purchased" establishes that "its sale" means sale of the same purchased personal property. If the purchased property is not sold in the same form as purchased, then the sale does not give rise to FBCSI. This regulatory conclusion is not surprising: this is exactly what the plain language of the statute means and follows Congress's explanation in the legislative history.

2. TREAS. REG. § 1.954-3(a)(4) SHOWS THAT WHEN THE PROPERTY SOLD IS IN A DIFFERENT FORM THAN THE PROPERTY PURCHASED, THE SALE DOES NOT GENERATE FBCSI.

Treas. Reg. § 1.954-3(a)(4) provides common sense guidance that sales of property manufactured or produced from raw materials, component parts, and supplies does not constitute sale of the raw materials, component parts, and supplies purchased.

a. Treas. Reg. § 1.954-3(a)(4)(i).

Treasury Regulation § 1.954-3(a)(4)(i), in particular, clarifies the circumstances in which the manufacture, production, or construction of personal property by a corporation will cause the property that a CFC sells to be different from the property that is purchased. This provision states as follows:

Foreign base company sales income does not include income of a controlled foreign corporation derived in connection with the sale of personal property manufactured, produced, or constructed by such corporation in whole or in part from personal property which it has purchased. A foreign corporation will be considered, for purposes of this subparagraph, to have manufactured, produced, or constructed personal property which it sells if the property sold is in effect not the property which it purchased.

(Emphases added.)

Respondent's complaint in this case is not whether the refrigerators and washers were manufactured, but by whom they were manufactured. As set forth in the undisputed facts, Respondent has admitted that the refrigerators and washers sold by WOM were manufactured at WOM's manufacturing plants from the raw materials, component parts, and supplies purchased by WOM using the equipment and tooling purchased by WOM, albeit by employees leased by WOM rather than hired directly by WOM. It defies logic for Respondent to argue that somehow "the property sold is in effect not the property which it purchased" if WOM hired the employees directly in the Ramos and Horizon Manufacturing Plants, but the refrigerators and washers magically remain the same property as the purchased raw materials, component parts, and supplies if WOM used leased employees in those same plants.

The language of Treas. Reg. § 1.954-3(a)(4)(i) shows the error in Respondent's position: the regulation states that a CFC will be "considered" to have "manufactured" the product if in essence the "property sold is not in essence the property which it purchased." Respondent has admitted the products sold were manufactured, thus necessarily admitting that the Products sold were not the same as the raw materials, component parts, and supplies purchased. Thus, under the regulation, WOM "will be considered, for purposes of this subparagraph, to have manufactured, produced, or constructed personal property which it sells[.]" As stated earlier in the exact same paragraph of the regulation, "[FBCSI] does not include income of a controlled foreign corporation derived in connection with the sale of personal property manufactured . . . by such corporation in whole — or in part from personal property which it has purchased." Because the property sold was not the property purchased, under Treas. Reg. § 1.954-3(a)(4)(i) WOM "will be considered . . . to have manufactured . . . personal property which it sells" and therefore cannot have FBCSI.

Thus, WOM's sales of refrigerators and washers that Respondent admits were manufactured from property purchased by WOM cannot give rise to FBCSI under either the plain language of the statute or Treas. Reg. § 1.954-3(a)(4)(i).

b. Treas. Reg. § 1.954-3(a)(4)(ii).

Treas. Reg. § 1.954-3(a)(4)(i) further provides that "[i]n the case of the manufacture, production, or construction of personal property, the property sold will be considered, for purposes of this subparagraph, as not being the property which is purchased if the provisions of subdivision (ii) or (iii) of this subparagraph are satisfied." (Emphases added.)

In turn, Treas. Reg. § 1.954-3(a)(4)(ii) provides that "[i]f purchased personal property is substantially transformed prior to sale, the property sold will be treated as having been manufactured, produced, or constructed by the selling corporation." (Emphases added.)⁵²

Although Treas. Reg. § 1.954-3(a)(4)(ii) does not define "substantially transformed," Webster's Third New International Dictionary defines "transformation" as "an act, process, or instance of transforming or being transformed." "Transform", in turn, is defined in relevant part as "to change completely or essentially in composition or structure"; "to change the outward form or appearance of: ALTER"; "to change in character or condition: CONVERT, TRANSFIGURE”. Webster's Third New International Dictionary of the English Language Unabridged (3d ed. 1963). "Substantially", an adverb form of "substantial", is defined as "consisting of, relating to, sharing the nature of, or constituting substance: existing as or in substance: MATERIAL"; "not seeming or imaginary: not illusive: REAL, TRUE"; "IMPORTANT, ESSENTIAL". Taken together, the common sense meaning of "substantially transformed" in this context is that the purchased property must be converted into something else of a different character and that the change must be significant and not illusive. Id.

