Whirlpool Maintains Entitlement to Summary Judgment in Tax Court

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

UNITED STATES TAX COURT

Judge Lauber

WHIRLPOOL'S RESPONSE TO RESPONDENT'S SUR-REPLY TO REPLY BRIEF INFURTHER SUPPORT OF PETITIONERS' MOTIONS FOR PARTIAL SUMMARYJUDGMENT UNDER SECTIONS 954(d)(1) AND 954(d)(2)

Mark A. Oates
T.C. No. OM0113
Cameron C. Reilly
T.C. No. RC0458

Baker & McKenzie LLP
300 E. Randolph Dr.
Suite 5000
Chicago, IL 60601
(312) 861-7594

Robert H. Albaral
T.C. No. AR0375

Baker & McKenzie LLP
1900 North Pearl St.
Suite 1500
Dallas, Texas 75201
(214) 978-3044

Summer Austin
T.C. No. AS0208
Brandon M. King
T.C. No. KB0240

Baker & McKenzie LLP
815 Connecticut Ave., N. W.
Washington, D.C. 20006
(202) 835-1643

Rodney H. Standage
T.C. No. SR1478

Whirlpool Corporation
325 N LaSalle
Chicago, IL 60605
(269) 277-6623

Attorneys for Petitioners

September 23, 2019

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TABLE OF CONTENTS

OVERVIEW

CONCLUSION

TABLE OF AUTHORITIES

CASES:

Amazon.com v. Commissioner, No. 17-72922, 2019 U.S. App. LEXIS 24453, (9th Cir. Aug. 16, 2019)

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

Barboza v. Cal. Ass'n of Prof'l Firefighters, 799 F.3d 1257 (9th Cir. 2015)

Blau v. Lehman, 368 U.S. 403 (1962)

Brown v. Gardner, 513 U.S. 115 (1994)

Carver v. United States, 412 F.2d 233 (Ct. Cl. 1969)

Chevron U.S.A., Inc. v. NRDC, 467 U.S. 837 (1984)

Commissioner v. Soliman, 506 U.S. 168 (1993)

Eckstein v. United States, 452 F.2d 1049 (Ct. Cl. 1971)

Estate of Connelly v. Commissioner, 34 T.C.M. (CCH) 1429 (1975)

Gitlitz v. Commissioner, 531 U.S. 206 (2001)

Good Fortune Shipping SA v. Commissioner, 897 F.3d 256 (D.C. Cir. 2018)

Gregory v. Helvering, 293 U.S. 465 (1935)

Morrill v. Jones, 106 U.S. 466 (1883)

NACS v. Bd. of Governors of the Fed. Reserve Sys., 746 F.3d 474 (D.C. Cir. 2014)

Nat'l Cotton Council of Am. v. United States EPA, 553 F.3d 927 (6th Cir. 2009)

Robinson v. Commissioner, 119 T.C. 44 (2002)

Shannon v. United States, 512 U.S. 573 (1994)

Snyder v. Commissioner, 66 T.C. 785 (1976)

Summa Holdings, Inc. v. Commissioner, 848 F.3d 779 (6th Cir. 2017)

The Dome Co. v. Commissioner, 26 BTA 967 (1932)

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

United States v. Calamaro, 354 U.S. 351 (1957)

United States v. Transocean, 767 F.3d 485 (5th Cir. 2014)

Zuber v. Allen, 396 U.S. 168 (1969)

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)(2)

Treas. Reg. § 1.954-3(a)(3)

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. § 1.954-3(b)

Treas. Reg. § 1.954-3(b)(1)(i)

Treas. Reg. § 1.954-3(b)(1)(ii)

Treas. Reg. § 1.954-3(b)(1)(ii)(b)

Treas. Reg. § 1.954-3(b)(2)

Treas. Reg. § 1.954-3(b)(2)(i)

Treas. Reg. § 1.954-3(b)(2)(i)(a)

Treas. Reg. § 1.954-3(b)(2)(i)(c)

Treas. Reg. § 1.954-3(b)(2)(ii)

Treas. Reg. § 1.954-3(b)(2)(ii)(c)

Treas. Reg. § 1.954-3(b)(2)(ii)(e)

Treas. Reg. § 1.954-3(b)(2)(ii)(f)

Treas. Reg. § 31.3121(d)-1(c)(2)

TREATIES:

Commentary to the OECD Model Convention, Articles 23 A and 23 B, OECD (2019), Model Tax Convention on Income and on Capital 2017 (Full Version)

Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital, Lux.-Mex., 2450 U.N.T.S. 95

OECD' (2019), Model Tax Convention on Income and on Capital 2017 (Full Version), OECD Publishing, at art. 7 (OECD Nov. 21, 2017)

U.S. Model Income Tax Convention of Feb. 17, 2016, art. 7

LEGISLATIVE HISTORY:

Treasury Department, "Draft of Statutory Language, with Accompanying Explanation, of the Amendments Proposed by the Secretary of the Treasury on May 10, 1962, to Sections 13, 15, 16, and 20 of H.R. 10650," 87th Cong. (May 31, 1962)

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

H.R. 10650, 87th Cong, Sec. 12(a), § 954(d)(August 16, 1962)

Joint Committee on Taxation, "Tax Effects of Conducting Foreign Business Through Foreign Corporations" (JCS-5-61), Appendix C, July 21, 1961

108 Cong. Rec. 11,983-86 (daily ed. July 9, 1962)(statement of Sen. Kerr)

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

ADMINISTRATIVE GUIDANCE:

1996 FSA LEXIS 463 (Apr. 30, 1996)

AM 2015-002 (February 9, 2015)

General Counsel Memorandum 33357 (Oct. 24, 1966)

General Counsel Memorandum 35961 (Aug. 23, 1974)

Internal Revenue Service News Release, Tax Regime Applicable to Maquiladoras, IR-INT-1999-13 (Oct. 29, 1999)

Internal Revenue Service News Release, Mexican and U.S. Tax Authorities Extend Tax Regime Applicable to Maquiladoras Beyond 2002, IR-2000-56 (Aug. 11, 2000)

Notice of Proposed Rulemaking, 73 Fed. Reg. 10,716 (Feb. 28, 2008)

Practice Unit 2.1.2, "Branch Rules for Foreign Base Company Sales Income" (June 18, 2015)

Practice Unit 2.1.2.2, "Sale by CFC to Unrelated Parties of Products Manufactured by Branch" (July 29, 2015)

Practice Unit 2.1.2.1, "Branch Sales to Unrelated Parties of Products Manufactured by CFC" (August 3, 2015)

Priv. Ltr. Rul. 6412105700A (Dec. 10, 1964)

Priv. Ltr. Rul. 7612101490A (Dec. 10, 1976)

Priv. Ltr. Rul. 8333008 (July 13, 1982)

Priv. Ltr. Rul. 8413062 (Dec. 29, 1983)

Priv. Ltr. Rul. 8509004 (Nov. 23, 1984)

Priv. Ltr. Rul. 8749060 (Sept. 8, 1987)

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

Treasury Decision 6734 (May 15, 1964)

MISCELLANEOUS:

A. Scalia & B. Garner, Reading Law: Interpretation of Legal Texts 142 (2012)

BNA Portfolio 6240-lst: CFCs — Foreign Base Company Income (Other than FPHCI), Chapter H

BNA Portfolio 6240-lst: CFCs — Foreign Base Company Income (Other than FPHCI), Chapter E

BNA Portfolio 900-2nd: Foundations of U.S. International Taxation, Chapter J

Boris Bittker & Lawrence Lokken, Federal Taxation of Income, Estates, and Gifts (2019)

Charles I. Kingson, "IRS Premises on Contract Manufacturing Are Wrong," Tax Notes Int'l (June 25, 2007)

D. Kevin Dolan et al, U.S. Taxation of International Mergers, Acquisitions and Joint Ventures (2019)

Jeremy Butterfield, Fowler's Dictionary of Modern English Usage (Oxford U. Press 2015)

Joel D. Kuntz et al, U.S. International Taxation (1992)

Webster's Dictionary of English Usage (2d rev. ed. 1989)

William W. Chip, "'Manufacturing' Foreign Base Company Sales Income," Tax Notes Int'l (Dec. 3, 2007)

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OVERVIEW¹

While Whirlpool disagrees with the conclusions and legal analysis in Respondent's Sur-Reply (the "Sur-Reply"), Whirlpool respectfully submits that the Sur-Reply serves to identify the stark differences between the parties' positions in this case. For the reasons set forth below, summary judgment should be granted in Whirlpool's favor on both its Section 954(d)(1) and Section 954(d)(2) Motions.

