Implications of the Sixth Circuit's Whirlpool Opinion

Implications of the Sixth Circuit’s Whirlpool Opinion


The US Court of Appeals for the Sixth Circuit recently issued its opinion in Whirlpool Financial Corporation & Consolidated Subsidiaries v. Commissioner,1 affirming the decision made by the US Tax Court. The Tax Court held that income derived by a controlled foreign corporation (CFC) was foreign base company sales income (FBCSalesI) under the regulatory manufacturing branch rule.2 While the Sixth Circuit’s majority decision would significantly expand the scope of the Subpart F branch rule, the opinion is best viewed as only affirming the Tax Court’s legal conclusion under the particular facts, and thus, the broad implications of the Court’s analysis are best viewed as dicta.

In Depth


Under the facts, Whirlpool owned a Luxembourg CFC (Lux CFC) that had one administrative employee located in Luxembourg. Lux CFC owned a Mexican disregarded entity (Mex DE) that manufactured products for the Lux CFC pursuant to a toll manufacturing services arrangement using seconded employees of a related Mexican CFC. Lux CFC sold the products to related persons. Lux CFC owned the raw materials, work-in-process and finished goods, as well as the machinery and equipment used to manufacture the products—all of which were located in Mexico.

Mexico taxed the manufacturing service fee earned by the Mex DE. Under a Mexican Maquiladora incentive regime, Lux CFC was deemed to not have a taxable permanent establishment (PE) in Mexico, and thus, its income was not subject to taxation in Mexico. Luxembourg viewed Lux CFC as deriving its sales income through a Mexican PE, and under the income tax treaty with Mexico, taxed only income derived in Luxembourg for administrative services.

The Tax Court addressed the application of the manufacturing branch rule to the income derived by Lux CFC. For this purpose, the Tax Court treated Lux CFC’s income from selling products to related persons as not FBCSalesI under the general rule of Section 954(d)(1) because it assumed that the manufacturing exception applied. The Tax Court, however, granted summary judgment to the Internal Revenue Service (IRS), holding that the income of Lux CFC not derived by the Mex DE was FBCSalesI under the regulatory manufacturing branch rule.

The taxpayer argued that the regulatory manufacturing branch rule was invalid because it was not provided for in Section 954(d)(2). The language of Section 954(d)(2) applies only to income derived by a foreign branch from purchasing or selling products and does not apply to income derived by the CFC in its home country. Nevertheless, the Tax Court concluded that the manufacturing branch rule in the US Department of the Treasury (Treasury) regulations, which treats purchasing or selling income derived by a CFC’s home office as FBCSalesI, was a valid exercise of the Treasury’s authority in carrying out the Court’s view of the purpose of Section 954(d)(2) by providing a mirror rule to the purchasing or selling branch rule set forth in the Code. This conclusion is not surprising but nevertheless open to question under Supreme Court of the United States precedent, which holds that administrative regulations that go beyond the plain meaning of the statute are not entitled to deference.3

The taxpayer also argued that Lux CFC’s income was not subject to the regulatory manufacturing branch rule because Lux CFC did not carry on purchasing or selling activities in Luxembourg through its single administrative employee as required by the regulations.4

Without explicitly addressing the regulatory requirement that a CFC’s home office engage in “purchasing or selling activities,” the Tax Court concluded that because Lux CFC derived income from selling products, the regulatory manufacturing branch regulations applied. This conclusion is questionable because in addition to departing from the plain language of the regulations, it is inconsistent with the long-held view of the IRS and tax professionals that having purchasing or selling activities of employees in the home country (or another branch) is a requirement for the regulatory manufacturing branch rule to apply.5

The regulatory manufacturing branch rule applies only to income derived outside the branch’s country. While the Tax Court opinion acknowledges this rule, a critical factual question not addressed by the Tax Court in granting summary judgment was the amount of Lux CFC’s income that was derived by the home office in Luxembourg, and thus, was FBCSalesI under the manufacturing branch rule. The IRS has indicated that this determination is made under US arm’s length transfer pricing principles.6 All of Lux CFC’s value-driving functions were performed, and assets located, in Mexico, not Luxembourg, and thus, only a small portion of Lux CFC’s income might be FBCSalesI under the regulatory manufacturing branch rule (which would be consistent with the conclusion of the Luxembourg tax authorities).7


The Sixth Circuit affirmed the Tax Court’s opinion, with a two-judge majority and one dissenting opinion which would have held for the taxpayer. However, the Sixth Circuit, based its conclusion solely on its interpretation of Section 954(d)(2) and not on the regulations. As a result, the opinion does not address the validity of the manufacturing branch regulations, nor the requirements in the regulations that must be met for a CFC to have FBCSalesI.