Importantly, like Treas. Reg. § 1.954-3(a)(4)(i), Treas. Reg. § 1.954-3(a)(4)(ii) does not require the selling corporation to be the actor causing the substantial transformation: the regulation provides that ”[i]f purchased property is substantially transformed prior to sale, the property sold will be treated as having been manufactured, produced or constructed by the selling corporation."

Treas. Reg. § 1.954-3(a)(4)(ii) provides three examples of purchased property that is "substantially transformed" and thus constituting the manufacture or production of products outside the scope of FBCSI. Treas. Reg. § 1.954-3(a)(4)(ii) (example 1) provides that the conversion of wood pulp to paper qualifies as manufacture or production for purposes of Treas. Reg. § 1.954-3(a)(4)(ii). Treas. Reg. § 1.954-3(a)(4)(ii) (example 2) provides that the production of screws and bolts from steel rods qualifies as manufacture or production for purposes of Treas. Reg. § 1.954-3(a)(4)(ii). Treas. Reg. § 1.954-3(a)(4)(ii) (example 3) provides that the processing and canning of tuna also qualifies as manufacture or production for purposes of Treas. Reg. § 1.954-3(a)(4)(ii). Each of these examples is completely consistent with the common sense meaning of "substantially transformed."

WOM similarly converted the raw materials, component parts, and supplies that it purchased into property of a different character, and that change was both significant and not illusive. WOM converted rolls of steel, plastic resin and sheets, paint, chemicals, nuts, screws, bolts, and myriad of other items into refrigerators and washers. Under Treas. Reg. § 1.954-3(a)(4)(ii), if the purchased property is "substantially transformed," the selling corporation will be considered as having manufactured the property sold, and thus such sales to be outside the scope of FBCSI. Respondent has already admitted the obvious: conversion of the raw materials, component parts, and supplies into refrigerators and washers at WOM's Ramos and Horizon Manufacturing Plants constituted the manufacture of the Products. Under Treas. Reg. § 1.954-3(a)(4)(ii), substantial transformation has occurred and thus WOM's sale of the manufactured products under Treas. Reg. § 1.954-3(a)(4)(i) "will be considered, for purposes of this subparagraph, as not being the property which is purchased[.]”

The fact that the refrigerators and washers were manufactured in WOM's Ramos and Horizon Manufacturing Plants using leased employees rather than directly hired employees has no bearing on the simple fact that what WOM sold was not what WOM purchased. In any event, under Treas. Reg. § 1.954-3(a)(4)(ii), because the purchased raw materials, component parts, and supplies were substantially transformed into refrigerators and washers, "the property sold [the refrigerators and washers] will be treated as having been manufactured . . . by the selling corporation [WOM]." Accordingly, WOM's sale of the refrigerators and washers cannot give rise to FBCSI under Treas. Reg. § 1.954-3(a)(4)(ii).

c. Treas. Reg. § 1.954-3(a)(4)(iii).

Treas. Reg. § 1.954-3(a)(4)(iii) provides that, "[i]f purchased property is used as a component part of personal property which is sold, the sale of the property will be treated as the sale of a manufactured product, rather than the sale of component parts, if the operations conducted by the selling corporation in connection with the property purchased and sold are substantial in nature and are generally considered to constitute the manufacture, production, or construction of property." (Emphases added.)

Thus, under Treas. Reg. § 1.954-3(a)(4)(iii), WOM's sale of the Products, which were manufactured in part from component parts, will be considered the sale of a manufactured product and not the sale of component parts if (a) WOM's operations were substantial in nature, and (b) the operations were generally considered to be the "manufacture” of property.

Respondent has already admitted that the refrigerators and washers were "manufactured" at WOM's Ramos and Horizon Manufacturing Plants. Hence, requirement (b) is admitted.

The issue under Treas. Reg. § 1.954-3(a)(4)(iii) thus turns on whether WOM's operations were "substantial in nature."