I. SUMMARY JUDGMENT ON WHIRLPOOL'S SECTION 954(d)(1) MOTION IS APPROPRIATE.

On the section 954(d)(1) issue, five key issues divide the parties, any one of which, if decided in Whirlpool's favor, is outcome determinative in this case.

A. THE PLAIN LANGUAGE OF SECTION 954(d)(1) DEFINES FBCSI TO REQUIRE A PURCHASE AND SALE OF THE SAME PERSONAL PROPERTY.

First, the plain language of section 954(d)(1) commands that FBCSI can arise, as relevant to this case, only when a CFC, in a transaction involving a related party, derives income from "the purchase of personal property and its sale[.]" Whirlpool's position is that Congress' use of the term "its" was intentional and by its common usage means that FBCSI can arise only when a CFC buys and sells the same personal property without adding appreciable value. Respondent contends that the word "its" should be construed to mean "any". See Sur-Reply at 60. In Respondent's view, (a) "the purchase of personal property . . . and its sale" to a related person really means (b) "the purchase of personal property . . . and the sale of any personal property" to a related person.

As more fully discussed in Whirlpool's Section 954(d)(1) Brief at 23-27 and in Whirlpool's Reply Brief at 6-11, the dictionary definition of "its" and the common usage of "its" demonstrate that "its" means "of or relating to itselff,]" while "it" is defined as "that one", and "itself" is defined as "that identical one". As stated in Fowler's Dictionary of Modern English Usage (Oxford U. Press 2015) at 442, "its is the possessive form of it (the cat licked its paws)". Respondent's interpretation of "its" would say that when the cat licked its paws, it was licking some other cat's paws (i.e., "any" cat's paws). Respondent's interpretation completely ignores that "its" is the possessive form of "it" and "its paws" refers to the cat's own paws, not "any" cat's paws.

In short, the cat is out of "its" bag: given the common meaning and usage of "its", Respondent's argument that "its" means "any" is simply untenable.

Perhaps in recognition that "its" does not mean "any", in his Sur-Reply, Respondent now advances another alternative reading of "its", although Respondent readily concedes it is not a reasonable interpretation. This time, Respondent says "its sale" means "its sale (in a different form)". See Sur-Reply at 61. To illustrate his argument, Respondent assumes that a CFC buys "metal" from an unrelated person, manufactures cookware from the metal, and sells cookware to a related person. Respondent then says that if "its sale" is interpreted to mean "its sale (in a different form)", then this new interpretation of "its" would cause the statute "to result in FBCSI where the personal property was substantially transformed", which Respondent admits is "an unreasonable result contrary to the legislative history of section 954(d)." See Sur-Reply at 61. Respondent's new proposed alternative meaning of "its" is not just an unreasonable result under the legislative history, it is flat out wrong under the plain language of the statute. As stated above, "its" is the possessive form of "it" and means "that one", "that identical one". Adding the words "(in a different form)" changes the statute from requiring the purchase and sale of the same personal property to requiring the sale of personal property that had its provenance in the purchased personal property, but is not the same thing. The cast iron frying pan in Respondent's example cannot be said to be even similar to the iron ingot from which it was manufactured, let alone be "that one" or "that identical one". Respondent's straw man argument on this point proves nothing.

Curiously, in his Sur-Reply, Respondent also now invokes "the last antecedent rule" of statutory interpretation to support his argument that "its" is ambiguous. See Sur-Reply at 59-60. The invocation of the last antecedent rule is curious because both the antecedent to which "its" relates is obvious — personal property — but it also directly undercuts Respondent's position. As Respondent recounts, "(t]he grammatical rule of the last antecedent provides that a limiting clause or phrase should ordinarily be read as modifying only the noun or phrase that it immediately follows.” See Sur-Reply at 59. "Its" is exactly the type of limiting clause or phrase that under the last antecedent rule modifies the closest antecedent. As discussed above, "its" means "of or relating to itself”, is the possessive form of "it" which means "that one", and "itself" means "that identical one". "Its" thus modifies the last antecedent, personal property, to be "that one", "that identical one", that is, the same personal property.

Application of the last antecedent rule thus yields the conclusion that the phrase "its sale" is a reference to the same personal property purchased. The last antecedent rule fully supports Whirlpool's position that the plain language of the statute is unambiguous and compels the conclusion that in this case FBCSI cannot arise unless WOM sells the same personal property it purchased.²

As WOM did not sell the same personal property that it purchased, summary judgment in Whirlpool's favor is appropriate under section 954(d)(1).

B. THE LEGISLATIVE HISTORY CONFIRMS THE PLAIN LANGUAGE OF THE STATUTE.

While Whirlpool contends that the plain language of the statute is unambiguous, resort to the legislative history confirms the plain meaning. See Section 954(d)(1) Brief at 23-30; Reply Brief at 6-11. As Congress explained some 57 years ago:

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.

See H.R. Rep. No. 87-1447, at A94-A95 (1962) (emphases added). The legislative history thus confirms that Congress meant the word "its" to connote, consistent with its common usage, that the definition of FBCSI covers "only transactions involving both a purchase and a sale" of the same property, and would not apply if, "in effect, the final product [sold] is not the property purchased." Respondent has wholly failed to address this legislative history confirming the common sense reading of the word "its".

As the legislative history confirms the plain meaning of the statute, summary judgment in Whirlpool's favor on the section 954(d)(1) issue is appropriate, because WOM did not sell the same property it purchased.

C. CONSISTENT WITH THE PLAIN LANGUAGE OF THE STATUTE AND THE CONFIRMING LEGISLATIVE HISTORY, THE REGULATIONS ARE CONCERNED WITH WHETHER, IN EFFECT, THE PROPERTY SOLD IS THE PROPERTY PURCHASED, NOT THE INDIVIDUALS WHO SUBSTANTIALLY TRANSFORM, MANUFACTURE, PRODUCE OR CONSTRUCT THE FINAL PRODUCT SOLD.

As set forth in Whirlpool's Section 954(d)(1) Brief at 30-31 and Reply Brief at 12-18, the regulations applicable to Whirlpool's 2009 tax year, Treas. Reg. § 1.954-3 (2002), do not require the CFC itself to carry on the manufacturing through use of its own common law employees, but rather deem or treat the CFC to be the manufacturer, regardless of whether the CFC's own employees do the manufacturing or the CFC uses a contract manufacturer or other agent to provide the manufacturing services. See Treas. Reg. § 1,954-3(a)(4)(i) ("A foreign corporation will be considered, for purposes of this paragraph, 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)); Treas. Reg. § 1.954-3(a)(4)(ii) ("If purchased personal property is substantially transformed prior to its sale, the property sold will be treated as having been manufactured, produced or constructed by the selling corporation." (Emphases added)); Treas. Reg. § 1.954-3(a)(4)(iii) ("If purchased property is used as a component part of personal property which is sold, the sale of the property will be treated as a 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)). See also Section 954(d)(1) Brief at 31-42; Reply Brief at 12-18. Each of these regulations deems, considers, or treats the selling corporation as selling a manufactured product, and thus not selling the same personal property that it purchased.

Respondent has never deigned to even respond to these regulations.

In particular, Respondent has failed to respond to Treas. Reg. § 1.954-3(a)(4)(iii), which treats the selling corporation as selling a manufactured product and thus not having FBCSI if the selling corporation's operations are substantial in nature and generally considered to constitute manufacturing. Respondent has repeatedly admitted that the refrigerators and washers were manufactured in Mexico in WOM's Ramos and Horizon Manufacturing Plants. That WOM's operations were substantial in nature is beyond dispute. WOM leased the Ramos and Horizon Manufacturing Plants, comprised of more than 1.3 million square feet of manufacturing space. WOM owned over $146 million of manufacturing equipment and tooling housed at the two plants. During 2009, WOM seconded and leased over 3300 employees to work in its plants manufacturing the refrigerators and washers. WOM purchased and used over $700 million in raw materials and component parts in its 2009 manufacturing operations. As a result of its operations, WOM in 2009 produced nearly a million refrigerators and a half million washers. WOM sold these products for over $800 million. See Section 954(d)(1) Brief at 40-42 and Exhibit B (Affidavit of Eduardo Elizondo Williams); Reply Brief at 35-36.

