Whirlpool: Law or Policy?

Echoing the position taken by the U.S. Treasury ever since it first issued regulations (T.D. 6734) on the matter in 1964, the U.S. Tax Court held, and the Court of Appeals for the Sixth Circuit affirmed, in Whirlpool that the foreign base company sales income (FBCSI) branch rule of section 954(d)(2) applies not only to sales branches but also to manufacturing branches.¹

That was the desirable outcome from a policy perspective, but was that what Congress intended? This article argues that a close reading of the statutory language suggests the answer is no.²

I. FBCSI

Added to the Internal Revenue Code by the Revenue Act of 1962, subpart F requires some U.S. shareholders of controlled foreign corporations to include in gross income their pro rata shares of a CFC’s subpart F income. Subpart F income includes FBCSI, which section 954(d)(1) defines as CFC income from the purchase and sale of personal property when at least one transaction is with a related person (or from the purchase or sale of personal property on behalf of a related person) if the property is neither produced nor consumed in the CFC’s country of incorporation. A related person is a person who controls the CFC or is controlled by the CFC or by a person who controls the CFC.

The general policy concern is income shifting,³ with subpart F acting “as a backstop to transfer pricing [by isolating] cases in which even arm’s length pricing between affiliates is no defense against unwarranted escape from current U.S. taxation.”⁴ The legislative history expressed the shifting concern as involving some situations in which:

In a classic U.S.-to-foreign FBCSI structure, a U.S. manufacturer sells its products to a related CFC in a lower-tax jurisdiction, and the CFC sells the products to consumers in other jurisdictions. The interposition of the CFC shifts profits from the U.S. base to the CFC’s. Treating those profits as FBCSI addresses the problem by restoring the U.S. base.

The shifting concern is not as categorical regarding foreign-to-foreign FBCSI. In a basic foreign-to-foreign FBCSI structure, a manufacturing CFC sells its products to a related sales CFC in a lower-tax jurisdiction, and the sales CFC sells the products to consumers in a third jurisdiction. Selling the products to consumers through the sales CFC shifts income from the manufacturing CFC to the sales CFC and lowers the overall foreign tax liability. That alone, however, does not justify treating the sales CFC income as FBCSI. While the legislative history indicated that the concern was “income of a selling subsidiary . . . which has been separated from manufacturing activities of a related corporation merely to obtain a lower rate of tax for the sales income,”⁶ that still does not explain why a foreign tax reduction was a concern in the first place, given that historically the goal was not a global minimum tax but ending unwarranted U.S. tax deferral. Perhaps the underlying concern was that addressing U.S.-to-foreign FBCSI without addressing foreign-to-foreign shifting would have created an incentive to offshore manufacturing activities where the after-tax value of shifting profits to related sales CFCs without U.S. tax consequences would have outweighed pretax preferences to manufacture at home. That kind of offshoring would have resulted in profit shifting and unwarranted deferral.

The policy rationale for addressing FBCSI remained valid after enactment of the Tax Cuts and Jobs Act, which changed the former credit and deferral outbound corporate tax system to a participation exemption system. Pre-TCJA, income shifting was a concern because it resulted in deferral. Doing away with deferral, the TCJA’s FBCSI concern became income shifting in its own right.⁷

II. The Branch Rule

Figure 1 shows a basic foreign-to-foreign FBCSI structure. A U.S. parent’s manufacturing CFC (M) is incorporated in Country A, where the tax rate is 15 percent. M manufactures in A and sells the products to its sister sales CFC (S), which is incorporated in Country B, where the tax rate is 10 percent. S sells the products to consumers in Country C.

M’s income is not FBCSI. M sells what it manufactures and its sales income is not what the statute is concerned about, because the sales function that remains with M is not separated from manufacturing.⁸ There is no purchase and sale, nor a purchase or sale on behalf of another party. Another reason M’s income is not FBCSI is because the manufacturing is in M’s country of incorporation.