Treas. Reg. § 1.954-3(a)(4)(iii) (example 2) illustrates when use of component parts in manufacture will result in the sale of, in essence, a different property than the component parts purchased. In Example 2, Corporation B operates an automobile assembly plant. Corporation B's operations include the purchase of assembled engines, transmissions, and certain other component, parts and the performance of stamping, machining, and subassembly operations. Corporation B also has a substantial investment in tools, jigs, welding equipment, and other machinery and equipment used in the assembly of an automobile. The example concludes that "[t]he product sold, an automobile, is not sufficiently distinguishable from the components purchased (the engine, transmission, etc.) to constitute a substantial transformation of purchased parts within the meaning of [Treas. Reg. § 1.954-3(a)(4)(ii)]." Nonetheless, Example 2 further concludes that "the operation conducted by B Corporation in connection with the property purchased and sold are substantial in nature and are generally considered to constitute the manufacture of a product." Thus, "Corporation B will be considered under this subdivision to have manufactured the product it sells."

Like Example 2, WOM's operations were substantial in nature. As discussed above, WOM's Ramos and Horizon Manufacturing Plants contained over 1.3 million square feet of manufacturing space. These plants housed over $146 million in equipment and tooling owned by WOM. See Bausch & Lomb v. Commissioner, T.C. Memo 1996-57, at *83 (holding the use of production facilities to assemble sunglasses and warehouses to store finished goods was substantial in nature). Over 3,300 employees leased by WOM worked in these plants around the clock, six days per week, with the seventh day used for necessary maintenance. See id. at *81 (recognizing the "substantial investment in human capital" needed to produce quality sunglasses and noting the value of a "trained and experienced workforce"). In 2009, WOM's costs to produce the refrigerators and washers was over $700 million, including the costs of the raw materials, component parts, and supplies, as well as the conversion costs (cost of labor and overhead) incurred to manufacture the Products. See id. at *83 (noting the "necessary and essential" activities performed and costs incurred to purchase and inspect component parts, prepare them for assembly, inspect finished products, and prepare finished products for distribution). In 2009, the Ramos and Horizon Manufacturing operations produced nearly a million refrigerators and over a half million washers.

Without question, WOM's operations were substantial in nature, regardless of whether its employees were leased or hired directly. Accordingly, under Treas. Reg. § 1.954-3(a)(4)(iii) WOM's sale of refrigerators and washers manufactured in part from component parts is considered to be the sale of manufactured products and, pursuant to Treas. Reg. § 1.954-3(a)(4)(i), WOM's sales therefore did not give rise to FBCSI.

D. RESPONDENT'S LONG HELD RULING POSITION UNDER REV. RUL. 75-7 SHOWS THAT RESPONDENT UNDERSTOOD FOR OVER 35 YEARS THAT THE PLAIN LANGUAGE OF SECTION 954(d)(1) MEANT WHAT IT SAID: IF A CFC DOES NOT SELL THE SAME PROPERTY IT PURCHASES, THE CFC DOES NOT HAVE FBCSI, EVEN IF A THIRD PARTY CONTRACT MANUFACTURES OR PRODUCES THE PROPERTY SOLD BY THE CFC.

Section 954(d)(1) was enacted in 1962 with regulations propounded in 1964. Since its promulgation and continuing for some 35 years, Respondent understood that the issue under section 954(d)(1) was whether property sold was the same property purchased, not the identity of the entity or persons manufacturing or transforming the purchased materials into different property that was then sold. Respondent's understanding of the plain language of section 954(d)(1) was reflected in Rev. Rul. 75-7, 1975-1 C.B. 244, revoked by Rev. Rul. 97-48, 1997-2 C.B. 89.

In Rev. Rul. 75-7, X, a CFC, incorporated in country M, purchased metal ore concentrate in the US and Canada from related persons. X hired Y, an unrelated foreign corporation incorporated in country 0, to convert the ore concentrate into a ferroalloy at Y's plant in country 0. Under the contract manufacturing arrangement, X paid Y a fee for the conversion of the ore concentrate. X at all times owned the ore concentrate and the resulting ferroalloy, and X alone purchased all raw materials and other ingredients needed for the conversion. X was responsible for all economic risks associated with the sale of the finished product. Y's only financial interest in the entire transaction was the fee paid by X for conversion of the ore. In short, Y acted as an unrelated consignment contract manufacturer for X. X sold the ferroalloy to unrelated persons for consumption in foreign countries other than country M, X's country of incorporation.

