Court Opinion

ID: 9370289
Source: CourtListenerOpinion
Date Created: 2023-02-12 05:01:01.749794+00
Date Added: 2024-06-11T16:48:52.670035
License: Public Domain

United States Tax Court

                           160 T.C. No. 3

               3M COMPANY AND SUBSIDIARIES,
                        Petitioner
                            v.

           COMMISSIONER OF INTERNAL REVENUE,
                       Respondent

                             —————

Docket No. 5816-13.                            Filed February 9, 2023.

                             —————

             P is the common parent company of the P
      consolidated group. As among the members of the P
      consolidated group (and among P’s foreign affiliates),
      ownership of trademarks had been centralized in P. Other
      intellectual property, including patents and nonpatented
      technology, was owned by S, a second-tier wholly owned
      U.S. subsidiary of P. S is a member of the P consolidated
      group.

             B is a wholly owned Brazilian subsidiary of S.
      During 2006, B used in its business operations the
      trademarks owned by P. B’s use of these trademarks was
      governed by three trademark licenses that P and B had
      executed in 1998. Each license concerned a separate set of
      trademarks. In accordance with the licenses, B paid a
      royalty to P equal to 1% of its sales of the trademarked
      products. Some products sold by B were subject to
      trademarks covered by more than one of the three
      trademark licenses. For such products, B and P calculated
      the trademark royalties using a stacking principle under
      which, for example, if a particular product used
      trademarks covered by all three trademark licenses, the
      royalties were 3% of the sales of the product. Computing
      the royalties using this stacking principle, B paid P
      trademark royalties in 2006.

                          Served 02/09/23
                              2

       B also used in its business operations patents and
nonpatented technology owned by S. B paid no patent
royalties and made no technology-transfer payments to S.
No patent license and no technology-transfer agreement
was in effect between S and B.

       On its 2006 consolidated federal income-tax return,
the P consolidated group reported as income the trademark
royalties that B paid to P in 2006.

       In the notice of deficiency, R determined that the
income of the P consolidated group should be increased
under I.R.C. sec. 482 to account for B’s use of the
intellectual property of P and S. The increase in income
determined in the notice of deficiency represents an arm’s-
length rate of compensation for the intellectual property
used by B.

      P’s position is that the I.R.C. sec. 482 allocation
should correspond to the maximum amount that B could
have paid for the intellectual property in question under
the laws of Brazil, less related expenses.

       R’s I.R.C. sec. 482 adjustment does not take into
account the effect of the Brazilian legal restrictions. A
1994 regulation, 26 C.F.R. sec. 1.482-1(h)(2) (2006), sets
forth the requirements that must be met before R “will take
into account the effect of a foreign legal restriction” under
I.R.C. sec. 482. T.D. 8552, 59 Fed. Reg. 34971 (July 8,
1994). The Brazilian legal restrictions do not meet the
requirements.

       P contends that some of the requirements are
invalid because they fail either the Chevron step 2 test or
the part of the State Farm test that requires the agency to
adequately respond to comments. See Chevron, U.S.A.,
Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 844
(1984); Motor Vehicle Mfrs. Ass’n of the U.S., Inc. v. State
Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983); Altera Corp.
& Subs. v. Commissioner, 145 T.C. 91, 120, 130 (2015),
rev’d, 926 F.3d 1061 (9th 2019). P also contends that the
entire regulation addressing foreign legal restrictions, 26
C.F.R. sec. 1.482-1(h)(2) (2006), is invalid under the part of
                              3

the State Farm test that requires the agency to give a
satisfactory explanation for the regulation and the part of
the State Farm test that requires the agency to respond to
comments. Furthermore, P contends that the entire
regulation is invalid under Chevron step 1 because
Commissioner v. First Security Bank of Utah, N.A., 405
U.S. 394 (1972), and its progenitor and progeny held that
under predecessors to I.R.C. sec. 482 R cannot make an
allocation of income to a taxpayer who did not receive
income and could not legally receive the income.

       Held: The requirement of 26 C.F.R. sec. 1.482-
1(h)(2)(i) (2006) that “a foreign legal restriction will be
taken into account only to the extent that it is shown that
the restriction affected an uncontrolled taxpayer under
comparable circumstances” is not invalid under Chevron
step 2.

       Held, further, the requirement that foreign legal
restrictions be taken into account under I.R.C. sec. 482 only
if they are publicly promulgated, 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(A) (2006), means that the foreign legal
restrictions must be in writing.

       Held, further, the Brazilian legal restrictions at
issue do not meet the requirement in 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(A) (2006) that foreign legal restrictions be taken
into account under I.R.C. sec. 482 only if they are publicly
promulgated.

       Held, further, the requirement that foreign legal
restrictions be taken into account under I.R.C. sec. 482 only
if they are publicly promulgated, 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(A) (2006), is not invalid under Chevron step 2.

       Held, further, the requirement that foreign legal
restrictions be taken into account under I.R.C. sec. 482 only
if they are “generally applicable to all similarly situated
persons (both controlled and uncontrolled)”, 26 C.F.R. sec.
1.482-1(h)(2)(ii)(A) (2006), is not invalid under Chevron
step 2.

      Held, further, the 1994 regulation, 26 C.F.R. sec.
1.482-1(h)(2) (2006), is valid under Chevron step 1.
                                                     4

              Held, further, the 1994 regulation, 26 C.F.R. sec.
        1.482-1(h)(2) (2006), is not invalid under P’s State Farm
        theory.

                                             —————

Walter A. Pickhardt and Michael J. Kaupa, for petitioner.

Justin L. Campolieta and William R. Peck, for respondent.

                                            CONTENTS

FINDINGS OF FACT .................................................................. 10

1.      3M do Brasil Ltda. (or 3M Brazil); its 1952 agreement
        with 3M Company ............................................................. 11

2.      The 1982 trademark licensing agreement ....................... 12

3.      The 1983 licensing agreement .......................................... 12

4.      The 1997 proposed licensing agreement .......................... 13

5.      Termination of the 1982 trademark licensing agreement
        and the 1983 licensing agreement; execution of the 1998
        trademark licenses; stipulations related to Brazilian
        law ...................................................................................... 18

6.      Texts of certain Brazilian legal documents referred to in
        the stipulations related to Brazilian law.......................... 35

7.      1999 assignment agreement; corporate restructuring .... 42

8.      Business operations during the 2006 tax year ................. 43

        a.        3M Global ................................................................ 43

        b.        3M Brazil ................................................................ 44

        c.        Intellectual property; services................................ 45

        d.        Payments by 3M Brazil .......................................... 47

9.      Tax reporting ..................................................................... 48
                                                    5

10.      The notice of deficiency ..................................................... 48

11.      Closing agreement ............................................................. 51

12.      The petition ....................................................................... 51

13.      The stipulation that the rate of compensation under the
         standard licensing agreement is an appropriate arm’s-
         length rate under section 482 ........................................... 53

14.      The stipulation that the section 482 adjustment must
         be reduced by $4,117,370 in unreimbursed research-
         and-development expenses incurred by 3M Brazil .......... 53

15.      The stipulation that under Brazilian law, the maximum
         amount that 3M Brazil could have paid to 3M IPC as
         patent royalties or technology-transfer payments in
         2006 was $4,283,153 after reduction for the $5,104,756
         in trademark royalties paid by 3M Brazil to 3M
         Company in 2006 ............................................................... 53

16.      The stipulation that if the Court holds that the section
         482 adjustment must take into account the Brazilian
         legal restrictions, then the minimum section 482
         adjustment should be $165,783 ........................................ 56

17.      Respondent’s position ........................................................ 56

18.      Petitioner’s position........................................................... 58

19.      Other stipulations ............................................................. 65

OPINION ...................................................................................... 65

I.       Procedural matters ............................................................ 65

II.      Review of the authorities under U.S. law relevant to
         the arguments by the parties............................................ 67

         A.        The Revenue Act of 1921 ........................................ 70

         B.        The Revenue Act of 1924 ........................................ 72

         C.        The Revenue Act of 1926 ........................................ 72
                                       6

D.   The Revenue Act of 1928 ........................................ 73

E.   The Revenue Act of 1932 ........................................ 74

F.   The Revenue Act of 1934 ........................................ 75

G.   Regulations 86 ........................................................ 75

H.   The Federal Register Act and the publication of
     the first issue of the Federal Register ................... 79

I.   The Revenue Act of 1936 ........................................ 83

J.   Regulations 94 ........................................................ 83

K.   The 1937 amendment to the Federal Register
     Act ........................................................................... 83

L.   The first edition of the Code of Federal
     Regulations ............................................................. 84

M.   The Revenue Act of 1938 ........................................ 86

N.   Regulations 101 ...................................................... 86

O.   Internal Revenue Code of 1939 .............................. 86

P.   Regulations 103 ...................................................... 87

Q.   The 1942 amendment to the Federal Register
     Act ........................................................................... 88

R.   Regulations 111 ...................................................... 89

S.   The Revenue Act of 1943 and the Treasury
     Decision 5426 amendments to Regulations 111 .... 94

T.   L.E. Shunk Latex v. Commissioner, 18 T.C. 940
     (1952) (involving tax years 1942, 1943, and
     1945) ........................................................................ 99

U.   The Administrative Procedure Act ...................... 105

V.   The lifting of the wartime suspension of the
     Federal Register Act requirement that
     regulations be codified every five years ............... 110
                                        7

W.    The second edition of the Code of Federal
      Regulations ........................................................... 110

X.    The 1953 amendment to the Federal Register
      Act ......................................................................... 111

Y.    Regulations 118 .................................................... 114

Z.    The Internal Revenue Code of 1954..................... 115

AA.   The 1960 notice of proposed rulemaking ............. 119

BB.   The creation of a new title of the Code of
      Federal Regulations.............................................. 120

CC.   The 1962 final regulations ................................... 120

DD.   The 1965 and 1966 notices of proposed
      rulemaking ............................................................ 125

EE.   The 1968 final regulations ................................... 129

FF.   Commissioner v. First Security Bank,
      405 U.S. 394 (1972) (involving tax years 1955 to
      1959) ...................................................................... 135

GG.   The Tax Reform Act of 1976 ................................. 146

HH.   Procter & Gamble Co. v. Commissioner, 95 T.C.
      323 (1990) (involving tax years ending
      June 30, 1978 and 1979), aff’d, 961
      F.2d 1255 (6th Cir. 1992); and Exxon Corp. v.
      Commissioner, T.C. Memo. 1993-616, 66 T.C.M.
      (CCH) 1707 (involving tax years 1979, 1980, and
      1981), aff’d sub nom. Texaco, Inc. v. Commissioner,
      98 F.3d 825 (5th Cir. 1996) .................................. 147

II.   The 1986 amendment to section 482 ................... 166

JJ.   The 1988 amendment to section 7805 regarding
      temporary regulations .......................................... 178

KK.   The 1992 notice of proposed rulemaking ............. 178
                                                  8

       LL.      The 1993 temporary regulations and the 1993
                redesignation of the 1968 regulations ................. 183

       MM. The 1993 notice of proposed rulemaking ............. 191

       NN.      The 1994 final regulations ................................... 200

       OO.      Stipulations regarding the 1994 final
                regulations ............................................................ 213

       PP.      The 1996 amendment to section 7805(a)
                regarding regulations relating to post-1996
                provisions of the Internal Revenue Code ............. 214

       QQ.      Post-2006 amendments to section 482................. 218

III.   Whether the Brazilian legal restrictions satisfy the
       seven requirements of 26 C.F.R. sec. 1.482-1(h)(2)
       (2006) for taking into account foreign legal
       restrictions ....................................................................... 222

       A.       Effect on uncontrolled taxpayers ......................... 223

       B.       Publicly promulgated ........................................... 224

       C.       Generally applicable ............................................. 229

       D.       Not part of commercial transaction ..................... 229

       E.       Exhaustion of remedies ........................................ 229

       F.       Restriction on payment in any form .................... 230

       G.       Circumvention or violation of restriction ............ 230

IV.    Chevron step one ............................................................. 231

V.     Whether 26 C.F.R. sec. 1.482-1(h)(2) (2006) is
       reasonable under Chevron step two ............................... 254

       A.       Effect on uncontrolled taxpayers ......................... 255

       B.       Publicly promulgated ........................................... 261

       C.       Generally applicable ............................................. 262
                                                 9

       D.        Not part of commercial transaction ..................... 262

       E.        Exhaustion of remedies ........................................ 262

       F.        Restriction on payment in any form .................... 262

       G.        Circumvention or violation of restriction ............ 263

VI.    The State Farm test for validity of regulations ............. 263

       A.        Satisfactory explanation....................................... 265

       B.        Adequate response to comments .......................... 267

                 1. Inconsistency with First Security Bank ........ 268

                 2. That some foreign legal restrictions apply
                 only to payments between related parties ........... 268

                 3. That some foreign legal restrictions are
                 unpublished (comment related to the second
                 requirement) ......................................................... 269

                 4. Difficulty of establishing that the remedies
                 were exhausted (comment related to the fifth
                 requirement) ......................................................... 269

                 5. Payment of dividends and the no-
                 circumvention requirement (comment related
                 to the seventh requirement) ................................. 270

                 6. Time for making deferral election ................. 270

VII.   Conclusion ....................................................................... 270

      MORRISON, Judge: 3M Company is the common parent
company of an affiliated group of corporations that filed a consolidated
federal income tax return for the tax year ending December 31, 2006. 1
This affiliated group is referred to here as the 3M consolidated group.
When we discuss 3M Company in its role as the representative of the
members of the 3M consolidated group, we refer to 3M Company as

       1   The return was filed on Form 1120, U.S. Corporation Income Tax Return.
                                         10

“petitioner”. See infra part I (discussing 3M Company’s status as
representative of the group).

       Respondent mailed a notice of the deficiency on December 12,
2012, determining the 3M consolidated group had an income tax
deficiency of $4,847,004 for 2006. A timely petition for redetermination
of the deficiency was filed. We have jurisdiction to redetermine the
deficiency under section 6214(a). 2

       Only one income adjustment in the notice of deficiency remains
at issue. Specifically, the notice of deficiency determined that the
income of the 3M consolidated group should be increased by $23,651,332
to reflect the arm’s-length compensation that 3M Brazil should have
paid for intellectual property under section 482. Petitioner contends
that the section 482 adjustment is improper to the extent that payments
were barred by Brazilian law and that therefore the proper section 482
adjustment is only $165,783. All other adjustments in the notice of
deficiency have been resolved by agreement of petitioner and
respondent.

      We hold that under 26 C.F.R. sec. 1.482-1(h)(2) (2006), which
governs the effect of foreign legal restrictions on section 482
adjustments, the Brazilian restrictions on payments by 3M Brazil are
disregarded.    We reject petitioner’s various arguments that the
regulation is invalid.

                             FINDINGS OF FACT

       Petitioner and respondent executed a stipulation of facts, which
they later replaced with an amended stipulation of facts. The amended
stipulation of facts is referred to here simply as the “stipulation”. The
Court adopts the statements in the stipulation as findings of fact. The
documents attached to the stipulation, Exhibits 1-J through 46-J, are
admitted as evidence.

     At all relevant times, including when it filed the petition, 3M
Company was a U.S. corporation with its principal place of business in

       2 Unless otherwise indicated, all references to sections are to the Internal

Revenue Code of 1986 as amended and in effect at all relevant times. All references to
Rules are to the Tax Court Rules of Practice & Procedure.
                                          11

Minnesota. 3 When we use the term “3M Company”, we refer to this
specific legal entity.

       At all relevant times, including during the 2006 tax year, 3M
Company and its U.S. and foreign subsidiaries engaged in
manufacturing, research, development, marketing, and sales of
products in the U.S. and throughout the world. We refer to 3M Company
and its U.S. and foreign subsidiaries as “3M Global”.

1.     3M do Brasil Ltda. (or 3M Brazil); its 1952 agreement with 3M
       Company

      In 1946 Durex, Lixas e Fitas Adesivas Ltda. was established in
Campinas, Brazil. The corporation was organized as a sociedade
limitada under the laws of Brazil. The corporation was later operated
under the name Minnesota Manufactureira e Mercantil, Ltda. The
corporation was later renamed 3M do Brasil Ltda., which is the name it
used during the 2006 tax year. 4 We refer to the corporation as “3M
Brazil”. 3M Brazil has always been a subsidiary of 3M Company. 5

      In 1952, 3M Brazil agreed with 3M Company to pay royalties for
the use of 3M Company’s intellectual property and for support services.
The agreement provided that 3M Brazil would pay a royalty equal to
10% of the gross selling price of products sold by 3M Brazil. The
agreement may not have included any license of trademarks.

       In 1966, 3M Brazil’s payment obligation under the 1952
agreement was reduced to cover only a fee for technical assistance
services, which was equal to 5% of the gross selling price of 3M Brazil’s
products.

       3   3M Company was originally named the Minnesota Mining and
Manufacturing Company. It is occasionally described or referred to by that name in
the record.
        4 The corporation is occasionally referred to by its previous names in documents

in the record.
       5For the period before 1999, the record suggests that 3M Brazil was wholly
owned by 3M Company through direct or indirect ownership. However, the exact
ownership structure of 3M Brazil before 1999 is not clear.
        In 1999, there was a corporate restructuring under which 3M Brazil becamea
wholly owned second-tier subsidiary of 3M Company. This 1999 restructuring and the
resulting ownership structure of 3M Brazil is described in detail infra part7.
                                    12

      In 1969, 3M Company and 3M Brazil agreed to temporarily
suspend all percentage-based payments under the 1952 agreement to
accommodate the then financial position of 3M Brazil. The percentage-
based payment schedule under the 1952 agreement was permanently
replaced with a $1,000 per month fee effective July 1, 1969.

2.    The 1982 trademark licensing agreement

       In March 1982, 3M Company and 3M Brazil entered into a
trademark licensing agreement. Under its terms 3M Company granted
3M Brazil a nonexclusive license to use in Brazil certain trademarks
identified in the agreement. Article V, entitled “COMPENSATION”,
provided that 3M Company waived any right to receive royalties “for as
long as subsidiaries are prevented from paying royalties to parent
companies in accordance with legislation presently in force in * * *
Brazil.” 3M Company and 3M Brazil entered into amendments of the
1982 trademark licensing agreement dated February 9, 1983, June 21,
1983, October 2, 1984, July 16, 1985, May 16, 1990, and December 30,
1994. None of the amendments affected Article V of the 1982 trademark
licensing agreement.

3.    The 1983 licensing agreement

       In April 1983, 3M Company and 3M Brazil entered into a
licensing agreement that replaced the 1952 licensing agreement. Under
the terms of the 1983 licensing agreement, 3M Company granted 3M
Brazil a nonexclusive and nonassignable license to commercially exploit
certain patents identified in the agreement. The 1983 licensing
agreement also granted 3M Brazil a right to receive technical know-how
and technical assistance from 3M Company in connection with 3M
Brazil’s exploitation of the licensed patents. The 1983 licensing
agreement contained a provision, entitled “COMPENSATION”, which
stated that 3M Company “hereby waives any right to compensation for
the patent license and other licenses and rights granted herein, and
grants same free of charge to * * * [3M Brazil] for as long as subsidiaries
are prevented from paying compensation to parent companies for
industrial property in accordance with legislation currently in force in
Brazil.” The 1983 licensing agreement had no other provision regarding
payments by 3M Brazil.
                                  13

4.    The 1997 proposed licensing agreement

        During 1997, 3M Company considered the possibility of entering
into a royalty-bearing licensing agreement with 3M Brazil to replace the
1983 licensing agreement, which did not provide for royalties. 3M
Company drafted and signed a licensing agreement that was similar to
licensing agreements that it had entered into with other foreign
affiliates.   The 1997 proposed licensing agreement was never
countersigned by 3M Brazil and never went into effect.

      In Article II of the 1997 proposed licensing agreement, 3M
Company granted to 3M Brazil the following rights: (1) an exclusive and
nonassignable license to make, convert, process, and use certain
products in Brazil and (2) a nonexclusive and nonassignable license to
market, lease, distribute, and offer for sale the products.

       In Article III of the 1997 proposed licensing agreement, 3M
Company granted to 3M Brazil an exclusive but nonassignable license
to use manufacturing know-how to manufacture the products in Brazil.
3M Company also agreed to make manufacturing data available to 3M
Brazil. 3M Brazil agreed to reimburse 3M Company for costs specially
incurred in preparing and furnishing drawings, samples, plans,
specifications, and other data.

       In Article IV of the 1997 proposed licensing agreement, 3M
Company agreed to place at the disposal of 3M Brazil, on a nonexclusive
basis, technical service data in connection with marketing, leasing,
selling, and servicing of 3M Company products. 3M Company also
agreed to provide to 3M Brazil technical assistance services, including
instructing and training a reasonable number of technical and other
qualified trainer-personnel of 3M Brazil.

       In Article V of the 1997 proposed licensing agreement, 3M
Company granted to 3M Brazil a nonexclusive and nonassignable
license to use certain trademarks in Brazil on all licensed products
converted, processed, or distributed by 3M Brazil. 3M Brazil agreed to
pay all items of expense as might arise in Brazil in connection with the
maintenance and upkeep of the trademarks, and to pay all items of
expense as might arise in Brazil in connection with the enforcement of
the trademarks.

     In Article VI of the 1997 proposed licensing agreement, 3M
Company granted to 3M Brazil a nonexclusive license within Brazil to
                                         14

use and to sublicense to the dealers and customers of 3M Brazil works
and documents covered by certain copyrights in connection with 3M
Brazil’s sales and marketing activities.

       In Article VIII of the 1997 proposed licensing agreement, 3M
Brazil agreed, in consideration of and as compensation for the licenses,
undertakings, and other rights granted pursuant to Articles II, III, IV,
and VI, to pay 3M Company a royalty of 4% of the net selling price of
licensed products manufactured in Brazil (excluding sales to 3M
Company and its affiliates).

       The Brazilian Patent and Trademark Office (BPTO) is an agency
of the Brazilian government that has regulatory authority over
industrial property in Brazil, including the recordation of certain
licensing agreements providing for the transfer of industrial property. 6
The BPTO exercised this regulatory authority during the 2006 tax year. 7
As part of the recordation process, the BPTO permits the parties to a
proposed industrial-property agreement to consult with the BPTO
before formally submitting an agreement for recordation. The purpose
of this informal consultation process is for the BPTO to identify issues
or deficiencies with a proposed agreement that could preclude
recordation if not appropriately addressed by the parties before formal
submission.

       In July 1997, 3M Company engaged in the BPTO’s consultation
process and sought the BPTO’s views on whether the 1997 proposed
licensing agreement satisfied the legal requirements for recordation. To
this end, on July 30, 1997, 3M Company transmitted the 1997 proposed
licensing agreement to the BPTO for review.

       By letter dated October 16, 1997, the BPTO notified 3M Company
that the 1997 proposed licensing agreement was not in compliance with
“the legislation and/or rules usually adopted by” the BPTO for
recordation purposes. The letter identified deficiencies in the agreement
that required amendment or removal. This is an English translation of
the body of the letter:

       6  The BPTO is also known as the National Institute of Industrial Property, or
Instituto Nacional da Propriedade Industrial.
        7 A more detailed discussion of Brazilian intellectual-property law, including

the relevant BPTO practices and procedures, is found in paragraphs 71 to 91 of the
stipulation, which are quoted infra part 5.
                             15

Concerning the request of this company’s letter of July 30,
1997, we inform that the agreement attached to the above
process, shows the following aspects which do not agree to
the legislation and/or rules usually adopted by this
Institute.

1--Inclusion of matters which are not provided by art. 211
of Law

n˚ 9279/96--Clause VI--LICENSED COPYRIGHTS and
items 1.12 and 1.13.

2--Lack of justification for the acquisition of the non
patented technology, since the agreement refers to the
license of several patents.

3--Establishment of a global remuneration for all the
licenses referred to in the agreement, which creates
difficulties for analysis, since the agreement includes
licenses which need not to be recorded at Patent Office
(copyrights) and licenses for which no remuneration is due
(use of trademark, according to Law 8383/91, art. 50 and
Act. n˚ 436/58, item II). We also remind that the payment
of royalties shall only be considered if derived from issued
patents.

4--The term of duration of the agreement has not been
fixed. We remind that said term, regarding licenses
concerning industrial property rights, shall not exceed the
term of validity of the licensed rights and, as for know how
acquisition, 5 years, according to Law n˚ 8383/91 art. 50
and Law n˚ 4131/62, art. 12, § 3˚.

5--Inclusion of clauses which may create difficulties for the
working of the company, such as:

a) restriction of the territory for commercialization--item
2.01

b) the licensee shall be in charge of taking all steps and
shall pay all the expenses concerning industrial property
rights (items 2.04, 5.11 and 7.04)
                                  16

      c) Prevision [sic] that all intellectual property rights,
      resulting from patents modification work shall become
      property of the licensor--item 13.06 c (art. 63 of Law n˚
      6279/96).

      Finally, we inform that, according to the provision of art.
      50 of Law 8383/91, no additional payment is allowed for the
      technical assistance since the maximum remuneration
      allowed by Law is already established by the agreement.

        3M Company did not submit the 1997 proposed licensing
agreement to the BPTO for formal recordation. Had it done so without
addressing the deficiencies identified in the BPTO’s October 16, 1997
letter, the BPTO would not have recorded the 1997 proposed licensing
agreement for the reasons identified in that letter.

       After receiving the October 16, 1997 letter from the BPTO, 3M
Company considered whether it should attempt to record with the BPTO
an agreement narrower in scope than the 1997 proposed licensing
agreement. In particular, 3M Company considered two types of
agreements: (1) a licensing agreement for its patents and (2) a
technology-transfer agreement for its unpatented technology (such as
trade secrets and know-how).

       With respect to patents, 3M Company reviewed the intellectual
property supporting approximately 40 of the biggest selling products
manufactured by 3M Brazil. The purpose of the review was to identify
which products in that group were supported by Brazilian patents. 3M
Company concluded that only a small number of these products was
supported by Brazilian patents. On the basis of that review, 3M
Company decided not to conduct a similar review for products having
smaller sales. 3M Company was aware that many of the products
manufactured and sold by 3M Brazil (such as abrasives, adhesives,
tapes, and scouring products) were mature products and therefore were
not likely to have any remaining patent protection. It was also aware
that many of the products manufactured and sold by 3M Brazil were
subject to the low royalty ceilings imposed under Brazilian law with
respect to payments between Brazilian companies (such as 3M Brazil)
and controlling foreign companies (such as 3M Company). 3M Company
decided not to enter into a patent licensing agreement and instead to
enter into royalty-bearing trademark licensing agreements.
                                   17

       With respect to unpatented technology, 3M Company was advised
by its Brazilian attorneys that, in order to enter into such an agreement,
3M Company would be required to disclose certain trade secrets to the
BPTO. As a result, 3M Company was unwilling to enter into an
agreement with respect to unpatented technology, for fear that its trade
secrets might be disclosed by the BPTO to 3M Company’s competitors
and that disclosure could weaken trade secret legal protections for its
unpatented technology under the laws of the various countries where
3M Global does business. The advice that 3M Company received in this
regard was not entirely accurate because 3M Company was not, in fact,
required to disclose its trade secrets to the BPTO. Rather, the BPTO
requires only a general description of the technology being transferred,
such as the field or industry to which the technology relates.
Nonetheless, on the basis of the advice it received at the time, 3M
Company decided not to enter into a technology transfer agreement and
instead to enter into royalty-bearing trademark licensing agreements.

      After it received the October 16, 1997 letter, 3M Company
reevaluated its royalty-free arrangement with 3M Brazil regarding
trademarks. As explained in paragraph 65 of the stipulation (which we
adopt as findings of fact):

      Following receipt of the October 16, 1997 letter from the
      BPTO, 3M Company determined that it would change the
      licensing of its trademarks to 3M Brazil. 3M Company
      consulted Brazilian intellectual property counsel, who
      advised 3M Company that it would be possible to obtain up
      to a three percent trademark royalty on certain products
      by entering into three separate trademark licenses
      covering different sets of trademarks. Counsel advised 3M
      Company that if a product used multiple trademarks
      covered by three separate agreements, then 3M Brazil
      could pay up to a three percent trademark royalty. That
      advice was not accurate for the reasons discussed below at
      paragraph 94.

The reference to “paragraph 94” in the above text is a reference to
paragraph 94 of the stipulation, which is quoted infra part 5.
                                           18

5.      Termination of the 1982 trademark licensing agreement and the
        1983 licensing agreement; execution of the 1998 trademark
        licenses; stipulations related to Brazilian law

       On August 18, 1998, 3M Company and 3M Brazil entered into an
agreement terminating the 1982 trademark licensing agreement,
effective January 1, 1998.