Because S purchases personal property from M, a related person, and sells it to consumers in C so that neither manufacture nor consumption is in S’s country of incorporation (B), S’s income is FBCSI.⁹ As shown in figures 2 and 3, that outcome could be avoided by restructuring either the sales CFC as a hybrid sales branch of the manufacturing CFC in B or the manufacturing CFC as a manufacturing branch of the sales CFC in A. Either way, the remaining CFC may still achieve the foreign-to-foreign shifting result while eliminating the requisite related-person transaction. Unlike a corporation, a branch is not a person.

When applicable, however, the branch rule of section 954(d)(2) restores the missing related-person element by treating the branch as a wholly owned subsidiary of the CFC for determining FBCSI. Section 954(d)(2) applies “in situations in which the carrying on of activities by a CFC through a branch or similar establishment outside [the CFC’s] country of incorporation” has substantially the same effect as if that branch or similar establishment were a wholly owned subsidiary deriving the FBCSI.

The regulations provide that the use of a branch would have substantially the same effect as if the branch were a wholly owned subsidiary of the CFC if there is a tax rate disparity. That is, if the income allocable to a sales branch (or, in a manufacturing branch situation, to the remainder of the CFC) is subject to an overall effective foreign tax rate that is less than 90 percent of, and at least 5 percentage points lower than, the overall foreign tax rate the income would be subject to if it were earned by the CFC in its home country (or, in a manufacturing branch situation, by the manufacturing branch in its host country).¹⁰ Dealing with pre-TCJA years, the courts in Whirlpool generalized the tax rate disparity standard as referring to a tax-deferral effect.¹¹ As noted, the tax-deferral effect naturally translates to a foreign-to-foreign shifting effect post-TCJA.

Since issuing the first FBCSI regulations in 1964, Treasury has interpreted the branch rule as applying to both sales and manufacturing branches. The two Whirlpool decisions affirmed that interpretation and dismissed the taxpayer’s argument that the rule applies only to sales branches. The appellate court’s interpretation, however, appears to significantly depart from Treasury’s long-standing interpretation.

III. Policy

As H. David Rosenbloom wrote recently, “As a matter of tax policy, there is absolutely no difference between a sales branch and a manufacturing branch.”¹² Details aside, each situation is a simple variation on the basic foreign-to-foreign FBCSI structure in Figure 1. Both variations are meant to eliminate the related-person element of FBCSI without compromising the foreign-to-foreign shifting result or changing the economic reality on the ground.¹³

Figure 2 is a sales branch variation. CFC M manufactures in its country of incorporation (A) and sells its products to S, M’s wholly owned limited liability company in B. S is a disregarded entity for U.S. tax purposes but a corporation under A’s tax laws. S sells the products to consumers in C.

Because S is a corporation from A’s perspective, its income is taxed only in B, achieving the foreign-to-foreign shifting effect through the separation of the manufacturing and sales functions.¹⁴ If S were a corporation for U.S. tax purposes, its income would be FBCSI under section 954(d)(1). Disregarding S as an entity separate from M for U.S. tax purposes turns S into M’s branch in B, which eliminates the requisite related-person element — hence the need for a branch rule.

The same happens, possibly more simply, with a manufacturing branch variation. In Figure 3, S is a Country B CFC. It manufactures through its branch (and its own employees) in A and sells its products to consumers in C.

While the income attributable to the manufacturing activity is taxed in A without residual taxation in B (given A’s higher tax rate), the sales income is taxed only in B. Here too, separating the sales and manufacturing functions achieves the same foreign-to-foreign shifting effect.¹⁵ If the manufacturing branch were a corporation for U.S. tax purposes, S’s sales income would be FBCSI under section 954(d)(1). Because the manufacturing branch is not a corporation, there is no transaction with a related person, and the need for a branch rule is once again clear.

The legislative history talked about taking advantage of the “multiplicity of foreign tax systems” in describing the situations it was concerned about. For a sales branch structure to work in the absence of a branch rule, the manufacturing jurisdiction must either have a territorial system or treat the sales branch as a corporation. No such systemic differences are necessary for a manufacturing branch structure to work.