Without question, WOM's operations were substantial. Since Respondent has admitted, as he must, that the refrigerators and washers were manufactured at WOM's manufacturing plants, both requirements of Treas. Reg. § 1.954-3(a)(4)(iii) are met and WOM's sale of the refrigerators and washers is treated as the sale of a manufactured product. In the language of Treas. Reg. § 1.954-3(a)(4)(iii), "the sale of property will be treated as the sale of a manufactured product . . . if the operations of the selling corporation in connection with the property purchased and sold are substantial in nature and are generally considered to constitute the manufacture . . . of property." Accordingly, under Treas. Reg. § 1.954-3(a)(4)(iii), WOM is treated as having sold a manufactured product, which is a sale that falls outside the definition of FBCSI.

Respondent has failed to respond to the application of the regulations. Indeed, in its Reply Brief at 36, Whirlpool specifically called out Respondent's failure to address this particular regulation: "Respondent has refused to address this argument, presumably because of the futility of doing so."

In his Sur-Reply, Respondent again has refused even to address his own regulations.

Summary judgment in Whirlpool's favor on the section 954(d)(1) issue is appropriate under Treas. Reg. § 1.954-3(a)(4) (2002).

D. RESPONDENT'S CONSISTENT RULING POSITION UNDER SECTION 954(d)(1) FROM 1964 TO 1996 SHOWS THAT A CFC DID NOT HAVE TO MANUFACTURE USING COMMON LAW EMPLOYEES IN ORDER TO BE CONSIDERED AS SELLING A MANUFACTURED PRODUCT UNDER TREAS. REG. § 1.954-3(a)(4).

Respondent and the Treasury Department issued Treas. Reg. § 1.954-3 in 1964.³ Later that same year, Respondent issued the first of an unbroken series of rulings over 32 years that blessed the use of a contract manufacturer under Treas. Reg. § 1.954-3(a)(4). See Priv. Ltr. Rul. 6412105700A (Dec. 10, 1964); General Counsel Memorandum 33357 (Oct. 24, 1966); General Counsel Memorandum 35961 (Aug. 23, 1974); Rev. Rul. 75-7, 1975-1 C.B. 244; Priv. Ltr. Rul. 8333008 (July 13, 1982); Priv. Ltr. Rul. 8413062 (Dec. 29, 1983); Priv. Ltr. Rul. 8749060 (Sept. 8, 1987); 1996 FSA LEXIS 463 (Apr. 30, 1996). These rulings consistently recognized the common sense proposition that a corporation can act through the actions of its agent as well as its own employees. These rulings recognized that it mattered not under section 954(d)(1) who manufactured the product, but rather recognized that the controlling issue was whether purchased personal property was manufactured, produced, constructed, or otherwise substantially transformed into a different product so that, in effect, the property purchased was not the property sold. These rulings reflected the plain language of the statute, the confirming legislative history, and the language of Treas. Reg. § 1.954-3(a)(4).

Thirty-three years later, six years after the IRS lost the branch rule argument in Ashland Oil, Inc. v. Commissioner, 95 T.C. 348 (1990), and Vetco, Inc. v. Commissioner, 95 T.C. 579 (1990), the IRS revoked Rev. Rul. 75-7 on the explicit ground that, unless an unrelated contract manufacturer could be considered a branch of the CFC, the "manufacturing exception" would be too broad and would allow taxpayers, in Respondent's view, to escape taxation under section 954.

Respondent's change in position occurred without any change in the statute, the legislative history, or the regulations. But it is the job of Congress, not Respondent, to legislate. Commissioner v. Soliman, 506 U.S. 168, 180 (1993) ("This result is compelled, by the language of the statute. Congress must change the statute's words if a different result is desired as a matter of tax policy."); Blau v. Lehman, 368 U.S. 403, 413 (1962) ("Congress can and might amend § 16(b) if the Commission would present to it the policy arguments it has presented to us, but we think that Congress is the proper agency to change an interpretation of the Act unbroken since its passage, if the changes is to be made."); Morrill v. Jones, 106 U.S. 466, 467 (1883) ("The Secretary of the Treasury cannot by his regulations alter or amend a revenue law . . . In our opinion, the object of the Secretary could only be accomplished by an amendment of the law. That is not the office of a treasury regulation.").

To this day, Congress has still not changed the language of section 954(d)(1). Respondent's prior thirty year plus ruling position confirms that a CFC need not use common law employees to manufacture products and therefore avoid FBCSI under section 954(d)(1).

E. EVEN IF TREAS. REG. § 1.954-3(a)(4) (2002) REQUIRED A CFC TO USE COMMON LAW EMPLOYEES AS RESPONDENT ARGUES, WOM'S SECONDED AND LEASED EMPLOYEES WERE COMMON LAW EMPLOYEES, AS WOM HAD THE LEGAL RIGHT TO CONTROL THE EMPLOYEES AND IN FACT CONTROLLED THE METHOD AND MANNER IN WHICH THE EMPLOYEES MANUFACTURED THE REFRIGERATORS AND WASHERS.

Respondent in his Sur-Reply at 72 recognizes that under Treas. Reg. § 31.3121(d)-1(c)(2) a common law employer-employee relationship exists "when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished." See also Sur-Reply at 74 ("employment relationship exists if the service recipient has the right to control the workers" both as to result and "the details and means by which that result is accomplished").

As discussed in detail in Whirlpool's Reply Brief at 27-29, WOM unquestionably had the legal right to exercise control over the seconded and leased employees under the various intercompany agreements. Moreover, as set forth in detail in Whirlpool's Reply Brief at 30-31, Whirlpool required the seconded and leased employees to manufacture the refrigerators and washers to WOM's specifications, using WOM's manufacturing equipment and tooling, using WOM's raw materials, component parts, and supplies, and using WOM's highly detailed and precise manufacturing instruction sheets. Thousands of pages of the manufacturing instruction sheets were produced to Respondent, and samples of the manufacturing instruction sheets were provided for the Court's benefit. See Reply Brief at 30 and Third Reilly Declaration at ¶ 9 and Attachment 7. These manufacturing instruction sheets directed the method and manner of production of the refrigerators and washers.

Thus, WOM had the legal right to control the seconded and leased employees, both as to the result of their work and the method and manner by which those employees accomplished their work. Under Treas. Reg. § 31.3121(d)-1(c)(2), WOM's seconded and leased employees constituted common law employees of WOM. Accordingly, even if Treas. Reg. § 1.954-3(a)(4) required a CFC to use common law employees in order to be treated as selling a manufactured product (which Whirlpool adamantly denies), WOM's seconded and leased employees constituted common law employees and summary judgment in Whirlpool's favor under section 954(d)(1) still would be appropriate.

II. SUMMARY JUDGMENT ON WHIRLPOOL'S SECTION 954(d)(2) MOTION IS APPROPRIATE.

Three key issues divide the parties on the section 954(d)(2) issue, any one of which, if decided in Whirlpool's favor, is outcome determinative in the case.

First, the Manufacturing Branch Rule exceeds the scope of section 954(d)(2) and is invalid. Neither the plain language of the statute nor its legislative history supports the Manufacturing Branch Rule.

Second, in determining whether a Tax Rate Disparity exists under Treas. Reg. § 1.954-3(b)(1)(ii)(b), the income at issue in this case must be excluded from the denominator in determining the actual effective tax rate for the Luxembourg Remainder because such income was not derived by the Luxembourg Remainder, but was derived by the Manufacturing Branch. While it is true that as a matter of incentive and legal fiction under Mexican domestic law (i.e., the maquiladora provisions) Mexico deems WOM's PE not to exist in Mexico, the legal fiction does not wipe away the fact that WOM conducted the entirety of its refrigerator and washer business in Mexico through dependent agents working from fixed places of business (the Ramos and Horizon Manufacturing Plants) at which WOM manufactured a million refrigerators and a half million washers using equipment and tooling that WOM maintained at the plants, using raw materials and components that WOM purchased and processed at the plants, with title to the refrigerators and washers passing to its customers at the end of its manufacturing lines at the Mexican plants, and with no substantive activities performed by its single, part-time employee in Luxembourg or anywhere else outside Mexico. These uncontroverted facts establish that the income at issue in this case was income derived by the Manufacturing Branch and was not income derived by the Luxembourg Remainder.