      On August 18, 1998, 3M Company and 3M Brazil entered into an
agreement terminating the 1983 licensing agreement, effective January
1, 1998.

       Effective January 1, 1998, 3M Company and 3M Brazil entered
into three separate licensing agreements for the purpose of licensing 3M
Company’s trademarks to 3M Brazil (collectively, the “1998 trademark
licenses”). Each of the 1998 trademark licenses related to a separate set
of trademarks that was identified in the respective license. Under each
of the 1998 trademark licenses, 3M Company granted 3M Brazil an
exclusive, nonassignable license to use trademarks in Brazil. Under
each of the 1998 trademark licenses, 3M Brazil agreed to pay 3M
Company a royalty of 1% of the net selling price 8 of the products sold
bearing a trademark identified in the license.

      Effective March 1, 1999, the 1998 trademark licenses were
amended. This amendment, which we refer to as the 1999 amendment,
did not affect the particular terms of the 1998 trademark licenses that
were discussed in the paragraph above.

       In June 1999 the BPTO recorded each of the 1998 trademark
licenses, as amended by the 1999 amendment.

        The 1998 trademark licenses were in effect during the 2006 tax
year.

       Petitioner and respondent made the following stipulations
relating to Brazilian law and its effect on 3M Brazil, which we adopt: 9

        The net selling price is defined not to include the price of any product sold by
        8

3M Brazil to 3M Company or the price of a prepackaged product bought by 3M Brazil
from 3M Company and resold.
        9   Some errors in punctuation have been corrected.
                            19

       71. The BPTO, which is an agency of the Brazilian
government, was created by Law No. 5648/1970, dated
December 11, 1970, to replace the earlier National
Department of Industrial Property. During 2006, the
BPTO operated pursuant to the legal authority contained
in Law No. 9279/1996, dated May 14, 1996 (“the Brazilian
Industrial Property Law”). Under Law No. 9279/1996, the
BPTO was vested with regulatory authority over industrial
property in Brazil. Acting pursuant to Law No. 9279/1996,
the BPTO exercised regulatory control within Brazil over
the recordation of agreements providing for the licensing of
industrial property and the transfer of technology,
including agreements with foreign counterparties.

       72.   The Ministry of Finance is an executive
department in charge of economic policy and the treasury
of the Brazilian federal government. During 2006, the
Ministry of Finance operated pursuant to the legal
authority set forth under Law No. 7739/1989, dated March
16, 1989, and was regulated by Decree 5510, dated August
12, 2005, the latter being revoked and replaced on October
31, 2006 by Decree 5949. Under Brazilian law, a Decree is
a binding rule issued by the executive branch of the
Brazilian government. The responsibilities of the Ministry
of Finance include monetary policy, including currency and
coinage; federal tax policy, including collection and
enforcement of tax laws; management of federal finances
and assets, including management of the Brazilian public
debt; public accounting; oversight and control of cross-
border trade; and oversight of financial institutions.

       73. During 2006, the Brazilian Central Bank was
the principal monetary authority in Brazil. Prior to the
establishment of the Brazilian Central Bank in 1964, the
monetary authority of Brazil was vested, in part, in the
Agency for Currency and Credit (“SUMOC”). In 1964, the
Brazilian Central Bank replaced SUMOC as the principal
monetary authority in Brazil.

       74. Law No. 4131/1962, dated September 3, 1962
(also known as the “Foreign Capital Law”), was enacted by
the Brazilian government for the purpose of regulating
foreign capital and remittance of funds abroad. Article 9 of
                             20

Law 4131/1962 provided that before any royalties relating
to patents or trademarks, payments relating to the transfer
of technology, or fees for technical assistance services could
be remitted abroad, evidence of the agreement providing
for such payments had to be submitted to SUMOC.
“Technical assistance services” are those provided by
persons with technical backgrounds, such as engineers,
chemists and biologists. Such services provide expertise in
the use of patented or unpatented technology. They are
distinguished from “consulting services” which are not
directly related to the use of patented or unpatented
technology. Consulting services include advice relating to,
for example, management, finance, law, marketing,
logistics, and information technology.

      75.

       a. On February 16, 1972, the Inspection and
Registration of Foreign Capital of the Central Bank
(“FIRCE”), a regulatory agency under the Brazilian
Central Bank, issued Comunicado FIRCE No. 19, an
instruction regarding the application of Article 9 of Law
No. 4131/1962. That instruction, known as Regulation No.
19, required that a party seeking to remit payments in
foreign currency abroad pursuant to an agreement that is
subject to registration at the Brazilian Central Bank must
produce evidence establishing that the agreement has been
recorded by the BPTO.

       b. Regulation No. 19 was later superseded by the
establishment of an electronic system of registration of
agreements at the Central Bank, which was implemented
by Circular No. 2816, dated April 15, 1998, and regulated
by Circular-Letter No. 2795, dated April 15, 1998. Under
Brazilian law, Circulars and Circular-Letters are binding
written orders issued by the Central Bank to government
employees and regulated entities. Circular-Letter No.
2795 expressly revoked Regulation No. 19. It required that
a party seeking to remit payments abroad pursuant to an
agreement that is subject to registration at the Brazilian
Central Bank must produce evidence establishing that the
agreement has been recorded by the BPTO.              This
                            21

requirement applied to all contracting parties, regardless
of relation, and remained in effect during 2006.

      c. Before authorizing a remittance of funds abroad,
the Brazilian Central Bank does not conduct an
independent review of the terms and conditions of an
agreement recorded with the BPTO for purposes of
determining compliance with the applicable laws,
regulations, and BPTO policies or procedures.

       76. Under Articles 62, 140, and 211 of the Brazilian
Industrial Property Law (which articles were included in
Law No. 9279/1996 and became effective on May 15, 1997),
as well as under Normative Act 135/1997, a binding
administrative regulation issued by the BPTO in 1997, the
following agreements are subject to recordation by the
BPTO:

      a. patent/industrial design license;

      b. trademark license;

      c. technology transfer (relating to unpatented
      technology);

      d. technical assistance services; and

      e. franchise.

       77. Agreements related to consulting services,
copyright licensing and software licensing are not among
the agreements specified in Articles 62, 140, and 211 of the
Brazilian Industrial Property Law as being subject to
recordation by the BPTO. Consulting services agreements,
copyright licenses and software licenses are not required
by law to be recorded at the BPTO. Recordation is not
required for payments to be made under such agreements,
including payments by Brazilian subsidiaries to their
controlling foreign parent companies. This continued to be
the law during 2006.

      78. Recording an agreement subject to recordation
by the BPTO is necessary for the following purposes:
                             22

        a. To permit the remittance to a foreign person of
(i) royalties for patents or trademarks, (ii) payments for
technology transfer (relating to unpatented technology), or
(iii) payments for technical assistance services (according
to Law No. 4131/1962 and Circular-Letter 2795);

       b. To qualify a licensee for deductions under
Brazilian tax law (according to Law No. 4131/1962 and
Law No. 4506/1964, dated November 30, 1964); and

      c. To make the agreement effective against third
parties (according to Law No. 9279/1996).

Unless one or more of the foregoing purposes are desired
by the contracting parties, recordation by the BPTO is not
required or necessary under Brazilian law.

        79. It is the BPTO’s internal policy to permit a party
to a license agreement that is subject to recordation by the
BPTO to initiate a consultation procedure, prior to
presenting the agreement for recordation, in order to
obtain the views of the BPTO regarding whether the
agreement satisfies the legal, regulatory, and BPTO policy
requirements for recordation.

       80. Article 14 of Law No. 4131/1962 instituted a
complete prohibition of the ability of Brazilian subsidiaries
of foreign companies to remit royalties abroad to their
controlling parent companies for the use of patents and
trademarks. Given this prohibition, prior to January 1,
1992, the BPTO would not record royalty-bearing patent or
trademark license agreements. Although Article 14 of Law
No. 4131/1962 expressly imposed a prohibition that applied
only to royalties for the use of patents and trademarks, the
BPTO interpreted the prohibition as applicable to fees paid
for technical assistance services and payments for the
transfer of unpatented technology between Brazilian
subsidiaries and controlling foreign companies providing
for remittances abroad. No similar prohibition applied to
unrelated companies. At all relevant times, including
during the 2006 tax year, both 3M Company and 3M IPC
                                        23

       were controlling foreign companies with respect to 3M
       Brazil for purposes of applying Brazilian law.[10]

              81. Article 43 of Law No. 4131/1962 imposed
       supplemental income taxes on dividends paid to foreign
       shareholders prior to 1992 that were in addition to a 25
       percent withholding tax imposed on the foreign recipient.
       Article 43 of Law No. 4131/1962 also imposed a
       supplemental income tax on the foreign recipient of
       dividends whenever the average remittances in a three-
       year period exceeded a specified percentage of the foreign
       shareholder’s equity interest and capital reinvestments in
       the Brazilian company. For average remittances of
       between 12 percent and 15 percent, the supplemental
       income tax rate was 40 percent; for average remittances of
       between 15 percent and 25 percent, the supplemental
       income tax rate was 50 percent; for average remittance in
       excess of 25 percent, the supplemental income tax rate was
       60 percent. In addition, Article 44 of Law No. 4131/1962
       provided that the supplementary income tax on dividends
       would be increased by an additional 20 percent in the case
       of companies with economic activities that were deemed of
       lesser importance to the national economy, as determined
       by regulations.

               82.

              a. On December 30, 1991, the Brazilian government
       enacted Law No. 8383/1991, which repealed in its entirety
       the supplemental income tax on dividends under Articles
       43 and 44 of Law No. 4131/1962, and repealed, in part, the
       prohibition on the remittance of royalties between
       Brazilian companies and controlling foreign companies
       contained in Article 14 of Law No. 4131/1962.           In
       particular, Law No. 8383/1991 permitted a Brazilian
       company to remit royalties to its controlling foreign
       company to the extent such payments were made

       10 As described infra part 7, in 1999 3M Company created a second-tier wholly

owned U.S. subsidiary, 3M Innovative Properties Company (“3M IPC”) and transferred
much of its intellectual property to 3M IPC. 3M Brazil was a wholly owned subsidiary
of 3M IPC.
                            24

deductible for Brazilian tax purposes under Article 50 of
Law No. 8383/1991.

       b. Accordingly, after December 31, 1991, the BPTO
began to record royalty-bearing patent and trademark
license agreements between Brazilian companies and
controlling foreign companies providing for remittances
abroad, provided that the amounts payable under such
agreements did not exceed the tax deductibility limitations
and provided that the agreements were otherwise in
compliance with the policies and procedures of the BPTO
and other applicable laws and regulations governing
industrial property transactions. The BPTO extended this
permission to technology transfer agreements and to
technical assistance services agreements between
Brazilian companies and controlling foreign companies.

       c. After the enactment of Law No. 8383/1991, if the
BPTO recorded a royalty-bearing patent or trademark
license agreement or technology transfer agreement
between a Brazilian company and a controlling foreign
company, then the amounts payable under such an
agreement could be remitted abroad to the foreign
company, subject to the fixed ceilings discussed in
paragraphs 89 and 90 of this Stipulation of Facts. In
addition, the Brazilian company could deduct such
payments for Brazilian tax purposes in accordance with
Article 50 of Law No. 8383/1991, subject to the fixed
ceilings discussed in paragraphs 87 and 88 of this
Stipulation of Facts. This was the law in 2006.

       83. The Brazilian Central Bank could impose a fine
on a Brazilian licensee of up to R$250,000 pursuant to
Article 58 of Law No. 4131/1962 and Provisional Measure
No. 2224, dated September 4, 2001, if the licensee made an
unauthorized remittance by either (a) making payments to
a foreign person (controlling or noncontrolling) without
prior recordation of an agreement required to be recorded
at the BPTO, or (b) making payments to a foreign
controlling entity in amounts exceeding the fixed ceilings
described in paragraphs 89 and 90 of this Stipulation of
Facts. The Brazilian Central Bank could also impose a
monetary penalty, pursuant to Article 23 of Law No.
                                         25

       4131/1962, of up to 300 percent of the non-authorized
       remitted amount on the licensee, the bank involved in
       remitting the funds, and any transactional broker. In
       addition, the Brazilian Central Bank could require the
       repayment of any such unauthorized remittance pursuant
       to item 3, Chapter 7 Title 1 of Circulars 3280/2005 and
       3325/2006, issued by the Brazilian Central Bank. This was
       the law in 2006.

              84. After the enactment of Law No. 8383/1991, the
       BPTO adopted the administrative position that, if a certain
       trademark or patent had been licensed prior to January 1,
       1992, by means of an agreement recorded with the BPTO
       on a royalty-free basis (because of the prohibition
       instituted by Article 14 of Law 4131/1962), the same
       trademark or patent could not be licensed on a royalty-
       bearing basis under a new agreement signed and recorded
       after January 1, 1992. This internal policy of the BPTO,
       which was in effect during 2006, was amended in 2009
       when the BPTO issued a formal opinion explaining that
       royalty payments would be allowed on a prospective basis,
       even if the licensed trademark or patent had been licensed
       free of charge prior to January 1, 1992. Although this was
       the policy of the BPTO during 1998, when the 1998
       Trademark Licenses[11] were recorded, the BPTO through
       an error did not apply this policy to the 1998 Trademark
       Licenses.     The BPTO recorded the 1998 Trademark
       Licenses although some of the covered trademarks had
       been previously covered by the 1982 Trademark Licensing
       Agreement.[12]

             85. Brazil’s Industrial Property Law (Law No.
       9279/1996) does not treat unpatented technology (such as
       trade secrets and know how) as industrial property. The
       BPTO does not consider unpatented technology to be a
       proprietary right that can be licensed. The BPTO does,
       however, record technology transfer agreements providing

       11 Elsewhere in this Opinion, the 1998 Trademark Licenses are referred to as
the 1998 trademark licenses (i.e., without capitalization).
        12 Elsewhere in this Opinion, the 1982 Trademark Licensing Agreement is

referred to as the 1982 trademark licensing agreement (i.e., without capitalization).
See supra part 4.
                            26

for the sale of unpatented technology.       This was the
internal policy of the BPTO in 2006.

      86.

       a.    During the mid-1990’s, Brazil altered the
legislation related to the corporate income tax.          In
particular, Law No. 9249/1995, dated December 26, 1995,
established a worldwide income tax on the net profits of
corporations domiciled in Brazil. One of the corporate tax
regimes adopted in Brazil is a combination of (i) the so-
called “real profit” regime, which adopts accounting records
of revenues and expenses, adjusted by additions and
exclusions determined by law, and (ii) a social contribution
payment based upon net profits. Taxable profits, if any,
are then taxed at a combined tax rate up to 34 percent.

       b. Roughly a year after the enactment of Law No.
9249/1995, the Brazilian government enacted Law No.
9430/1996, dated December 27, 1996, which established a
system of transfer pricing rules in Brazil to address, among
other things, pricing and taxation of cross-border
transactions between related corporations. Although the
transfer pricing methodologies under the Brazilian tax
system are, in some respects, similar to the methodologies
set forth in the guidelines published by the international
Organization for Economic Cooperation and Development
(“OECD”), Brazil’s transfer pricing regime also deviates in
some respects from the OECD transfer pricing guidelines.
For example, instead of applying the general “arm’s length
principle” embodied in the OECD guidelines as the guiding
principle for pricing of intercompany transactions, a
number of Brazilian transfer pricing rules provide for
statutory-based tests, such as fixed profits margins,
maximum ceilings for deductibility of expenses on imports,
minimum gross income floors for exports, and limitations
on the deductibility of interest expenses based upon fixed
rates and ranges.

       c. Under paragraph 9 of Article 18 of Law No.
9430/1996, transactions involving patent or trademark
royalties, technology transfer payments, or payments for
technical assistance services in connection with the
                                          27

       transfer of intangibles are exempt from the transfer pricing
       regime. Deductibility of these amounts is governed by the
       fixed ceilings discussed in paragraph 87 of this Stipulation
       of Facts.

              87. Brazilian tax law imposes fixed ceilings on the
       deductibility of royalties for trademarks and patents and
       for remuneration paid for technology transfer and
       technical assistance services. The ceilings were initially
       established by Article 74 of Law No. 3470/1958, dated
       November 28, 1958, which introduced a cap on the amount
       deductible as royalties for the license of trademarks and
       patents, and also on the amount deductible for
       remuneration paid for technology transfer and technical
       assistance services. Law No. 3470/1958 established a
       maximum deductibility limit of five percent of the gross
       sales price of products manufactured and sold under
       license, technology transfer, or technical assistance
       services agreements. Law No. 3470/1958 also provided
       that the maximum deductibility limit of five percent would
       be reviewed periodically by the Brazilian Ministry of
       Finance and adjusted according to the degree of
       essentiality of the industries or activities involved, so that
       it could be less than five percent.

               88.

              a. Acting pursuant to Law No. 3470/1958, the
       Brazilian Ministry of Finance in 1958 promulgated
       Portaria No. 436/58, which established decreasing
       maximum deductibility ceilings, ranging from five percent
       to one percent of gross sales, in connection with (i) royalties
       paid for the license of patents; (ii) technology transfer
       payments for unpatented technology (see paragraph 90 of
       this Stipulation of Facts); and (iii) amounts paid for
       technical assistance services.[13] Under Brazilian law, a

        13 Petitioner and respondent have stipulated the English translation of the text

of Portaria No. 436/58. See paragraph 88c of the stipulation; Exhibit 28-J. We gather
from the English translation that Portaria No. 436/58 additionally established a
maximum deductibility ceiling of 1% for royalties for the use of trademarks. This may
be the same as the 1% cap that is referred to in paragraph 88.e of the stipulation.
                            28

Portaria is a binding        rule   promulgated    by   an
administrative agency.

        b. By Article 6 of Decree-Law No. 1730/1979, dated
December 17, 1979, the percentage limitation on
deductions, which initially applied to gross sales of
products covered by licensed technology, was amended so
as to apply to net sales of such products. Under Decree-
Law No. 1598/1977, dated December 26, 1977, and
confirmed by Rule-Making Instruction No. 51, dated
November 3, 1978, net sales are calculated by reducing the
following amounts from gross sales: (1) products returned
and canceled sales; (2) discounts granted on an
unconditional basis; and (3) taxes levied thereon. This was
the law in 2006. In addition, it was the BPTO’s unwritten
policy in 2006 to require, for purposes of computing net
sales for patent royalties and technology transfer
agreements, that gross sales be reduced by the amounts set
forth in Decree-Law No. 1598/1977, as well as by the cost
of all inputs or components imported from the supplier of
technology or from parties related to the supplier,
regardless of whether such inputs or components were
manufactured by the supplier or third parties. A Decree-
Law is a binding law that was issued by the executive
branch during the military dictatorship that ruled Brazil
between 1964 and 1985.

       c. The percentages under Portaria 436/58 were
applied to a comprehensive list of industries and products
identified in the Portaria. In 1959, 1970 and 1994, the
Ministry of Finance promulgated Portaria Nos. 113/59,
314/70 and 60/94, setting maximum deductibility ceilings
for the cement, glass and informatics industries,
respectively. Copies of these Portarias (in the original
Portuguese version followed by an English translation) are
attached as Exhibits 28-J, 29-J, 30-J and 31-J. These
Portarias were in effect during 2006. They apply to the
deductibility of any (i) royalty payments made for the
license of patents, (ii) technology transfer payments for
unpatented technology (see paragraph 90 of this
Stipulation of Facts), and (iii) amounts paid for technical
assistance services, regardless of whether such royalties
were paid in a related or unrelated party transaction.
                            29

Royalties paid that exceed the deductible amount, to the
extent such payments are otherwise permitted, are not
deductible for Brazilian tax purposes. This was the law in
2006.

       d. To the extent that the contracting parties are not
able to determine to which product category a particular
product belongs, the parties may apply for an
administrative consultation, in which the Ministry of
Finance may indicate the appropriate rate ceiling for the
tax deduction under the Portarias. This practice was in
place during 2006.

       e. The deduction permitted for the payment of
royalties for the license of trademarks is capped at one
percent of net sales, regardless of the type of industry or
product involved. This restriction was in effect during 2006
and applies to the deductibility of any royalty payments
made for the license of trademarks, regardless of whether
such royalties were paid in a related or unrelated party
transaction.    Royalties paid pursuant to trademark
licenses that exceed the deductible amount, to the extent
such payments are otherwise permitted, are not deductible
for Brazilian tax purposes. This was the law in 2006.

       f. The Federal Revenue Service, which is a division
of the Ministry of Finance, interpreted Portaria 436/58 in
Decision No. 283 (November 30, 2000), a copy of which (in
the original Portuguese version followed by an English
transaction) is attached as Exhibit 32-J. According to
Decision No. 283, the deduction for royalties under a
license of trademarks is capped at one percent of net sales
for each product, even if more than one trademark is used
on the product. In addition, the Decision further provides
that no deduction for trademark royalties is allowable
when the use of the trademark derives from the use of a
patent, manufacturing process, or formula. As a result, the
Ministry of Finance will not permit a taxpayer to deduct
trademark royalties if a deduction was already claimed on
the same product for the license of patents, or for the use
of manufacturing processes or formulas. Under Brazilian
law, a Decision is a ruling by an administrative agency
made in the context of a particular case or consultation.
                             30

Although a Decision does not have any binding effect
beyond the parties to the case, a Decision functions as a
precedent to be followed by the administrative agency in
future cases involving similar facts.

       89. Since January 1, 1992, and the enactment of
Law No. 8383/1991, the BPTO has imposed fixed ceilings
on amounts payable by a Brazilian company to a
controlling foreign company under a patent or trademark
license agreement. See paragraph 82 of this Stipulation of
Facts. The ceilings, which were in place during 2006,
correspond to the ceilings for tax deductibility set forth in
Portaria 436/58, as amended. See paragraph 88 of this
Stipulation of Facts. The BPTO will not record an
agreement between a Brazilian company and a controlling
foreign company that does not comply with these ceilings.
These ceilings do not apply to agreements and payments
between unrelated companies.

       90. Under its interpretation of Law Nos. 4131/1962
and 8383/1991, the BPTO also applies the same fixed
ceilings that apply to royalties under a patent or trademark
license agreement to payments under an agreement
between a Brazilian company and a controlling foreign
company providing for the transfer of unpatented
technology (“technology transfer payments”) and also to
payments for technical assistance services.             This
interpretation is not published. The BPTO applied this
interpretation during 2006.

       91. The base against which royalties are calculated
under licensing agreements recorded at the BPTO
generally differs between payments for trademark
royalties and payments for patent royalties or transfers of
unpatented technology.         With respect to trademark
royalties, it is the general practice for licensing agreements
to calculate the one percent royalty based upon the net
sales of all trademarked merchandise sold by the licensee
(whether or not manufactured by the licensee), using the
definition of net sales under [Decree-]Law No. 1598/1977.
Conversely, it is the general practice to calculate patent
royalties and technology transfer payments (which, as
described above, range from one percent of net sales to five
                             31

percent of net sales) based upon the net sales of products
manufactured and sold by the licensee that incorporate
patented or unpatented technology. These are general
practices that are not required by Brazilian law or BPTO
policy.

       92. It is the BPTO’s policy to limit the duration of a
technology transfer agreement to a maximum of five years.
As an exception to the general rule, if the parties can
objectively demonstrate to the BPTO the need to continue
the technology transfer, the BPTO may allow duration of a
technology transfer agreement to be renewed for one
additional five-year term. At the end of the five or ten-year
period, the BPTO requires that the transferee be entitled
to use the unpatented technology without further payment.
This maximum term for a technology transfer agreement
is not established in the Industrial Property Law (Law No.
9279/1996) or in any other law or regulation, but results
from the application, by analogy, of Law No. 4131/1962,
which provides that technical assistance services fees paid
under technology transfer agreements may be deducted
during only the first five years of the agreement, renewable
for one additional five year term. Limiting the duration of
technology transfer agreements as described above was the
policy of the BPTO in 2006. This policy was not published.

       93. The BPTO will not record one or more licensing
agreements between a Brazilian company and a controlling
foreign company providing for a license of patents or
trademarks or providing for the transfer of unpatented
technology if such agreement or agreements relate to the
same product and call for royalties or payments that,
combined, exceed the deductibility limits under Brazilian
tax law. In such a case, the deductibility limitation
represents the maximum allowable payment, even if more
than one category of royalty or payment is involved. The
BPTO normally requests that the parties precisely indicate
which category of royalty is being paid. This was the policy
of the BPTO in 2006. This policy was not published.
                             32

      94.

       a. If a product is covered by a patent license or by a
technology transfer agreement between a Brazilian
company and a controlling foreign company, then the
BPTO by unwritten policy requires that any trademark
license between the same Brazilian company and the same
controlling foreign company for that same product be
granted royalty-free. If a trademark royalty may be paid
under that policy, the BPTO by unwritten policy requires
that the royalties for the license of trademarks payable by
a Brazilian company to a controlling foreign company must
be capped at one percent of net sales for each product, even
if more than one trademark is used on the product. These
unwritten policies of the BPTO were in effect at the time
that the 1998 Trademark Licenses were recorded and
during 2006, and they remain in effect. These unwritten
policies of the BPTO correspond to the administrative
ruling set forth in Decision No. 283 (Exhibit 32-J),
described in paragraph 88.f, above.

      b. As described above at paragraphs 65-68, 3M
Company and 3M Brazil entered into three licensing
agreements, the 1998 Trademark Licenses, covering three
separate sets of trademarks. The BPTO recorded them in
June 1999. 3M Company had received erroneous legal
advice that if a product used multiple trademarks covered
by three separate agreements, then 3M Brazil could pay a
royalty of up to three percent of net sales (one percent for
each trademark covered by a separate agreement, as
described in paragraph 65 above). That legal advice was
contrary to the BPTO’s unwritten policy that the maximum
trademark royalty for a product is one percent of net sales,
regardless of how many licensed trademarks are identified
on the product.

       c. The three 1998 Trademark Licenses (Exhibits 20-
J, 21-J and 22-J) described the trademarks but did not
describe the products on which the trademarks would be
used. The parties have not been able to determine whether
3M Brazil submitted additional information to the BPTO
indicating that 3M Brazil would use trademarks covered
by different licensing agreements on a single product and
                              33

pay more than a one percent royalty. However, 3M Brazil
did pay 3M Company trademark royalties of up to three
percent on products bearing trademarks covered by more
than one licensing agreement based on the erroneous legal
advice that it received.

       95. Article 63 of the Brazilian Industrial Property
Law (Law No. 9279/1996) provides that any improvement
introduced in a licensed patent belongs to the party that
made the improvement. The other party is entitled to a
right of first refusal to obtain a license of the improvement.
Although the law refers to patents (and not to unpatented
technology), the BPTO applies this rule to unpatented
technology by analogy. If an agreement contains a
provision contrary to this rule and does not require the
licensor to make additional payment for the improvements
or reciprocate in some equivalent fashion, the BPTO may
record the agreement but with a notation that such
provision is not enforceable. This was the policy of the
BPTO in 2006. This policy was not published.

       96. If a license agreement contains one or more
provisions that the BPTO considers to be burdensome to a
licensee’s rights, the BPTO will generally notify the parties
that the BPTO considers such provisions to be burdensome,
but the inclusion of such provisions will not interfere with
the BPTO’s recordation of the agreement. This was the
policy of the BPTO in 2006. The policy was not published.

       97. Based upon its interpretation of the Industrial
Property Law (Law No. 9279/1996), the BPTO does not
permit the payment of royalties for patent and trademark
applications. However, in the case of patent applications,
royalties can be charged and credited in a licensee’s
financial statements, but payment can be made only after
the grant of the patent. This was the policy of the BPTO in
2006. This policy was not published.

       98. Brazilian law allows 3M Brazil, as a sociedade
limitada, to make two kinds of distributions out of its
profits to its shareholders in respect of its shares: dividends
and interest on net equity.
                              34

       99. Dividends can be paid by a Brazilian sociedade
limitada to the extent of its current and retained earnings,
as determined using Brazilian generally accepted
accounting principles.       Apart from this limitation,
Brazilian law imposes no restriction on the ability of a
sociedade limitada to pay dividends abroad to its
shareholders, including to a controlling foreign company,
and authorization from the Central Bank of Brazil is not
required. Dividends of a sociedade limitada must be
declared by the shareholders. Dividends are not deductible
by the company paying the dividend under Brazilian tax
law. Dividends are not taxable income to the recipient
under Brazilian tax law. Brazil does not impose a
withholding tax on dividends paid by a Brazilian company
to a foreign shareholder. This was the law in 2006.