Those differences, however, do not appear to be what the legislative history was talking about. The “multiplicity of foreign tax systems” language was not used in the branch rule context but in the general FBCSI context, where neither hybridity nor territoriality were necessary. All that was needed there was tax rate differences, which seem to be what the “multiplicity of foreign tax systems” language was referring to.

There is no escaping the conclusion that the distinction between sales and manufacturing branches in that context is normatively irrelevant once one accepts that FBCSI should address foreign-to-foreign shifting in a basic, no-branch setting. It is immaterial from a policy standpoint whether shifting is achieved through a branch or a related CFC.

The question remains, however, whether Congress fully implemented that policy rationale in enacting the branch rule. The answer requires a close analysis of the statutory language.

IV. Section 954(d)(2)

Section 954(d)(1) defines FBCSI as CFC income derived from the purchase and sale of personal property when at least one transaction is with a related person (or from the purchase or sale of personal property on behalf of a related person) and the property is neither produced nor consumed in the CFC’s country of incorporation. Section 954(d)(2) follows with a single, very long sentence:

The language has three main components: an introductory purpose part, two preconditions, and two consequences. A plain and harmonious reading of the statutory language suggests it is incompatible with manufacturing branches because section 954(d)(2) applies only to, and works only with, a CFC’s branch whose income would be FBCSI if the branch were a subsidiary CFC of the actual CFC. When applicable, section 954(d)(2) treats the branch as a subsidiary CFC for applying section 954(d)(1) and assigns the resulting FBCSI to the actual CFC.

A. The Purpose Part

Section 954(d)(2) starts by defining its own purpose: “For purposes of determining FBCSI.” As we shall see, that introductory language must mean for purposes of applying section 954(d)(1). That reading is in line with the interpretations of Treasury and the Tax Court, but not of the Sixth Circuit. For now, it is enough to accept that a determination of FBCSI is to be made with the help of, but not necessarily by, section 954(d)(2).

B. The Preconditions Part

The provision then defines two conjunctive preconditions for its application by describing the situations in which it applies. The first precondition is straightforward, requiring “the carrying on of activities by a CFC through a branch or similar establishment outside the country of incorporation of the CFC.” The second precondition is that the carrying on of those activities must have “substantially the same effect as if such branch or similar establishment were a wholly owned subsidiary corporation deriving such income.”

All agree that a difference between the foreign tax burden on the branch income and the remaining income of the CFC is required for meeting the “substantially the same effect” standard. As noted, Treasury defined the requirement in bright-line terms of tax rate disparity, and the Whirlpool courts reconceptualized it as a deferral effect requirement, which translates to a shifting effect requirement post-TCJA.¹⁶ Without tax rate differences, there can be no foreign-to-foreign shifting.

Tax rate disparity or a shifting effect would have been the only requirement of the second precondition if its language were “has substantially the same effect as if such branch or similar establishment were a wholly owned subsidiary corporation.” But the language does not end there. The words “subsidiary corporation” are followed by the qualifier “deriving such income.” The phrase “for purposes of determining foreign base company sales income” is the only language before the phrase “deriving such income” that mentions income. Therefore, “such income” refers to the FBCSI being determined.

The regulations ignore the language “deriving such income.” They provide for the tax rate disparity test by reference to the regulatory phrase “have substantially the same tax effect as if it were a wholly owned subsidiary corporation,” which parallels the statutory phrase “has substantially the same effect as if such branch or similar establishment were a wholly owned subsidiary corporation.” The regulations say nothing about the words “deriving such income.”¹⁷

The Tax Court referred to the phrase “deriving such income” in passing in a paragraph that suggests that by carrying on activities through a manufacturing branch outside its country of incorporation, a CFC achieved substantially the same deferral effect it would have achieved if its manufacturing branch were a wholly owned subsidiary deriving such income — which, as used by the court, referred to the CFC’s sales income. The court then said “that is precisely the situation that the statute covers.” That, however, is precisely what the statute does not cover. If a manufacturing branch were a wholly owned subsidiary deriving the CFC’s sales income, there would be no separation of the sales and manufacturing functions, no tax rate differences, no income shifting or unwarranted deferral, no FBCSI, and as noted below, no application of the branch rule.¹⁸

The Sixth Circuit also mentioned the words “deriving such income” in passing but as referring to “the income attributable to the branch’s activities,” which it said could include the FBCSI being determined. It did not attach any importance to the language “deriving such income” and effectively ignored it.