Third, application of the "special rules" of Treas. Reg. § 1.954-3(b)(2)(i) is mandatory in allocating income to the Luxembourg Remainder under Treas. Reg. § 1.954-3(b)(1)(ii)(b), not optional or an "overlay", as Respondent contends. See Respondent's Memorandum in Support of Motion for Summary Judgment ("Cross Motion") at 86. Treas. Reg. § 1.954-3(b)(1)(ii)(b) and the "special rules" of Treas. Reg. § 1.954-3(b)(2)(i) allocate income to the Remainder only with respect to the actual sales or purchasing activities conducted in the Remainder. As no sales or purchasing activities were conducted in the Luxembourg Remainder, no income can be allocated to the Luxembourg Remainder, no Tax Rate Disparity Exists, and and hence no FBCSI under section 954(d)(2) can arise.

A. NEITHER SECTION 954(d)(2) NOR THE LEGISLATIVE HISTORY AUTHORIZES THE MANUFACTURING BRANCH RULE; TREAS. REG. § 1.954-3(b)(1)(ii) IS INVALID.

Respondent makes three arguments in his Sur-Reply in support of his argument that the Manufacturing Branch Rule under Treas. Reg. § 1.954-3(b)(1)(ii) is valid: (a) Respondent argues that the language of section 954(d)(2) permits the Manufacturing Branch Rule; (b) Respondent claims that the legislative history supports his view that the statutory language permits the Manufacturing Branch Rule; and (c) Respondent asserts that Whirlpool's position "would lead to an absurd result that is incompatible with the purpose of the statute." See Sur-Reply at 48-49. None saves his regulation.

1. THE PLAIN LANGUAGE OF SECTION 954(d)(2) DOES NOT AUTHORIZE THE MANUFACTURING BRANCH RULE.

In Whirlpool's Section 954(d)(2) Brief at 28-33 and its Reply Brief at 55-62, Whirlpool parsed the language of section 954(d)(2) and showed that while the Language fully supports the Sales Branch Rule of Treas. Reg. § 1.954-3(b)(1)(i), the language in no way provides any statutory support for the Manufacturing Branch Rule. Parsing the statutory language, the statute says "the income . . . of such branch . . . shall constitute [FBCSI] of the [CFC]." See Reply Brief at 57. This language fully supports the Sales Branch Rule, which treats certain income earned by the branch as FBCSI of the CFC. The statutory language, however, provides no support whatsoever for the Manufacturing Branch Rule, which, if triggered, treats certain income earned by the CFC as FBCSI.

In his Sur-Reply, Respondent's only response to this statutory language is to claim that "the statutory text itself encompasses FBCSI attributable to the remainder of a CFC that manufactures through a branch.” See Sur-Reply at 49. The only support for this assertion is a reference back to Respondent's Cross Motion at 107-111. Respondent's position appears to be based on his statement that "[w]here manufacturing occurs in a branch, however, there is no need to provide special language to explain that the sales income ends up in the remainder of the CFC because the CFC sold the manufactured property and the sales income necessarily belongs in the CFC.” See Cross Motion at 109-10. Respondent's argument fails for the simple reason that while the income may be in the CFC, absolutely nothing in section 954(d)(2) authorizes that income to be treated as FBCSI.

Moreover, under the priority of application rule of Treas. Reg. § 1.954-3(b)(2)(ii)(f), the Sales and Manufacturing Branch Rules of Treas. Reg. § 1.954-3(b) apply only if there is no FBCSI under section 954(d)(1). Therefore, unless there is a specific authorization by Congress to create a new sub-class of FBCSI in section 954(d)(2) (as in the case of the Sales Branch Rule under section 954(d)(2)), income earned by a CFC relating to a manufacturing branch simply cannot constitute FBCSI.

Perhaps recognizing the lack of statutory support for the Manufacturing Branch Rule, Respondent also asserts that "[s]ection 954(d)(2) can also be construed as providing that all income derived by a branch that mimics a wholly owned subsidiary will be considered FBCSI, regardless of whether the branch is engaged in manufacturing or selling activities." See Cross Motion at 110. However, Respondent then admits that treating a branch that manufactures a product as creating FBCSI would be contrary to Congressional intent. Id. To fix this problem in his interpretation, Respondent then blithely asserts that Treasury "achieves parity of treatment between subsidiaries and branches by narrowing the scope of section 954(d)(2) to provide that income of a branch that manufactures will not be treated as FBCSI (so that, in this instance, only sales income of the remainder of the CFC will be FBCSI)." See Sur-Reply at 110-11. The problem with this argument is two-fold. First, as Respondent admits, this is not a reasonable interpretation of section 954(d)(2) as it completely conflicts with the legislative history. Second, even taking Respondent's assertion at face value, Congress still does not authorize income earned by the CFC — as opposed to income earned by the branch — to be treated as FBCSI.

The plain language of section 954(d)(2) simply does not provide any support for the Manufacturing Branch Rule.

2. NO LEGISLATIVE HISTORY SUPPORTS THE MANUFACTURING BRANCH RULE.

As set forth in Whirlpool's Section 954(d)(2) Brief at 30-33 and Reply Brief at 58-59, the legislative history underlying section 954(d)(2) establishes that Congress enacted section 954(d)(2) solely to address income attributable to a Sales Branch. From the time of the introduction of the section 954(d)(2) statutory language by Senator Kerr on July 9, 1962, see 108 Cong. Rec. 11,983-86 (daily ed. July 9, 1962) (statement of Sen. Kerr), which was taken verbatim from a May 10, 1962 report by the Treasury Department proposing statutory amendments to the House version of the 1962 Revenue Act, see Treasury Department, "Draft of Statutory Language, with Accompanying Explanation, of the Amendments Proposed by the Secretary of the Treasury on May 10, 1962, to Sections 13, 15, 16, and 20 of H.R. 10650," 87th Cong. (May 31, 1962), through the enactment of section 954(d)(2), the legislative history makes no mention of a Manufacturing Branch Rule nor even more generally manufacturing activity by a Branch. See Section 954(d)(2) Brief at 30-33; Reply Brief at 58-59.

To support his assertion that the legislative history supports the notion of a Manufacturing Branch Rule, Respondent points to a passing reference in a report prepared by the staff of the Joint Committee on Taxation more than a year before any statutory language was even proposed. See Cross Motion at 72, 111-12 (citing Joint Committee on Taxation, "Tax Effects of Conducting Foreign Business Through Foreign Corporations” (JCS-5-61), Appendix C, July 21, 1961 (the "JCT Report”)).⁴

As Respondent full well knows, legislative materials that are not "anchored in the text of the statute" are not given authoritative weight and are not considered when interpreting the text of a statute. Shannon v. United States, 512 U.S. 573, 583-84 (1994); see Reply Brief at 59. Notwithstanding Supreme Court precedent to the contrary, Respondent attempts to pass off the JCT Report as authoritative legislative history even though no statutory language had even been proposed until more than a year after the JCT Report was issued. See Cross Motion at 111, fn. 39 and accompanying text. Rather than advising the Court that the JCT Report predated any statutory language and thus is not authoritative legislative history under Shannon, Respondent lumps the JCT Report in with the authoritative legislative history in the text of his brief and then states in a footnote that the JCT Report was published prior to the enactment of the Revenue Act of 1962 and "therefore is part of the history of that legislation. See Robinson v. Commissioner, 119 T.C. 44, 73 (2002) See Cross Motion at 111, fn. 39.

Respondent's reference to Robinson in preference to the adverse Supreme Court precedent in Shannon is plainly wrong: in Robinson, the Joint Committee staff summary at issue was a summary of legislative provisions then pending before Congress, not, as in this case, a staff report written more than a year before any statutory language was even proposed. See Robinson, 119 T.C. at 73 (quoting the staff summary's statement that "Interest on underpayments of tax . . . is treated as personal interest under the provision [sec. 163(h)]"). The Tax Court's use of the JCT staff summary in Robinson was thus firmly "anchored in the text of the statute" and proper under Shannon.

The JCT Report in this case, however, has no "anchor in the text of the statute" and cannot be considered authoritative legislative history. To give credence to a passing reference in the JCT Report runs afoul of the Supreme Court's admonition in Shannon: ”To give effect to this snippet of legislative history, we would have to abandon altogether the text of the statute as a guide in the interpretative process." Shannon, 512 U.S. at 583-84.

3. APPLICATION OF THE PLAIN LANGUAGE OF SECTION 954(d)(2) AND ITS CONFIRMING LEGISLATIVE HISTORY DOES NOT GIVE RISE TO AN "ABSURD RESULT", BUT RATHER IMPLEMENTS CONGRESSIONAL INTENT TO ESTABLISH A SALES BRANCH RULE AND NOT A MANUFACTURING BRANCH RULE.