       100. As a sociedade limitada, 3M Brazil is allowed
under Brazilian law to pay interest on net equity. Interest
on net equity must be declared by the shareholders of a
sociedade limitada. Interest on net equity is calculated by
applying a long term interest rate set by the Brazilian
government (the “Taxa de Juros de Longo Prazo”), to the
company’s equity (i.e., net assets). The amount that can be
paid as interest on net equity is limited to greater of: (i) 50
percent of the entity’s profits of the current year; or (ii) 50
percent of the entity’s accumulated profits (not including
profits of the current year). Apart from this limitation,
Brazilian law imposes no restriction on the ability of a
sociedade limitada to remit interest on net equity abroad
to its shareholders, including to a controlling foreign
company, and authorization from the Central Bank of
Brazil is not required. Under Brazilian tax law, interest
on net equity is (subject to the previous limitations)
deductible by the company paying the interest on net
equity, and is taxable income to the recipient. Brazil
imposes a withholding tax on interest on net equity paid to
foreign recipients. The withholding tax rate applicable to
payments to United States shareholders is 15 percent. The
Brazilian entity that makes the payment is required to
withhold the withholding tax, and the tax is not a credit
against any other tax imposed under Brazilian law. This
was the law in 2006.
                                 35

            101. Under Brazilian income tax law, withholding
     is generally required on cross-border payments made by a
     Brazilian company to a foreign company in the following
     amounts: 25% with respect to payments for services; 15%
     with respect to royalty payments for patents and
     trademarks; 15% with respect to payments under
     technology transfer agreements (i.e., unpatented
     technology); and 15% with respect to payments for
     technical assistance services. These are the withholding
     rates applicable where the recipient of a payment is
     resident in the United States because there is no tax treaty
     between Brazil and the United States and the United
     States is not considered a tax haven. The withholding
     rates may differ where the recipient is a resident of a
     country having a tax treaty with Brazil or of a country that
     is considered a tax haven. The Brazilian entity that makes
     the payment is required to withhold the withholding tax,
     and the tax is a not credit against any other tax imposed
     under Brazilian law. This was the law in 2006.

            102. Brazil imposes a CIDE (Contribuição sobre
     Intervenção no Domínio Econômico) tax. The CIDE tax is
     imposed at the rate of ten percent on payments of royalties,
     technical assistance services, copyrights, and other
     compensation derived from contractual obligations
     involving the transfer of technology, made by a Brazilian
     company to a foreign company. The CIDE tax is not a
     withholding tax. It is imposed on the Brazilian paying
     company. This was the law in 2006.

           103.    The BPTO’s authority does not include
     supervision over the payment of dividends or interest on
     net equity.

6.   Texts of certain Brazilian legal documents referred to in the
     stipulations related to Brazilian law

       Certain Brazilian legal documents were referred to in the
stipulations that we quoted supra part 5:
                                      36

 Exhibit number of legal     Stipulation paragraph     Title of legal document
       document                that refers to legal
                                   document
          28-J                        88.c            Portaria No. 436/58
          29-J                        88.c            Portaria No. 113/59
          30-J                        88.c            Portaria No. 314/70
          31-J                        88.c            Portaria No. 60/94
          32-J                        88.f            Decision No. 293 (Nov. 30,
                                                      2000)

The original documents are in Portuguese. Petitioner and respondent
have stipulated the English translations of the documents, which we
reproduce below.

      The English translation of Exhibit 28-J (Portaria 436/58) is:

                           MINISTRY OF FINANCE

                      OFFICE OF THE MINISTER

             DIRECTIVE 436 of December 30, 1958

             The Minister of Finance, exerting the authority
      conferred upon him and in view of the provisions referred
      to in Article 74, paragraphs 1 and 2 of Law 3470, of
      November 28, 1958, pertaining to the deduction of royalties
      for the use of trademarks and patents, expenses for
      technical, scientific, administrative and similar assistance,
      as well as amortization quotas for patents, in ascertaining
      the real profits of legal entities, decides:

             a) to establish the following maximum percentual
                coefficients for the above mentioned deductions,
                taking into consideration the types of production
                or activity, according to their degree of
                essentiality:

                     I--royalties for the use of invention patents,
                     manufacturing processes and formulas,
                     expenses       for    technical,     scientific,
                     administrative and similar assistance:
                                         37

FIRST GROUP--BASIC INDUSTRIES

Type of production                                                   Percentage

1. Electric Power
   01--Production and distribution . . . . . . . . . . . . . . . . . 5%
2. Fuel
   02--Petroleum and by-products . . . . . . . . . . . . . . . . . . 5%
3. Transportation
   03--Street-car transportation . . . . . . . . . . . . . . . . . . . 5%
4. Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
5. Transportation materials
   01--Automobiles, trucks and similar vehicles . . . . . . 5%
   02--Parts thereof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
   03--Tires and tubes . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
6. Fertilizers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
7. Basic Chemicals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
8. Heavy Metallurgy
   01--Iron and Steel . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
   02--Aluminum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
9. Electrical Material
   01--Transformers, Dynamos and Generators . . . . . . . 5%
   02--Electric motors for industrial use . . . . . . . . . . . . 5%
   03--Telephonic, telegraphic and signalling
       equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
10. Miscellaneous
    01--Tractors and Combines for agriculture . . . . . . . . 5%
    02--Equipment for Road Construction, and parts
         thereof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
    03--Equipment for the extractive and transformation
        industries, and parts thereof . . . . . . . . . . . . . . . . 5%
11. Shipbuilding
    01--Ships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
    02--Equipment for ships . . . . . . . . . . . . . . . . . . . . . . . 5%
                                         38

SECOND     GROUP—PROCESSING                                      INDUSTRY—
ESSENTIALS

Type of Production                                                   Percentage
1. Packaging Equipment . . . . . . . . . . . . . . . . . . . . . . . . . 4%
2. Foodstuffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4%
3. Chemicals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4%
4. Pharmaceuticals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4%
5. Textile materials, yarn and thread . . . . . . . . . . . . . . . 4%
6. Footwear and similar goods . . . . . . . . . . . . . . . . . . . . 3.5%
7. Manufactured metal goods . . . . . . . . . . . . . . . . . . . . 3.5%
8. Manufactured cement and asbestos goods . . . . . . . . 3.5%
9. Electric material . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3%
10. Machinery and appliances
    01--Household appliances, not classified as
        sumptuary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3%
    02--Office machinery and appliances . . . . . . . . . . . . 3%
    03--Appliances for scientific use . . . . . . . . . . . . . . . . 3%
11. Rubber and plastic manufactured goods . . . . . . . . . . 2%
12. Sanitary and toilet goods
    01--Shaving articles . . . . . . . . . . . . . . . . . . . . . . . . . . 2%
    02--Toothpaste . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2%
    03--Regular bathing soap . . . . . . . . . . . . . . . . . . . . . 2%
13. Other processing industries . . . . . . . . . . . . . . . . . . . . 1%

                   II--royalties for the use of industrial and
                   commercial trademarks or trade name, in any
                   type of production or activity, when the use of
                   the trademark or name does not derive from
                   the utilization of the patent; manufacturing
                   process, or formula: 1%

         b) The maximum percentages established will incur
            on the gross operating income, in the case of
            public service concessionaries, or on the gross
            receipt value of products referred to in the license
            or assistance services contracts;

         c) in cases of payment based on goods produced
            each year, the coefficients established as a limit
            for the deductions referred to in numbers I and II
            of (a) will be applied on the sales value of the
            goods;
                            39

      d) should the situation in (c) occur, the gross receipt
         shall be readjusted, including the corresponding
         value of goods produced and not sold, on the basis
         of the last invoiced price and excluding the
         amounts that may have been added in the same
         way to the gross receipt of the previous year;

      e) for tax purposes, as of 1959, to each fiscal year
      there shall be an addition of the following
      differences:

             I--between the amounts of royalties and other
             expenses referred to in article 74 of the
             mentioned Law, credited or paid during the
             base-year, and the minimum percentages
             established for the respective deduction,
             according to (b) and (d);

             II--between the quotas for the purpose of
             forming depreciation reserves for industrial
             patents evaluated in accordance with article
             68 of the same Law, and the maximum limit
             of the deduction allowed, with respect to the
             gross receipt value of the goods sold, referring
             to the patent incorporated in the assets of the
             company;

      f) the legal entities whose types of production are
      not included in the aforementioned groups may have
      them included by applying to the Director of the
      Income Tax Division; until such application is made,
      the minimum percentage allowed shall be applied to
      such types of production.

                     LUCAS LOPES

      (Official Gazette, December 30, 1958)

The English translation of Exhibit 29-J (Portaria 113/59) is:
                            40

                   MINISTRY OF FINANCE

              OFFICE OF THE MINISTER

      DIRECTIVE 113 of May 25, 1959

             The Minister of Finance decides:

      To include in Directive 436, of December 30, 1958,
number I -- First Group -- Basic Industry, the cement
industry, with a percentage of 5%, in view of its degree of
essentiality and in accordance with reports from the
Income Tax Division and the General Management of the
National Treasury.

                      LUCAS LOPES

File n˚ 9413-59.

(Official Gazette, May 29, 1959).

The English translation of Exhibit 30-J (Portaria 314/70) is:

Ordinance/MF n˚ 314/70. Includes the 2nd Group--
processing industry

Eng. MF 314/70--Port.--Ordinance FINANCE MINISTER
OF--MF n˚ 314 of 25.11.1970

D.O.U.: 12/01/1970

(Includes the 2nd Group--Manufacturing Industry--
Essential--of the table Ordinance No. 436, of December 30,
1958, with the percentage of 4%, glass and glass artifacts,
for the purposes referred to in the Article 12 of Law No.
4131 of 3 September 1962.)

The Minister of Finance, in exercise of the powers
conferred on it by Article 12, § 1 of Law No. 4,131, of
September 1962, and Considering the need to improve the
national glass industry by importing the latest technical
achievements in the sector; considering the wide range of
applications of the products of that industry.
                             41

RESOLVES:

Include in the 2nd Group -- Manufacturing Industry --
Essential -- of the table Ordinance No. 436, of December
30, 1958, with the percentage of 4%, glass and glass
artifacts, for the purposes referred to in Article 12 of Law
No. 4,131, of September 3, 1962.

ANTONIO DELFIM NETTO

The English portion of Exhibit 31-J (Portaria 60/94) is:

MF Ordinance No. 60
D.O.U.: 2/01/1994

The MINISTER OF FINANCE, in exercise of its statutory
duties, taking into view the provisions of art. 50 of Law No.
8,383, of December 30, 1991 and Ordinance No. 303, of
November 25, 1959, decides:

Article 1. Include in the 2nd Group--Processing Industries-
-Essential, Ordinance No. MF 436, of December 30, 1958,
the following item:

Types of Production Percentage 14--INDUSTRIAL
COMPUTER          SYSTEMS,         AUTOMATION            AND
INSTRUMENTATION              01--Machinery,       equipment,
apparatus, instruments and devices based on digital or
analog technique with technical functions of collection,
treatment, structuring, storage, switching, retrieval and
presentation of information, its respective electronic inputs
and opto-electronics, parts, pieces and physical support for
the operation, as well as technological update sets and
performance optimization (. . .) 5% [ellipses are in the
original]

Art. 2. This Ordinance shall enter into force on the date of
its publication.

Fernando Henrique Cardoso

The English portion of Exhibit 32-J (Decision No. 283) is:
               MINISTRY OF FINANCE
                                  42

                  FEDERAL REVENUE SERVICE

               DECISION N˚ 283 of November 30, 2000

      SUBJECT: Corporate Income Tax

      SYLLABOUS: ROYALTIES. The percentages established
      over gross revenue to limit the deductibility of the amounts
      due in connection with royalties, must be applied to each
      product, and not to each trademark used on a same
      product. In case of royalties for the use of industrial and
      commercial trademarks or trade name, in any type of
      production or activity, when the use of the trademark or
      name does not derive from the utilization of the patent,
      manufacturing process or formula, the maximum limit is
      of 1% (one per cent).

7.    1999 assignment agreement; corporate restructuring

      In 1999, 3M Global had sales in more than 180 countries.

        In 1999, 3M Company decided that much of its intellectual
property should be held and managed by a newly formed U.S.
subsidiary, 3M Innovative Properties Company (“3M IPC”). 3M
Company also added to its corporate structure another newly formed
U.S. corporation, 3M Financial Management Company (“3M Financial
Management”). The purpose of 3M Financial Management was to
facilitate currency management and intercorporate lending between 3M
Company and its affiliates. The ownership structure of the four
corporations was as follows: (1) 3M Company owned 3M Financial
Management, (2) 3M Financial Management owned 3M IPC, (3) 3M IPC
owned 3M Brazil.

        In 1999, 3M Company executed an assignment agreement to
transfer certain intellectual property to 3M IPC to facilitate, through
standardization and centralization, the licensing, management,
enforcement, and control of 3M Company’s intellectual property. The
assignment agreement was effective April 1, 1999.           Under the
agreement, 3M Company assigned to 3M IPC all U.S. patents owned,
licensed to, or possessed by 3M Company; all copyrights owned, licensed
to, or possessed by 3M Company; all proprietary information (defined as
business, technical and other information of any kind, including both
confidential and nonconfidential information) owned, licensed to, or
                                   43

possessed by 3M Company; and all other intellectual property (except
trademarks) owned, licensed to, or possessed by 3M Company.

       As part of the assignment agreement, 3M Company also granted
an exclusive license to 3M IPC, including the right to sublicense, all
foreign patents controlled by 3M Company and to use any foreign
trademarks controlled by 3M Company. 3M Company retained
ownership of the trademarks.

      As part of the assignment agreement, 3M Company also assigned
to 3M IPC its ownership interest in most licenses of intellectual property
from 3M Company to its affiliates or third parties.

8.    Business operations during the 2006 tax year

      a.     3M Global

      As of the 2006 tax year, 3M Global was one of the largest
technology-and- manufacturing enterprises in the world, reporting in its
annual report that it had over $23 billion in worldwide gross sales and
over $21 billion in worldwide assets. At the close of the 2006 tax year,
3M Global employed 75,333 people worldwide, with 34,553 employed in
the United States and 40,780 employed in foreign countries. 3M Global
derived roughly 60% of its annual revenues in the 2006 tax year from
sources outside the United States.

       3M Global’s business operations are organized, managed, and
internally grouped into segments based on differences in products,
technologies, and services. During the 2006 tax year, 3M Global’s
business consisted of six primary segments: Industrial and
Transportation; Health Care; Display and Graphics; Consumer and
Office; Safety, Security and Protection Services; and Electro and
Communications. 3M Global sold more than 50,000 different products.

       During the 2006 tax year, research and product development
constituted an important part of 3M Global’s business activities.
Research, development, and related expenses for 3M Global totaled
$1.522 billion in 2006, up from $1.274 billion in 2004 and $1.246 billion
in 2005.
                                         44

       b.      3M Brazil

       During the 2006 tax year, neither 3M Company nor 3M IPC
owned any plant, property, or equipment in Brazil. During the 2006 tax
year, 3M Brazil reported for U.S. income-tax purposes approximately
$563 million in sales and employed approximately 3,120 people at its
corporate headquarters and its three manufacturing sites throughout
Brazil, including a research and development facility at one of the
manufacturing sites.

         At all relevant times, including during the 2006 tax year, 3M
Brazil’s primary business operations included the manufacturing and
distribution of 3M Global’s products. The products that 3M Brazil
manufactured, marketed, or sold during the 2006 tax year included
abrasives, adhesives and adhesive tapes, automotive products, office
and consumer products, medical-and-dental-care products, graphic-
communication products, electrical products, telecommunication
products, tapes (including masking tapes, packaging tapes, and diaper
tapes), labels, respirators, and hearing-protection products.

       3M Brazil also engaged in research-and-development activities,
which led to the creation of intellectual property. During the 2006 tax
year, 3M IPC had 167 patent applications pending in Brazil. During
that year, Brazil granted 32 patents to 3M IPC. Two of those were
developed by 3M Brazil personnel, and four were developed in Brazil by
unrelated persons and were acquired by 3M Brazil from those persons. 14

       A Form 5471 pertaining to 3M Brazil was attached to the
consolidated federal income tax return filed by the 3M consolidated
group for the 2006 tax year. The Form 5471 is titled “Information
Return of U.S. Persons with Respect to Certain Foreign Corporations”.
The consolidated federal income tax return was made on Form 1120.
The average exchange rate for converting U.S. dollars ($) to Brazilian
reais (R$) for the 2006 taxable year, as reported by the 3M consolidated
group on its Form 5471 for 3M Brazil, was 2.1705157. That exchange
rate is used in this Opinion unless otherwise indicated.

       14 We describe infra part 14 paragraph 128 of the stipulation, which relates to

research-and-development expenses incurred by 3M Brazil.
                                     45

      c.     Intellectual property; services

      3M IPC owns substantially all of the intellectual property used or
developed by 3M Global, with the exception of trademarks, which are
owned by 3M Company. During the 2006 tax year, 3M IPC owned, or
held licenses to use, a wide variety of U.S. and foreign patents in
connection with 3M Global’s products. 15

      During the 2006 tax year, 3M Global’s products were sold under
various trademarks owned by 3M Company.

       The intellectual property of 3M Company and 3M IPC is
collectively referred to as the 3M Intellectual Property.

        Including during the 2006 tax year, 3M Company and 3M IPC
had jointly licensed the 3M Intellectual Property (1) to most of the
affiliates of 3M Global (but not to 3M Brazil) and (2) to third parties.

        During the 2006 tax year, 3M Company and 3M IPC jointly
licensed the 3M Intellectual Property to most affiliates of 3M Global
using a standard licensing agreement. 3M Brazil was not among those
affiliates. The standard licensing agreement recites that “[i]nstead of
negotiating separate agreements for different technologies, products,
services and intellectual property rights, the Parties wish to negotiate a
single agreement that will grant a license to Affiliate under the entire
portfolio of 3M IPC’s intellectual property rights, and will transfer
intellectual property rights developed or obtained by Affiliate to 3M
IPC.” The word “Affiliate” refers to a foreign affiliate. “Parties” refers
to the Affiliate, 3M Company, and 3M IPC. Under the standard
licensing agreement, the licensors (3M Company and 3M IPC,
individually and collectively) grant to the licensee (a foreign affiliate) a
license to manufacture goods using the licensor’s intellectual property
and to exercise all rights that are protected by or arise under the
licensor’s intellectual property. A licensee under the standard licensing
agreement agrees to pay a royalty to 3M IPC equal to 6% of the net price
charged by the licensee for products manufactured using the licensor’s

       15 As explained before, the 1999 assignment agreement transferred U.S.

patents from 3M Company to 3M IPC. The record does not appear to show when or
how the foreign patents were transferred from 3M Company to 3M IPC.
                                       46

intellectual property. 16 Trademarks are not used in the manufacture of
products, and therefore the royalty payment does not cover the use of
trademarks. The licensee also agrees to pay to 3M IPC 6% of the net
price charged by the licensee to any buyer other than a 3M Global
company for services provided by the licensee under the licensor’s
intellectual property. The licensee also agrees to pay to 3M IPC 1% of
the net price charged by the licensee for products sold, licensed, leased,
or otherwise disposed of by the licensee (using the licensor’s intellectual
property) to any buyer other than a 3M Global company. Under the
standard licensing agreement, 3M Company agrees to reimburse the
licensee its actual costs incurred for laboratory work undertaken by the
licensee or performed by an entity other than the licensor for the licensee
at the licensee’s request, and related to product development or
modification, or research, including basic and applied research. 3M
Company also agrees to pay a markup of 10% (or other agreed markup).
All types of intellectual property developed by the licensee through this
arrangement would become the property of 3M IPC, except for the
trademarks, which would become the property of 3M Company. The
types of intellectual property include (1) patents, trademarks, domain
names, copyrights, proprietary information, and (2) all intellectual
rights of any kind other than patents, trademarks, domain names,
copyrights and proprietary information.          The standard licensing
agreement does not relate to technical and support services, which are
the subject of a separate agreement, as described in the next paragraph.
With only a few exceptions, all of the foreign affiliates in 3M Global
operated under a version of the standard licensing agreement during the
2006 tax year. 3M Brazil was one such exception.

        The standard services agreement is a reciprocal agreement under
which 3M Company and 3M IPC, on the one hand, and the foreign
affiliate, on the other, agree to provide technical and support services to
each other as may be agreed from time to time. The services include
technical assistance services and selling, marketing, and general and
administrative services. Under the standard services agreement, the
foreign affiliate agrees to compensate 3M Company and 3M IPC at cost,
and 3M Company and 3M IPC agree to compensate the foreign affiliate
at cost plus a 10% markup. Most of the foreign affiliates in 3M Global
operated under a version of the standard services agreement during the
2006 tax year. 3M Brazil was one exception. 3M Company and 3M

        16 The calculation of the net price includes a reduction for the cost of

semifinished goods incorporated into the manufactured products that were purchased
from a 3M Global company.
                                          47

Brazil entered into a version of the standard services agreement
effective January 1, 2009.

       At all relevant times, including the 2006 tax year, 3M Brazil had
access to, and used in its business operations, the 3M Intellectual
Property, including patents, trademarks, trade names, name
recognition, copyrights, software, and nonpatented technology (such as
technical know-how and trade secrets). 3M Brazil’s right to 3M
Intellectual Property throughout the years was sometimes governed by
one or more licensing agreements. The only such arrangements in effect
during the 2006 tax year were the 1998 trademark licensing
agreements. At all relevant times, including during the 2006 tax year,
3M Company provided services to 3M Brazil. During the 2006 tax year,
those services consisted of consulting services and technical assistance
services. During 2006, 3M Company provided significantly more
consulting services and technical assistance services. The terms
“consulting services” and “technical assistance services” are defined in
paragraph 74 of the stipulation, which is quoted infra part 9.

       d.      Payments by 3M Brazil

       The 1998 trademark licenses required 3M Brazil to pay 3M
Company 1% of its net sales. Brazil required that the maximum royalty
for a product be 1% of net sales, regardless of how many licensed
trademarks were used on the product. During 2006, 3M Brazil paid
$5,104,756 in royalties to 3M Company under the 1998 trademark
licenses. This $5,104,756 royalty payment, though calculated at 1% of
net sales, was calculated using a stacking principle under which if a
product used multiple trademarks covered by three separate
agreements, then the licensee (3M Brazil) should pay up to a 3%
trademark royalty. We make no finding as to what the royalty payment
would have been if computed without the stacking principle. 17

        17 Petitioner contends that 3M Brazil’s net sales were $466,618,701 and that

therefore had 3M Brazil calculated the trademark royalties at 1% of sales without
stacking, 3M Brazil would have paid $4,666,187 in royalties. We do not find as fact
that 3M Brazil’s net sales were $466,618,701. First, petitioner failed to state this
contention in its proposed findings of fact, as it was required to do by Rule 151(e)(3).
Second, the only evidence supporting the contention is information in the tax return of
the 3M consolidated group. A tax return is a weak source of information in a deficiency
case such as this one. See Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979).
                                           48

      During 2006, 3M Brazil paid $52,522,080 in dividends and
$11,978,720 in interest on net equity to 3M IPC. The total of these
payments is $64,500,800.

      In 2006, 3M Brazil made no payments to 3M Company for
consulting services or technical assistance services. Nor did 3M Brazil
pay 3M IPC for the use of patents, trade names, name recognition,
copyrights, software, or unpatented technology.

9.      Tax reporting

      The 3M consolidated group reported on its consolidated federal
income tax return for 2006 that it had taxable income of $4,466,124,618
and a tax liability of $1,049,490,347.

       The members of the 3M consolidated group included 3M Company
(the common parent of the group) and 3M IPC.

       On its consolidated federal income tax return, the 3M
consolidated group reported as income the $5,104,756 in trademark
royalties paid by 3M Brazil to 3M Company.

       The total of dividends and interest on net equity paid by 3M
Brazil in 2006 ($64,500,800) was reported by the 3M consolidated group
as dividends paid on Schedule M of the 3M Brazil Form 5471 for 2006.

10.     The notice of deficiency

       In the notice of deficiency, respondent made 47 adjustments to
the income of the 3M consolidated group. 18

       One adjustment in the notice of deficiency, labeled “Brazil
Royalties”, was a net $23,651,332 increase in the income of the 3M
consolidated group. Petitioner and respondent have stipulated, in
paragraph 120 of the stipulation, that this adjustment was calculated
by “[a]pplying the royalty rates under the Standard Licensing
Agreement to the intercompany licensing transactions between 3M
Company, 3M IPC, and 3M Brazil at issue in this case.” The phrase

        18 Respondent mailed the notice of deficiency to 3M Company because 3M

Company was the common parent company of the 3M consolidated group. See 26
C.F.R. sec. 1.1502-77B(a)(2)(viii) (2018) (providing that notices of deficiency are mailed
to the common parent of a consolidated group and that mailing to the common parent
is considered a mailing to each member of the consolidated group).
                                          49

“intercompany licensing transactions between 3M Company, 3M IPC,
and 3M Brazil at issue in this case” refers to the following: (1) the use
by 3M Brazil of trademarks owned by 3M Company, (2) the use by 3M
Brazil of patents owned by 3M IPC, and (3) the transfer of technology
from 3M IPC to 3M Brazil. 19

       The royalty rate used by the notice of deficiency was 6% of net
sales. The notice of deficiency calculated that the royalty at the 6% rate
was $27,768,702 and that this amount should be reduced by $4,117,370
for 3M Brazil’s unreimbursed expenditures on research and
development.     Thus, the adjustment to the income of the 3M
consolidated group was $23,651,332, equal to $27,768,702 minus
$4,117,370. The notice of deficiency explained the $23,651,332 increase
as follows:

        19 As the parties have stipulated, the adjustment in the notice of deficiency was
based on the terms of the standard licensing agreement. The standard licensing
agreement contained two major provisions: one was the license of intellectual property
at a 1% royalty; the other was the license of intellectual property other than
trademarks at a 6% royalty. The notice of deficiency applied a 6% royalty, rather than
a 1% royalty. This suggests that the notice of deficiency did not make an adjustment
for trademark royalties and that the adjustment in the notice of deficiency related to
intellectual property other than trademarks. The notice of deficiency did not expressly
say which types of nontrademark intellectual property bore the 6% imputed royalty.
On brief, respondent contends that the 6% imputed royalty is compensation for the use
of patents owned by 3M IPC and for technology transferred by 3M IPC. See infra part
17 (third paragraph). So far the adjustment in the notice of deficiency, as defended by
respondent in litigation, may not seem to be related to the use of trademarks.
        However, further analysis shows that the use of trademarks is relevant to the
appropriate section 482 adjustment in this case, as we explain below. Petitioner
opposes the 6% royalty adjustment in the notice of deficiency on the ground that 3M
Brazil was prevented by Brazilian law from paying patent royalties and making
technology-transfer payments to 3M IPC in excess of ceilings of between 1% and 5%.
3M Brazil was also barred by Circular-Letter 2795 from paying any patent royalties
and technology-transfer payments to 3M IPC because 3M Brazil had failed to record
with the BPTO a licensing agreement with respect to such royalties and payments.
Petitioner recognizes, however, that 3M Brazil could have recorded such a licensing
agreement and that, had it done so, it could have paid patent royalties and technology-
transfer payments to 3M IPC up to the 1%-5% ceilings. However, had 3M Brazil
recorded such a licensing agreement, it would have been prohibited from paying
trademark royalties to 3M Company. Thus, petitioner contends that the section 482
adjustment should be limited to the maximum amount 3M Brazil could have paid 3M
IPC under the 1%-5% ceilings for patent royalties and technology-transfer payments
minus the trademark royalty payments it actually made. In summary, the section 482
adjustment urged by petitioner partly implicates the use of 3M Company’s trademarks
by 3M Brazil and the Brazilian restrictions on the payment of trademark royalties.
                                          50

       It is determined that in order to clearly reflect the income
       of the entities, in accordance with section 482 of the
       Internal Revenue Code, we have allocated royalty income
       to you from 3M do Brasil Limitada (“3M Brazil”) in
       connection with 3M Brazil’s use of intellectual property.
       We have determined that Brazilian legal restrictions are
       not taken into account for purposes of computing the arm’s
       length amount of royalty income from 3M Brazil because it
       has not been established that the Brazilian legal
       restrictions affected an uncontrolled taxpayer under
       comparable circumstances for a comparable period of time,
       and because it has not been established that the
       restrictions satisfied the conditions pursuant to Treasury
       Regulations sections 1.482-1(h)(2)(i) and (ii). In addition,
       we have determined that you are ineligible to elect the
       deferred income method of accounting pursuant to
       Treasury      Regulations      section     1.482-1(h)(2)(iii).
       Accordingly, your taxable income for the tax year ended
       December 31, 2006 is increased by $23,651,332, as shown
       in the computation below:

a. Total cost of goods sold of products
    manufactured by 3M Brazil (from Form 5471,
    Sch. C, line 2)                                            $332,547,422

 Cost of goods sold (other than raw materials)
   purchased from:

        b. U.S. affiliates (from Form 5471, Sch. M,
            Line 10(b)+(c))                                    (42,966,307)

        c. Foreign affiliates (from Form 5471, Sch. M,
            Line 10(d))                                        (16,537,910)

d. Net cost of goods sold for manufactured products            $273,043,205
e. Gross sales from Form 5471 (Sch. C, line 1a)                $563,672,096
f. Times: Ratio of net to total cost of goods sold
    (d divided by a)                                           0.821065469
g. Net sales of manufactured products                          $462,811,694
h. Times: Manufacturing royalty rate                                     6%
i. Proposed manufacturing royalty                               $27,768,702
j. Setoff for unreimbursed R & D expenses                        (4,117,370)
k. Proposed net adjustment                                      $23,651,332
                                   51

      Another adjustment in the notice of deficiency was a $4,751,136
increase in income of the 3M consolidated group for “Support Service
Fee--3M do Brasil LTDA”. The notice of deficiency explained this
“Support Service Fee” adjustment as follows:

      It is determined that an adjustment is required under
      section 482 of the Internal Revenue Code to reallocate
      $4,751,136 of income to you from 3M do Brasil LTDA [i.e.,
      3M Brazil] relating to support services which were never
      charged. Accordingly, your taxable income for the tax year
      ended December 31, 2006 is increased by $4,751,136.