But the words “deriving such income” are crucial. With those words, the second precondition requires that the use of the branch have substantially the same effect as if the branch were a wholly owned subsidiary corporation deriving FBCSI. There is no question that the “substantially the same effect” language refers to a shifting effect, however expressed. There is also no question that the language requires comparing the shifting effect of using the branch with the shifting effect of hypothetically using a comparator. But what is that comparator?

Ignoring the words “deriving such income,” Treasury determined that the comparator is a hypothetical wholly owned subsidiary of the CFC that would replace the branch by incorporating the branch in the country where the branch is located.¹⁹ (That interpretation also appears to be implicit in the Whirlpool decisions.) Under that interpretation, if there is a shifting effect, the second precondition would cover not only suspect sales and manufacturing branches but also a branch whose incorporation would not result in FBCSI, such as a manufacturing CFC’s sales branch in the consumption country.²⁰

The words “such branch” of the second precondition refer to the branch described in the first precondition: The actual branch through which the CFC carries on its actual activities outside its country of incorporation. The subjunctive language “as if such branch . . . were a wholly owned subsidiary corporation” requires hypothesizing the presence of a corporation instead of the branch in the sense that both cannot coexist. That is, hypothesizing the presence of a corporation requires hypothesizing the non-presence of the branch. Because the subjunctive language “as if . . . were” refers to the branch but not to its actual activities, the activities persist intact in the hypothetical. For branch activities to be carried on by a corporation without a branch, the corporation must be incorporated where the activities are carried on.²¹

Therefore, the language “as if such branch or similar establishment were a wholly owned subsidiary corporation” hypothesizes incorporation of the actual branch in the country where the branch is located. Without the “deriving such income” qualifier, the comparator would be any hypothetical wholly owned subsidiary of the CFC in the branch country. The qualifier then narrows down the comparator from that to a subset that would derive FBCSI.

That means that for the comparator corporation to hold, its use must result in FBCSI that is derived by it. Because a manufacturing CFC — the only potential comparator for a manufacturing branch — cannot derive FBCSI, it appears that the second precondition cannot apply to manufacturing branches. That is, the branch rule can apply only to sales branches, and only to those branches whose incorporation would result in their income becoming FBCSI.

Rosenbloom agrees that Congress had in mind sales branch situations but believes that because “both types of branches produce substantially the same effect . . . the focus on a sales branch does not preclude coverage of a manufacturing branch.”²² That argument is based on equivalence: If a sales branch produces substantially the same effect as a sales CFC, and a manufacturing branch produces substantially the same effect as a sales branch, then a manufacturing branch produces substantially the same effect as a sales CFC.

It is true that, as the U.S. Supreme Court recently said, “the limits of the drafters’ imagination supply no reason to ignore the law’s demands.”²³ But “when the express terms of a statute give us one answer and extratextual considerations suggest another, it’s no contest,” the Court said. “Only the written word is the law, and all persons are entitled to its benefit.” Rosenbloom’s argument has intuitive appeal and makes policy sense, but it deviates from the written word.