Respondent complains at page 51 of his Sur-Reply that invalidating the Manufacturing Branch Rule would lead to an absurd result because, in essence, the Manufacturing Branch Rule would not exist if invalidated.

With all due respect, such a result is not an "absurd result," it is the law. Nothing in the plain language of the statute supports Treasury's and Respondent's creation of the Manufacturing Branch Rule. Nothing in the legislative history evinces any Congressional intent to provide authority to Treasury and Respondent to create a Manufacturing Branch Rule. Rather, both the plain language of section 954(d)(2) and its legislative history establish that Congress intended to create a Sales Branch Rule, not a Manufacturing Branch Rule. If Treasury and the IRS wanted a Manufacturing Branch Rule, rather than attempt to pound a square peg into a round hole through administrative fiat, Treasury and Respondent should have attempted to persuade Congress to adopt statutory language providing legislative support for a Manufacturing Branch Rule. See United States v. Calamaro, 354 U.S. 351, 357 (1957) ("neither we nor the Commissioner may rewrite the statute simply because we may feel that the scheme it creates could be improved upon."); see also Soliman, 506 U.S. at 180; Blau, 368 U.S. at 413; Morrill, 106 U.S. at 467.

Nor does the fact that the Manufacturing Branch Rule has been in place for over fifty years save the rule from invalidity. While section 954(d)(2) has not changed in any material respects since its enactment in 1962, Congressional silence does not transform an agency's invalid interpretation of a statute into a valid one. Brown v. Gardner, 513 U.S. 115, 121 (1994) ("As we have recently made clear, congressional silence 'lacks persuasive significance' . . . particularly where administrative regulations are inconsistent with the controlling statute[.]") (quoting Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 187 (1994)); Zuber v. Allen, 396 U.S. 168, 185-86, n.21 (1969) ("The verdict of quiescent years cannot be invoked to baptize a statutory gloss that is otherwise impermissible. . . . Congressional inaction frequently betokens unawareness, preoccupation, or paralysis.").⁵

Finally, Respondent argues again (Sur-Reply at 51-52) that section 954(d)(2) is a tax "loop-hole plugging provision" and the Court should, in essence, embrace the Manufacturing Branch Rule as a necessary outgrowth of the policy of section 954(d)(2). As in Ashland, 95 T.C. at 354, 358, and Vetco, 95 T.C. at 593, Congress gave no authorization for the rule that Respondent seeks to impose by administrative fiat. As stated in Whirlpool's Reply Brief at 61, Respondent's purported tax loop-hole plugging provision argument must fail for the same reasons as in Ashland and Vetco. See also Gitlitz v. Commissioner, 531 U.S. 206, 219-20 (2001) ("Because the Code's plain text permits the taxpayers here to receive these benefits, we need not address this policy concern."); Gregory v. Helvering, 293 U.S. 465, 469 (1935) ("The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted."); Summa Holdings, Inc. v. Commissioner, 848 F.3d 779, 787-89 (6th Cir. 2017) ("But it's odd to reject a Code-compliant transaction in the service of general concerns about tax avoidance . . . The best way to effectuate Congress's nuanced policy judgements is to apply each provision as its text requires—not to elevate purpose over text when taxpayers structure their transactions in unanticipated tax-reducing ways.”).

4. THE MANUFACTURING BRANCH RULE FAILS UNDER CHEVRON STEPS ONE AND TWO.

As discussed in Whirlpool's Section 954(d)(2) Brief at 28-33 and Reply Brief at 60-62, the plain language of section 954(d)(2) and its legislative history are fatal to the validity of the Manufacturing Branch Rule under both a Chevron Step One and a Chevron Step Two analysis. Chevron U.S.A., Inc. v. NRDC, 467 U.S. 837, 842-43 (1984). Under Chevron Step One, Congress spoke directly to the issues raised and authorized only the Sales Branch Rule, as confirmed by both the plain language of the statute and the legislative history. As the intent of Congress is clear, the Chevron inquiry ends at Step One, "for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress." Id.; Nat'l Cotton Council of Am. v. United States EPA, 553 F.3d 927, 939 (6th Cir. 2009) (agency interpretation invalid under Chevron Step One when the agency exceeded the scope of the statute).

If the statute and the legislative history are silent or ambiguous on the issue presented, Chevron Step Two requires the Court to give deference to the agency's interpretation, so long as that interpretation is not arbitrary, capricious, or manifestly contrary to the statute. Chevron, 467 U.S. at 842-43. As the plain language of the statute and the legislative history establish that Congress intended to establish a Sales Branch Rule and not a Manufacturing Branch Rule, the Manufacturing Branch Rule is arbitrary, capricious and manifestly contrary to the statute. See Good Fortune Shipping SA v. Commissioner, 897 F.3d 256, 266 (D.C. Cir. 2018) (Treasury interpretation invalid under Chevron Step Two when the agency's interpretation was unreasonable, and thus manifestly contrary to the statute).

B. THE INCOME AT ISSUE IN THIS CASE MUST BE EXCLUDED FROM THE DENOMINATOR IN CALCULATING THE ACTUAL EFFECTIVE TAX RATE IN LUXEMBOURG UNDER THE TAX RATE DISPARITY TEST BECAUSE THE INCOME WAS DERIVED BY THE MANUFACTURING BRANCH AND WAS NOT DERIVED BY THE LUXEMBOURG REMAINDER.

As the regulation makes plain and both parties agree, in order for the Manufacturing Branch Rule to apply, there must be a Tax Rate Disparity under Treas. Reg. § 1.954-3(b)(1)(ii)(b). If no Tax Rate Disparity exists, the Manufacturing Branch Rule is inapplicable. Whether a Tax Rate Disparity exists in this case is wholly dependent on whether the income at issue was income derived by the Manufacturing Branch (as Whirlpool contends) or was income derived by the Remainder (as Respondent contends).

A Tax Rate Disparity is deemed to exist under Treas. Reg. § 1.954-3(b)(1)(ii)(b) when the actual effective tax rate imposed on the Remainder (in this case, the Luxembourg Remainder) is taxed in the year when earned at an effective rate of tax that is less than 90 percent of, and at least 5 percentage points less than, the effective rate of tax which would apply to such income under the laws of the country in which the Manufacturing Branch is located (in this case, Mexico), if, under the laws of Mexico, the entire income of the CFC were considered derived by such corporation from sources within Mexico from doing business through a PE in Mexico, received in Mexico, and allocable to such PE, and the corporation were considered created or organized under the laws of, and managed and controlled in, such country.

To determine the actual effective rate of tax in Luxembourg on the Luxembourg Remainder, Treas. Reg. § 1.954-3(b)(1)(ii)(b) provides that the determination:

shall be made by allocating to the remainder of such controlled foreign corporation [the Luxembourg Remainder] only that income derived by the remainder of such corporation, which, when the special rules of subparagraph (2)(i) of this paragraph are applied, is described in paragraph (a) of this section (but determined without applying subparagraphs (2), (3), and (4) of such paragraph). The use of the branch or similar establishment for such activities will be considered to have substantially the same tax effect as if it were a wholly owned subsidiary corporation of the controlled foreign corporation if income allocated to the remainder of the controlled foreign corporation under the immediately preceding sentence is, by statute, treaty obligation, or otherwise, taxed in the year when earned at an effective rate of tax that is less than 90 percent of, and at least 5 percentage points less than, the effective rate of tax which would apply to such income under the laws of the country in which the branch or similar establishment is located. . . [.]

(Emphases added.) As is evident from the highlighted language, the actual effective rate of tax for the Remainder in Luxembourg is equal to the sum of the tax payments paid by the Remainder to Luxembourg on income derived by the Remainder, divided by "only that income derived by the remainder".

The parties disagree fundamentally over the "income derived by the remainder", that is, the denominator of the fraction used to compute the actual effective Luxembourg tax rate.⁶ Whirlpool respectfully submits that the regulation mandates that the income to be included in the denominator includes only income derived by the remainder, and then only after the application of the special rules of Treas. Reg. § 1.954-3(b)(2)(i).

"Income derived by the remainder" is by definition not income derived by the Manufacturing Branch. Stated as an equation, the income of the CFC [WOM] is equal to the income derived by the Mexican Manufacturing Branch plus the income derived by the Luxembourg Remainder.