Section 954(d)(2) provides that if a CFC carries on activities through a foreign branch, the branch rule applies if the arrangement has “substantially the same effect as if such branch or similar establishment were a wholly owned subsidiary,” deriving the income attributable to the branch’s activities. The Sixth Circuit interprets that language as applying when the CFC’s income is subject to deferral (which would be the case with the income of any CFC branch structure that is not reported as FBCSalesI). The opinion then states that the amount of a CFC’s FBCSalesI income is not determined by reapplying the general definition of Section 954(d)(1) treating the branch as a separate CFC but rather that 100% of the CFC’s income, including the income of the manufacturing branch, would be FBCSalesI under Section 954(d)(2).

The Sixth Circuit’s interpretation of Section 954(d)(2) is inconsistent with the uniform interpretation of that provision by the Treasury, the IRS, the Tax Court and tax professionals for over 50 years (as discussed in the dissenting opinion) and is not supported by the legislative history discussing the branch rule. Importantly, the majority’s interpretation is fundamentally contrary to the manufacturing branch regulations.

Under the manufacturing branch regulations, if a CFC manufactures products in a foreign branch, the arrangement is treated as having “substantially the same tax effect as if such branch or similar establishment were a wholly owned subsidiary” only if the income derived by the home office from purchasing or selling activities meets a tax rate disparity test (i.e., is subject to a materially lower tax rate than if the income were subject to tax in the branch’s country). In addition, the regulations provide that income derived by the CFC in the manufacturing branch’s country is not FBCSalesI under the regulations because, if such income had been derived by a separate CFC, it would qualify for the manufacturing exception or same-country-of-manufacture exception. Furthermore, while purchasing or selling income derived by the home office of a CFC generally would be FBCSalesI, it is not FBCSalesI if the home office also satisfies the manufacturing exception or the products are sold for use in the CFC’s country. While the majority opinion acknowledges these limiting rules in the regulations—and that Section 954(d)(2) states that the consequences of Section 954(d)(2) are to be prescribed by regulations—the majority opinion indicates that, to the extent the regulations would narrow the majority’s new interpretation of Section 954(d)(2), they are invalid.

The Sixth Circuit majority seemed particularly offended by the fact that no current tax was paid on income not derived by the Mex DE. This is far from an unusual result for US multinationals operating outside the United States, and, for many years, CFC structures providing zero or low-taxed income have been recognized by US Congress, the Treasury and the IRS, and upheld by the courts, as entirely permissible under Subpart F.8 The obvious truth is that when Congress enacted the FBCSalesI rules in 1962, it could not have contemplated all of the planning structures that would develop over the next 50 years. The courts have consistently stated that Congress needs to amend the law to subject to taxation zero-taxed or low-taxed income of CFCs that falls outside the plain meaning definition of Subpart F income.9 In the Tax Cuts and Jobs Act of 2017, Congress changed the law in response to such structures, subjecting essentially all of a CFC’s income to current US taxation under a new current-inclusion regime.10

The dissenting opinion would have held for the taxpayer. The dissenting judge would apply the rules in the regulations and hold that, once it is concluded that the branch rule applies, the amount of FBCSalesI would be determined by reapplying Section 954(d)(1), treating the branch as a separate CFC. The dissent concluded that the income of Lux CFC was derived from the manufacture of the products (or at least there was a question of material fact precluding summary judgment), and therefore, no portion of Lux CFC’s income would be FBCSalesI under the manufacturing exception.


The Sixth Circuit’s decision may not be the last word on the Whirlpool case. The taxpayer has an option to file a petition for rehearing en banc, which may be entertained by the entire Sixth Circuit in light of the split panel. The taxpayer may also petition the Supreme Court to hear the case, which is unlikely.