To calculate the adjustment, the notice of deficiency applied the rate of
compensation provided under the standard services agreement (which
was cost, if services were provided by 3M Company or 3M IPC; or cost
plus 10%, if services were provided by a licensee of intellectual property
owned by 3M Company or 3M IPC) to the intercompany services
transactions during 2006 between 3M Company and 3M Brazil.

11.   Closing agreement

       After the notice of deficiency was issued, but before the petition
was filed, petitioner and respondent entered into a partial closing
agreement under section 7121. One of the terms of the closing
agreement was that petitioner agreed to the “Support Services Fee”
adjustment of $4,751,136. At that time, petitioner understood that
Brazilian law imposed no limits on what 3M Brazil could pay to 3M
Company for the services it provided (which consisted of consulting
services and technical assistance services). Petitioner subsequently
learned that its understanding was partially incorrect because, as
explained in paragraphs 74, 76, and 77 of the stipulation, Brazilian law
distinguishes between remuneration for technical assistance services (to
which the fixed ceilings described in paragraph 90 of the stipulation
apply) and remuneration for consulting services (to which such fixed
ceilings do not apply). As explained supra part 5, 3M Company provided
significantly more consulting services to 3M Brazil than technical
assistance services.

12.   The petition

      On March 6, 2013, the petition was filed. It challenged only one
adjustment in the notice of deficiency, the $23,651,332 adjustment for
                                         52

“Brazil Royalties”. The petition explained the basis for the challenge as
follows:

      5.a.18. 3M Brazil’s Legal Inability to Pay Royalties.
      Brazilian law precluded 3M Brazil from paying any
      royalties to the Petitioner[20] other than one-percent
      royalties on the licensed Trademarks, which were paid and
      which Petitioner included in its income. In addition, under
      no circumstances could the royalties payable by 3M Brazil
      have been at a rate of six percent of net sales under
      Brazilian law in addition to the one-percent royalty
      payable on Trademarks.

      5.a.19. The Allocation Was Erroneous. The Commissioner
      has no authority under I.R.C. § 482 to allocate income to a
      taxpayer from a related party where the related party is
      legally prohibited from paying the income to the taxpayer,
      and where the taxpayer did not in fact receive the income
      from the related party. Because 3M Brazil could not legally
      pay the imputed royalty income to Petitioner, and because
      Petitioner did not receive the royalties, the Commissioner’s
      allocation was erroneous.

      5.a.20. The Commissioner’s Reliance on Treas. Reg.
      § 1.482-1(h)(2). In the Notice, the Commissioner stated
      that restrictions on the payment of royalties under
      Brazilian law would not be “taken into account for purposes
      of computing the arm’s length amount of royalty income”
      because the conditions under Treas. Reg. § 1.482-1(h)(2)(i)
      and (ii) had not been satisfied.

      5.a.21. Invalidity of Treas. Reg. § 1.482-1(h)(2)(i) and (ii).
      Treasury exceeded its legal authority when, in Treasury
      Decision 8552 (59 Fed. Reg. 34971-01, 1994-2 C.B. 93 (July
      8, 1994)), it adopted Treas. Reg. § 1.482-1(h)(2)(i) and (ii).
      That regulation is invalid.

       In recognition of the binding effect of the closing agreement, the
petition did not dispute the “Support Services Fee” adjustment of
$4,751,136 in the notice of deficiency.

      20   “Petitioner” meant the 3M consolidated group.
                                          53

13.    The stipulation that the rate of compensation under the standard
       licensing agreement is an appropriate arm’s-length rate under
       section 482

       As we previously observed, paragraph 120 of the stipulation
includes a stipulation that the $23,651,332 increase to the income of the
3M consolidated group in the notice of deficiency was calculated by
applying the royalty rates in the standard licensing agreement. See
supra part 10. In the same paragraph of the stipulation, petitioner and
respondent also agreed that the rate of compensation provided under
the standard licensing agreement is “an appropriate arm’s length rate
under section 482 for the intercompany licensing transactions between
3M Company, 3M IPC, and 3M Brazil at issue in this case”. The
combined effect of these two stipulations is that petitioner and
respondent agree that the $23,651,332 adjustment in the notice of
deficiency reflects an appropriate arm’s-length rate of compensation
under section 482. 21

14.    The stipulation that the section 482 adjustment must be reduced
       by $4,117,370 in unreimbursed research-and-development
       expenses incurred by 3M Brazil

       In paragraph 128 of the stipulation, petitioner and respondent
agreed that, as determined in the notice of deficiency, the 3M
consolidated group is entitled to a “setoff against any section 482
adjustment for royalties from 3M Brazil” in an amount equal to
$4,117,370 for research-and-development expenses incurred by 3M
Brazil that 3M Company did not reimburse but would have reimbursed
had the standard agreement been in effect.

15.    The stipulation that, under Brazilian law, the maximum amount
       that 3M Brazil could have paid to 3M IPC as patent royalties or
       technology-transfer payments in 2006 was $4,283,153 after
       reduction for the $5,104,756 in trademark royalties paid by 3M
       Brazil to 3M Company in 2006

      Petitioner and respondent have stipulated that under Brazilian
law the maximum amount that 3M Brazil could have paid to 3M IPC as
patent royalties or technology-transfer payments in 2006 was

        21 Because the adjustment in the notice of deficiency reflects the royalty rate

in the standard licensing agreement, and because the royalty rate in the standard
licensing agreement is an arm’s-length rate of compensation, it follows that the
adjustment in the notice of deficiency reflects arm’s-length compensation.
                                            54

$4,283,153. This amount equals $9,387,909, which is the maximum
amount of such payments calculated before application of the Brazilian
prohibition on a Brazilian company paying trademark royalties to its
controlling foreign company for a product covered by a patent license or
a technology-transfer agreement, reduced by the $5,104,756 of
trademark royalties as required by the prohibition.

       Petitioner and respondent performed an analysis of 3M Brazil’s
net sales made during 2006 by commodity code 22 for the purpose of
computing the maximum amount of “additional royalties or technology
transfer payments” that 3M Brazil would have been permitted to deduct
under Brazilian tax law and to pay to 3M Company and 3M IPC. 23 We
refer to this analysis as the “maximum-deductibility analysis”. The
maximum-deductibility analysis assumed that all the products sold by
3M Brazil were manufactured by 3M Brazil and were covered by either
(1) a currently valid patent, (2) unpatented technology that was in use
for not more than five years, (3) or both. The maximum-deductibility
analysis was performed in 3M Brazil’s functional currency, Brazilian
reais.

       The maximum-deductibility analysis was jointly conducted by
two Brazilian attorneys (one for petitioner and one for respondent) who
practice Brazilian intellectual-property law and who are knowledgeable
concerning the limitations on the deductibility under Brazilian tax law
of trademark and patent royalties and technology-transfer payments.
These Brazilian attorneys consulted with 3M Brazil to determine the
maximum deductions under Brazilian tax law for “patent royalties or
technology transfer payments” 24 with respect to the products sold by 3M
Brazil according to commodity code. The highest rates were then
applied to the net sales of products for each commodity code, not
including intercompany sales (because intercompany sales are not
subject to the payment of royalties under the standard licensing
agreement), to determine the maximum amount that 3M Brazil could
have deducted if it had paid 3M IPC for the “use [of] its patents or for
the transfer of its unpatented technology.” 25 Given that 3M Company
and 3M IPC, at all relevant times, were controlling foreign companies of

       223M Brazil sold products having more than 100 product codes in 2006. Those
products were subdivided, within each product code, by commodity codes.
       23   The quoted text is from the stipulation.
       24   The quoted text is from the stipulation.
       25   The quoted text is from the stipulation.
                                           55

3M Brazil, the maximum-deductibility analysis also determined the
maximum amount that the BPTO would have permitted 3M IPC and
3M Brazil to include as payable to 3M IPC in any recorded agreement
providing for the “use of patents or the transfer of unpatented
technology”. 26 See paragraphs 89 and 90 of the stipulation.
Consequently, the maximum-deductibility analysis also determined the
maximum amount that the Brazilian Central Bank would have
permitted 3M Brazil to remit to 3M IPC as “royalties or as technology
transfer payments”, 27 given that Circular-Letter No. 2795 requires such
payments to be made pursuant to a written agreement recorded by the
BPTO. See paragraph 75.b of the stipulation.

       The maximum-deductibility analysis showed that the maximum
amount that 3M Brazil could have deducted as “patent royalties or
technology transfer payments” 28 in 2006 was $9,387,909 subject to the
following. To arrive at the maximum amount of “additional royalties or
technology transfer payments” 29 that 3M Brazil could have deducted in
2006, the above amount must be reduced by the royalties that 3M Brazil
paid and deducted under the 1998 trademark licenses during 2006,
because, if a product is covered by a patent license or by a technology-
transfer agreement between a Brazilian company and controlling
foreign companies, then any trademark license between the same
Brazilian company and the same controlling foreign companies for that
same product must be granted royalty free. Therefore, because 3M
Brazil deducted 30 and paid trademark royalties in connection with
certain of the same products during 2006, the maximum amount that
could have been paid as “patent royalties or as technology transfer
payments” 31 must be reduced by the amount of trademark royalties paid
and deducted by 3M Brazil. Petitioner and respondent have stipulated,
in paragraph 126 of the stipulation, that, on the basis of the maximum-
deductibility analysis, the “maximum amount of additional patent
royalties and technology-transfer payments for 2006, after reduction for
the trademark royalties actually paid by 3M” was $4,283,153.

      26   The quoted text is from the stipulation.
      27   The quoted text is from the stipulation.
      28   The quoted text is from the stipulation.
      29   The quoted text is from the stipulation.
      30   Deducted for Brazilian tax purposes.
      31   The quoted text is from the stipulation.
                                          56

       Petitioner and respondent have stipulated, in paragraph 127 of
the stipulation, that the “maximum additional amount” that 3M Brazil
could have deducted 32 and paid in 2006 to 3M IPC as “patent royalties
or as technology transfer payments”, in “excess of the trademark
royalties actually paid to 3M Company”, and using the assumptions
underlying the maximum-deductibility analysis, was $4,283,153, and
that the Brazilian Central Bank would have permitted 3M Brazil to
make such a payment had the BPTO recorded an agreement among 3M
Company, 3M IPC, and 3M Brazil providing for the payment of such
amounts.

16.   The stipulation that if the Court holds that the section 482
      adjustment must take into account the Brazilian legal
      restrictions, then the minimum section 482 adjustment should be
      $165,783

      Petitioner and respondent have stipulated, in paragraph 129 of
the stipulation, that the “minimum section 482 adjustment” with
respect to the intercompany licensing transactions among 3M Brazil,
3M Company, and 3M IPC for the 2006 year is $165,783 (equal to
$4,283,153 minus an offset of $4,117,370 for unreimbursed research-
and-development expenses (R & D offset)). We interpret the term
“minimum section 482 adjustment” to be the minimum section 482
adjustment that would be made if petitioner were to prevail in its
argument that the Brazilian legal restrictions should be taken into
account. We refer to the $4,117,370 offset for unreimbursed research-
and-development expenses as the $4,117,370 R & D offset.

17.   Respondent’s position

       Respondent’s position is that the relevant adjustment in the
notice of deficiency is correct. The notice of deficiency adjusted the
income of the 3M consolidated group by $23,651,332, equal to
$27,768,702 minus $4,117,370. The latter two amounts have the
following significance:

      ●         The $27,768,702 amount corresponds to the 6% royalty
                rate set forth in the standard licensing agreement for
                intellectual property other than trademarks. 33

      32   Deducted for Brazilian tax purposes.
      33   This point was discussed supra part 10 note 18.
                                        57

       ●      The $4,117,370 amount is the research-and-development
              expenses incurred by 3M Brazil for which it was not
              reimbursed. The standard licensing agreement requires
              the licensor to reimburse the licensee for certain research.

       Respondent’s position can be illustrated as follows:

        Respondent’s position regarding appropriate sec. 482 adjustment for
                  3M Brazil’s use of 3M Company’s trademarks,
                     3M Brazil’s use of 3M IPC’s patents, and
                 technology transfers from 3M IPC to 3M Brazil

                       Explanation                                 Amount

 6% royalty provided by standard licensing agreement for              $27,768,702
 intellectual property other than trademarks
 R&D offset, as provided by standard licensing agreement               –4,117,370
 Equals the section 482 adjustment urged by respondent                 23,651,332

       As we have explained before, because the adjustment in the notice
of deficiency reflects the compensation in the standard licensing
agreement and because the standard licensing agreement reflects arm’s-
length compensation, it follows that the adjustment in the notice of
deficiency reflects arm’s-length compensation. See supra part 13. What
is disputed is whether arm’s-length compensation can serve as the basis
for the section 482 adjustment. Respondent contends that the arm’s-
length compensation results in the appropriate section 482 adjustment
because, respondent contends, the Brazilian legal restrictions should be
disregarded. By contrast, petitioner contends that the appropriate
section 482 adjustment is constrained by the amounts payable under
Brazilian law.

       It bears emphasis that respondent contends that the 6% royalty
component of the section 482 adjustment is justified only by (1) 3M
Brazil’s use of 3M Company’s patents and (2) the transfer of technology
from 3M IPC to 3M Brazil. See supra part 10 note 18. Respondent’s
section 482 adjustment makes no adjustment directly concerning
compensation for 3M Brazil’s use of 3M Company’s trademarks. Recall
that 3M Company, which owned all of the trademarks of 3M Global,
allowed 3M Brazil to use its trademarks during the 2006 tax year.
Pursuant to the 1998 trademark licenses, 3M Brazil paid 3M Company
$5,104,756 of trademark royalties. This payment was reported as
                                           58

income by the 3M consolidated group on its 2006 tax return. Respondent
does not argue that this reporting should be adjusted under section 482
for 3M Brazil’s use of 3M Company’s trademarks.

       Although respondent’s main position is that the Brazilian legal
restrictions should not be taken into account in making the section 482
adjustment, respondent has an alternative position should petitioner
prevail in its argument that the Brazilian legal restrictions be taken into
account. As previously explained, paragraph 129 of the stipulation
means that respondent agrees that if petitioner prevails in its argument
that the Brazilian legal restrictions should be taken into account, the
minimum section 482 adjustment should be $165,783. See supra part
16. Although paragraph 129 says the minimum section 482 adjustment
was $165,783, and therefore does not technically limit respondent’s
claiming that the section 482 adjustment should be more than $165,783,
respondent’s briefs do not argue that the section 482 adjustment should
be more than $165,783 in the event that petitioner prevails in its
argument that the section 482 adjustment must take into account the
Brazilian legal restrictions. Thus, we consider respondent’s position to
be that the section 482 adjustment should be $165,783 in the event that
petitioner prevails in its argument that the section 482 adjustment must
take into account the Brazilian legal restrictions.

18.     Petitioner’s position

       Petitioner concedes that the $23,651,332 allocation determined
by respondent reflects an arm’s-length compensation for the use of the
intellectual property. 34   However, it disputes respondent’s legal
authority to make an allocation under section 482 because 3M Brazil
was prevented under Brazilian law from paying more than $165,783 in
compensation. This $165,785 amount is equal to (1) $4,283,153 minus
(2) the R&D offset of $4,117,370. Petitioner contends that the
appropriate transfer-pricing adjustment is $165,785. We pause here to
explain petitioner’s computation of this adjustment more completely.

        34 This concession is the result of paragraph 120 of the stipulation, which stated

two things: (1) respondent’s $23,651,332 sec. 482 adjustment was determined from the
royalty rates under the standard licensing agreement, and (2) the rate of compensation
under the standard licensing agreement is an arm’s-length rate for the transactions at
issue. Combining these two statements means that respondent’s $23,651,332 sec. 482
adjustment reflects an arm’s-length rate for the transactions at issue. See supra part
14.
                                         59

       The $4,283,153 amount is the maximum of patent-royalty
payments and technology-transfer payments 3M Brazil could make to
3M Company assuming it had recorded with the BPTO a licensing
agreement regarding such payments. Computation of the $4,283,153
amount starts with $9,387,909, an amount that does not account for the
Brazilian restriction that, if a product is covered by a patent license or
by a technology-transfer agreement between a Brazilian company and
its controlling foreign company, any trademark license between the
same companies for that same product must be granted royalty free. To
account for the restriction, the $9,387,909 amount would be reduced by
the $5,104,756 of trademark royalties to arrive at $4,283,153.

       Finally, paragraph 128 of the stipulation requires that the section
482 adjustment be reduced by the $4,117,370 R&D offset. When
$4,283,153 is reduced by $4,117,370, the result is $165,783. This is the
correct section 482 adjustment in petitioner’s view. The adjustment
supposes that the Brazilian legal restrictions are taken into account.

       Petitioner’s calculations of the adjustment can also be illustrated
in the table below:

         Petitioner’s position regarding appropriate sec. 482 adjustment for
                    3M Brazil’s use of 3M Company’s trademarks,
                       3M Brazil’s use of 3M IPC’s patents, and
                   technology transfers from 3M IPC to 3M Brazil
                         Explanation                                  Amount
 Maximum amount that 3M Brazil could pay 3M IPC as                       $9,387,909
 royalties or as technology-transfer payments, before
 application of the Brazilian restriction that, if a product is
 covered by a patent license or by a technology-transfer
 agreement between a Brazilian company and controlling
 foreign companies, any trademark license for that same
 product must be granted royalty free. (This maximum
 amount implicitly assumes that 3M Brazil records an
 agreement with 3M IPC regarding the use of 3M IPC’s patents
 and the transfer of 3M IPC’s technology.)
 Reduction in trademark royalties paid, as required by the               –5,104,756
 Brazilian restriction referred to above
 Equals the sec. 482 adjustment urged by petitioner before
                                                                          4,283,153
 R&D offset
 R&D offset, as required by paragraph 128 of the stipulation             –4,117,370
 Equals final sec. 482 adjustment urged by petitioner                          165,783
                                    60

       We now discuss petitioner’s position in the event it loses its
argument that the section 482 adjustment must take into account the
Brazilian legal restrictions. In its opening brief, petitioner takes the
position that if the Court agrees with respondent that the Brazilian legal
restrictions should be disregarded, then the proper section 482
adjustment is $23,651,332. This position is consistent with petitioner’s
concession, described supra part 14, that the $23,651,332 reflects arm’s-
length compensation for the use of the intellectual property.

        Paragraph 128 of the stipulation states that the section 482
adjustment should be reduced by the $4,117,370 R&D offset. Taken
literally, paragraph 128 could be construed to mean that if the Court
sustains respondent’s position that the correct section 482 adjustment
is $23,651,332, then the $23,651,332 adjustment should be reduced by
the $4,117,370 R&D offset. But the $23,651,332 calculation already
incorporates the R&D offset. So a further reduction would not make
sense. Perhaps recognizing this, petitioner declines to argue that
paragraph 128 of the stipulation requires that the $23,651,332 should
be further reduced by the $4,117,370 R&D offset. In the event the
Brazilian legal restrictions are not taken into account, petitioner accepts
that the section 482 adjustment should be $23,651,332.

       The $23,651,332 adjustment made by the notice of deficiency did
not include any adjustment related to the $5,104,756 of trademark
royalties paid by 3M Brazil to 3M Company and reported as income by
the 3M consolidated group (of which 3M Company was a member). The
$5,104,756 trademark royalty payment was equal to 1% of sales,
calculated using a stacking principle when multiple trademarks were
used on the same product. The use of the stacking principle to calculate
the 1% trademark royalty was improper under Brazilian law. Petitioner
asserts that if the 1% trademark royalty had been calculated without
using the stacking principle, the royalty would have been $4,666,187. If
true, this means that 3M Brazil overpaid the trademark royalty to 3M
Company by $438,569, which is the difference between $5,104,756 and
$4,666,187. But petitioner does not assert that the income of the 3M
consolidated group should be reduced by $438,569 to adjust for any such
overpayment. Thus, we need not consider whether such a reduction
would be warranted.

      Thus far, we have described separately the calculations of
respondent’s and petitioner’s litigating positions. It is worth pointing
out that both positions incorporate an R&D offset of $4,117,373.
Additionally, petitioner’s position expressly accounts for, and
                                    61

respondent’s position implicitly accounts for, the $5,104,756 of
trademark royalties paid by 3M Brazil to 3M Company and reported as
income by the 3M consolidated group. Petitioner’s position includes a
reduction for the trademark royalties paid of $5,104,756 to account for
the Brazilian restriction that, if a product is covered by a patent license
or by a technology-transfer agreement between a Brazilian company and
a controlling foreign company, a trademark license between the same
companies for that same product must be granted royalty free. 3M
Company reported the $5,104,756 trademark royalty it received from
3M Brazil as income; but under petitioner’s position the $5,104,756
should not have been reported as income by 3M Company because 3M
Brazil could not have paid the amount had it entered into a patent
license or technology-transfer agreement.           Respondent’s position
implicitly accounts for the $5,104,756 in that respondent did not make
an adjustment to 3M Company’s reporting of the amount in income.
Thus, respondent’s position on the tax treatment of the $5,104,756
trademark royalty payment can be viewed as a $0 adjustment because
respondent agrees with the tax reporting of this amount by the 3M
consolidated group. Equivalently, one can think of respondent’s position
on the tax treatment of the $5,104,756 trademark royalty payment as
comprising two separate steps: (1) a determination that $5,104,756
should be included in 3M Company’s income and (2) a $5,104,756 offset
to reflect that the reported income of the 3M consolidated group included
the $5,104,756 amount. The advantage of the two-step approach is that
it makes it easier to compare respondent’s position to petitioner’s
position. Such a comparison is made in the table below:
                                          62

   Petitioner’s and respondent’s computations of appropriate sec. 482 adjustment:
                                side-by-side comparison
                                                  Respondent           Petitioner

Compensation for use of patents and for             $27,768,702            $9,387,909
transfer of technology 35

Compensation for use of trademarks 36                  5,104,756                    –0–

Reduction for trademark royalty reported by          –5,104,756            –5,104,756
3M Company 37

R&D offset                                           –4,117,370            –4,117,370

Sec. 482 adjustment                                  23,651,332               165,783

     The positions of petitioner and respondent can also be usefully
compared in the following diagram of the relevant transactions and
payments:

       35   Respondent: adjustment justified by arm’s-length compensation.
       Petitioner: adjustment should not exceed maximum payment under Brazilian
law.
       36  Respondent: implicitly agrees that a 1% trademark royalty should be
included in the income of 3M Company.
        Petitioner: 1% trademark royalty should not be included in the income of 3M
Company because Brazil requires that, if a product is covered by a patent license or by
a technology-transfer agreement between a Brazilian company and a controlling
foreign company, any trademark license between the same companies for that same
product must be granted royalty free.
       37 Respondent: this adjustment accounts for the fact that 3M Company already
reported the 1% trademark royalty in its income.
       Petitioner: this adjustment is necessary because the 1% trademark royalty
should not be included in the income of 3M Company and because 3M Company
reported the royalty as income.
63
                                            64
        1Although the sec. 482 adjustments favored by petitioner and respondent are
shown as running to 3M IPC, in actuality the adjustments are to the income of the 3M
consolidated group, which includes both 3M Company and 3M IPC.
        2Explanation   of respondent’s position:
       (1) Respondent’s adjustment is stipulated to be equal to payments that would
have been required of 3M Brazil if it had executed the standard licensing agreement.
       (2) The rate of compensation under the standard licensing agreement is the
appropriate arm’s-length rate under sec. 482.
       (3) Thus, respondent’s adjustment (the 6% royalty and the R&D setoff) is based
on arm’s-length compensation. It does not account for Brazilian legal restrictions.
         (4) Respondent’s adjustment reflects no adjustment for trademark royalties,
implying a judgment that no adjustment should be made to the $5,104,756 trademark
royalty.
        3Explanation   of petitioner’s position:
       (1) 3M Brazil did not record any licensing agreements regarding patents and
technology transfers and was therefore barred from making payments for use of
patents and for technology transfers under Circular-Letter 2795.
        (2) However, had 3M Brazil recorded licensing agreements regarding patents
and technology transfers, then (A) it would have been able to pay 3M IPC royalties of
up to 1% to 5%, resulting in total payments for use of patents and for technology
transfers of $9,387,909 (B) but 3M Brazil would have not been permitted to pay
trademark royalties.
        (3) Petitioner and respondent have stipulated that $4,117,370 should be a
setoff against the sec. 482 adjustment.
        (4) Petitioner does not argue that an adjustment should be made because 3M
Brazil overpaid its trademark royalty payment by calculating the payment using
stacking.
       Brazilian legal restrictions referred to in explanation 2(A) of petitioner’s sec.
482 adjustment:
        (1) Law No. 8383/1991, partly repealing Article 14 of Law No. 4131/1962,
permits a Brazilian company to pay patent and trademark royalties to its controlling
parent company to the extent such payments are deductible.
        (2) Law No. 3470/1958 and Portaria No. 436/58 (as amended by Portaria Nos.
113/59, 314/70, and 60/94) sets maximum deductibility ceilings of 1% to 5% for patent
royalties and technology-transfer payments and 1% for trademark royalties.
        (3) BPTO imposes fixed ceilings on royalties payable by a Brazilian company
to a controlling parent corporation under a patent or trademark license agreement that
are equal to the maximum deductibility ceilings on patent or trademark royalties.
       (4) BPTO, by unpublished interpretation of Law Nos. 4131/1962 and
8383/1991, applies the same fixed ceilings that apply to royalties under a patent or
trademark license agreement to payments under an agreement between a Brazilian
company and a controlling foreign company providing for technology transfer.
        4Licensors   are 3M Company and 3M Brazil.
                                    65
      5100%   owned by 3M IPC.

19.   Other stipulations

       In addition to the stipulations discussed so far, petitioner and
respondent have stipulated that the rate of compensation provided
under the standard services agreement (which was cost, if services were
provided by 3M Company or 3M IPC; or cost plus 10%, if services were
provided by a licensee of intellectual property owned by 3M Company or
3M IPC) is an appropriate arm’s-length rate under section 482 for the
provision of services by 3M Company to 3M Brazil during the 2006 tax
year in this case. As explained before, the notice of deficiency calculated
the transfer-pricing adjustment for services performed for 3M Brazil
based on the rate of compensation provided under the standard services
agreement and petitioner does not challenge this adjustment. See supra
parts 10 & 11.

      The parties have also stipulated that the operations of 3M Brazil
were “owned or controlled” by 3M Company and 3M IPC within the
meaning of section 482 during the 2006 tax year.