Among treaty partners, the international norm for determining income derived by a branch is the determination of profits attributable to a PE. See OECD (2019), Model Tax Convention on Income and on Capital 2017 (Full Version), OECD Publishing, at art. 7 (OECD Nov. 21, 2017); U.S. Model Income Tax Convention of Feb. 17, 2016, art. 7; Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital, Lux.-Mex., art. 7, Feb. 7, 2001, 2450 U.N.T.S. 95. Treas. Reg. § 1.954-3(b)(1)(ii)(b) similarly uses PE language in defining the income to be included in the denominator when determining the hypothetical rate of tax in the Manufacturing Branch jurisdiction (in this case, Mexico).

The entirety of WOM's business cycle, from purchasing of raw materials and components to the manufacture of products to the transfer of title to customers, occurs in Mexico at WOM's manufacturing plants. Indeed, WOM has no substantive operations outside of Mexico. As Respondent has admitted, WOM has only a single, part-time employee in Luxembourg, and has further admitted that that employee performed only nominal accounting and administrative activities. Prior to establishing WOM's Luxembourg headquarters and its Mexican maquiladora and related operations and activities, Whirlpool sought a ruling from Luxembourg as to what profits Luxembourg would consider to be attributable to a PE in Mexico and what profits would be attributable to WOM's minimal headquarter operations. As set forth in the Luxembourg ruling, see Schaffner Aff. at Attachment 13 at Bates No. WP010764, Luxembourg determined, based on the facts above, that but for a markup on the relatively minimal costs attributable to the Luxembourg headquarter operations, all of the profits were attributable to WOM's PE in Mexico.

Under the Mexico-Luxembourg Treaty, Mexico and Luxembourg agreed, as is the international norm, that profits attributable to a PE of a Luxembourg resident in Mexico would be taxable by Mexico. See Article 7(2) of the Mexico-Luxembourg Treaty. As Mexico and Luxembourg utilized the OECD Model Convention Article 23 A approach to ameliorating double taxation, under the terms of that provision Luxembourg was precluded from taxing profits attributable to a PE in Mexico. This grant to Mexico of taxing jurisdiction over Mexican PEs of Luxembourg residents and Luxembourg's inability to tax such income remains unchanged even though Mexico decided not to tax the PE of Luxembourg maquiladora principals (such as WOM). Lest there be any doubt, the OECD Commentary to Article 23 at ¶ 56.2, provides that Luxembourg is precluded from taxing, inter alia, the profits attributable to a Mexican PE of a Luxembourg maquiladora principal, notwithstanding Mexican domestic legislation choosing not to tax such income. See Commentary to the OECD Model Convention, Articles 23 A and 23 B, OECD (2019), Model Tax Convention on Income and on Capital 2017 (Full Version), OECD Publishing, at C(23)-19, ¶ 56.2 (OECD Nov. 21, 2017).

Respondent attempts to sidestep the fact that the income at issue constitutes the profits attributable to a PE in Mexico by noting that Mexico by virtue of domestic legislation (i.e., the maquiladora statutes) deems the PE of a foreign maquiladora principal not to exist so long as, inter alia, the maquiladora is properly authorized and the foreign principal complies with the transfer pricing requirements of Article 216-bis under Mexican law. As Respondent's Mexican law expert confirms, in the event that the maquiladora and the foreign maquiladora principal fail to comply with the Article 216-bis transfer pricing requirements, Mexico reserves the right to tax the foreign maquiladora principal's Mexican PE. See Gonzalez Bendiksen Affidavit at ¶ 20.

Notwithstanding the legal fiction under the Mexican maquiladora statute ignoring the existence of, in this case, WOM's Mexican PE, and notwithstanding Mexico's stated intent to tax WOM's Mexican PE in the event of non-compliance, Respondent argues that since WOM's Mexican PE is not legally recognized by Mexico, no profits can be attributable to such PE. Rather, in Respondent's words, all income (or profit) at issue in this case "from the sale of the Products was derived by WOM in Luxembourg or, in any event outside of Mexico, but not taxed by Luxembourg or any other country." See Sur-Reply at 7-8. Further, "Regardless of the reasons for Luxembourg not taxing the income from WOM's sales of the Products in 2009, the bottom line is that this income was not taxed." See Sur-Reply at 8. Contrary to Respondent's naked assertion, the reason that Luxembourg did not tax the income is indeed of critical importance under Treas. Reg. § 1.954-3(b)(1)(ii)(b) : Luxembourg did not tax the income from the sale of the Products because that income was not derived by the Luxembourg Remainder, but rather was income derived by (that is, profits attributable to) a Mexican PE under the Mexico-Luxembourg Treaty. See Article 7(2) and 23(a)(1) of the Mexico-Luxembourg Treaty.

Respondent's response is nothing more than a "gotcha": Respondent contends that the profits cannot be attributable to WOM's Mexican PE because of the Mexican legal fiction under its domestic maquiladora statute deeming the PE not to exist. But of course the legal fiction does not change the facts. The entirety of WOM's business operations occurred in Mexico. WOM conducted its Mexican operations in two fixed places of business comprising nearly 1.4 million square feet of manufacturing space used solely for WOM's manufacture of products, WOM used dependent agents in Mexico to routinely contract for the purchase of raw materials and components, WOM purchased and processed those raw materials and components (comprising some $700 million of purchases in 2009) at its Mexican plants, WOM manufactured these $700 million in raw materials and components into a million refrigerators and a half-million washers using over $146 million of equipment and tooling located and owned by WOM at the Mexican plants, and WOM transferred title to its customers to over $800 million worth of refrigerators and washers at the end of its manufacturing lines in those Mexican plants. Unquestionably, the facts give rise to the conclusion that, but for legal fiction of the maquiladora legislation, WOM had a PE in Mexico. See Section 954(d)(1) Brief at 19. Even with the legal fiction, if WOM failed to comply with the transfer pricing requirements, Mexico stood ready to erase the legal fiction and tax the profits attributable to WOM's Mexican PE.⁷

Moreover, WOM had no substantive operations outside Mexico. As Respondent has admitted, WOM's single part-time employee in Luxembourg carried out only nominal accounting and administrative duties in Luxembourg, which Respondent admits are not related to the Luxembourg Remainder's purchasing and selling activities. See Sur-Reply at 17.

As discussed above, in 2007, the Government of Luxembourg considered the facts surrounding WOM's proposed Mexican maquiladora operations and considered whether WOM's activities and operations in Mexico would give rise to a Mexican PE under the Mexico-Luxembourg Treaty. See Schaffner Aff. at Attachment 13 at Bates Nos. WP010763-WP010764. The Luxembourg Government concluded that WOM would indeed have a PE in Mexico as a result of its maquiladora operations. Id. The Luxembourg Government further considered what profits would be attributable to the Mexican PE under the Mexico-Luxembourg Treaty. The Luxembourg Government concluded that all profits save a small markup on costs related to WOM's Luxembourg headquarters would constitute the profits attributable to the Mexican PE. Id. The Government of Luxembourg issued a ruling to WOM memorializing its views. The profits reported by WOM in Luxembourg reflect the 2007 Luxembourg ruling.

Jean Schaffner, Whirlpool's Luxembourg law expert, also examined the facts and circumstances surrounding WOM's operations in Luxembourg and Mexico. See Schaffner Aff. at 55 19-25. Schaffner concluded, consistent with the Luxembourg ruling, that WOM had a PE in Mexico as a result of its Mexican maquiladora operations. See Schaffner Aff. at 55 24-25. Schaffner further considered what profits under Luxembourg law and the Mexico-Luxembourg Treaty would be attributable to the Mexican PE. Consistent with the ruling of the Luxembourg Government, Schaffner concluded that all of WOM's profits were attributable to the Mexican PE other than a small cost plus markup on costs relating to WOM's Luxembourg headquarters. See Schaffner Aff. at 55 21, 25.

Arturo Perez Robles, Whirlpool's Mexican law expert, also examined the facts and circumstances surrounding WOM's Mexican operations and activities relating to its maquiladora operations. Perez Robles also concluded that WOM had a Mexican PE under the Mexico-Luxembourg Treaty. Perez Robles also recognized that under the Mexican domestic maquiladora law, as an incentive for bringing manufacturing jobs to the country, Mexican law provided that WOM's Mexican PE would be deemed not exist so long as the maquiladora was properly authorized and complied with transfer pricing requirements under Article 216-bis. Perez Robles further recognized that in the event of non-compliance, Mexico reserved the right to tax WOM's Mexican PE. Perez Robles concluded that while Mexican domestic law deemed WOM's PE not to exist, under the Mexico-Luxembourg Treaty, WOM in fact had a Mexican PE that was taxable by Mexico. In terms of profits attributable to the Mexican PE under the treaty, Perez Robles opined that, because all activity in 2009 relating to WOM's Mexican maquiladora operations occurred in Mexico, all profits relating to the manufacture and sale of the refrigerators and washers would be attributable to WOM's Mexican PE, other than a small markup on costs relating to the Luxembourg headquarters. See Perez Aff. at St 37.