Rosenbloom’s argument requires hypothesizing not incorporation of the actual branch as the statutory text mandates but instead the incorporation of a sales branch even if one does not exist. The statutory language does not allow that. The first precondition requires the carrying on of activities by a CFC through a branch or similar establishment outside its country of incorporation. That precondition refers to the actual branch and its actual activities. The second precondition then requires that the carrying on of the activities through the branch have substantially the same effect as if the branch were a wholly owned subsidiary deriving FBCSI. Reference here is to the branch mentioned in the first precondition, which is the actual branch. Therefore, the question that the second precondition poses is not whether the branch produces substantially the same effect as a sales branch or as a sales CFC deriving FBCSI, but whether the branch produces substantially the same effect as if it were incorporated and deriving FBCSI. The comparator depends on the nature of the branch. For a sales branch, the comparator is a sales CFC deriving FBCSI. For a manufacturing branch, the comparator would be an (impossible) manufacturing CFC deriving FBCSI. Because under the statute the comparator for a manufacturing branch is neither a sales branch nor a sales CFC, saying that a manufacturing branch produces substantially the same effect as a sales branch or a sales CFC deriving FBCSI would be of no moment for purposes of the branch rule.²⁴

Independent of that, Rosenbloom’s argument also stops short of responding to the crucial question of why Congress added the words “deriving such income.” The second precondition would cover both sales and manufacturing branches if it did not include that language. Saying that adding those words does not change the meaning would mean the words are meaningless. But “words cannot be meaningless, else they would not have been used.”²⁵ It is true that without the qualifier “deriving such income,” the precondition would also cover sales branches whose incorporation would not result in FBCSI (like a manufacturing CFC’s sales branch in a consumption country).²⁶ But if the qualifier were aimed just at that, the choice of words would have been different. Congress could have used “resulting in such income” instead, which would not have required the resulting FBCSI to be that of the hypothetical CFC. But Congress did not do that — it used the words “deriving such income,” and it must have meant what it said.

Finally, the second precondition cannot be read as hypothesizing not only incorporation of the branch but also derivation by the hypothetical corporation of FBCSI or of the sales income that would otherwise be FBCSI. Hypothesizing the incorporation of a branch is logical but hypothesizing the derivation of FBCSI by a manufacturing CFC would be absurd. And hypothesizing derivation by the manufacturing CFC of the sales income that would otherwise be FBCSI would not achieve anything because, as noted, the statute would not cover that situation: The hypothetical manufacturing CFC, which is the comparator, would derive both the manufacturing and sales income and, unlike the actual manufacturing branch, would perversely have no shifting effect.²⁷ That is, a manufacturing branch would not satisfy the second precondition because the branch and its comparator would not have substantially the same effect.

Therefore, it appears that the second precondition does not cover manufacturing branches and that the only plausible meaning that remains is that the precondition covers only sales branches whose incorporation would result in their income becoming FBCSI. If only a sales branch can satisfy the second precondition, the branch rule cannot apply to manufacturing branches.

This article could end here, but it makes sense to proceed because the remaining language of section 954(d)(2) supports the conclusion above.

C. The Consequences Part

The following analysis maintains that when applicable, the consequences part of the branch rule treats the branch income as income of a deemed wholly owned subsidiary of the CFC for section 954(d)(1) to make that income FBCSI, which the branch rule then assigns to the actual CFC. That is, for the consequences part of the branch rule to work, the branch income, treated as derived by a wholly owned subsidiary of the CFC, must be FBCSI under section 954(d)(1). That result does not work with manufacturing branches: Treating a manufacturing branch’s income as income of a wholly owned subsidiary of the CFC makes it the income of a (deemed) manufacturing CFC, which cannot be FBCSI. That supports the conclusion that the branch rule does not apply to manufacturing branches.

1. Textual Analysis

If the branch rule applies — that is, if the two preconditions are met — section 954(d)(2) provides that two consequences must follow regarding “the income attributable to [the branch activities]”²⁸: The income (i) “shall be treated as income derived by a wholly owned subsidiary of the CFC” and (ii) “shall constitute FBCSI of the CFC.”

Read in isolation, the phrases “the income attributable to [the branch activities]” and “shall constitute FBCSI of the CFC” seem ambiguous in the sense that they could have more than one meaning.