       Some other stipulations are relevant to 26 C.F.R. sec. 1.482-
1(h)(2) (2006), a portion of the 1994 final regulations. These stipulations
are discussed infra part II.OO.

                                 OPINION

I.    Procedural matters

       Petitioner and respondent submitted this case without trial under
Rule 122. The record in this case consists of the stipulation and the
documents attached to the stipulation. Our findings of fact are based on
the stipulation and the documents attached to the stipulation.

      As a general rule, the petitioner in a Tax Court case has the
burden of proving that the determinations in the notice of deficiency are
incorrect. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
The identity of the petitioner in this case requires some explanation.

      An affiliated group is a group of corporations that are connected
through stock ownership with a common parent corporation. Sec.
1504(a)(1). An affiliated group does not include foreign corporations.
Sec. 1504(a)(1), (b)(3). An affiliated group of corporations may file a
                                   66

consolidated return with respect to income tax. Sec. 1501. An affiliated
group that has filed a consolidated return for a year is referred to as a
consolidated group.      26 C.F.R. sec. 1.1502-1(h), (a) (2019).        A
consolidated group has only one income tax liability for the year. Sec.
1503(a); 26 C.F.R. sec. 1.1502-2(a) (2019).        Each member of a
consolidated group is severally liable for the income tax. Sec. 1503(a);
26 C.F.R. sec. 1.1502-6(a) (2019). The income tax of a consolidated group
is generally equal to the tax imposed by section 11 on consolidated
taxable income. 26 C.F.R. sec. 1.1502-2(a) (2019). Consolidated taxable
income is determined by taking into account (1) the separate taxable
income of each member of the consolidated group and (2) certain items
of income and deduction that are determined on a consolidated basis. 26
C.F.R. sec. 1.1502-11(a) (2019). Each member’s separate taxable income
is calculated as if the member were a separate corporation, with certain
modifications. 26 C.F.R. sec. 1.1502-12 (2019); Norwest Corp. & Subs.
v. Commissioner, 111 T.C. 105, 165 (1998).

       As a general rule, the common parent corporation of a
consolidated group is the representative of all members of the
consolidated group with respect to the group’s tax liability. 26 C.F.R.
sec. 1.1502-77B(a)(1)(i) (2019). The notice of deficiency is mailed to the
common parent corporation of a consolidated group, and that mailing is
considered a mailing to each member of the consolidated group. 26
C.F.R. sec. 1.1502-77B(a)(2)(viii) (2019).        The common parent
corporation files petitions in the Tax Court; any such petition is
considered to have been filed by each member of the consolidated group.
26 C.F.R. sec. 1.1502-77B(a)(2)(x) (2019).         The common parent
corporation conducts proceedings before the Tax Court on behalf of the
members of the consolidated group. Id.

       The common parent corporation of the 3M consolidated group is
3M Company. 3M Company was the company to which respondent
mailed the notice of deficiency. 3M Company filed the petition on behalf
of the members of the 3M consolidated group. See id. As stated at the
beginning of this Opinion, we use “petitioner” to refer to 3M Company
in discussing 3M Company in its role as the representative of the 3M
consolidated group.

       In a Tax Court case, it is the petitioner that bears the burden of
proof unless an exception applies. Rule 142(a)(1). Petitioner in this case
does not contend that any exception applies. Nor does the record
indicate that any exception applies. Therefore petitioner has the burden
                                    67

of proof. This conclusion is not altered by the case’s having been
submitted under Rule 122. See Rule 122(b).

        In the case of a corporation seeking redetermination of a tax
liability, the venue for appeal is generally the U.S. Court of Appeals for
the circuit in which is located the corporation’s principal place of
business or principal office or agency. Sec. 7482(b)(1)(B). However, the
parties to the appeal may stipulate that venue is another circuit. Sec.
7482(a), (b)(2). This case involves a corporation (3M Company) seeking
a redetermination of tax liability (the tax liability of the 3M consolidated
group). See 26 C.F.R. sec. 1.1502-77B(a)(1)(i), (2)(x) (2019). It is
stipulated that 3M Company’s principal place of business was in
Minnesota when the petition was filed. Therefore the venue for appeal
in this case will be the U.S. Court of Appeals for the Eighth Circuit
unless the parties stipulate another circuit. See sec. 7482(a), (b)(1)(B),
(2); 28 U.S.C. sec. 41 (2018).

       Rule 146 provides, in part: “The Court, in determining foreign
law, may consider any relevant material or source, including testimony,
whether or not submitted by a party or otherwise admissible. The
Court’s determination shall be treated as a ruling on a question of law.”
Our determinations regarding Brazilian law are based on the
stipulation.

II.   Review of the authorities under U.S. law relevant to the
      arguments by the parties

       In support of its argument that respondent’s section 482
allocation is improper because it ascribes income to 3M Company and
3M IPC that could not be paid to these companies by 3M Brazil under
Brazilian law, petitioner relies on various authorities. These authorities
include (1) the text of section 482; (2) the legislative history of section
482; and (3) four cases, that, interpreting prior versions of section 482
and the regulations thereunder, held that respondent did not have
authority to allocate income to a taxpayer that the taxpayer did not
receive and could not legally receive. These are the four cases:

      ●      L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C. 940
             (1952)

      ●      Commissioner v. First Sec. Bank of Utah, N.A, 405 U.S.
             394 (1972)
                                           68

        ●       Procter & Gamble Co. v. Commissioner, 95 T.C. 323 (1990),
                aff’d, 961 F.2d 1255 (6th Cir. 1992).

        ●       Exxon Corp. & Affiliated Cos. v. Commissioner, T.C. Memo.
                1993-616, 66 T.C.M. (CCH) 1707 (1993), aff’d sub nom.
                Texaco, Inc., & Subs. v. Commissioner, 98 F.3d 825 (5th
                Cir. 1996).

In petitioner’s view, “these precedents control the outcome here.”
Respondent disagrees with this. He contends that the judicial opinions
did not determine the statutory text to be clear, that the reasoning of
the opinions was influenced by regulatory text that was not applicable
for tax years beginning after April 21, 1993, and that the operative
statutory text was changed in 1986. 38

         The regulations related to sec. 482 contained two sentences, which, before
        38

they were eliminated as to tax years beginning after Apr. 21, 1993, were as follows:
        The interests controlling a group of controlled taxpayers are assumed
        to have complete power to cause each controlled taxpayer so to conduct
        its affairs that its transactions and accounting records truly reflect the
        net income from the property and business of each of the controlled
        taxpayers. If, however, this has not been done, and the taxable
        incomes are thereby understated, the district director shall intervene,
        and, by making such distributions, apportionments, or allocations as
        he may deem necessary of gross income, deductions, credits, or
        allowances, or of any item or element affecting taxable income,
        between or among the controlled taxpayers constituting the group,
        shall determine the true taxable income of each controlled taxpayer.
        ***
26 C.F.R. sec. 1.482-1A(b)(1) (2019) (applicable for tax years beginning on or before
Apr. 21, 1993).
        The two sentences had appeared in 1962 regulations related to sec. 482 of the
Internal Revenue Code of 1954. T.D. 6595, 27 Fed. Reg. 3595, 3598 (Apr. 14, 1962); 26
C.F.R. sec. 1.482-1(b)(1) (1968). In 1968, when the regulations were substantially
revised, these two sentences were unaffected. T.D. 6952, 33 Fed. Reg. 5848-5857 (Apr.
16, 1968); 26 C.F.R. sec. 1.482-1(b)(1) (1969). In 1993, the regulations containing the
two sentences were redesignated and limited to tax years beginning on or before Apr.
21, 1993. T.D. 8470, 58 Fed. Reg. 5271 (Jan. 21, 1993). As redesignated and limited,
the two sentences continue to appear in the annual codifications of federal regulations.
26 C.F.R. sec. 1.482-1A(b)(1) (2019) (applicable for tax years beginning on or before
Apr. 21, 1993).
        The two sentences also had a place in the regulations before 1962. Versions of
the two sentences appeared in the comprehensive income tax regulations promulgated
by the Treasury Department in 1934, 1936, 1939, 1940, 1943, and 1953:
                                        69

      Respondent argues that the legal principles that govern this
dispute are found in the 1994 regulation that is applicable for the 2006
tax year at issue in this case. T.D. 8552, 59 Fed. Reg. 34971 (July 8,
1994); 26 C.F.R. sec. 1.482-1(h)(2) (2019) (setting forth rules regarding
the effect of foreign legal restrictions). The 1994 regulation was
published on July 8, 1994. T.D. 8552, 59 Fed. Reg. 35000-35001 (July 8,
1994). It is generally effective for tax years beginning after October 6,
1994. 26 C.F.R. sec. 1.482-1(j)(1) (2019). Petitioner contends that the
1994 regulation is invalid under various administrative-law principles
and therefore does not control the outcome of this case.

      The paragraph above is merely an overview of petitioner’s and
respondent’s major arguments. A detailed discussion of their arguments
takes place later in parts III, IV, and V of this Opinion. The parties’
arguments implicate a century’s worth of legal materials, such as

      •      The relevant portion of the 1934 regulations is art. 45-1(b), Regulations
             86, Regulations 86 Relating to the Income Tax Under the Revenue Act
             of 1934, at 123 (Gov’t Prtg. Off. 1935).
      •      The relevant portion of the 1936 regulations is art. 45-1(b), Regulations
             94, Regulations 94 Relating to the Income Tax Under the Revenue Act
             of 1936, at 157 (Gov’t Prtg. Off. 1936), 1 Fed. Reg. 1856 (Nov. 14, 1936);
             26 C.F.R. sec. 3.45-1(b) (1939).
      •      The relevant portion of the 1939 regulations is art. 45-1(b), Regulations
             101, Regulations 101 Relating to the Income Tax Under the Revenue
             Act of 1938, at 189-190 (Gov’t Prtg. Off. 1939), 4 Fed. Reg. 680 (Feb.
             10, 1939); 26 C.F.R. sec. 9.45-1 (1939 Supp.).
      •      The relevant portion of the 1940 regulations is sec. 19.45-1(b),
             Regulations 103, Regulations 103 Relating to the Income Tax Under
             the Internal Revenue Code 204 (Gov’t Prtg. Off. 1940), 5 Fed. Reg.
             417 (Feb. 1, 1940); 26 C.F.R. sec. 19.45-1 (1940 Supp.).
      •      The relevant portion of the 1943 regulations is sec. 29.45-1(b),
             Regulations 111, Regulations 111 Relating to the Income Tax Under
             the Internal Revenue Code 276 (Gov’t Prtg. Off. 1943); sec. 9.45-1,
             Regulations 111, 8 Fed. Reg. 14968 (Nov. 3, 1943); 26 C.F.R. sec. 29.45-
             1(b) (Cum. Supp. 1944). There was a minor amendment to this portion
             of the 1943 regulations in 1944. T.D. 5426, 10 Fed. Reg. 23, 24 (Jan. 2,
             1945); 26 C.F.R. sec. 29.45-1, at 1905 (1944 Supp.); 26 C.F.R. sec. 29.45-
             1 (1949).
      •      The relevant portion of the 1953 regulations was sec. 39.45-1(b)(1),
             Regulations 118, Income Tax Regulations 118, Internal Revenue Code
             Part 39 of Title 26, Code of Federal Regulations 5886 (Gov’t Prtg. Off.
             1953), 18 Fed. Reg. 5886 (Sept. 26, 1953); 26 C.F.R. sec. 39.45-1(b)(1)
             (1953).
      The history of the two sentences is discussed more extensively infra part II.
                                          70

statutes, amendments to statutes, legislative history, regulations,
public comments on regulations, preambles to regulations, and caselaw.
In this part II, we discuss these materials chronologically. Using
chronological order helps place the legal materials in their proper
context.

      A.        The Revenue Act of 1921

       The central statutory provision involved in this case is section 482
of the Internal Revenue Code of 1986, as amended. As in effect for the
tax year at issue, 2006, section 482 of the Internal Revenue Code of 1986
contains only these two sentences:

              In any case of two or more organizations, trades, or
      businesses (whether or not incorporated, whether or not
      organized in the United States, and whether or not
      affiliated) owned or controlled directly or indirectly by the
      same interests, the Secretary may distribute, apportion, or
      allocate gross income, deductions, credits, or allowances
      between or among such organizations, trades, or
      businesses, if he determines that such distribution,
      apportionment, or allocation is necessary in order to
      prevent evasion of taxes or clearly to reflect the income of
      any of such organizations, trades, or businesses. In the
      case of any transfer (or license) of intangible property
      (within the meaning of section 936(h)(3)(B)[39]), the income
      with respect to such transfer or license shall be

      39   Sec. 936(h)(3)(B) provided:
      The term “intangible property” means any--
      (i) patent, invention, formula, process, design, pattern, or know-how;
      (ii) copyright, literary, musical, or artistic composition;
      (iii) trademark, trade name, or brand name;
      (iv) franchise, license, or contract;
      (v) method, program, system, procedure, campaign, survey, study,
          forecast, estimate, customer list, or technical data; or
      (vi) any similar item,
      which has substantial value independent of the services of any
      individual.
                                      71

       commensurate with the income attributable to the
       intangible.

       The first sentence quoted above had its statutory origins in
section 240(d) of the Revenue Act of 1921, ch. 136, 42 Stat. at 260. 40 See
G.D. Searle & Co. v. Commissioner, 88 T.C. 252, 356 (1987); Reuven S.
Avi-Yonah, “The Rise and Fall of Arm’s Length: A Study in the Evolution
of U.S. International Taxation”, 15 Va. Tax Rev. 89, 95 (1995). Under
section 240(d) of the Revenue Act of 1921, respondent had the power to
consolidate the accounts of affiliated corporations and other related
trades or businesses. Subsection (d) provided:

       [I]n any case of two or more related trades or businesses
       (whether unincorporated or incorporated and whether
       organized in the United States or not) owned or controlled
       directly or indirectly by the same interests, the
       Commissioner [of Internal Revenue] may consolidate the
       accounts of such related trades and businesses, in any
       proper case, for the purpose of making an accurate
       distribution or apportionment of gains, profits, income,
       deductions, or capital between or among such related
       trades or businesses.

Section 240(d) of the Revenue Act of 1921 was one of the Act’s
consolidated-return provisions, all of which were in section 240 of the
Act. The Senate Finance Committee explained section 240(d) of the
Revenue Act of 1921 as follows:

       A new subdivision is added to this section giving the
       Commissioner power to consolidate the accounts of related
       trades or businesses owned or controlled by the same
       interests, for the purpose only of making a correct
       distribution of gains, profits, income, deductions, or capital,
       among the related trades or businesses. This is necessary
       to prevent the arbitrary shifting of profits among related
       businesses * * *

        40 Revenue acts such as the Revenue Act of 1921 have been explained as

follows: “There was no Internal Revenue Code before 1939. Instead each Congress
reenacted revenue laws with whatever amendments were necessary.” Gail Levin
Richmond & Kevin M. Yamamoto, Federal Tax Research: Guide to Materials and
Techniques 54 (10th ed. 2018).
                                   72

S. Rept. No. 67-275, at 20 (1921), 1939-1 C.B. (Part 2) 181, 195.
Petitioner cites this committee report in support of its arguments. See
infra part IV (discussing the significance of the committee report).

      B.     The Revenue Act of 1924

       After the Revenue Act of 1921, the next revenue act was the
Revenue Act of 1924, ch. 234, 43 Stat. 253. Section 240(d) of the Revenue
Act of 1924, 43 Stat. at 288, was similar to section 240(d) of the Revenue
Act of 1921; but whereas section 240(d) of the Revenue Act of 1921 had
allowed only respondent to consolidate accounts, section 240(d) of the
Revenue Act of 1924 allowed either respondent or the taxpayer to
consolidate accounts. It provided:

      In any case of two or more related trades or businesses
      (whether unincorporated or incorporated and whether
      organized in the United States or not) owned or controlled
      directly or indirectly by the same interests, the
      Commissioner may and at the request of the taxpayer
      shall, if necessary in order to make an accurate distribution
      or apportionment of gains, profits, income, deductions, or
      capital between or among such related trades or
      businesses, consolidate the accounts of such related trades
      or businesses.

Section 240(d) of the Revenue Act of 1924 was part of the consolidated-
return provisions of the Act. These provisions were in section 240 of the
Act.

      C.     The Revenue Act of 1926

       The next revenue act was the Revenue Act of 1926, ch. 27, 44 Stat.
9. Section 240(f) of the Revenue Act of 1926, 44 Stat. at 46, was the
same as section 240(d) of the Revenue Act of 1924. See G.D. Searle &
Co. v. Commissioner, 88 T.C. at 356. Section 240(f) of the Revenue Act
of 1926 was part of the consolidated-return provisions of the Act. These
provisions were in section 240 of the Act, 44 Stat. at 46. Section 240(a)
of the Revenue Act of 1926, 44 Stat. at 46, permitted affiliated
corporations to file consolidated returns.
                                          73

        D.      The Revenue Act of 1928

       The next revenue act was the Revenue Act of 1928, ch. 852, 45
Stat. 791. The text of section 240(f) of the Revenue Act of 1926, with
significant alterations, was placed into section 45 of the Revenue Act of
1928, 45 Stat. at 806. The other consolidated-return provisions of the
Revenue Act of 1926 were placed into sections 141 and 142 of the
Revenue Act of 1928, 54 Stat. at 831-832. See G.D. Searle & Co. v.
Commissioner, 88 T.C. at 356. 41 Section 45 of the Revenue Act of 1928
provided:

        41 The complicated history of the Revenue Act of 1928 led some to think that it
did not reenact the other consolidated-return provisions of the Revenue Act of 1926.
For example, the U.S. Court of Appeals for the Third Circuit stated: “The Revenue Act
of 1928 entirely eliminated the right of affiliated corporations to file consolidated
returns and the provisions of Section 240 of the 1926 Act accordingly do not appear in
the 1928 Act.” Nat’l Sec. Corp. v. Commissioner, 137 F.2d 600, 602 (3d Cir. 1943), aff’g
46 B.T.A. 562 (1942). And the U.S. Court of Appeals for the Second Circuit stated:
“The Revenue Act of 1928 eliminated the right of affiliated corporations to file
consolidated returns”. B. Forman Co. v. Commissioner, 453 F.2d 1144, 1150 (2d Cir.
1972), aff’g in part, rev’g in part 54 T.C. 912 (1970). These statements are incorrect.
The history of the Revenue Act of 1928 began with a bill that was introduced in the
House and then referred to the House Ways & Means Committee. H.R. 1, 70th Cong.
(Dec. 6, 1927) (the bill introduced in the House and referred to the Ways & Means
Committee). This bill was passed by the House, and an identical bill was then
introduced in the Senate. H.R. 1, 70th Cong. (Dec. 17, 1927) (the identical bill that
was introduced in the Senate). The House bill (and the identical bill introduced in the
Senate) eliminated the consolidated-return provisions, except for the text of sec. 240(f)
of the Revenue Act of 1926, which would have been reenacted had the bill been enacted
as written. H.R. 1, 70th Cong., secs. 45, 141, 142 (Dec. 6, 1927) (the bill introduced in
the House and referred to the Ways & Means Committee); H.R. 1, 70th Cong., secs. 45,
141, 142 (Dec. 17, 1927) (the identical bill that was introduced in the Senate); see
Jasper L. Cummings, Jr., “Consolidating Foreign Affiliates”, 11 Fla. Tax Rev. 143, 188
(2011) (“[T]he House bill for the 1928 Revenue Act proposed to eliminate consolidated
returns”.).     Committee reports observed that the House bill eliminated the
consolidated-return provisions except for the text of section 240(f) of the Revenue Act
of 1926. H.R. Rept. No. 70-2, at 20 (Dec. 7, 1927), 1939-1 C.B. (Part 2) 384, 397 (“The
consolidated return is abolished in the bill for the taxable year 1929 and following
taxable years, and thereafter affiliated corporations are required to file separate
returns.”); S. Rept. No. 70-960, at 29 (May 1, 1928), 1939-1 C.B. (Part 2) 409, 429 (“The
House bill abolished the right to file consolidated returns for years after 1928.”); H.R.
Conf. Rept. No. 70-1882, at 16 (May 25, 1928), 1939-1 C.B. (Part 2) 444, 448 (“The
House bill made no provision for the filing by affiliated corporations of a consolidated
return after the taxable year 1928.”). However, the Senate approved an amendment
that preserved the consolidated-return provisions. See H.R. Conf. Rept. No. 70-1882,
at 16 (May 25, 1928), 1939-1 C.B. (Part 2) 444, 448 (“The Senate amendment permits
the filing of a consolidated return by an affiliated group * * *.”); Cummings, supra, 188
(“The Senate rejected the elimination of consolidated returns”.). It was this Senate
                                         74

              In any case of two or more trades or businesses
       (whether or not incorporated, whether or not organized in
       the United States, and whether or not affiliated) owned or
       controlled directly or indirectly by the same interests, the
       Commissioner is authorized to distribute, apportion, or
       allocate gross income or deductions between or among such
       trades or businesses, if he determines that such
       distribution, apportionment, or allocation is necessary in
       order to prevent evasion of taxes or clearly to reflect the
       income of any of such trades or businesses.

There were two differences between section 45 of the Revenue Act of
1928 and section 240(f) of the Revenue Act of 1926. First, a taxpayer
did not have the power to invoke section 45 of the Revenue Act of 1928.
See G.D. Searle & Co. v. Commissioner, 88 T.C. at 356. Only respondent
could invoke the provision. Second, respondent did not have the express
authority to “consolidate” accounts under section 45 of the Revenue Act
of 1928. Instead, that provision gave respondent the power to distribute,
apportion, and allocate gross income or deductions.

       The House Ways & Means Committee in its report explained that
the purpose of section 45 of the Revenue Act of 1928 was to allow
respondent “in the case of two or more trades or businesses owned or
controlled by the same interests” to make allocations “in order to prevent
evasion (by the shifting of profits, the making of fictitious sales, and
other methods frequently adopted for the purpose of ‘milking’), and in
order clearly to reflect their true tax liability.” H.R. Rept. No. 70-2, at
16-17 (1927), 1939-1 C.B. (Part 2) 384, 395. The Senate Finance
Committee made a similar statement in its own report leading up to
section 45 of the Revenue Act of 1928. S. Rept. No. 70-960, at 24 (1928),
1939-1 C.B. (Part 2) 409, 426. Petitioner cites the reports of both
committees. See infra part IV.

       E.      The Revenue Act of 1932

      The Revenue Act of 1932, ch. 209, 47 Stat. 169, was the next
revenue act after the Revenue Act of 1928. Section 45 of the Revenue
Act of 1932 was the same as section 45 of the Revenue Act of 1928.
Revenue Act of 1932, sec. 45, 47 Stat. at 186.

amendment that made it into the Revenue Act of 1928 and became the law. Revenue
Act of 1928, secs. 141 and 142, 54 Stat. at 831-832. Thus, the Revenue Act of 1928 did
not eliminate the right of affiliated corporations to file consolidated returns.
                                         75

       F.      The Revenue Act of 1934

       The Revenue Act of 1934, ch. 277, 48 Stat. 680, was the next
revenue act after the Revenue Act of 1932. Section 45 of the Revenue
Act of 1934 was the same as section 45 of the Revenue Act of 1932, except
that the words “trades or businesses” in the 1932 act were replaced with
“organizations, trades, or businesses” in the 1934 act. Revenue Act of
1934, sec. 45, 48 Stat. at 695. Below is the text of section 45 of the
Revenue Act of 1934:

               In any case of two or more organizations, trades, or
       businesses (whether or not incorporated, whether or not
       organized in the United States, and whether or not
       affiliated) owned or controlled directly or indirectly by the
       same interests, the Commissioner is authorized to
       distribute, apportion, or allocate gross income or
       deductions between or among such organizations, trades,
       or businesses, if he determines that such distribution,
       apportionment, or allocation is necessary in order to
       prevent evasion of taxes or clearly to reflect the income of
       any such organizations, trades, or businesses.[42]

       G.      Regulations 86

      In 1934, the Treasury Department promulgated art. 45-1,
Regulations 86, which related to section 45 of the Revenue Act of 1934.
Regulations 86 Relating to the Income Tax Under the Revenue Act of
1934, at 122-124 (Gov’t Prtg. Off. 1935). 43 Reproduced below is art. 45-
1, Regulations 86 (emphasis added):

        42 The income-tax provisions of the Revenue Act of 1934, including section 45

of that Act, were applicable for tax years beginning on or after Jan. 1, 1934. Revenue
Act of 1934, sec. 1, 48 Stat. at 683.
       43 In the days before the Federal Register and the Code of Federal Regulations,
the Treasury Department published its regulations in consecutively numbered
pamphlets. Henry Campbell Black, A Treatise on the Law of Income Taxation Under
Federal and State Laws sec. 71 (2d ed. 1915) (available at heinonline.org); Richmond
& Yamamoto, supra, 148. One of these numbered pamphlets was Regulations 86
Relating to the Income Tax Under the Revenue Act of 1934. This publication bears a
publication date of 1935. The last sentence of the regulations reads: “In pursuance of
the Act the foregoing regulations are hereby prescribed.” Underneath that sentence is
the name and title of the Commissioner of Internal Revenue. Underneath this are the
words “Approved February 11, 1935” and the name and title of the Secretary of the
Treasury. Although the year of publication (1935) and the date “Approved” (Feb. 11,
                                         76

              Art. 45-1. Determination of the taxable net income
       of a controlled taxpayer.--

               (a) Definitions.--When used in this article--

                       (1) The term “organization” includes any
               organization of any kind, whether it be a sole
               proprietorship, a partnership, a trust, an estate, or
               a corporation (as each is defined or understood in the
               Act or these regulations), irrespective of the place
               where organized, where operated, or where its trade
               or business is conducted, and regardless of whether
               domestic or foreign, whether exempt, whether
               affiliated, or whether a party to a consolidated
               return.

                      (2) The terms “trade” or “business” include
               any trade or business activity of any kind, regardless
               of whether or where organized, whether owned
               individually or otherwise, and regardless of the
               place where carried on.

                       (3) The term “controlled” includes any kind of
               control, direct or indirect, whether legally
               enforceable, and however exercisable or exercised.
               It is the reality of the control which is decisive, not
               its form nor the mode of its exercise. A presumption
               of control arises if income or deductions have been
               arbitrarily shifted.

                     (4) The term “controlled taxpayer” means any
               one of two or more organizations, trades, or
               businesses owned or controlled directly or indirectly
               by the same interests.

1935) would seem to indicate that Regulations 86 was promulgated in 1935, there is
authority it was promulgated in 1934. Commissioner v. First Sec. Bank of Utah, N.A,
405 U.S. 394, 400 n.10 (1972) (“[The] regulations * * * were issued in 1934.”); R.C.
Reynolds, Inc. v. Commissioner, 44 B.T.A. 356, 364 (1941) (“Respondent’s Regulations
86 were approved on September 6, 1934.”); Thomas E. Jenks, “Treasury Regulations
Under Section 482”, 23 Tax Lawyer 279, 279 (1970) (“The * * * regulations were issued
in 1934”.).
                            77

           (5) “Group” or “group of controlled taxpayers”
      means the organizations, trades, or businesses
      owned or controlled by the same interests.

             (6) The term “true net income” means, in the
      case of a controlled taxpayer, the net income (or, as
      the case may be, any item or element affecting net
      income) which would have resulted to the controlled
      taxpayer, had it in the conduct of its affairs (or, as
      the case may be, in the particular contract,
      transaction, arrangement, or other act) dealt with
      the other member or members of the group at arm’s
      length. It does not mean the income, the deduction,
      or the item or element of either, resulting to the
      controlled taxpayer by reason of the particular
      contract, transaction, or arrangement, the
      controlled taxpayer, or the interests controlling it,
      choose to make (even though such contract,
      transaction, or arrangement be legally binding upon
      the parties thereto).