Thus, the income from sale of the refrigerators and washers at issue in this case constitute profits attributable to WOM's Mexican PE under the Mexican-Luxembourg Treaty. Holding aside the semantics around the legal fiction deeming the PE not to exist under Mexican law, under the facts of this case and Treas. Reg. § 1.954-3(b)(1)(ii)(b), the income at issue from WOM's manufacture and sale of the refrigerators and washers constitutes income derived by the Manufacturing Branch, and not income derived by the Luxembourg Remainder. As Treas. Reg. § 1.954-3(b)(1)(ii)(b) commands that only income derived by the Remainder may be included in the denominator, the income at issue in this case must be excluded from the denominator when computing the actual effective tax rate in Luxembourg. If, as the regulations command, only income derived by the Remainder is included in the denominator, then there is no Tax Rate Disparity and the Manufacturing Branch Rule cannot apply.

C. THE "SPECIAL RULES" OF TREAS. REG. § 1.954-3(b)(2)(i) ARE MANDATORY AND NOT OPTIONAL.

With the filing of his Sur-Reply, Respondent has made plain his position that the application in Treas. Reg. § 1.954-3(b)(1)(ii)(b) of the "special rules” of Treas. Reg. § 1.954-3(b)(2)(i) are optional in that they are not the sole means for allocating income to the Remainder. See Sur-Reply at 29-30; Cross Motion at 86 (special rules are an "overlay" and are not to be applied in isolation). Respondent's position is novel and he does not appear to have taken a similar position in any prior regulation, ruling, litigation, or other forum or document. Whirlpool disagrees with Respondent's novel position. Rather than being optional, the special rules are mandatory.

Respondent's position appears to be based on his desire in this case to circumvent the specific requirements in the "special rules", principally the requirements that (a) income is only to be allocated to the Remainder in connection with selling and purchasing activities performed by the Remainder on behalf of the Manufacturing Branch, and (b) the only income to be tested under the Tax Rate Disparity test is the income allocated under the "special rules".

Treas. Reg. § 1.954-3(b)(1)(ii)(b) defines the Tax Rate

Disparity test as follows:

(b) Allocation of income and comparison of effective tax rates.

The determination as to whether such use of the branch or similar establishment has substantially the same tax effect as if the branch or similar establishment were a wholly owned subsidiary corporation of the controlled foreign corporation shall be made by allocating to the remainder of such controlled foreign corporation only that income derived by the remainder of such corporation, which, when the special rules of subparagraph (2)(i) of this paragraph are applied, is described in paragraph (a) of this section (but determined without applying subparagraphs (2), (3), and (4) of such paragraph). The use of the branch or similar establishment for such activities will be considered to have substantially the same tax effect as if it were a wholly owned subsidiary corporation of the controlled foreign corporation if income allocated to the remainder of the controlled foreign corporation under the immediately preceding sentence is, by statute, treaty obligation, or otherwise, taxed in the year when earned at an effective rate of tax that is less than 90 percent of, and at least 5 percentage points less than, the effective rate of tax which would apply to such income under the laws of the country in which the branch or similar establishment is located. . . [.]

(Emphases added.)

Parsing the statute, the first sentence of the Tax Rate Disparity test provides that ”[t]he determination . . . shall be made by allocating to the remainder . . . only that income derived by the remainder . . . which, when the special rules of subparagraph (2)(i) of this paragraph are applied, is described in paragraph (a) of this section (but determined without applying subparagraphs (2), (3), and (4) of such paragraph).”

The first sentence of the Tax Rate Disparity test is thus mandatory ("the determination . . . shall be made"). The income to be allocated to the remainder is also tightly defined ("by allocating to the remainder . . . only that income derived by the remainder . . . which, when the special rules of subparagraph (2)(i) of this paragraph are applied . . .").

The second sentence of the Tax Rate Disparity test again limits the test to taxes paid on the income allocated "under the immediately preceding sentence", that is, the first sentence.

The import of these two sentences is to limit the Tax Rate Disparity test to only that income derived by the Remainder which, when the special rules are applied, is described in Treas. Reg. § 1.954-3(a), but without considering the exceptions set forth in Treas. Reg. §§ 1.954-3(a)(2), -3(a)(3), or -3(a)(4).

The "special rules" of Treas. Reg. § 1.954-3(b)(2)(i) in relevant part essentially impose two requirements in this case when applying the Tax Rate Disparity test. First, Treas. Reg. § 1.954-3(b)(2)(i)(a) provides that "The branch or similar establishment will be treated as a wholly owned subsidiary corporation of the [CFC], and such branch or similar establishment will be deemed to be incorporated in the country in which it is located." (Emphasis added.) Second, Treas. Reg. § 1.954-3(b)(2)(i)(c) provides in relevant part that ”[w]ith respect to manufacturing . . . activities performed by or through the branch or similar establishment, purchasing or selling activities performed by or through the remainder of the [CFC] with respect to personal property manufactured . . . by or through the branch or similar establishment shall be treated as performed on behalf of the branch or similar establishment." (Emphases added.) Neither of these requirements is discretionary.

Returning to Treas. Reg. § 1.954-3(b)(1)(ii)(b), the parsed language is "[t]he determination . . . shall be made by allocating to the remainder . . . only that income derived by the remainder . . . which, when the special rules of subparagraph (2)(i) of this paragraph are applied, is described in paragraph (a) of this section (but determined without applying subparagraphs (2), (3), and (4) of such paragraph)." (Emphases added.) The special rules therefore have two effects.

First, because the branch is now deemed to be a separately incorporated subsidiary, any transaction between a CFC and its branch now involves a related party transaction, one between the CFC and its hypothetically incorporated subsidiary.

Second, Treas. Reg. § 1.954-3(b)(2)(i)(c) provides that selling or purchasing activities performed by the Remainder with respect to personal property manufactured by the branch "shall be treated as performed on behalf of the branch[.]" The legislative history makes plain that the "on behalf of" language was added to the statute to take into account situations in which a CFC "does not take title to the property but acts on a fee or commission basis." S. Rep. No. 87-1881, at 84 (1962); see also H.R. 10650, 87th Cong, Sec. 12(a), § 954(d) (Aug. 16, 1962). The import of this special rule, then, is that the Remainder is deemed not to hold title, but rather to act as a fee or commission agent working on behalf of the Manufacturing Branch. Any transaction, therefore, in which the Remainder performs selling or purchasing activities on behalf of the Manufacturing Branch will be a transaction on behalf of a related party and, because the Remainder does not hold title in an "on behalf of" transaction, the Remainder cannot avail itself of the ability to sell a product that is different from the personal property that it purchased and therefore escape FBCSI.⁸

Until this case, Respondent, like Whirlpool, interpreted this language as calling for the mandatory application of the "special rules" of Treas. Reg. § 1.954-3(b)(2)(i). See, e.g., Priv. Ltr. Rul. 7612101490A (Dec. 10, 1976) ("The first step requires an allocation of income and a comparison of effective rates of tax pursuant to the special rules of sections 1.954-3(b)(2) and 1.954-3(b)(1)(ii)(b) of the regulations.") (emphasis added); Priv. Ltr. Rul. 8509004 (Nov. 23, 1984); Notice of Proposed Rulemaking, 73 Fed. Reg. 10,716 (Feb. 28, 2008) ("the income considered to be derived by the remainder of the CFC is determined first by applying the rules of § 1.954-3(b)(2)(i)"); AM 2015-002 (February 9, 2015); Practice Unit 2.1.2.2, "Sale by CFC to Unrelated Parties of Products Manufactured by Branch" at 3 (July 29, 2015) ; Practice Unit 2.1.2.1, "Branch Sales to Unrelated Parties of Products Manufactured by CFC" at 3 (August 3, 2015); Practice Unit 2.1.2, "Branch Rules for Foreign Base Company Sales Income" at 4 (June 18, 2015).