The Sixth Circuit’s majority opinion in Whirlpool should not have implications for the application of the branch rule provided by Section 954(d)(2) beyond the specific facts of the case and the Tax Court’s opinion applying the regulatory manufacturing branch rule. McDermott’s Tax team is unaware of a court ever denying a taxpayer the ability to rely on final Treasury regulations, let alone ones that have been in effect for over 50 years. Taxpayers operating through branches of CFCs should be able to rely on the rules in the branch regulations, including the tax rate disparity requirement, the manufacturing exception and the same-country exceptions, and that only the amount of purchasing or selling income derived outside a manufacturing branch’s country is potentially FBCSalesI. Taxpayers outside the Sixth Circuit (or taxpayers in the Sixth Circuit filing in the Court of Federal Claims) with facts similar to Whirlpool might consider challenging an IRS proposed adjustment because the Tax Court’s decision is questionable in (1) upholding the validity of the manufacturing branch regulations, (2) eviscerating the requirement in the regulations that the CFC’s home office carry on purchasing or selling activities with respect to products manufactured by the branch and (3) not attributing any portion of the income, other than the amount derived by the Mex DE, to the manufacturing branch’s country, where all of the CFC’s value-driving functions were performed and assets were located.

1 Nos. 20-1899/1900 (6th Cir. 2021), aff’g 154 T.C. 142 (2020).

2 Treas. Reg. §1.954-3(b).

3 See, e.g., Chevron USA Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837, 843 n. 9 (1984); United States v. Mead Corp., 533 U.S. 218, 226–227 (2001). Courts have applied this principle specifically to tax regulations. See, e.g., Walton v. Comm’r, 115 T.C. 589, 598–599 (2000); Iglesias v. United States, 848 F.2d 362, 366–367 (2d Cir. 1988).

4 Treas. Reg. §1.954-3(b)(1)(ii)(b) and (c), (2)(i)(c) and (ii)(c) (1964); Treas. Reg. §1.954-3(b)(1)(i) and (ii) and (2) (2009).

5 See, e.g., TAM 8509004.

6 AM 2015-002 (Feb. 13, 2015), n. 19.

7 The dissenting opinion to the Sixth Circuit majority opinion may have arrived at a similar view and therefore would have held that Lux CFC’s income qualified for the manufacturing exception provided in the branch regulations. See also Treas. Reg. §1.954-3(b)(4), Ex. 3 (where all manufacturing and selling activities occurred in the country where the CFC operated through a foreign branch, none of the branch’s income was FBCSalesI because it qualified for the manufacturing exception, even though 90% of the income was not subject to tax).

8 See, e.g., Ashland Oil v. Commissioner, 95 T.C. 348, 357-58 (1990); Vetco, Inc. v. Commissioner, 95 T.C. 579 (1990). In Vetco, the sales income was earned by a Swiss CFC that hired a related U.K. CFC to engage in all of the supply chain activities, and the Swiss CFC itself had no employees. The Tax Court refused the IRS’s exhortations to “look past [the taxpayer’s] ‘contractual wizardry’ and apply the branch rule as a loophole-closing device to circumvent [the taxpayer’s] attempted tax avoidance,” because the government’s arguments lacked a basis in the language of the Code or regulations. See also Brown Group, Inc. v. Commissioner, 77 F.3d 217 (8th Cir. 1996), vacating and remanding 104 T.C. 105 (1995) (sales income derived by a Cayman Islands CFC—that was not subject to tax in any country—was not Subpart F income because the income did not fall within the statutory or regulatory definition of foreign base company sales income).

9 In Lovett v. United States, 621 F.2d 1130 (Ct. Cl. 1980), the taxpayer argued that a regulation issued under Subpart F was invalid because it lacked support from the language of the Code. The government argued that the Subpart F regulation was “necessary to avoid the ‘absurd’ results which flow from a literal application of the language of §951(d).” The court rejected the government’s argument and held the regulation invalid, stating that: “Neither we nor the Commissioner may rewrite the statute simply because we may feel that the scheme it creates could be improved upon.” Id. at 1140 (quoting United States v. Calamaro, 354 U.S. 351, 357 (1957)).

10 Sections 951A and 250.