       (b) Scope and purpose.--The purpose of section 45 is
to place a controlled taxpayer on a tax parity with an
uncontrolled taxpayer, by determining, according to the
standard of an uncontrolled taxpayer, the true net income
from the property and business of a controlled taxpayer.
The interests controlling a group of controlled taxpayers
are assumed to have complete power to cause each
controlled taxpayer so to conduct its affairs that its
transactions and accounting records truly reflect the net
income from the property and business of each of the
controlled taxpayers. If, however, this has not been done,
and the taxable net incomes are thereby understated, the
statute contemplates that the Commissioner shall
intervene, and, by making such distributions,
apportionments, or allocations as he may deem necessary
of gross income or deductions, or of any item or element
affecting net income, between or among the controlled
taxpayers constituting the group, shall determine the true
net income of each controlled taxpayer. The standard to be
applied in every case is that of an uncontrolled taxpayer
dealing at arm’s length with another uncontrolled
taxpayer.
                                          78

              Section 45 and this article apply to the case of any
       controlled taxpayer, whether such taxpayer makes a
       separate or a consolidated return. If a controlled taxpayer
       makes a separate return, the determination is of its true
       separate net income. If a controlled taxpayer is a party to
       a consolidated return, the true consolidated net income of
       the affiliated group and the true separate net income of the
       controlled taxpayer are determined consistently with the
       principles of a consolidated return.

              Section 45 grants no right to a controlled taxpayer
       to apply its provisions at will, nor does it grant any right to
       compel the Commissioner to apply such provisions. It is
       not intended (except in the case of the computation of
       consolidated net income under a consolidated return) to
       effect in any case such a distribution, apportionment or
       allocation of gross income, deductions, or any item of
       either, as would produce a result equivalent to a
       computation of consolidated net income under section
       141.[44]

               (c)    Application.--Transactions    between     one
       controlled taxpayer and another will be subjected to special
       scrutiny to ascertain whether the common control is being
       used to reduce, avoid, or escape taxes. In determining the
       true net income of a controlled taxpayer, the Commissioner
       is not restricted to the case of improper accounting, to the
       case of a fraudulent, colorable or sham transaction, or to
       the case of a device designed to reduce or avoid tax by
       shifting or distorting income or deductions. The authority
       to determine true net income extends to any case in which
       either by inadvertence or design the taxable net income, in
       whole or in part, of a controlled taxpayer, is other than it
       would have been had the taxpayer in the conduct of his
       affairs been an uncontrolled taxpayer dealing at arm’s
       length with another uncontrolled taxpayer.

Regulations 86 Relating to the Income Tax Under the Revenue Act of
1934, at 122-124 (Gov’t Prtg. Off. 1935). We have added emphasis to the
sentence that contains the phrase “complete power”. Petitioner argues

         44 Section 141 of the Revenue Act of 1934, 48 Stat. at 720-722, related to the

filing of a consolidated return by an affiliated group of corporations.
                                           79

that this crucial sentence was not in the version of the regulation that
was in effect for the tax years at issue in L.E. Shunk Latex Products,
Inc. v. Commissioner, 18 T.C. at 955, i.e., calendar years 1942, 1943, and
1945. Petitioner argues that therefore the decision in L.E. Shunk Latex
did not depend on the sentence. 45 Because of petitioner’s argument, our
review of legal authorities will include the various versions in the
regulations that contain this sentence. The sentence containing the
phrase “complete power” is related to the sentence that follows it. Thus,
we will include this sentence too in our review of legal authorities.

       H.        The Federal Register Act and the publication of the first
                 issue of the Federal Register

        In 1935 Congress enacted the Federal Register Act, ch. 417, 49
Stat. 500 (1935). Section 5 of the Federal Register Act, 49 Stat. at 501, 46
defined four classes of documents that had to be published in the Federal
Register: (1) “all Presidential proclamations and Executive orders,
except such as have no general applicability and legal effect or are
effective only against Federal agencies or persons in their capacity as
officers, agents, or employees thereof”; (2) “such documents or classes of
documents as the President shall determine from time to time have
general applicability and legal effect”; (3) “such documents or classes of
documents as may be required so to be published by Act of the
Congress”; and (4) “such other documents or classes of documents as
may be authorized to be published pursuant hereto by regulations
prescribed hereunder with the approval of the President”. For these
purposes, a “document” was defined as “any Presidential proclamation
or Executive order and any order, regulation, rule, certificate, code of
fair competition, license, notice, or similar instrument issued,
prescribed, or promulgated by a Federal agency”. Federal Register Act
sec. 4, 49 Stat. at 501. 47

      The Federal Register Act imposed a series of requirements that
had to be followed regarding any document in the four classes of
documents. Section 2 of the Federal Register Act, 49 Stat. at 500, 48
provided that each document had to be filed with the Federal Register

       45   The portion of petitioner’s brief containing this argument is excerpted infra
part IV.
       46   Codified as amended at 44 U.S.C. sec. 1505(a) and (b) (2012).
       47   Codified as amended at 44 U.S.C. sec. 1501 (2012).
       48   Codified as amended at 44 U.S.C. sec. 1503 (Supp. IV 2017).
                                            80

Division by the relevant agency; 49 that after filing, a copy of each
document had to be made immediately available for public inspection at
the Federal Register Division; and that once filed with the Federal
Register Division each document had to be immediately transmitted by
the Federal Register Division to the Government Printing Office.
Section 3 of the Federal Register Act, 49 Stat. at 500-501, 50 required
that when the Government Printing Office received each document, it
was to print it “forthwith” in the Federal Register.

       Section 7 of the Federal Register Act, 49 Stat. at 502, 51 set forth
the legal consequences of satisfying the requirements of the Federal
Register Act, including the filing requirement (in section 2 of the Act),
the public-inspection requirement (also in section 2 of the Act), and the
publication requirement (in section 3 of the Act). First, section 7 of the
Federal Register Act provided that a document in the first, second, and
third classes of documents is not valid against someone without actual
knowledge of the document until the agency files the document with the
Federal Register Division and a copy of the document is made available
for public inspection. 52 Second, section 7 of the Federal Register Act
provided that the filing of a document with the Federal Register Division

        49 The Division of the Federal Register was not referred to by name in the
Federal Register Act, which referred only to a “division established * * * in the National
Archives Establishment”. Federal Register Act sec. 1, 49 Stat. at 500. A 1936 law
referred to the Division of the Federal Register by its exact name. Act of Feb. 11, 1936,
ch. 49, 49 Stat. at 1110. In 1968, the Division of the Federal Register was renamed
the Office of the Federal Register. Act of Oct. 22, 1968, Pub. L. No. 90-620, sec. 1502,
82 Stat. at 1273-1274 (1968) (enacting 44 U.S.C. sec. 1502 (1982)). The National
Archives Establishment was created in 1934. Act of June 19, 1934, ch. 668, secs. 2-3,
48 Stat. at 1122 (codified as amended at 44 U.S.C. secs. 300(a), 300(c) (1946)). In 1949,
it became part of the General Services Administration and was renamed the National
Archives and Records Service. Federal Property and Administrative Services Act of
1949, ch. 288, sec. 104(a), 63 Stat. at 381 (codified as amended at 44 U.S.C. sec. 391(a)
(1964)); Fed. Reg. Div. et al., United States Government Organization Manual 1950-
51, at 355-356. In 1984, the National Archives and Record Service was transferred to
the National Archives and Records Administration, which was established as an
independent agency in the executive branch. National Archives and Records
Administration Act of 1984, Pub. L. No. 98-497, sec. 101, 98 Stat. at 2280 (codified as
amended at 44 U.S.C. sec. 2102 (2018)); National Archives and Records Administration
Act of 1984, sec. 103(a), 98 Stat. at 2283.
        50   Codified as amended at 44 U.S.C. sec. 1504 (Supp. IV 2017).
        51   Codified as amended at 44 U.S.C. sec. 1507 (2012).
        52 This provision has been described as “requiring filing as a condition

precedent to validity”. James H. Ronald, “Publication of Federal Administrative
Legislation”, 7 Geo. Wash. L. Rev. 52, 75 (1938).
                                            81

is generally “sufficient” to give notice of its contents to any person
subject to it or affected by it. Third, section 7 of the Federal Register
Act provided that the publication in the Federal Register of a document
creates the following rebuttable presumptions: (1) the document was
duly issued, prescribed, or promulgated; (2) the document was filed with
the Federal Register Division and was made available for public
inspection; (3) the copy of the document contained in the Federal
Register is the true copy of the document; and (4) all the other
requirements of the Federal Register Act have been complied with.

       Section 10 of the Federal Register Act, 49 Stat. at 503, 53 contained
provisions regarding the effective dates for the requirements of the
Federal Register Act discussed so far, including a provision that
section 2 of the Federal Register Act (which contained the filing
requirement, the public-inspection requirement, and the transmission-
for-publication requirement) was effective 60 days after the approval of
the Act, and including a provision that publication of the Federal
Register would begin three days after approval of the Act. Section 10 of
the Federal Register Act stated in full:

        The provisions of section 2 shall become effective sixty days
        after the date of approval of this Act[54] and the publication
        of the Federal Register shall begin within three business
        days thereafter: Provided, That the appropriations
        involved have been increased as required by section 9 of
        this Act.    The limitations upon the effectiveness of
        documents required, under section 5(a),[55] to be published
        in the Federal Register shall not be operative as to any
        document issued, prescribed, or promulgated prior to the
        date when such document is first required by this or

        53   Codified with changes at 44 U.S.C. sec. 310 (1940).
        54By “the date of approval of this Act”, the Federal Register Act referred to the
date the President had signed the Act. See U.S. Const. art. I, sec. 7, cl. 2 (“Every Bill
which shall have passed the House of Representatives and the Senate, shall, before it
become a Law, be presented to the President of the United States; If he approve he
shall sign it”.); see also Edwards v. United States, 286 U.S. 482, 492-494 (1932)
(equating the approval of an act with the President’s signature in holding that a bill
became a law upon its approval by the President, regardless of Congress’s
adjournment).
        55 The reference to documents required under sec. 5(a) to be published in the

Federal Register was to the first, second, and third classes of documents that we
discussed earlier.
                                       82

       subsequent Act of the Congress or by Executive order to be
       published in the Federal Register.

The Federal Register Act was “[a]pproved” on July 26, 1935. 49 Stat. at
503. Thus, under section 10 of the Federal Register Act, section 2 was
to become effective on September 24, 1935, and the publication of the
Federal Register was to begin September 27, 1935. Actual publication
was delayed, however, because of the lack of appropriated money.
James H. Ronald, “Publication of Federal Administrative Legislation”,
7 Geo. Wash. L. Rev. 52, 75 (1938).

        The Federal Register Act also required each agency to make a
compilation of “all documents which have been issued or promulgated
prior to the date documents are required or authorized by this Act to be
published in the Federal Register [September 24, 1935] and which are
still in force and effect and relied upon by the agency as authority for, or
invoked or used by it in the discharge of, any of its functions or
activities.” Federal Register Act sec. 11, 49 Stat. at 503. 56 The deadline
for the agencies to compile the documents was January 26, 1936. Id.
The compilation was required to be published, but no specific deadline
was set for publication. Id. Because of legislative developments
described later, no compilation was made or published. Bernard
Kennedy, “The Code of Federal Regulations and the United States
Statutes at Large”, 44 Law Libr. J. 1, 1 (1951).

       On February 11, 1936, Congress enacted a law that appropriated
money “[f]or the printing and distribution of the Federal Register”. Act
of Feb. 11, 1936, ch. 49, 49 Stat. at 1110 (codified as amended at 44
U.S.C. sec. 309 (1940)). The law provided that “the provisions of section
2 of the Federal Register Act shall become effective thirty days after said
appropriations become available and the publication of the Federal
Register shall begin within two business days thereafter.” Id.

      On March 14, 1936, the first issue of the Federal Register was
published. 1 Fed. Reg. 1; see Ronald, supra, at 69.

        56 This provision has been described as requiring “a compilation of all

documents issued before the start of publication of the Federal Register and which
were still in force and effect.” Ronald, supra, at 78.
                                             83

        I.        The Revenue Act of 1936

       The Revenue Act of 1936, ch. 690, 49 Stat. 1648, was the next
revenue act after the Revenue Act of 1934. Section 45 of the Revenue
Act of 1936 incorporated the text of section 45 of the Revenue Act of 1934
without change. Revenue Act of 1936, ch. 690, sec. 45, 49 Stat. at 1667-
1668. 57

        J.        Regulations 94

       In late 1936, the Treasury Department promulgated art. 45-1,
Regulations 94, Regulations 94 Relating to the Income Tax Under the
Revenue Act of 1936, at 156-158 (Gov’t Prtg. Off. 1936), which related to
section 45 of the Revenue Act of 1936. 58 Article 45-1, Regulations 94,
was identical to its 1934 predecessor, art. 45-1, Regulations 86.
Regulations 94 was filed on November 13, 1936. 1 Fed. Reg. 1863.
Article 45-1, Regulations 94, was published verbatim in the Federal
Register--meaning that the text published in the Federal Register was
identical to the text published in the pamphlet Regulations 94 Relating
to the Income Tax Under the Revenue Act of 1936. Compare id. with
1 Fed. Reg. 1855-1856 (Nov. 14, 1936).

        K.        The 1937 amendment to the Federal Register Act

       In 1937, Congress amended the provisions of the Federal Register
Act that required the compilation of pre-September 24, 1935 documents.
Act of June 19, 1937, ch. 369, 50 Stat. 304. The reason for the
amendment was the realization that “mere compilations of documents
were almost unusable because of their bulk and lack of uniformity.”
Titles 1-6 C.F.R. v (1939). The 1937 amendment replaced the
requirement that the pre-September 24, 1935 documents be compiled.
Act of June 19, 1937, 50 Stat. 304; Title 1-6 C.F.R. v (1939). Instead, the
1937 amendment required each agency to prepare a complete
codification of documents that were in effect on June 1, 1938:

        On July 1, 1938, and on the same date of every fifth year
        thereafter, each agency of the Government shall have
        prepared and shall file with the Administrative Committee
        a complete codification of all documents which, in the

        57The income-tax provisions of the Revenue Act of 1936 were applicable for tax
years beginning on or after Jan. 1, 1936. Revenue Act of 1936, sec. 1, 49 Stat. at 1652.
        58   Regulations 94 did not have a provision regarding its effective date.
                                           84

        opinion of the agency, have general applicability and legal
        effect and which have been issued or promulgated by such
        agency and are in force and effect and relied upon by the
        agency as authority for, or invoked or used by it in the
        discharge of, any of its functions or activities on June 1,
        1938. * * *

Federal Register Act sec. 11(a), as amended by Act of June 19, 1937, 50
Stat. at 304-305, 44 U.S.C. sec. 311(a) (1940). The 1937 amendment
authorized the President to direct the publication of the codification. 59
No deadline was set for publishing the codification, but the deadline for
making the codification was July 1, 1938. Id. The codification of
documents was to be done again every five years after July 1, 1938. Id.
Under the literal text of the 1937 amendment (which is quoted above),
the subsequent codifications to be made every five years after July 1,
1938, were to be of the same documents required to be codified by July
1, 1938. Id. Thus, the 1937 amendment required that essentially the
same documents be codified and republished every five years until the
end of time. This was a drafting error. See Ronald, supra, at 79 n.110
(“The drafters forgot the five-year clause in setting the date of
determining general applicability and legal effect.”).

       On November 10, 1937, the President authorized the publication
of the codification of documents pursuant to the Federal Register Act as
amended in 1937. Titles 1-6 C.F.R. vi (1939).

        L.      The first edition of the Code of Federal Regulations

      In 1939, the first edition of the Code of Federal Regulations was
published, which contained documents in force on June 1, 1938. Titles
1-6 C.F.R. iii (1939). 60 Regulations 94 was apparently assumed to be in

        59 The 1937 amendment provided: “[T]he President * * * may authorize and

direct the publication of such codification in special or supplemental editions of the
Federal Register.” Federal Register Act sec. 11(a), as amended by Act of June 19, 1937,
50 Stat. at 304-305, 44 U.S.C. sec. 311(a) (1940).
        60  As explained in the preface to the first edition of the Code of Federal
Regulations, the Code of Federal Regulations was “divided into 50 titles analogous to
the titles of the United States Code.” Titles 1-6 C.F.R. iii (1939). Title 26 of the Code
of Federal Regulations was “Internal Revenue”. Titles 1-6 C.F.R. iii (1939). Title 26 of
the Code of Federal Regulations was analogous to title 26 of the United States Code,
which was the codified version of the various revenue acts. See titles 1-6 C.F.R. iii
(1939) (stating that titles of the C.F.R. are analogous to titles of the U.S.C.); 26 U.S.C.
sec. 10 note (1940) (History of the Internal Revenue Code) (“In June 1926 Congress
                                          85

force on June 1, 1938, 61 for it was published in the first edition of the
Code of Federal Regulations (1939). As printed in that publication,
article 45-1 of Regulations 94 was renamed “section 3.45-1”. 26 C.F.R.
sec. 3.45-1 (1939). 62 The renaming required nonsubstantive changes to
be made to the text of article 45-1 when it was published in the first
edition of the Code of Federal Regulations as section 3.45-1.

       The preface to the first edition of the Code of Federal Regulations
observed that the edition included only documents in force on June 1,
1938. Titles 1-6 C.F.R. ix (1939). The preface stated that regulations
that related to later periods would be covered by periodic supplements
to the Code of Federal Regulations and that the first such supplement
would be a 1938 Supplement that would cover the last half of 1938. 63

passed the ‘Code of the Laws of the United States’ which was the first general
codification of Federal statutes since the Revised Statutes. It was revised in 1934 and
again in 1940. The compilers of the United States Code acting under the supervision
of the Revision of Laws Committee of the House of Representatives, incorporated all
internal revenue laws of a general and permanent nature in Title 26, Internal
Revenue.”).
        61 This seems to be a valid assumption. Although Regulations 94 did not have
an effective-date provision, it was published in the Federal Register in 1936 and it was
related to the income-tax provisions of the Revenue Act of 1936. 1 Fed. Reg. 1802 (Nov.
14, 1936). These provisions were applicable for tax years beginning on or after Jan. 1,
1936. Revenue Act of 1936, sec. 1, 49 Stat. at 1652.
        62Other articles in Regulations 94 were similarly renamed. See 26 C.F.R. sec.
3.1-1 (1939).
        63According to the preface to the first edition of the Code of Federal
Regulations:
                                     Supplements
                The 1938 Supplement to the Code covers the period beginning
       June 2 and ending December 31, 1938. Each succeeding supplement
       will cover the period of one calendar year. Since the rules and
       regulations contained in the Code of Federal Regulations were codified
       as of June 1, 1938, it follows that this edition should be used in
       conjunction with the annual supplements, and in conjunction with the
       daily issues of the FEDERAL REGISTER.
Titles 1-6 C.F.R. ix (1939); see also infra next note (discussing the publication of the
1938 and 1939 Supplements to the first edition of the Code of Federal Regulations).
                                          86

        M.      The Revenue Act of 1938

       Section 45 of the Revenue Act of 1938 incorporated the text of
section 45 of the Revenue Act of 1936 without change. Revenue Act of
1938, ch. 289, sec. 45, 52 Stat. at 474.

        N.      Regulations 101

        In 1939, the Treasury Department promulgated art. 45-1,
Regulations 101, Regulations 101 Relating to the Income Tax Under the
Revenue Act of 1938, at 188-190 (Gov’t Prtg. Off. 1939), which related to
section 45 of the Revenue Act of 1938. Article 45-1, Regulations 101,
was identical to art. 45-1, Regulations 94. Regulations 101 was filed on
February 7, 1939. 4 Fed. Reg. 687 (Feb. 10, 1939). Article 45-1,
Regulations 101, was published verbatim in the Federal Register, 4 Fed.
Reg. 616, 680, meaning that the text of article 45-1 published in the
Federal Register was identical to the text of article 45-1 published in the
pamphlet Regulations 101 Relating to the Income Tax Under the
Revenue Act of 1938. Compare id. with 4 Fed. Reg. 616, 680. In addition
to being published in the Federal Register, Regulations 101 was
published in the 1939 Supplement to the Code of Federal Regulations. 64
As printed in that supplement, art. 45-1, Regulations 101 was
redesignated “§ 9.45-1.” 26 C.F.R. sec. 9.45-1 (1939 Supp.). As printed
in the supplement, each “article” of Regulations 101 was redesignated a
“section”, and the number of each section was given the prefix “9.” See
26 C.F.R. sec. 9.1-1 (1939 Supp.). As a consequence of the redesignation
of art. 45-1, Regulations 101, nonsubstantive changes had to be made to
its text when it was published in the 1939 Supplement to the Code of
Federal Regulations as 26 C.F.R. sec. 9.45-1 (1939 Supp.).

        O.      Internal Revenue Code of 1939

       In 1939, Congress codified the tax laws as the Internal Revenue
Code of 1939. Section 45 of the Internal Revenue Code of 1939 was
identical to section 45 of the Revenue Act of 1938. Internal Revenue
Code of 1939, ch. 2, sec. 45, 53 Stat. at 25. Section 45 was among the
provisions of the Internal Revenue Code of 1939 that applied for tax
years beginning on or after January 1, 1939. Id. sec. 1, 53 Stat. at 4.

        64 The first edition of the Code of Federal Regulations contained regulations in

force on June 1, 1938. Titles 1-6 C.F.R. iii (1939). A 1938 Supplement contained
regulations filed from June 2 to Dec. 31, 1938, except for regulations having effective
dates before June 2, 1938. C.F.R. iii (1938 Supp.). The 1939 Supplement contained
regulations filed during calendar year 1939. Titles 1-25 C.F.R. iii (1939 Supp.).
                                           87

Thus, for calendar-year taxpayers, the first year for which section 45 of
the Internal Revenue Code of 1939 applied was the 1939 tax year.

       Provisions of the Internal Revenue Code of 1939 authorized the
Treasury Department to prescribe regulations. 65 One such provision,
section 62, provided: “The Commissioner, with the approval of the
Secretary, shall prescribe and publish all needful rules and regulations
for the enforcement of this chapter [sections 1 to 373, the income-tax
provisions of the Internal Revenue Code of 1939].”

       The Internal Revenue Code of 1939 also contained provisions
relating to the effective dates of regulations. 66 One such provision was
section 3791(b). It provided: “The Secretary, or the Commissioner with
the approval of the Secretary, may prescribe the extent, if any, to which
any ruling, regulation, or Treasury Decision, relating to the internal
revenue laws, shall be applied without retroactive effect.”

        P.      Regulations 103

        In 1940, the Treasury Department promulgated sec. 19.45-1,
Regulations 103, Regulations 103 Relating to the Income Tax under the
Internal Revenue Code 203-205 (Gov’t Prtg. Off. 1940), 26 C.F.R. sec.
19.45-1 (1940 Supp.), 5 Fed. Reg. 417 (Feb. 1, 1940), which related to
section 45 of the Internal Revenue Code of 1939. Section 19.45-1,
Regulations 103, was substantively identical to art. 45-1, Regulations
101. 67 Regulations 103 did not have an express effective-date provision.
Regulations 103 was filed on January 30, 1940. 5 Fed. Reg. 424.
Regulations 103 was published in the Federal Register and in the 1940
Supplement to the Code of Federal Regulations. 5 Fed. Reg. 348; 26
C.F.R. secs. 19.1-1 to 19.3801(e)-1 (1940 Supp.). 68

        These types of authorizations had been in the tax statutes before the Internal
        65

Revenue Code of 1939. See, e.g., Revenue Act of 1934, sec. 62.
        66 These types of provisions had been extant in pre-1939 tax statutes. See, e.g.,

Revenue Act of 1934, sec. 506, 48 Stat. at 757, amending Revenue Act of 1926, sec.
1108(a).
        67 The only differences were in each provision’s internal self-references.
Section 19.45-1, Regulations 103 referred to itself as a “section” (because it was a
section) and article 45-1, Regulations 101, referred to itself as an “article” (because it
was an article).
        68 The 1940 Supplement to the Code of Federal Regulations contained

regulations filed during 1940. Titles 1-20 C.F.R. iii (1940 Supp.).
                                         88

       Q.      The 1942 amendment to the Federal Register Act

      In 1942, the Federal Register Act was amended again. Act of Dec.
10, 1942, ch. 717, 56 Stat. 1045. The 1942 amendment consisted of three
changes, which we describe below.

       First, the 1942 amendment to the Federal Register Act changed
the requirement that each codification to be made every five years
should correspond to documents effective as of June 1, 1938. See
Federal Register Act sec. 11(a), as amended by Act of June 19, 1937, 50
Stat. at 304-305, 44 U.S.C. sec. 311(a) (1940) (before 1942
amendment). 69 The first codification had already been published as the
first edition of the Code of Federal Regulations (1939). See titles 1-6
C.F.R. iii (1939). The next codification would have been required to be
made on or before July 1, 1943. Federal Register Act sec. 11(a), as
amended by Act of June 19, 1937, 50 Stat. at 304-305, 44 U.S.C. sec.
311(a) (1940) (before 1942 amendment). The 1942 amendment provided
that, instead of documents effective June 1, 1938, the next codifications
were to be of documents effective as of June 1 of the respective year in
which the codification was made. Act of Dec. 10, 1942, sec. 2, 56 Stat. at
1045. Thus, under the 1942 amendment, the codification of documents
to made be on or before July 1, 1938, and to also be made on or before
the same date every five years thereafter, would consist of “all
documents which, in the opinion of the agency, have general
applicability and legal effect and which have been issued or promulgated
by such agency and are in force and effect and relied upon by the agency
as authority for, or invoked or used by it in the discharge of, any of its
functions or activities on June 1, 1938, or on the same date of every fifth
year thereafter.” Act of Dec. 10, 1942, sec. 2, 44 U.S.C. sec. 311 (Supp.
V 1946). This meant that the codification due July 1, 1943, would
consist of documents effective on June 1, 1943.

       The second change made by the 1942 amendment to the Federal
Register Act was to temporarily suspend the requirement that
documents be codified every five years. The reason for this suspension
related to the American participation in World War II, which had
resulted in a “notable increase in Federal administrative documents”
and “the preoccupation of all agencies with the war effort”. Titles 1-3
C.F.R. xvii (1949). These factors made it impractical to meet the July 1,
1943 deadline for the next codification. Id. The suspension of the

       69 As explained before, this requirement was the result of a drafting error in

the 1937 amendment to the Federal Register Act.
                                          89

requirement that documents be codified every five years was only
temporary. Act of Dec. 10, 1942, sec. 1, 56 Stat. at 1045. The suspension
was to last until “such time after the termination of the present war as
the Administrative Committee of the Federal Register shall determine.”
Id.

       The third change made by the 1942 amendment to the Federal
Register Act was to require that there be published, instead of a “new
codification”, a “cumulative supplement” to the Code of Federal
Regulations. Id. The 1942 amendment did not set a specific deadline
for publishing the cumulative supplement. As discussed below, the
cumulative supplement to the Code of Federal Regulations was
published in 1944.

       R.      Regulations 111

       In 1943, the Treasury Department promulgated Regulations 111.
Regulations 111 Relating to the Income Tax Under the Internal Revenue
Code (Gov’t Prtg. Off. 1943). Like Regulations 103, Regulations 111
interpreted the provisions of the Internal Revenue Code of 1939. Sec.
29.1-1, Regulations 111, Regulations 111 Relating to the Income Tax
Under the Internal Revenue Code 1; sec. 19.1-1, Regulations 103,
Regulations 103 Relating to the Income Tax Under the Internal Revenue
Code 1. Regulations 111 was applicable “only with respect to taxable
years beginning after December 31, 1941.” Sec. 29.1-1, Regulations 111.
Thus, 1942 was the first tax year governed by Regulations 111 for
calendar-year taxpayers. Regulations 111 was filed on October 28, 1943.
8 Fed. Reg. 14379. 70

      Section 29.45-1 of Regulations 111, which related to section 45 of
the Internal Revenue Code of 1939, was identical to section 19.45-1 of
Regulations 103 except for a difference in prefixes. In Regulations 111
the section had the prefix “29.” instead of the prefix “19”. Regulations
111 Relating to the Income Tax Under the Internal Revenue Code 275-
277; Regulations 103 Relating to the Income Tax Under the Internal
Revenue Code 203-205. The sentence containing the term “complete

        70 The filing date of a regulation has been explained as follows: “Because they

are not statutes, regulations are not enacted. Instead they are issued or promulgated
by being filed with the Federal Register. The filing date generally precedes the
publication date by a day or two.” Richmond & Yamamoto, supra at 126. Respondent
considers a Treasury regulation to be promulgated when the regulation is filed with
the Federal Register Division. Rev. Rul. 56-517, 1956-2 C.B. 966.
                                  90

power”, and the sentence that followed, remained the same in section
29.45-1 of Regulations 111:

      The interests controlling a group of controlled taxpayers
      are assumed to have complete power to cause each
      controlled taxpayer so to conduct its affairs that its
      transactions and accounting records truly reflect the net
      income from the property and business of each of the
      controlled taxpayers. If, however, this has not been done,
      and the taxable net incomes are thereby understated, the
      statute contemplates that the Commissioner shall
      intervene, and, by making such distributions,
      apportionments, or allocations as he may deem necessary
      of gross income or deductions, or of any item or element
      affecting net income, between or among the controlled
      taxpayers constituting the group, shall determine the true
      net income of each controlled taxpayer. * * *

       Regulations 111 was published in three different ways. First, it
was published in pamphlet form. Regulations 111 Relating to the
Income Tax Under the Internal Revenue Code. Second, it was published
in the Federal Register. 8 Fed. Reg. 14882 (Nov. 3, 1943). Third, it was
published in the Cumulative Supplement to the Code of Federal
Regulations. It was not published, as we explain later, in the 1943
Supplement to the Code of Federal Regulations. 26 C.F.R. secs. 29.1-1
to 29.3801(e)-1 (Cum. Supp. 1944).