Commentators are in accord with Whirlpool's interpretation and Respondent's prior interpretation that use of the special rules is mandatory. See D. Kevin Dolan et al, U.S. Taxation of International Mergers, Acquisitions and Joint Ventures, ¶ 18.06[3][b][ii] (2019); Joel D. Kuntz et al, U.S. International Taxation, ¶ B3.05[3][f] (1992); Boris Bittker & Lawrence Lokken, Federal Taxation of Income, Estates, and Gifts, ¶ 69.5.5 (2019); BNA Portfolio 6240-lst: CFCs — Foreign Base Company Income (Other than FPHCI), Chapter H at (4)(c)(3); BNA Portfolio 6240-lst: CFCs — Foreign Base Company Income (Other than FPHCI), Chapter E at (4)(c)(2); BNA Portfolio 900-2nd: Foundations of U.S. International Taxation, Chapter J, at (2)(e)(1) and (2)(e)(2).

In this case, however, Respondent now takes the position that application of the special rules is optional, an "overlay," a set of special rules to apply "in conjunction with" the general rules, and are not to be applied in isolation. See Cross Motion at 86. Most clearly, in his Sur-Reply at 29 Respondent proclaims that:

the clause ", which, when the special rules . . . are applied," does not limit the application of Treas. Reg. § 1.954-3(a) so as to require the allocation of income to the remainder of the CFC solely on the basis of the special rules.

Why does the Respondent now take this position? The answer lies in the carry-over sentence on pages 29 to 30 of the Sur-Reply. Recall that any selling or purchasing activity by the Remainder will be deemed to be performed "on behalf of” the Manufacturing Branch, that is, as an agent not holding title. Recall further that the Luxembourg Remainder in this case undertakes no selling or purchasing activities on behalf of the Manufacturing Branch. Respondent is forced to argue that the "fact of sale” is a selling activity by the Remainder. See Sur-Reply at 33-34; Cross Motion at 93-95. Respondent then allocates all the income at issue in this case to that "fact of sale" in order to have some theory as to why the income at issue in this case is derived by the Remainder rather than the Manufacturing Branch. However, the "special rule" of Treas. Reg. § 1.954-3(b)(2)(i)(c) provides that the Remainder does not hold title and therefore cannot sell the products, which blocks Respondent from making his "fact of sale" argument.

In the carry-over sentence from page 29 to 30 of the Sur-Reply, Respondent argues:

Because Treas. Reg. § 1.954-3(a)(1) includes the purchase of personal property from a related person and its sale to any person and the purchase of personal property from any person and its sale to a related person, it is appropriate to allocate income to the remainder of a CFC if the remainder meets those criteria, without the need to also apply the special rule in Treas. Reg. § 1.954-3(b)(2)(i)(c).

In other words, Respondent wants to be able to make his "fact of sale" argument. See Sur-Reply at 34. Unless he can get out from under the "on behalf of" language in the "special rules" of Treas. Reg. § 1.954-3(b)(2)(i)(c) that provide that the Remainder does not sell the product, Respondent cannot make his "fact of sale" argument and allocate all the income in the case to the Remainder based on the fact that the contracts between WOM and Whirlpool US and Whirlpool Mexico were signed two years earlier by members of WOM's Board of Managers.⁹

To do this, Respondent takes a position that has never been taken before. As this Court is aware, courts have routinely rejected an agency's interpretation of its regulations when announced for the first time through its court briefs in an enforcement proceeding. See, e.g., Barboza v. Cal. Ass'n of Prof'l Firefighters, 799 F.3d 1257, 1267 (9th Cir. 2015) (quoting Christopher v. SmithKline Beecham Corp., 567 U.S. 142, 158 (2012)) ("Where an agency announces its interpretation for the first time in an enforcement proceeding, and has not previously taken any action to enforce that interpretation, 'the potential for unfair surprise is acute.'"); Amazon.com v. Commissioner, No. 17-72922, 2019 U.S. App. LEXIS 24453, at *36-37 (9th Cir. Aug. 16, 2019) ("Here, the Commissioner does not identify a specific document (e.g., policy manual or court brief) definitively expressing the agency's view of its regulations . . . Indeed, as discussed above, Treasury's contemporaneous explanations of the regulations are to the contrary.").

Respondent's novel and self-serving argument disregarding the command of Treas. Reg. § 1.954-3(b)(1)(ii)(b) to apply the "special rules" of Treas. Reg. § 1.954-3(b)(2)(i) should be summarily rejected.

Not only is Respondent's position new and contrary to the established position that he has taken consistently since 1964 when the regulations were issued, but Respondent's novel regulatory interpretation is in err. Specifically, Respondent's sole ground for arguing that application of the "special rules" is optional is his "which versus that" regulatory interpretation argument. See Sur-Reply at 29. However, ”[t]his grammatical convention — preferring that for restrictive clauses and comma — which for nonrestrictive ones — is unfortunately a weak basis for deciding statutory meaning. For while grammarians have sought heroically to establish this as a firm rule, they have been unsuccessful." A. Scalia & B. Garner, Reading Law: Interpretation of Legal Texts 142 (2012).¹⁰ Justice Scalia and his co-author continue:

What H.W. Fowler wrote in 1926 remains entirely true today:

[I]f writers would agree to regard that as the defining relative pronoun, and which as the non-defining, there would be much gain both in lucidity and in ease. Some there are who follow this principle now; but it would be idle to pretend that it is the practice either of the most or of the best writers.

Id. at 142-43. See also Webster's Dictionary of English Usage 895 (2d rev. ed. 1989) ("We conclude that at the end of the 20th century, the usage of which and that — at least in prose — has pretty much settled down. You can use either which or that to introduce a restrictive clause — the grounds for your choice should be stylistic — and which to introduce a nonrestrictive clause."); NACS v. Bd. of Governors of the Fed. Reserve Sys. 746 F.3d 474, 478 (D.C. Cir. 2014); United States v. Transocean, 767 F.3d 485, 494 (5th Cir. 2014) ("We note first that reading the comma-which clause to mean 'that' is consistent with subsection (E) as a whole and the subsection's other uses of the word 'which' . . . Although Congress is presumed to know the rules of grammar, see United States v. Goldenberg, 168 U.S. 95, 18 S. Ct. 3, 4, 42 L. Ed. 394 (1897), this grammatical oversight is understandable, as '[u]sing which for that is perhaps the most common blunder with these words.' Bryan A. Garner, Garner's Dictionary of Legal Usage 889 (3d ed. 2011); see also Strunk & White at 59 ('The use of which for that is common in written and spoken language.')”).

Therefore, this Court should reject Respondent's unprecedented argument that "which" designates a nonrestrictive clause in Treas. Reg. § 1.954-3(b)(1)(ii)(b), and rather follow how the IRS and commentators have previously read the special rules of Treas. Reg. § 1. 954-3(b)(2)(i) as a necessary part of defining income allocable to the Remainder of the CFC under the Tax Rate Disparity test.

Importantly, the "special rules" of Treas. Reg. § 1.954-3(b)(2) are used for two purposes, first to allocate income to determine if a Tax Rate Disparity exists (see Treas. Reg. § 1.954-3(b)(2)(i)), and then, if a Tax Rate Disparity exists, to allocate income to the Remainder under Treas. Reg. § 1.954-3(b)(2)(ii) to determine if the Remainder has FBCSI under Treas. Reg. § 1.954-3(b)(2)(ii)(e). Even if Respondent could get past the Tax Rate Disparity test, the mandatory nature of the "special rules" and the lack of selling or purchasing activities by the Remainder would be fatal to Respondent's position under Treas. Reg. § 1.954-3(b)(2)(ii)(c) as there would be no income to allocate to the Remainder to test under Treas. Reg. § 1.954-3(b)(2)(ii)(e) to determine if any of that income were FBCSI under the normal rules of section 954(d)(1). Specifically, Respondent's "which versus that" argument in Treas. Reg. § 1.954-3(b)(1)(ii)(b) expressly applies only to the. "special rules" of Treas. Reg. § 1.954-3(b)(2)(i) used in the Tax Rate Disparity test. No "which versus that" argument is available to Respondent to argue that the "special rules" under Treas. Reg. § 1.954-3(b)(2)(ii)(c) are optional. Thus, even if Respondent prevailed on his "which versus that" argument under Treas. Reg. §§ 1.954-3(b)(1)(ii)(b) and -3(b)(2)(i), he would still lose under Treas. Reg. § 1.954-3(b)(2)(ii)(c) as that rule (a) is not optional even under Respondent's "which versus that" argument, and (b) the Luxembourg Remainder engaged in no selling or purchasing activities.

CONCLUSION

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), Motion for Partial Summary Judgment Under Section 954(d)(2), and grant such other and further relief as this Court deems just and proper.

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

Attorney for Petitioners

Dated: September 23, 2019