Tax Court applies manufacturing branch rules

Tax Hot Topics newsletter The Tax Court granted summary judgment for the government in Whirlpool Financial Corp. v. Commissioner (154 T.C. No. 9), finding that income generated by a controlled foreign corporation (CFC) of Whirlpool as part of a foreign manufacturing and sales structure was foreign base company sales income (FBCSI) under Section 954(d), and that the subpart F “branch rules” applied.

The case arises as a result of the IRS’s review of Whirlpool’s 2009 federal income tax return. The IRS determined that income Whirlpool’s Luxembourg CFC earned from sales of appliances manufactured through the CFC’s Mexican branch was FBCSI under Section 954(d) and was taxable to Whirlpool as subpart F income under Section 951(a). Whirlpool filed a petition with the Tax Court refuting that the sales income was FBCSI.

In reaching its conclusion in the case, the Tax Court examined the “branch rule” under Section 954(d)(2). Specifically, the branch rule provides that if activities through a branch have substantially the same tax effect as if the branch were a wholly owned subsidiary, then the branch will be treated as a subsidiary of the CFC for purposes of determining FBCSI. Upon review of the statute, the court concluded that because Whirlpool’s CFC was incorporated in Luxembourg and carried on its manufacturing activities through its branch in Mexico, the arrangement satisfied the first prong of the branch rule.

The court also found that the second prong of the branch rule was satisfied because the CFC was not taxable in Luxembourg on any of its sales income, nor was it subject to tax on any income in Mexico. The court stated that the arrangement had substantially the same effect for U.S. tax purposes as if the Mexican branch were a wholly owned subsidiary of the CFC. Thus, it agreed with the IRS that the sales income was FBCSI taxable to Whirlpool under Section 954(d)(2). In denying Whirlpool’s motion for partial summary judgment, the Tax Court stated that “the Luxembourg sales affiliate epitomizes the abuse at which Congress aimed.”

The case is a reminder to taxpayers that the Subpart F and branch rules, continue to be important in evaluating the tax effect of international transactions and structures. It has significance for entities with non-U.S.-owned maquiladora structures, as well as other CFC structures where manufacturing and sales operations are in separate jurisdictions. It also highlights the application of the branch rules and provides guidance to taxpayers in an area that has largely been unclear.

David Sites
Washington National Tax Office
T +1 202 861 4104

David Zaiken
Managing Director
Washington National Tax Office
T +1 202 521 1543

Cory Perry
Senior Manager
Washington National Tax Office
T +1 202 521 1509

Yasmin Dirks
Washington National Tax Office
T +1 202 521 1506

Mike Del Medico
Washington National Tax Office
T +1 202 521 1522

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