      We discuss in greater detail below each of these publications.

      Regulations 111 in pamphlet form. In the pamphlet form, the
number of each particular section of Regulations 111 was preceded by
the prefix “29.” Secs. 29.9-1 to 29.3801(e)-1, Regulations 111 Relating
to the Income Tax Under the Internal Revenue Code. Thus, the
introduction in the pamphlet observed that the number of each section
of Regulations 111 is “preceded by the number 29 and a decimal point.”
Regulations 111 Relating to the Income Tax Under the Internal Revenue
Code II.

      Section 29.3-1 of Regulations 111, as published in pamphlet form,
stated that Regulations 111 “constitute Part 29 of Title 26 of the 1943
Supplement to the Code of Federal Regulations”.            Sec. 29.3-1,
Regulations 111 Relating to the Income Tax Under the Internal Revenue
Code 1. This statement that Regulations 111 would be published in the
                                    91

1943 Supplement to the Code of Federal Regulations was incorrect.
Regulations 111 was actually published in the Cumulative Supplement
to the Code of Federal Regulations, not the 1943 Supplement to the Code
of Federal Regulations. 26 C.F.R. secs. 29.1-1 to 29.3801(e)-1 (Cum.
Supp. 1944).

       Regulations 111 in the Federal Register. On November 3, 1943,
Regulations 111 was published in the Federal Register. 8 Fed. Reg.
14882 (Nov. 3, 1943). The text of section 29.45-1 of Regulations 111 that
was published in the Federal Register was the same text that was in the
pamphlet Regulations 111 Relating to the Income Tax Under the
Internal Revenue Code 275-277, except that for some reason the prefix
“9.” was used in the Federal Register rather than the prefix “29.” for that
particular section of Regulations 111. 8 Fed. Reg. 14968). All other
sections of Regulations 111 published in the Federal Register had the
prefix “29.” The Federal Register contained a table of contents for
Regulations 111. 8 Fed. Reg. 14882-14888. For each section of
Regulations 111, including section 9.45-1, the table of contents used the
prefix “29.” Id. This suggests that the use of the prefix “9.” in the
numbering of section 9.45-1 of Regulations 111 was inadvertent. The
Federal Register contained the following introduction to Regulations
111 that stated that each section of Regulations 111 had the prefix “29.”:
“Inasmuch as the regulations constitute Part 29 of Title 26 of the Code
of Federal Regulations, each key number is preceded by the number 29
and a decimal point.” 8 Fed. Reg. 14882. This statement suggests that
the use of the prefix “9.” in the numbering of section 9.45-1 of
Regulations 111 was inadvertent. Finally Regulations 111 was printed
in the Federal Register with the following heading: “Part 29--Income
Tax; Taxable Years Beginning After December 31, 1941”. 8 Fed. Reg.
14882. The wording of this heading suggests that the use of the prefix
“9.” in the numbering of section 9.45-1 of Regulations 111 was
inadvertent.

      Section 29.3-1 of Regulations 111, as published in the Federal
Register, stated that Regulations 111 “constitute Part 29 of Title 26 of
the 1943 Supplement to the Code of Federal Regulations”. 8 Fed. Reg.
14889. The same statement had been made in the pamphlet version of
Regulations 111. Sec. 29.3-1, Regulations 111 Relating to the Income
Tax Under the Internal Revenue Code 1. As we observed in discussing
the pamphlet version of Regulations 111, the statement was incorrect
because Regulations 111 was actually published in the Cumulative
Supplement to the Code of Federal Regulations rather than the 1943
                                            92

Supplement to the Code of Federal Regulations. 26 C.F.R. secs. 29.1-1
to 29.3801(e)-1 (Cum. Supp. 1944).

      Regulations 111 in the Cumulative Supplement to the Code of
Federal Regulations. Regulations 111 was published in the Cumulative
Supplement to the Code of Federal Regulations. The Cumulative
Supplement to the Code of Federal Regulations, which was published in
1944, was the publication required by the 1942 amendment to the
Federal Register Act. Act of Dec. 10, 1942. 71 The Cumulative
Supplement to the Code of Federal Regulations contained two sets of
documents:

       ●         The first set of documents was “a codification of documents
                 filed with the Division of the Federal Register during the
                 period from June 2, 1938, to June 1, 1943, inclusive, which
                 supplement the first edition of the Code of Federal
                 Regulations and which were still in force and effect on June
                 1, 1943.” Titles 26-27 C.F.R. iii (Cum. Supp. 1944).
                 Regulations 111 did not fall into the first set of documents
                 because it was filed on October 28, 1943. 8 Fed. Reg. 14979.

       ●         The second set of documents was described in the following
                 sentence in the Cumulative Supplement: “In order to
                 complete the presentation of the regulations of the Bureau
                 of Internal Revenue as of June 1, 1943, this codification
                 contains documents filed with the Division subsequent to
                 June 1, which were effective on that date.” Titles 26-27
                 C.F.R. iii (Cum. Supp. 1944). 72 Regulations 111 apparently

       71   Titles 1-3 C.F.R. xvii (1949) explained:
       Section 11 of the act [the Federal Register Act], as amended, was
       consequently further amended by the Act of December 10, 1942 (56
       Stat. 1045; 44 U.S.C. 311a). This amendment provided that, instead
       of a new codification, there should be published a cumulative
       supplement prepared under the supervision of the Division of the
       Federal Register.
              The Cumulative Supplement to the Code of Federal
       Regulations was compiled as of June 1, 1943. * * *
        72 Between the publication of the 1940 Supplement to the Code of Federal

Regulations and the publication of the Cumulative Supplement to the Code of Federal
Regulations, there had been published a 1941 Supplement to the Code of Federal
Regulations. This annual supplement contained regulations filed during 1941. See
Titles 1-7 C.F.R. iii (1941 Supp.). It did not include Regulations 111, which was not
filed until the second half of 1943.
                                   93

             was thought to fall into the second set of documents.
             Regulations 111 was filed “subsequent to” June 1, 1943--
             because it was filed on October 28, 1943. And Regulations
             111 was seemingly “effective on” the “date” June 1, 1943,
             in that Regulations 111 was effective with respect to tax
             years beginning after December 31, 1941, and therefore
             was effective for any tax year that included June 1, 1943.

       Section 29.3-1 of Regulations 111, as published in the Cumulative
Supplement to the Code of Federal Regulations, referred to Regulations
111 in the following way: “These regulations [i.e., Regulations 111],
which constitute Part 29 of Title 26 of the 1943 Supplement to the Code
of Federal Regulations, are divided into six subparts.” 26 C.F.R. sec.
29.3-1 (Cum. Supp. 1944). Thus the Cumulative Supplement to the
Code of Federal Regulations, a publication in which Regulations 111 was
actually printed, suggested that Regulations 111 was printed in the
1943 Supplement to the Code of Federal Regulations, a publication in
which Regulations 111 was not printed. The same error had been made
in the pamphlet form of Regulations 111 (sec. 29.3-1, Regulations 111
Relating to the Income Tax Under the Internal Revenue Code 1) and in
the text of Regulations 111 that was published in the Federal Register
(sec. 29.3-1 of Regulations 111, 8 Fed. Reg. 14889). This error would
eventually be corrected through an amendment to Regulations 111
published in the Federal Register. Specifically, Treasury Decision 5391,
9 Fed. Reg. 8009 (July 18, 1944), amended section 29.3-1 of Regulations
111 to say: “These regulations [i.e., Regulations 111], which constitute
Part 29 of Title 26 of the Cumulative Supplement to the Code of Federal
Regulations, are divided into eight subparts.”

      In the Cumulative Supplement to the Code of Federal
Regulations, the section of Regulations 111 relating to section 45 of the
Internal Revenue Code of 1939 was numbered “§ 29.45-1”. 26 C.F.R. sec.
29.45-1 (Cum. Supp. 1944). This prefix “29.” was used for all sections of
Regulations 111 in the Cumulative Supplement to the Code of Federal
Regulations. Finally Regulations 111 as printed in the Cumulative
Supplement to the Code of Federal Regulations had the following
heading: “PART 29--INCOME TAX; TAXABLE YEARS BEGINNING
AFTER DECEMBER 31, 1941”. Title 26 (ch. I, parts 2-178) C.F.R. 5973
(Cum. Supp. 1944). This was the same heading used for Regulations
111 in the Federal Register.

      Regulations 111 was not published in the 1943 Supplement to the
Code of Federal Regulations. Besides the Cumulative Supplement to
                                         94

the Code of Federal Regulations, the Government Printing Office also
published a 1943 Supplement to the Code of Federal Regulations. The
1943 Supplement contained “a codification of regulations filed by
Federal agencies and published in the Federal Register during the
period from June 2, 1943 through December 31, 1943.” Titles 1-31
C.F.R. iii (1943 Supp.). Because Regulations 111 was filed on
October 28, 1943, 8 Fed. Reg. 14979, and was published in the Federal
Register on November 3, 1943, 8 Fed. Reg. 14882, Regulations 111
seemingly should have been published in the 1943 Supplement to the
Code of Federal Regulations. Yet it was not. In any event, Regulations
111 had already been published in the Cumulative Supplement to the
Code of Federal Regulations.

       S.      The Revenue Act of 1943 and the Treasury Decision 5426
               amendments to Regulations 111

       Effective for tax years beginning after December 31, 1943, the
Revenue Act of 1943 amended section 45 of the Internal Revenue Code
of 1939 by replacing the phrase “gross income or deductions” with “gross
income, deductions, credits, or allowances.” Revenue Act of 1943, ch. 63,
secs. 101, 128(b) and (c), 58 Stat. at 26, 48. Thus, for calendar-year
taxpayers, the first year for which the 1943 amendment applied was
1944. Prior calendar years (i.e., 1939-43) were governed by section 45 of
the Internal Revenue Code of 1939 before the 1943 amendment. See
Internal Revenue Code of 1939 sec. 1.

       To reflect the amendment of section 45 of the Internal Revenue
Code of 1939 by the Revenue Act of 1943, section 29.45-1 of Regulations
111 73 was amended by Treasury Decision 5426, 10 Fed. Reg. 23-24 (filed
Dec. 30, 1944; published in the Federal Register Jan. 2, 1945).
Specifically, Treasury Decision 5426 made the following amendments to
sec. 29.45-1, Regulations 111:

       ●       “the income, the deduction, or the item or element of either”
               in sec. 29.45-1(a)(6) was replaced with “the income, the

        73 Treasury Decision 5426, 10 Fed. Reg. 24 (published Jan. 2, 1945), referred

to the section it amended as “section 29.45-1”, not “section 9.45-1”. The use of the
prefix “29.” in the number of this section was consistent with the pamphlet form of
Regulations 111 and with the copy of Regulations 111 that was published in the
Cumulative Supplement to the Code of Federal Regulations, but not with the copy of
Regulations 111 published in the Federal Register, which used the prefix “9.”
Regulations 111 Relating to the Income Tax Under the Internal Revenue Code 275-
277; 8 Fed. Reg. 14968 (Nov. 3, 1943); 26 C.F.R. sec. 29.45-1 (Cum. Supp. 1944).
                                      95

              deductions, the credits, the allowances, or the item or
              element of income, deductions, credits, or allowances”;

       ●      “gross income or deductions” in the first paragraph of
              section 29.45-1(b) was replaced with “gross income,
              deductions, credits, or allowances”;

       ●      “gross income, deductions, or any item of either” in the
              third paragraph of section 29.45-1(b) was replaced with
              “gross income, deductions, credits, or allowances, or any
              item of gross income, deductions, credits, or allowances”;

       ●      “income or deductions” in the first paragraph of section
              29.45-1(c) was replaced with “income, deductions, credits,
              or allowances”.

T.D. 5426, 10 Fed. Reg. 24.

       The particular sentences of section 29.45-1 of Regulations 111
that were amended by Treasury Decision 5426 were printed in their
amended form in the 1944 Supplement to the Code of Federal
Regulations. 26 C.F.R. sec. 29.45-1, at 1905 (1944 Supp.). 74 The
complete text of section 29.45-1 of Regulations 111, including the
portions of the text amended by Treasury Decision 5426 and the portions
of the text not amended by Treasury Decision 5426, were printed in the
1949 edition of the Code of Federal Regulations. 26 C.F.R. sec. 29.45-1,
at 315-316 (1949). Thus, the 1949 edition of the Code of Federal
Regulations contained the text of section 29.45-1 of Regulations 111
after it was amended by Treasury Decision 5426. However, the 1949
edition of the Code of Federal Regulations omitted a comma between
“gross income” and “deductions” in the following sentence:

       If, however, this has not been done, and the taxable net
       incomes are thereby understated, the statute contemplates
       that the Commissioner shall intervene, and, by making
       such distributions, apportionments, or allocations as he
       may deem necessary of gross income deductions, credits, or
       allowances or of any item or element affecting net income,

        74 The 1944 Supplement to the Code of Federal Regulations “contains a

codification of regulations promulgated by Federal agencies and published in the
Federal Register which were filed during the period from January 1, 1944 through
December 31, 1944.” Titles 11-32 C.F.R. iii (1944 Supp.).
                                            96

        between or among the controlled taxpayers constituting
        the group, shall determine the true net income of each
        controlled taxpayer. * * *

26 C.F.R. sec. 29.45-1, at 316 (1949). The 1949 edition of the Code of
Federal Regulations was the second edition of the Code of Federal
Regulations. 26 (parts 1-79) C.F.R. v (1949). 75 The first edition was the
1939 edition. 26 C.F.R. v (1949).

       The amendments to sec. 29.45-1, Regulation 111, made by
Treasury Decision 5426 had no effective-date provisions. These
regulatory amendments mirrored the statutory amendments by the
Revenue Act of 1943, which were effective starting with the 1944 tax
year for calendar-year taxpayers. 76 We assume that Treasury Decision

        75The 1949 edition of the Code of Federal Regulations contained documents
promulgated on or before Dec. 31, 1948, and effective as to facts or circumstances
arising on or after January 1, 1949. See Titles 1-3 C.F.R. xv (1949). Between the
printing of the 1944 Supplement to the Code of Federal Regulations and the printing
of the 1949 edition of the Code of Federal Regulations, the following three annual
supplements to the Code of Federal Regulations were published:
  Supp. to the      Filing dates or publication dates of documents printed in the Supp.
    C.F.R.                                      to the C.F.R.
1945 Supp.         Filed during 1945. See Titles 1-9 C.F.R. iii (1945 Supp.).

1946 Supp.         Filed with Division of Federal Register and published in Federal
                   Register during 1946. See Titles 1-8 C.F.R. iii (1946 Supp.).

1947 Supp.         Filed with Division of Federal Register and published in Federal
                   Register during 1947. See Titles 1-7 C.F.R. iii (1947 Supp.).

       Sec. 29.45-1, Regulations 111, was not printed in any of these three
supplements.
        76   We explain in this note the merits of this assumption in the context of this
case.
        Sec. 3791(b) of the Internal Revenue Code of 1939, 53 Stat. at 467, authorized
the Treasury Department to “prescribe the extent, if any, to which any ruling,
regulation, or Treasury Decision, relating to the internal revenue laws, shall be applied
without retroactive effect.” A similar provision of the Internal Revenue Code of 1954
(sec. 7805(b)) has been interpreted to mean that a tax regulation that does not have an
express effective date should be considered to have an effective date that is the same
as the effective date (or at least the date of enactment) of the statute to which the
regulation relates. See, e.g., Pollack v. Commissioner, 47 T.C. 92, 110-111 (1966)
(holding, under sec. 7805(a) and (b) of the Internal Revenue Code of 1954, “that unless
the Commissioner otherwise specifies, regulations are retroactive to the date on which
                                            97

5426, like the corresponding portions of the Revenue Act of 1943, was
effective starting with the 1944 tax year for calendar-year taxpayers.
For the three tax years involved in L.E. Shunk Latex, this assumption
means that Treasury Decision 5426 was not effective for the 1942 and
1943 years, but was effective for the 1945 year. Under the assumption
that the Treasury Decision 5426 regulatory amendments applied for the
1945 tax year, the relevant provisions of the Internal Revenue Code and
regulations applicable for the 1942, 1943, and 1945 years (for calendar-
year taxpayers) are:

the statute was enacted”) (citations omitted)), aff’d, 392 F.2d 409 (5th Cir. 1968). It
would be consistent with this interpretation to assume that the amendments to sec.
29.45-1, Regulation 111 made by Treasury Decision 5426 had the same effective date
as the statutory amendment made by the Revenue Act of 1943: that is, for the Treasury
Decision 5426 regulatory amendments to apply for tax years beginning after December
31, 1943. This would include the 1945 tax year at issue in L.E. Shunk Latex.
         In theory there might be an argument against Treasury Decision 5426 being
effective for the 1945 tax year. There is caselaw holding that the Treasury Department
cannot give a regulation retroactive effect if to do so would be an abuse of its discretion.
See Anderson, Clayton & Co. v. United States, 562 F.2d 972, 980-981 (5th Cir. 1977)
(“[A] list of some of the considerations that are relevant to a court in reviewing the
Secretary’s exercise of his discretionary power to adopt retroactive regulations * * *
includes: (1) whether or to what extent the taxpayer justifiably relied on settled prior
law or policy and whether or to what extent the putatively retroactive regulation alters
that law; (2) the extent, if any, to which the prior law or policy has been implicitly
approved by Congress, as by legislative reenactment of the pertinent Code provisions;
(3) whether retroactivity would advance or frustrate the interest in equality of
treatment among similarly situated taxpayers; and (4) whether according retroactive
effect would produce an inordinately harsh result.”). To make Treasury Decision 5426
effective for the 1945 tax year might arguably be seen as giving Treasury Decision
5426 retroactive effect. This is so because, although Treasury Decision 5426 was filed
on Dec. 30, 1944, which was before the beginning of the 1945 tax year, it was not
published until Jan. 2, 1945, which is two days into the 1945 tax year. It appears
unnecessary to delve further into the question of whether it would be impermissible to
give Treasury Decision 5426 effect for the 1945 tax year. This is so because the subject
matter of Treasury Decision 5426 does not appear to be relevant to the dispute in L.E.
Shunk Latex. Indeed, because the regulatory amendments of Treasury Decision 5426
merely mirrored changes made to the relevant statute, it would appear that even a
dispute implicating the text of the regulatory amendments of Treasury Decision 5426
would be resolved by recourse to the statutory amendment, not to the regulatory
amendments found in Treasury Decision 5426.
                                              98

  Year                        Statute                                  Regulation
 1942         Internal Revenue Code of 1939, ch.      Sec. 29.45-1, Regulations 111, 26
              2, sec. 45, 53 Stat. at 25.             C.F.R. sec. 29.45-1, at 6141-6142
                                                      (Cum Supp. 1944).

 1943         Internal Revenue Code of 1939, ch.      Sec. 29.45-1, Regulations 111, 26
              2, sec. 45, 53 Stat. at 25.             C.F.R. sec. 29.45-1, at 6141-6142
                                                      (Cum Supp. 1944).

 1945         Internal Revenue Code of 1939, ch.      Sec. 29.45-1, Regulations 111, as
              2, sec. 45, 53 Stat. at 25, as          amended by T.D. 5426, 10 Fed.
              amended by the Revenue Act of           Reg. 24 (Jan. 2, 1945), complete
              1943, ch. 63, sec. 128(b) and (c), 58   text as amended in 26 C.F.R. sec.
              Stat. at 48.                            29.45-1, at 315-316 (1949),
                                                      amended sentences only in 26
                                                      C.F.R. sec. 29.45-1, at 1905 (1944
                                                      Supp.).

The significance of tax years 1942, 1943, and 1945, is that these were
the tax years at issue in L.E. Shunk Latex Products, Inc. v.
Commissioner, 18 T.C. at 955.

      As indicated in the table above, tax years 1942 and 1943 (for
calendar-year taxpayers) were governed by section 29.45-1 of
Regulations 111, before its amendment by Treasury Decision 5426. 77 As
indicated in the table above, tax year 1945 (for calendar-year taxpayers)
was governed by section 29.45-1 of Regulations 111 after the
amendment by Treasury Decision 5426. 78

         77We have not reprinted in this Opinion the pre-Treasury Decision 5426 text
of sec. 29.45-1 of Regulations 111. This pre-Treasury Decision 5426 text can be found
in the following source: 26 C.F.R. sec. 29.45-1, at 6141-6142 (Cum. Supp. 1944). Also,
this text is the same as the text of art. 45-1 of Regulation 86, which is printed supra
Opinion pt. II.G, with the following substitutions:
         •    “Art. 45-1” was replaced with “Sec. 29.45-1”,
         •    “article” was replaced with “section”, and
         •    “this article” was replaced with “this section”.
         78The text of the section as amended is not reprinted in this Opinion. However,
it can be found in the following source: 26 C.F.R. sec. 29.45-1, at 315-316 (1949). Also,
this text is the same as art. 45-1 of Regulation 86, which is printed supra Opinion pt.
II.G, with the following substitutions:

         •    “Art. 45-1” was replaced with “Sec. 29.45-1”,
                                          99

       T.       L.E. Shunk Latex v. Commissioner, 18 T.C. 940 (1952) (a
                case involving tax years 1942, 1943, and 1945)

       In L.E. Shunk Latex Products, Inc. v. Commissioner, 18 T.C. at
954-957 (1952), two manufacturers of condoms sold their products to a
then-unrelated wholesaler during the period from July 1937 to July
1939. 79 Because the two manufacturers were not related to the
wholesaler, id. at 957, the prices charged by the manufacturers to the
wholesaler during this period were arm’s-length prices, see id. at 955,
957. The wholesaler sold the products to its customers, who were not
related to either the manufacturers or the wholesaler. See id. at 948,
955.

      In July 1939, the two manufacturers and the wholesaler were
brought under common control. Id. at 954-957. The prices charged by
the manufacturers to the wholesaler did not change. Id. at 957. These
(now-intercompany) prices were arm’s-length prices because they had
been the prices during the period from July 1937 to July 1939 when the
two manufacturers and the wholesaler were not commonly controlled.
Id. The prices charged by the wholesaler to its customers also stayed
the same. Id.

       In January 1942, the wholesaler raised its prices to its customers
in accordance with an increase in the market price of the products. Id.
The intercompany prices of the products sold by the two manufacturers
to the wholesaler remained unchanged. Id. at 958. Had the two
manufacturers been unrelated to the wholesaler, they would have
increased the prices they charged to the wholesaler. Id. Therefore the
unchanged intercompany prices charged by the two manufacturers to
the wholesaler were below arm’s-length prices. Id.

       Effective May 1942, the federal government imposed a wartime
price-control regulation that made it illegal for the two manufacturers
to raise their prices above the prices charged in March 1942. Id. at 959.

       •    “article” was replaced with “section”,

       •    “this article” was replaced with “this section”, and

       •    the phrase “gross income and deductions”, in each instance, was replaced
            with “gross income, deductions, credits, or allowances”.
        79 The two manufacturers were L.E. Shunk Latex Products, Inc., and the

Killian Manufacturing Co. L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C.
940, 941 (1952). The wholesaler was Killashun Sales Division. Id. at 945.
                                        100

Because the prices the two manufacturers charged in March 1942 were
the same as the prices charged since July 1939, the price-control
regulation effectively froze in place the July 1939 prices. 80 These prices
were below arm’s-length prices and had been since January 1942. Id. at
958. Each sale of products at these below-arm’s-length-prices to the
wholesaler resulted in shifting income from the two manufacturers to
the wholesaler. Id. In order to correct for the income distortion resulting
from the below-arm’s-length intercompany prices, respondent in L.E.
Shunk Latex determined an allocation under section 45 of the Internal
Revenue Code of 1939 to increase the income of the two manufacturers
for taxable years 1942, 1943, and 1945. Id. at 952-955.

       The opinion in L.E. Shunk Latex, can be divided into several
parts. In the first part, the Court rejected an argument by the two
manufacturers that they and the wholesaler were not commonly
controlled. Id. at 956. The Court reasoned that (1) ownership of these
businesses was largely in the hands of three persons, and (2) these three
persons also controlled the operations of the businesses through their
management positions. Id. The Court relied on and quoted the
definition of the term “controlled” from sec. 29.45-1(a)(3) of Regulations
111. L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C. at 956.
Thus, the following statement appears in the L.E. Shunk Latex opinion:

       “The term ‘controlled’ includes any kind of control, direct
       or indirect, whether legally enforceable, and however
       exercisable or exercised. It is the reality of the control
       which is decisive, not its form or the mode of its exercise.”
       Treasury Regulations 111, sec. 29.45-1(a)(3). Cf. Granada
       Industries, Inc., 17 T.C. 231, 254. * * *

Id.

       In the second part of the opinion, the L.E. Shunk Latex Court
rejected respondent’s argument that the wholesaler was merely acting
as an agent for the two manufacturers. Id. at 956-957. The Court held

        80 Effective February 1943, the federal government replaced the May 1942

price- control regulation. L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C. at
959. The new February 1943 price-control regulation required prices charged by the
manufacturers not to exceed the price charged on Dec. 1, 1941. Id. The new price-
control regulation had the same effect on the two manufacturers as the May 1942 price-
control regulation because the prices the two manufacturers charged on Dec. 1, 1941,
were the same as the prices they charged in May 1942. Id. The price-control
regulations did not affect the prices charged by the wholesaler. Id.
                                  101

that to consider the wholesaler an agent of the two manufacturers would
be inconsistent with the purpose of section 45 of the Internal Revenue
Code of 1939, a purpose that the Court described in the following
passage:

             Allocation between controlled businesses of “gross
      income, deductions, credits or allowances” is permitted
      under section 45 of the Code where “necessary in order to
      prevent evasion of taxes, or clearly to reflect the income of
      any of such organizations, trades, or businesses.” Section
      45 empowers the Commissioner to act to rectify
      abnormalities and distortions in income which come about
      through the common control to which separate taxpaying
      entities may be subject. “The purpose of section 45 is to
      place a controlled taxpayer on a tax parity with an
      uncontrolled taxpayer, by determining, according to the
      standard of an uncontrolled taxpayer, the true net income
      from the property and business of a controlled taxpayer.”
      Treasury Regulations 111, sec. 29.45-1(b).

               Using this standard, we think respondent erred
      * * *.

Id. at 956. The Court reasoned that the two manufacturers and the
wholesaler dealt with each other during the years at issue in that case
under a contract, negotiated before they were commonly controlled,
under which the wholesaler was not an agent of the two manufacturers.
Id.

      In the third part of the opinion, the L.E. Shunk Latex Court
explained that after the wholesaler raised its prices to its customers in
January 1942, the prices charged by the two manufacturers to the
wholesaler were not arm’s-length prices because had the two
manufacturers not been related to the wholesaler they would have
charged higher prices. Id. at 957-958. We quote below the third part of
the opinion:

             However, in 1942 that common control was
      exercised in such manner as to shift income from
      petitioners [the two manufacturers] to Killashun [the
      wholesaler], and, but for certain wartime price regulations
      on which petitioners rely, we would be constrained to
      regard action under section 45 as warranted. With the
                                 102

      coming of the war, and the consequent critical shortage of
      rubber, there appeared to be a likelihood that petitioners’
      products could be sold at a substantial increase in prices.
      In these circumstances, Killashun halted all sales in
      December 1941. It resumed sales in January 1942, and at
      the same time imposed a one-dollar per gross across-the-
      board increase on all products sold by it. There was no
      change in the items sold, or in the services or functions
      performed by Killashun; conditions simply made it possible
      to get a higher price from the trade for the same products.
      In the case of unpackaged goods, the increase was
      considerably in excess of one hundred per cent. However,
      although Killashun raised the price to its customers,
      Shunk and Killian [the two manufacturers] kept their
      prices to Killashun completely unchanged. On the very
      products on which Killashun was realizing increased
      income of one dollar per gross, Shunk and Killian
      deliberately refrained from increasing their own profits at
      all through an increase in the prices charged to Killashun.