The phrase “the income attributable to [the branch activities]” could mean the branch income — that is, the income directly derived by the branch or, more accurately, the income that would be derived by the resulting corporation if the branch were incorporated where it operates. It could also mean all the CFC’s income (both the branch income and the CFC’s remaining income) that results from the branch activities.²⁹

Depending where one places the emphasis, the phrase “shall constitute FBCSI of the CFC” could mean the income — which will be FBCSI under section 954(d)(1) by reason of being treated as income of a deemed CFC — is treated as FBCSI of the actual, not the deemed, CFC (“shall constitute FBCSI of the CFC”). It could also be read as independently determining FBCSI of the actual CFC (“shall constitute FBCSI of the CFC”). Either way, it would apply only to the income attributable to the branch activities, whatever that income is for now.

Those apparent ambiguities are resolved when each phrase is read in the context of section 954(d)(2) as a whole. The section clearly mandates that the income attributable to the branch activities be treated as income derived by a wholly owned subsidiary of the CFC. That deemed incorporation language, which would treat the branch as a subsidiary CFC of the actual CFC, is the heart of the branch rule. The whole point was to treat the branch as a subsidiary CFC in order to restore the related-person element for determining FBCSI under section 954(d)(1).

That is the only possible way to read the deemed incorporation language. There would be no point in treating the branch as a subsidiary of the actual CFC if the branch rule did not contemplate the determination of FBCSI under section 954(d)(1).

Therefore, the deemed incorporation language must be read together with the introductory language (“for purposes of determining FBCSI”) to mean that when the branch rule applies, the income attributable to the branch is treated as derived by a subsidiary CFC of the actual CFC in applying section 954(d)(1). The language cannot possibly serve any other purpose, so any other reading would render it meaningless.

Even on its own, the introductory language supports that interpretation because it indicates that the purpose of section 954(d)(2) is to help in determining, not to independently determine, FBCSI. That reading is in line with Treasury’s interpretation, which the Tax Court adopted, and the legislative history.³⁰

What, then, does the language “and shall constitute FBCSI of the CFC” mean? A key starting point is that the phrase refers to the same income the deemed incorporation language applies to.

The Sixth Circuit said that when applicable, the phrase independently determines FBCSI without referring back to section 954(d)(1). According to the court, reading the introductory language as referring back to section 954(d)(1) would render the “shall constitute FBCSI of the CFC” language meaningless.

But that is not true, and neither is the court’s description of the language as emphatic and peremptory. As noted, there is another way to read the phrase “shall constitute FBCSI of the CFC”: that it does not determine FBCSI but instead assigns to the actual (not deemed) CFC FBCSI that results from applying section 954(d)(1) after applying the deemed incorporation language. That is how Treasury interpreted the language³¹ and what the legislative history suggests.³²

That reading is consistent with, and gives full effect to, the other parts of section 954(d)(2). It gives the introductory language a meaningful purpose as referring back to section 954(d)(1) after the deemed incorporation of the branch, which in turn gives full effect and purpose to the deemed incorporation language as the operative language reinstating the missing related-person element. It also gives full effect to the “shall constitute FBCSI of the CFC” language as assigning the resulting FBCSI to the actual CFC, which has obvious implications for other parts of subpart F to work properly with the resulting FBCSI.³³

The Sixth Circuit’s interpretation, however, renders both the introductory and deemed incorporation language purposeless and meaningless. If the branch rule independently determined FBCSI, section 954(d)(2) would have the same meaning with or without the introductory and deemed incorporation language, and that cannot be right:

Congress could have written the branch rule that way, but it did not. The question is not what Congress could have done but how to give full effect to what it did do. Both readings of the “shall constitute FBCSI of the CFC” language would give it effect, but one would render the introductory and deemed incorporation language meaningless. That reading cannot be correct.

Further, the introductory language would be superfluous without the deemed incorporation language and would make no sense relative to the “shall constitute FBCSI of the CFC” language. It makes sense to say that for purposes of determining FBCSI, the income attributable to the branch activities shall be treated as income derived by a wholly owned subsidiary of the CFC. But it makes no sense to say that for purposes of determining FBCSI, the income attributable to the branch activities shall constitute FBCSI of the CFC. To say that income is FBCSI of the CFC for purposes of determining FBCSI would be awkward and circular.

