Life definitely ain’t getting easier for multinationals in terms of tax risk…  In the latest big transfer pricing (TP) case, the US tax court sided with the Inland Revenue Service (IRS) in a case that will send shockwaves through the tax departments of international companies around the world. The fallout from this case will be immense as it will have wide-spread effects on TP agreements as well as the accounting impact of disclosing and quantifying Uncertain Tax Positions (UTP’s), in particular in respect to royalties, and where different intra-group pricing is effected across different jurisdictions. Furthermore, the case highlights the well known (but often ignored) risk of applying different remuneration mechanisms for the same transactions in different jurisdictions.

Case Background

The IRS disputed the royalty rate charged by 3M to its Brazilian subsidiary (3M Brazil). Historically 3M had implemented intellectual property (IP) agreements with its related party manufacturers at a 6% rate of local entity net sales, a royalty rate agreed upon between 3M and 3M Brazil. However, the Brazilian agency governing IP transactions intervened by stating that the 6% royalty rate surpassed that of local regulations. As a result, 3M and 3M Brazil remedied their agreement to pay a reduced royalty rate of 1%. Of course, this 1% was at odds with what all the other group entities were paying.  The IRS of course argued that thus the transaction was not conducted at arm’s length and that a transfer pricing adjustment should be made.

The legislation at play and the case environment

  1. Whether the IRS could allow additional royalty income to 3M based on Section 482.
  2. Whether Treasury Section 1. 482- 1 (h)(2) was invalid. This stipulates how a Section 482 adjustment can be made based on when and how foreign legal restrictions have been considered.

3M referenced Brazilian laws to support its claim that the IRS cannot assign revenue to a taxpayer who never received nor is eligible to receive revenue due to local law prohibiting such payment or receipt. Naturally the IRS disagreed.

The IRS first claimed that 3M Brazil had benefitted significantly from the IP that 3M had given. The illustration was that 3M Brazil had surplus profit because of the below arm’s length transfer pricing, which led to the $64.5 million dividend payout by 3M Brazil.

The IRS argued that Section 482 grants it extensive jurisdiction to “distribute, apportion, or allocate gross income, deductions, credits, or allowances between and among such organizations, trades, or businesses.” The IRS maintained that this gives them the right to make these transfer price modifications.

The IRS asserted that the arm’s length principle is applicable in every circumstance. The IRS further emphasised that only foreign limitations that satisfy each of the following requirements were applicable:

  • The restrictions explicitly forbid the payment or receipt of any part or all the arm’s length amount
  • The limits are not imposed because of a business deal between the taxpayer and the foreign sovereign; rather, they are publicly publicised, usually applicable to all similarly situated individuals (both controlled and uncontrolled), and publicly promulgated.
  • Except for remedies with a negligible chance of success, the taxpayer has exhausted all options available to them under applicable foreign law or practice for requesting a waiver of these restrictions.
  • The restricted related parties did not enter into any agreement with controlled or uncontrolled parties that had the effect of getting around the limitation, and the restricted related parties have not in any other major way broken the restriction.

The IRS presented that none of the above requirements were satisfied by 3M.

The tax court ultimately sided with the IRS and 3M was forced to pay a whopping $24 million including penalties. This is a stern slap on the wrist that should be the wake-up call multinationals needed to ensure their consistent compliance regarding their transfer pricing documentation and policies.


The 3M case highlights the complexities of international tax law and the importance of diligent compliance with the applicable regulations, and shows how much money is on the table with TP. This case serves as a reminder that companies engaged in cross-border transactions, (in particular complex areas like IP) must carefully navigate the regulatory landscape in order to avoid tax liabilities.

If in doubt, please contact us to discuss any of your TP headaches.

Glen from regan van rooy in transfer pricing - international trade expert

About the Author:

Glen Groenewald is an Economics and International trade graduate, who has just started his career in Transfer Pricing at Regan van Rooy and can be contacted via email at