US Court Shields Blocked Income

The United States Court of Appeals for the Eighth Circuit’s decision in 3M Company and Subsidiaries v. Commissioner of Internal Revenue (No. 23-3772, October 1, 2025), titled “Eighth Circuit Shields Blocked Income,” represents a pivotal development in international tax jurisprudence. The court reversed the Tax Court’s judgment that had upheld the IRS’s allocation of nearly $23.7 million in additional royalty income which Brazilian law prohibited 3M’s subsidiary from paying. The decision underscores the primacy of statutory limits under § 482 of the Internal Revenue Code and curtails the IRS’s authority to tax income that cannot legally be received under foreign law.

Factual Background

3M Company operates through subsidiaries across the globe and files a single consolidated federal tax return in the United States each year. The controversy centered on whether 3M’s 2006 federal return should have included additional royalty income from its Brazilian subsidiary, 3M do Brasil Ltda.

Intellectual property constitutes one of 3M’s most valuable assets. Its foreign subsidiaries pay royalties to use this property. Under Brazilian law at the time, the amount of royalties payable by a subsidiary to a non-Brazilian parent was capped by regulatory limits tied to deductible expenses. As a result, 3M do Brasil paid only USD 5.1 million in royalties to 3M, which 3M duly reported on its 2006 federal tax return.

Several years later, the IRS issued a Notice of Deficiency, asserting that 3M owed considerably more. The agency reallocated approximately USD 23.7 million in additional royalty income, representing what it believed an unrelated party would have paid for comparable use of the intellectual property. The dispute thus turned on whether § 482 authorized the IRS to impute income that Brazilian law had explicitly barred 3M from receiving.

Key Legal Findings

The Eighth Circuit concluded that the Internal Revenue Service lacked authority under § 482 to reallocate income over which a taxpayer had no legal control. Relying on Commissioner v. First Security Bank of Utah, 405 U.S. 394 (1972), the Court reaffirmed that the concept of taxable income presupposes dominion and control that is, the taxpayer must have the legal right to receive the income. Consistent with the principle that income does not encompass amounts the taxpayer “did not receive and was prohibited from receiving,” the Court held that § 482 cannot be invoked to attribute income beyond the taxpayer’s legal capacity to possess or enjoy it. Because Brazilian law restricted royalty payments to foreign controlling entities, 3M lacked the requisite dominion, and the IRS’s reallocation exceeded the statute’s limits.

The Court also rejected the IRS’s reliance on the “commensurate with income” clause added to § 482 in 1986, holding that it merely specifies the measure of income for intangible property, not its scope. The second sentence does not override the first, which limits the IRS’s authority to “gross income” lawfully receivable by the taxpayer.

Importantly, the Court dismissed the IRS’s attempt to distinguish First Security Bank on the basis that the prior case involved domestic legal restrictions, whereas 3M’s situation arose from foreign law. The Court explained that “if dominion or control is the dividing line for income under § 482, and income attribution requires the taxpayer to be an entity that ‘could have received it,’ it is not clear why the source of the restriction makes a difference. A foreign restriction, like the one in Brazil, can deprive an American company of control over potential income just as effectively as a federal one.”

Analytical Commentary

The decision redefines the limits of the IRS’s adjustments authority on royalties. It confirms that § 482 reallocations cannot extend to hypothetical income that the taxpayer is legally barred from realizing. By grounding its reasoning in statutory text and rejecting regulatory deference post-Loper Bright Enterprises v. Raimondo (2024), the Eighth Circuit reaffirmed judicial primacy in interpreting revenue statutes.

The ruling also harmonizes U.S. law with OECD principles requiring that intercompany transactions reflect both economic reality and legal enforceability. Transactions constrained by foreign regulatory frameworks such as capped royalties or foreign exchange controls fall outside the arm’s-length paradigm when compliance with local law precludes payment.

Strategic Insight

Since the US Court Shields Blocked Income it provides for significant practical consequence. Companies facing “blocked income” situations where foreign law limits cross-border payments should document such restrictions meticulously and ensure their transfer pricing documentation reflects these legal barriers. This decision provides taxpayers with a robust defense against IRS adjustments based on theoretical reallocation of non-remittable income.

From a policy perspective, the ruling strengthens the principle that tax obligations must reflect legally realizable income. It signals the judiciary’s intention to confine administrative agencies within statutory bounds and underscores the importance of integrating international legal compliance into U.S. transfer pricing strategies.

At MCORE LAW, we view Eighth Circuit Shields Blocked Income as a reaffirmation of the fundamental principle that U.S. tax law must operate within both statutory and international legal boundaries. The ruling reinforces that foreign legal restrictions are not mere formalities but binding determinants of what constitutes taxable income under § 482. Our firm stands ready to assist clients in navigating these complexities through strategic planning, dispute resolution, and proactive compliance measures.