That indicates that the introductory language relates only to the deemed incorporation language, which is also what the legislative history suggests.³⁴ That conclusion further supports the view that the introductory language refers back to section 954(d)(1) after application of the deemed incorporation language and before application of the “shall constitute FBCSI of the CFC” language. That, in turn, further supports reading the phrase “shall constitute FBCSI of the CFC” as merely assigning the resulting FBCSI to the actual CFC.

Thus, the language must be read not as independently determining FBCSI but as assigning to the actual (not deemed) CFC the FBCSI that results from applying section 954(d)(1) to the income attributable to the branch after applying the deemed incorporation language.

That reading assumes that applying section 954(d)(1) after the deemed incorporation of the branch must make the income attributable to the branch activities FBCSI because the language “and shall constitute FBCSI of the CFC” allows for no exception. That necessary assumption confirms the reading of the second precondition as covering only branches whose incorporation would result in their income becoming FBCSI. The deemed incorporation language provides for that necessary deemed incorporation, which results in FBCSI under section 954(d)(1). The “and shall constitute FBCSI of the CFC” language then assigns that FBCSI to the actual CFC.

A corollary is that the phrase “the income attributable to [the branch activities]” refers only to the branch income, not to the remaining income of the CFC that results from the branch activities. Saying otherwise would lead to the absurd result that treating the branch as a subsidiary would never produce FBCSI. If the income attributable to the branch activities referred to both the branch income and the remaining income of the CFC that results from the branch activities, the deemed incorporation language and “shall constitute FBCSI of the CFC” language would have to apply to both items.³⁵ The deemed incorporation language would then treat both items as “derived by a wholly owned subsidiary of the CFC” for applying section 954(d)(1). That would mean that one subsidiary would be deemed to have conducted all the activities and earned all the CFC’s income. That would result in no FBCSI under section 954(d)(1) because there would be no separation of activities or transaction with a related person. That absurdity would defeat the very purpose of the branch rule and could not be reconciled with the language “and shall constitute FBCSI of the CFC.”

2. Interpretive Implications

If, as I suggest, the phrase “the income attributable to [the branch activities]” means only the branch income, the consequences part of the branch rule would work only in sales branch situations.

In a sales branch situation that meets the preconditions part of the branch rule, “the income attributable to [the branch activities]” would be the sales branch’s income. The consequences part of the rule and section 954(d)(1) would treat that income as FBCSI and assign it to the actual CFC. The remaining income of the CFC would not be subject to the consequences part of the branch rule. But treating the branch’s income as the income of a deemed CFC for applying section 954(d)(1) must mean that the branch is treated as a deemed CFC for applying the section. That would make the remaining income of the actual CFC FBCSI if the CFC is not a manufacturing CFC and is not incorporated in the manufacturing or consumption jurisdiction.³⁶

If the preconditions were to cover manufacturing branches, the deemed incorporation language of the consequences part would treat the manufacturing branch’s income as the income of a deemed subsidiary CFC of the actual CFC for applying section 954(d)(1). Under no circumstance would section 954(d)(1) make that income FBCSI because the deemed CFC would be a manufacturing CFC.

That outcome would be irreconcilable with the “and shall constitute FBCSI of the CFC” language, which, as noted, assumes that applying section 954(d)(1) after the deemed incorporation of the branch must make the branch income FBCSI. It is true that depending on its location, it would be possible for the actual CFC’s remaining income to be FBCSI under section 954(d)(1) if the branch rule were to apply to manufacturing branches, but that would not be the result of directly applying the consequences part of the branch rule to that income³⁷ — it would be the result of treating the branch as a deemed subsidiary CFC as a corollary of treating its income as the income of a deemed subsidiary CFC. Still, only the manufacturing branch’s income, which cannot be FBCSI, would be subject to the language “and shall constitute FBCSI of the CFC,” leading to an irreconcilable contradiction.