Rev. Rul. 75-7 posed the question of whether X's purchase of the ore concentrate and other raw materials from related persons and X's sale of finished ferroalloy to unrelated persons gave rise to FBCSI. After discussing the provisions of the statute and Treas. Reg. §§ 1.954-3(a)(4)(i) and (ii), Respondent concluded in Rev. Rul. 75-7:

Under the contractual arrangement between X and Y, the performance by Y of the operations whereby the ore concentrate is processed into a ferroalloy is considered to be a performance by X. Therefore, X will be treated as having "substantially transformed personal property" within the meaning of section 1.954-3(a)(4) of the regulations.

In Rev. Rul. 75-7, Respondent thus recognized that the change causing the personal property sold to be different from the personal property purchased (e.g., the manufacture or substantial transformation of the item sold) need not be physically performed by the CFC in question. Thus, a CFC's use of an unrelated consignment contract manufacturer to convert the raw materials purchased by the CFC into a different property that was then sold by the CFC did not give rise to FBCSI.

In Rev. Rul. 75-7, a second issue was present: did the use of the unrelated contract manufacturer in country 0 give rise to a branch under section 954(d)(2). In Rev. Rul. 75-7, the Respondent concluded that use of an unrelated contract manufacturer in a different country did give rise to a branch and section 954(d)(2) was potentially applicable.⁵³

From the promulgation of section 954(d)(1) in 1962 through 1997 — some 35 years — Respondent recognized that the plain language of section 954(d)(1) meant what it said: a CFC would not have FBCSI so long as the property it sold was not the property it purchased.

Respondent lost the branch issue in Ashland Oil, Inc, v. Commissioner, 95 T.C. 348 (1990) and Vetco, Inc., v. Commissioner, 95 T.C. 579 (1990). In Rev. Rul. 97-48, 1997-2 C.B. 89, Respondent revoked Rev. Rul. 75-7 both as to the branch rule determination which it had lost, but also as to its ruling that a CFC's sales of property manufactured by an unrelated consignment contract manufacturer did not constitute FBCSI. "The Service will follow the Ashland and Vetco opinions. The activities of a contract manufacturer cannot be attributed to a controlled foreign corporation for purposes of either section 954(d)(1) or section 954(d)(2). Accordingly, Rev. Rul. 75-7 is revoked." However, Rev. Rul. 97-48 provided that for taxable years beginning before December 8, 1997, taxpayers could still rely upon Rev. Rul. 75-7 so long as they agreed to treat unrelated contract manufacturers as a branch, notwithstanding the decisions in Ashland and Vetco.

The Respondent's revocation of Rev. Rul. 75-7 thus appears to be result oriented and a function of losing the branch issue in Ashland and Vetco, rather than a principled decision under section 954(d)(1) and Treas. Reg. § 1.954-3(a)(4). The revocation of Rev. Rul. 75-7's manufacturing ruling has been highly criticized.⁵⁴

Despite Respondent's revocation of Rev. Rul. 75-7, for 35 years both taxpayers and Respondent understood the plain language of section 954(d)(1): a CFC earns FBCSI on related party sales or purchases only if the CFC resells the same property it purchased. If in essence the property sold is not the property purchased, the sale cannot give rise to FBCSI. The statute did not change in any way between 1962 and 2009, the year at issue.⁵⁵ Indeed, the statute still has not changed to this day. The plain language of section 954(d)(1) establishes that WOM does not have FBCSI because it did not sell the same property it purchased.

CONCLUSION

As shown by the plain language of the statute, the legislative history, and the applicable regulations, FBCSI cannot arise under section 954(d)(1) from WOM's sale of refrigerators and washers manufactured from raw materials, component parts, and supplies. As no genuine questions of material fact exist, Petitioners pray that this Court grant Petitioners' Motion for Partial Summary Judgment Under Section 954(d)(1) and grant such other and further relief as this Court deems just and proper.

Dated: February 4, 2019

Respectfully submitted,

Mark A. Oates
T.C. No. OM0113

BAKER & MCKENZIE LLP
300 East Randolph Street, Suite 5000
Chicago, IL 60601
(312) 861-7594
Mark.Oates@bakermckenzie.com
Attorneys for Petitioner