That is why the consequences part of the branch rule is incompatible with manufacturing branch situations — which supports the conclusion that the branch rule does not apply to manufacturing branches.

Treasury and the Whirlpool courts interpreted the phrase “the income attributable to [the branch activities]” in manufacturing branch situations as covering only the remaining income of the CFC, not the branch income. To get there, the regulations focused on treating the branch as a deemed subsidiary CFC for applying section 954(d)(1) and ignored the statutory requirement that the two consequences of the branch rule apply regarding “the income attributable to [the branch activities].” The courts (and perhaps Treasury) read that phrase as referring to the sales income attributable to the branch activities, which they said excludes a manufacturing branch’s income but includes the remaining income of the CFC.

But the statutory text does not allow for that selective approach. What is subject to the consequences part of the branch rules is “the income attributable to [the branch activities].” It is not just income, or sales income, attributable to the branch activities. Just as courts cannot ignore the word “the,” they cannot add the word “sales”; otherwise, they would be altering, rather than interpreting, the statute.³⁸

The branch income is the income directly derived by the branch and cannot be excluded from the phrase “the income attributable to [the branch activities]” under even the narrowest reading. Broader readings of the phrase can only broaden coverage, and the only valid question would be whether the remaining income of the CFC is also covered. That is, the only question is whether the phrase covers only the branch income (which in a manufacturing branch situation cannot be FBCSI) or both the branch income and the remaining income of the CFC that results from the branch activities. As noted, the second, broader reading leads to the absurdity that application of the branch rule would never produce FBCSI (not even in sales branch situations), which leaves the narrower reading as the only possible one.

It is also not clear that reading the phrase “the income attributable to [the branch activities]” as definitionally referring to sales income under the courts’ approach would achieve the goal of excluding manufacturing branch income wholesale. A manufacturer can generate income as a contract manufacturer, in which case the income would be compensation for services and not sales income. But a manufacturer could also sell its products and generate sales income, at least in part. Therefore, the courts’ approach does not necessarily exclude a manufacturing branch’s income from the phrase “the income attributable to [the branch activities].”

Presumably, what the courts had in mind was not sales income in that general sense but income that would be FBCSI if the branch were a subsidiary CFC. Their intuition was generally correct, but the only textually coherent way to get close to that goal is consequential, not definitional, by accepting that the branch rule applies only to sales branches. As noted, the phrase “the income attributable to [the branch activities]” must refer to branch income only. Because the preconditions part of the branch rule limits its application to sales branches whose income would be FBCSI if they were incorporated, the branch income ends up consequentially (not definitionally) referring to the income of a sales branch only.

V. Conclusion

All textual indications point to the branch rule not applying to manufacturing branches. Manufacturing branches cannot meet the preconditions for applying the rule without violating the statutory language; and the consequences part of the rule does not work with manufacturing branches without violating the statutory text. The rule works elegantly and harmoniously when read as applying only to sales branches whose income would be FBCSI if they were incorporated.

When Congress enacted the branch rule in 1962, it was not as easy to form hybrid entities as it has been since the 1997 issuance of the check-the-box regulations. Perhaps that could explain why Congress was not concerned with manufacturing branches. Although from a U.S. tax perspective, manufacturing branches do not require hybridity, non-hybrid branch structures may be inadvisable for (nontax) limited liability or jurisdictional reasons. But that explanation is hard to reconcile with the fact that the 1964 branch rule regulations were very much concerned with manufacturing branch situations.

Be that as it may, the statutory text is clear. It applies only to, and can work only with, sales branches whose income would be FBCSI if they were incorporated. If lawmakers do not like that result, Congress — not Treasury or the courts — should fix it. Until then, it is, once again, well established that when the express terms of a statute provide one answer and extratextual considerations suggest another, there is no contest; “only the written word is the law, and all persons are entitled to its benefit.”³⁹