             We cannot believe that business organizations free
      of control by common interests would have acted in this
      way. If there had been no ties of common control or
      ownership between petitioners and Killashun, it would
      have been reasonable to expect petitioners to take
      advantage of market conditions and to raise their prices as
      was done by Killashun. Their failure to do so can be viewed
      only as a consequence of the common ownership and
      control which dominated all three entities, and plainly
      shifted income of petitioners to Killashun. This sort of
      distortion in income, springing from arrangement or
      manipulation made possible by common control or
      ownership, was exactly the kind of vice at which section 45
      was aimed. Cf. Treasury Regulations 111, sec. 29.45-1;
      Advance Machinery Exchange, Inc., 196 F.2d 1006 (C.A.2,
      1952); Asiatic Petroleum Co. v. Commissioner, 79 F.2d 234
      (C.A.2, 1935), certiorari denied 296 U.S. 645; National
      Securities Corporation v. Commissioner, 137 F. 2d 600
      (C.A. 3, 1943), certiorari denied 320 U.S. 794.

Id.
                                       103

       In the fourth part of the opinion, the L.E. Shunk Latex Court
considered and rejected the argument by the two manufacturers that
they had a nontax reason for declining to raise the price they charged
the wholesaler in January 1942. Id. at 958. The two manufacturers
claimed that increasing their prices to the wholesaler would have
created an incentive to competitors to enter the market. Id. The Court
rejected this explanation, id. at 958-959, and stated that competitors
would not know, or care about, the price charged by the two
manufacturers to the related wholesaler, id. The competitors would
have cared only about the price charged by the wholesaler to its
customers because that price would affect the price the competitors
could charge their customers. Id.

       In the fifth part of the opinion the L.E. Shunk Latex Court
considered whether the two manufacturers could have legally raised
their prices during the years at issue. Id. at 959-960. The Court
analyzed the provisions of the price-control regulation and concluded
that the regulation prohibited an increase in the prices charged by the
two manufacturers to the wholesaler. Id. 81

       In the sixth part of the opinion the L.E. Shunk Latex Court
considered the significance of the fact that the two manufacturers
voluntarily decided not to raise their prices to the wholesaler in January
1942. Id. at 960. The Court explained that what mattered was that this
price later became a legal maximum:

              We recognize that the price structure of petitioners
       [the two manufacturers] and Killashun [the wholesaler]
       from December 1941 through March 1942 was not shaped
       in reliance on the price regulations which followed. The
       regulations, so far as those prices of petitioners and
       Killashun were concerned, were purely a subsequent
       fortuitous development. The regulations merely froze a
       condition theretofore deliberately created without
       reference to them by the interests in control of the three
       entities. There is no basis in the record for believing that
       petitioners would have raised their prices to Killashun in
       the absence of these regulations, and we can only infer that
       the respective prices of the controlled entities, in relation

        81 However, it seems that from January 1942 to May 1942 the prices charged

by the two manufacturers to the wholesaler were not subject to the price-control
regulation. L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C. at 950, 957-959.
                                    104

      to each other, would not have been any different even if the
      price regulations had never come into being. To say,
      therefore, that because of the price regulations an improper
      shift of income is to be insulated from the corrective
      provisions of the statute, is to permit petitioners to enjoy
      an unexpected piece of good fortune in reduction of their
      taxes. But we can see no logical basis on which petitioners
      can be denied this windfall, in view of the uncontroverted
      effect of those regulations in prohibiting petitioners from
      receiving the very income sought to be attributed to them.
      We think that the Commissioner had no authority to
      attribute to petitioners income which they could not have
      received. We therefore conclude that, in allocating
      Killashun’s income to petitioners, respondent acted in
      excess of his power.

Id. at 960-961. The quotation above articulates the Court’s main holding
in the case: The predecessor of section 482 cannot be used to allocate
income to a taxpayer that the taxpayer is barred by law from receiving.
Id. at 961. This holding is also reflected in the Court’s description of the
main argument made by the two manufacturers, an argument with
which the Court agreed. Here is the Court’s description of the two
manufacturers’ argument:

      Petitioners argue that it is improper, under section 45, to
      allocate income to them based on prices higher than they
      were permitted to charge under the price regulations,
      which they assert to be their pre-1942 prices, and that
      section 45 does not authorize an allocation of income to
      them which under other laws they were prohibited from
      earning.

Id. at 959.

      For purposes of our case, there are additional questions to
consider about the holding in L.E. Shunk Latex. For example, was the
holding compelled by the unambiguous text of the statute? And what
role did Regulations 111 play in the Opinion? We set aside these
questions for now and take them up infra Opinion part IV.

       The last observation we make about L.E. Shunk Latex relates to
the statute quoted in the Opinion. The Opinion quotes section 45 of the
Internal Revenue Code of 1939, as that section was amended by section
                                          105

128(b) and (c) of the Revenue Act of 1943. L.E. Shunk Latex Prods., Inc.
v. Commissioner, 18 T.C. at 955 n.4. By way of background, recall that
the case involved three tax years: 1942, 1943, and 1945. Tax years 1942
and 1943 were governed by section 45 of the Internal Revenue Code of
1939 before its amendment by section 128(b) and (c) of the Revenue Act
of 1943. Tax year 1945 was governed by section 45 of the Internal
Revenue Code of 1939 as amended by section 128(a) and (b) of the
Revenue Act of 1943. It was this later provision that was printed in a
footnote in L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C. at
955 n.4, as follows:

               In any case of two or more organizations, trades, or
       businesses (whether or not incorporated, whether or not
       organized in the United States, and whether or not
       affiliated) owned or controlled directly or indirectly by the
       same interests, the Commissioner is authorized to
       distribute, apportion, or allocate gross income, deductions,
       credits, or allowances between or among such
       organizations, trades, or businesses, if he determines that
       such distribution, apportionment, or allocation is
       necessary in order to prevent evasion of taxes or clearly to
       reflect the income of any of such organizations, trades or
       businesses.

       U.        The Administrative Procedure Act

       In 1946, Congress enacted the Administrative Procedure Act, or
APA. 82 Ch. 324, 60 Stat. 237 (codified as amended at 5 U.S.C. secs. 551-
559, 701-705 (2018)). The APA generally took effect on September 11,
1946. APA sec. 12, 60 Stat. at 244 (general effective date is three months
after approval of APA); 60 Stat. at 244 (APA approved June 11, 1946).
Section 12 of the APA, 60 Stat. at 244, 83 provided that no subsequent
legislation would supersede the APA unless it did so expressly. Section
3(a) of the APA 84 required each federal agency to “separately state and
currently publish in the Federal Register * * * (3) substantive rules
adopted as authorized by law and statements of general policy or

         82 When we quote the provisions of the APA, we quote the provisions as they

were originally worded in 1946. The provisions of the APA that we quote are still in
effect, although sometimes the wording has changed from the original 1946 text. For
the current text of the provisions, the United States Code can be consulted.
       83   Codified as amended at 5 U.S.C. sec. 559 (2018).
       84   Codified as amended at 5 U.S.C. sec. 552(a)(1) (2018).
                                         106

interpretations formulated and adopted by the agency for the guidance
of the public * * *”. A “rule” was defined for purposes of the APA to
include an “agency statement of general or particular applicability and
future effect designed to implement, interpret, or prescribe law or
policy”. Section 2(c) of the APA (codified as amended at 5 U.S.C. sec.
551(4) (2018)).

       Section 4 of the APA 85 dealt with “rule making” by agencies.
“Rule making” was defined as “agency process for the formulation,
amendment, or repeal of a rule”. Section 2(c) of the APA (codified as
amended at 5 U.S.C. sec. 551(5) (2018)). Section 4(a) of the APA 86
required that “[g]eneral notice of proposed rule making” be published in
the Federal Register. There was an exception to the notice-of-proposed-
rulemaking requirement for “interpretive rules”, for “general
statements of policy”, or “in any situation in which the agency for good
cause finds (and incorporates the finding and a brief statement of the
reasons therefor in the rules issued) that notice and public procedure
thereon are impracticable”. Id. This exception did not apply when notice
or hearing was required by statute. Id. Section 4(a) of the APA 87
required the notice of proposed rulemaking to include: “(1) a statement
of the time, place, and nature of public rule making proceedings;
(2) reference to the authority under which the rule is proposed; and
(3) either the terms or substance of the proposed rule or a description of
the subjects and issues involved.” Section 4(b) of the APA 88 provided:

      After notice required by this section, the agency shall
      afford interested persons an opportunity to participate in
      the rule making through submission of written data, views,
      or arguments with or without opportunity to present the
      same orally in any manner; and, after consideration of all
      relevant matter presented, the agency shall incorporate in
      any rules adopted a concise general statement of their
      basis and purpose. * * *

       Section 4(c) of the APA 89 provided: “The required publication
* * * of any substantive rule (other than one granting or recognizing

      85   Codified as amended at 5 U.S.C. sec. 553 (2018).
      86   Codified as amended at 5 U.S.C. sec. 553(b).
      87   Codified as amended at 5 U.S.C. sec. 553(b).
      88   Codified as amended at 5 U.S.C. sec. 553(c).
      89   Codified as amended at 5 U.S.C. sec. 553(d).
                                          107

exemption or relieving restriction or interpretive rules and statements
of policy) shall be made not less than thirty days prior to the effective
date thereof except as otherwise provided by the agency upon good cause
found and published with the rule.” According to the legislative history
of the APA, the term “required publication” in section 4(c) of the APA 90
referred back to the requirement in section 3(a) of the APA91 that a rule
must be published in the Federal Register, and did not refer to the
requirement in section 4(a) of the APA 92 that a notice of proposed
rulemaking be published in the Federal Register. 93 Consistent with the
legislative history, Rowell v. Andrus, 631 F.2d 699, 702-704 (10th Cir.
1980), held that an agency violated section 4(c) of the APA by publishing
a final rule in the Federal Register less than 30 days before its effective
date, and rejected the agency’s argument that section 4(c) of the APA
“only requires that a proposed rule be published no less than 30 days
before its effective date”.

       Section 4(c) of the APA 94 potentially conflicted with section
3791(b) of the Internal Revenue Code of 1939 (and with analogous
provisions in the Internal Revenue Codes of 1954 and 1986). 95 Section

       90   Codified as amended at 5 U.S.C. sec. 553(d).
       91   Codified as amended at 5 U.S.C. sec. 552(a)(1).
       92   Codified as amended at 5 U.S.C. sec. 553(b).
       93  The Attorney General’s Manual on the Administrative Procedure Act 36
(1947) stated:
                The discussion on section 4(c) in the report of both the Senate
       and House Committees on the Judiciary makes clear that the phrase
       “The required publication or service of any substantive rule” does not
       relate back or refer to the publication of “general notice of proposed
       rule making” required by section 4(a); rather it is a requirement that
       substantive rules which must be published in the Federal Register (see
       section 3(a)(3)) shall be so published at least thirty days prior to their
       effective date. * * * The purpose of the time lag required by section
       4(c) is to “afford persons affected a reasonable time to prepare for the
       effective date of a rule or rules or to take any other action which the
       issuances of rules may prompt”. Sen. Rep. p. 15; H.R. Rep. 25 (Sen.
       Doc. pp. 201, 259).
        The Senate and House reports referred to in the quotation above were S. Rept.
No. 79-752 (1945) and H.R. Rept. 79-1980 (1946).
       94   Codified as amended at 5 U.S.C. sec. 553(d).
       95 The analogous provisions are sec. 7805(b) of the Internal Revenue Code of
1954 and sec. 7805(b) of the Internal Revenue Code of 1986. Sec. 7805(b) of the
Internal Revenue Code of 1954 was substantively the same as sec. 3791(b) of the
                                          108

4(c) of the APA 96 required that a rule generally have an effective date
30 days or more after the publication of the rule in the Federal Register.
APA section 4(c) 97 seemingly meant that a rule may not generally have
retroactive effect. See Georgetown Univ. Hosp. v. Bowen, 821 F.2d 750,
757 n.11 (D.C. Cir. 1987) (“The fact that the APA requires legislative
rules to be given only ‘future effect’ is underscored by 5 U.S.C. § 553(d)
(1982), which requires that such rules be published not less than 30 days
before their effective date, except ‘as otherwise provided by the agency
for good cause found and published with the rule.’”), aff’d on other
grounds, 488 U.S. 204 (1988). However, for tax regulations, section
3791(b) of the Internal Revenue Code of 1939 authorized the Treasury
Department to determine the extent to which a regulation shall be
applied without retroactive effect. Section 3791(b) of the Internal
Revenue Code of 1939 can be interpreted to mean that the Treasury
Department could give retroactive effect to a regulation. 98 The
relationship between section 4(c) of the APA and section 3791(b) of the
Internal Revenue Code of 1939 was not definitively resolved. 99

Internal Revenue Code of 1939. Sec. 7805(b) of the Internal Revenue Code of 1986 was
substantially the same as sec. 7805(b) of the Internal Revenue Code of 1954 until it
was amended in 1996. With the 1996 amendment, a Treasury regulation can be made
retroactive only if it was filed or issued within 18 months of the enactment of the
statute to which it relates. Sec. 7805(b), as amended by the Taxpayer Bill of Rights 2,
Pub. L. No. 104-168, sec. 1101(a), 110 Stat. at 1468 (1996). This rule has exceptions.
The 1996 amendment, and its effective date, are discussed infra part II.PP.
       96   Codified as amended at 5 U.S.C. sec. 553(d).
       97   Codified as amended at 5 U.S.C. sec. 553(d).
        98 A similar provision of the Internal Revenue Code of 1954 (sec. 7805(b)) was

interpreted to mean that the Treasury Department can give retroactive effect to a tax
regulation. See Excel Corp. v. United States, 451 F.2d 80, 84-85 (8th Cir. 1971); Butka
v. Commissioner, 91 T.C. 110, 128 (1988), aff’d without published opinion, 886 F.2d
442 (D.C. Cir. 1989).
       99 Wendland v. Commissioner, 79 T.C. 355, 379-382 (1982), aff’d per curiam,
739 F.2d 580 (11th Cir. 1984), and aff’d sub nom. Redhouse v. Commissioner, 728 F.2d
1249 (9th Cir. 1984), considered a taxpayer’s challenge to a Treasury regulation under
the Administrative Procedure Act (APA), ch. 324, sec. 4(c), 60 Stat. at 239. On
November 2, 1976, the proposed regulation was published in the Federal Register.
Wendland v. Commissioner, 79 T.C. at 379. Taxpayers were informed that Treasury
intended to make the regulation retroactive to October 29, 1976. Id. at 382. On
December 19, 1977, the final version of the regulation was published in the Federal
Register and was to be applied retroactively to October 29, 1976. Id. at 379. The
taxpayer in Wendland argued that the regulation violated sec. 4(c) of the APA because
the regulation was not published at least 30 days before its effective date. Id. at 379-
380. Wendland recognized a “seeming conflict” between (1) the requirement of 30 days’
notice in sec. 4(c) of the APA and (2) the authority of the Treasury Department to
                                           109

       Section 10(a) of the APA 100 provided that except as statutes
preclude judicial review (or except as agency action is by law committed
to agency discretion) any person suffering legal wrong because of any
agency action, or adversely affected or aggrieved by agency action within
the meaning of a relevant statute, is entitled to judicial review thereof.
The rules regarding the scope of judicial review were set forth in section
10(e) of the APA. 101 Section 10(e) of the APA generally required a
reviewing court to decide questions of law, interpret constitutional and
statutory provisions, and determine the meaning or applicability of the
terms of an agency action. Section 10(e)(B) of the APA 102 required a
reviewing court to hold unlawful and set aside agency action that is
arbitrary, capricious, an abuse of discretion, or otherwise not in
accordance with law (section 10(e)(B)(1) of the APA 103); or excessive of
statutory authority (section 10(e)(B)(3) of the APA 104).

promulgate retroactive regulations granted by the successor to sec. 3791(b) of the
Internal Revenue Code of 1939 (i.e., sec. 7805(b) of the Internal Revenue Code of 1954).
Id. at 380. However, Wendland held that the conflict was “more apparent than real”
in the context of the facts of that case. Id. at 382. Wendland observed that the parties
affected by the regulation knew that the Treasury Department intended to make the
regulation retroactive and could prepare for the final publication of the rule. Wendland
therefore held that the purpose of sec. 4(c) of the APA, which was to “afford affected
persons a reasonable time to prepare for final effectiveness of a rule or to take any
action which the issuance of the rule may require”, was “fulfilled.” Id. at 381-382.
Wendland explained that “[m]ere technical violation of the APA will not be considered
cause to invalidate a regulation.” Id. at 38 n.14. The relationship between these
statutory provisions also came up in Wing v. Commissioner, 81 T.C. 17, 29-30 (1983),
a case involving a challenge to the same regulation that had been challenged in
Wendland. The Tax Court in Wing v. Commissioner, 81 T.C. at 29-30, applied the
holding in Wendland, but additionally suggested that if there were a conflict between
the successor to sec. 3791(b) of the Internal Revenue Code of 1939 (i.e., sec. 7805(b) of
the Internal Revenue Code of 1954) and sec. 4(c) of the APA, the former provision would
prevail because it was the more specific provision. Wing v. Commissioner, 81 T.C. at
30 n.17; see also Redhouse v. Commissioner, 728 F.2d at 1253.
        100   Codified as amended at 5 U.S.C. sec. 702 (2018).
        101   Codified as amended at 5 U.S.C. sec. 706 (2018).
        102   Codified as amended at 5 U.S.C. sec. 706(2).
        103   Codified as amended at 5 U.S.C. sec. 706(2)(A).
        104   Codified as amended at 5 U.S.C. sec. 706(2)(C).
                                         110

       V.      The lifting of the wartime suspension of the Federal
               Register Act requirement that regulations be codified every
               five years

       On November 12, 1947, the Administrative Committee of the
Federal Register terminated the 1942 suspension of the requirement
that each agency codify certain documents every five years. See Exec.
Order No. 9,930, 13 Fed. Reg. 519 (Feb. 5, 1948), reprinted in 44 U.S.C.
sec. 311 note (Supp. II 1949); Act of Dec. 10, 1942, secs. 1, 2 (amending
Act of June 19, 1937 (amending Federal Register Act of 1935, sec. 11)).
The termination of the suspension was effective December 31, 1948. See
Exec. Order No. 9,930, 13 Fed. Reg. 519 (Feb. 5, 1948), reprinted in 44
U.S.C. sec. 311 note (Supp. II 1949).

       W.      The second edition of the Code of Federal Regulations

        On February 4, 1948, the President signed Executive Order No.
9,930 stating that “the required codification of documents in force and
effect on December 31, 1948, will, under present procedures, be on file
with the Administrative Committee of the Federal Register on that
date”; and that “the publication of the said codification as it is in force
and effect on December 31, 1948, is hereby authorized and directed to
be made”. Thus, the 1948 executive order was the President’s directive
to publish the second edition of the Code of Federal Regulations. This
edition, published in 1949, contained documents promulgated on or
before December 31, 1948, and effective for facts and circumstances
arising on or after January 1, 1949. See titles 1-3 C.F.R. xv (1949)
(describing scope of documents contained in the second edition of the
C.F.R.). It contained the complete text of section 29.45-1 of Regulations
111, as amended to reflect the change to section 45 of the Internal
Revenue Code of 1939 made by the Revenue Act of 1943, sec. 128(b) and
(c), 58 Stat. at 48. 105

        105 A 1952 pocket part, which supplemented the volume of the second edition

Code of Federal Regulations relating to parts 1 to 79 of title 26 of the Code of Federal
Regulations, contained changes and additions to parts 1 to 79 of title 26 of the Code of
Federal Regulations that had been published in the Federal Register during 1949-53
and which were in force and effect on December 31, 1952. See 26 (parts 1-79) C.F.R.
(1949 ed. 1952 Supp.) ii. No amendments had been made to sec. 29.45-1 of Regulations
111 (26 C.F.R. sec. 29.45-1 (1949)) during 1949-53, so the pocket part did not contain
any text relating to sec. 29.45-1 of Regulations 111.
                                          111

       X.      The 1953 amendment to the Federal Register Act

       In 1953, Congress replaced the requirement in the Federal
Register Act that a new codification of regulations be made every five
years. Act of Aug. 5, 1953, ch. 333, 67 Stat. 388. Under the 1953
amendment, the Executive was authorized to require the codification
and publication of regulations “from time to time as it may deem
necessary”. Federal Register Act sec. 11(a), as amended by Act of Aug.
5, 1953. The 1953 amendment expressly provided that its provisions
“shall apply to the Code of Federal Regulations, 1949 Edition”. Federal
Register Act sec. 11(g), as amended by Act of Aug. 5, 1953, 67 Stat. at
389. As a result of the 1953 amendment, the Executive was free to
publish new volumes of the Code of Federal Regulations when it saw fit.
See Cervase v. Office Fed. Reg., 580 F.2d 1166, 1169 (3d Cir. 1978).

       The publication of the Code of Federal Regulations up to this
point can be summarized as follows:

                          The Code of Federal Regulations
               from the 1935 enactment of the Federal Register Act
                             until its 1953 amendment
        Publication requirements                   Resulting Publications
 Federal Register Act (1935) required, by
 1/26/1936, the compilation of documents
 issued or promulgated before 9/24/1935.      None.
 Publication of the compilation was
 required, but there was no deadline.
                                              1st edition of C.F.R. was published,
 1937 amendment replaced the above
                                              containing documents in force on
 requirement with the requirement that,
                                              6/1/1938. Supplements to 1st edition
 on or before 7/1/1938, documents in
                                              were also published: 1938 Supp.
 force and effect on 6/1/1938 be codified.
                                              (documents filed 6/2/1938 to
 The President was authorized to have
                                              12/31/1938); 1939 Supp. (documents
 the codification published.
                                              filed during 1939); and 1940 Supp.
                                              (documents filed during 1940).
 1937 amendment also required
 subsequent codifications every five
 years of the same documents. For
                                              No publications met this requirement
 example, it required a codification, on or
                                              before it was modified and suspended in
 before 7/1/1943, of documents in force
                                              1942.
 and effect on 6/1/1938. The President
 was authorized to have the subsequent
 codifications published.
                                          112

        Publication requirements                     Resulting Publications

 1942 amendment (first change) modified
 the temporal scope of the documents to
 be codified every five years. For
 example, the codification to be made on
 or before 7/1/1943 was to be of
 documents in force and effect on
 6/1/1943.                                  No codification was published until
                                            1949 due to suspension noted in the left
 1942 amendment (second change)             column.
 suspended the requirement that there
 be subsequent codifications every five
 years.

 1942 amendment (third change)              A Cumulative Supplement was
 required the publication of a cumulative   published containing documents
 supplement during the suspension of        (1) filed from 6/2/1938 to 6/1/1943 that
 the requirement of subsequent              were in force and effect on 6/1/1943, and
 codifications every five years.            (2) filed after 6/1/1943 that were
                                            effective on 6/1/1943.

                                            Annual supplements were published:
                                            1943 Supp. (documents filed and
                                            published in Federal Register from 6/2
                                            to 12/31/1943); 1944 Supp. (documents
                                            filed during 1944); 1945 Supp.
                                            (documents filed during 1945); 1946
                                            Supp. (documents filed during 1946);
                                            1947 Supp. (documents filed during
                                            1947).

 1953 amendment to Federal Register
 Act eliminated requirement of
 subsequent codifications every five
 years; the timing of codifications was
 now up to the Executive.

       The publication of the Code of Federal Regulations after the 1953
amendment to the Federal Register Act (an amendment that was
effective starting with the 1949 edition of the Code of Federal
Regulations) has been summarized as follows:

              In 1949, the second edition of the Code of Federal
       Regulations was finally published. It included all the
       regulations still in effect as of January 1, 1949, and was
       largely taken from the 1938 edition, the supplements, and
       the regulations issued in the Federal Register in 1948.
                             113

However, there were some additional regulations added
that were not published in the Federal Register. These
were generally either rules of procedure or rules received
by the Division of the Federal Register and considered as
officially promulgated and applicable to the general public
or a class of the public and effective on or after January 1,
1949. Each book of the 1949 CFR, containing one or more
titles, also had a subject index and a place at the back to fit
a cumulative pocket supplement. Cumulative pocket
supplements were issued annually for each book until it
was deemed appropriate that a new edition of a particular
book should be published with space in the back for
subsequent pocket supplements. Each supplement also
contained various finding aids, including a “Codification
Guide” or “List of Sections Affected” as it was later called.

       After considerable discussion on the best way to
proceed, beginning in 1963 for some titles and for all titles
in 1967, the Office of the Federal Register (OFR) began
publishing yearly revisions to the titles of the CFR,
effective on January 1 of each year. The new books were
bound in soft covered, dark blue paper stock, but beginning
in 1970 each annual edition of the CFR has a different color
on its outside binding. If there are no changes to
regulations in certain books then a colored paper stock is
issued so it can be used to cover the older edition. Although
ponderous in size, an annual republication of the CFR in
softbound books, instead of cumulative supplements or
loose-leafs, allows the researcher to determine how a
regulation read on any given date.

       Soon, however, it became apparent to the OFR that
revising the entire Code of Federal Regulations, at the
same time, was administratively unmanageable.               So
beginning on October 1, 1972, the OFR has divided the
titles of the CFR into four groups with each group being
revised in staggered quarters of the year. Titles 1-16 are
revised effectively on January 1 of each year. Titles 17-27
are revised effectively on April 1 of each year. Titles 28-41
are revised effectively on July 1 of each year, and titles 42-
50 are revised effectively on October 1 of each year.
                                        114

Rick McKinney, “A Research Guide to the Federal Register and the Code
of Federal Regulations,” 46 L. Libr. Lights 10, 11 (2002) (footnotes
omitted).

       Y.      Regulations 118

       In 1953, the Treasury Department promulgated section 39.45-1
of Regulations 118 to replace section 29.45-1 of Regulations 111.
Regulations 118 was a comprehensive set of income-tax regulations that
was promulgated, and published in the Federal Register, in 1953. 18
Fed. Reg. 5771 (Sept. 26, 1953); see sec. 39.1-1(a) of Regulations 118, 18
Fed. Reg. 5782. Regulations 118 was also printed as a pamphlet by the
Government Printing Office. Income Tax Regulations, 118 Internal
Revenue Code; Part 39 of Title 26, Code of Federal Regulations (Gov’t
Prtg. Off. 1953). The pamphlet version of Regulations 118 was for the
most part a photocopy of the version of Regulations 118 that was
published in the Federal Register. 18 Fed. Reg. 5771. The pamphlet
had the page numbers that were used in the Federal Register.
Regulations 118 was also published in the Code of Federal Regulations.
26 C.F.R. pt. 39 (1953). In 1953, a two-volume revision to the Code of
Federal Regulations was published, containing those tax regulations
that were (1) published in the Federal Register on or before December
31, 1953, and (2) effective on or after January 1, 1954. 26 (parts 1-79)
C.F.R. v (1953). 106 These two volumes replaced title 26 of the 1949
edition of the Code of Federal Regulations. 26 (parts 1-79) C.F.R. v
(1953). Like Regulations 111, Regulations 118 generally interpreted the
provisions of the Internal Revenue Code of 1939. 26 C.F.R. sec. 39.1-
1(a) (1953). Regulations 118 was “applicable only with respect to taxable
years beginning after December 31, 1951.” Id. para. (b). Section 39.45-
1, Regulations 118, related particularly to section 45 of the Internal
Revenue Code of 1939. See Income Tax Regulations 118, Internal
Revenue Code; Part 39 of Title 26, Code of Federal Regulations III
(“Each section of the regulations is preceded by the section, subsection,
or paragraph of the Internal Revenue Code which it interprets.”). The
regulatory provision was virtually identical to its predecessor, section
29.45-1, Regulations 111. 26 C.F.R. sec. 29.45-1 (1949). The only
difference was in form. In Regulations 111, paragraph (b) of section
29.45-1 had consisted of three unnumbered subparagraphs. 26 C.F.R.
sec. 29.45-1(b) (1949). In Regulations 118, the three subparagraphs of

        106 The two volumes were: 26 (parts 1-79) C.F.R. (1953) and 26 (parts 183-299)

C.F.R. (1953).
                                        115

paragraph (b) of section 39.45-1 were separately numbered. 26 C.F.R.
sec. 39.45-1(b)(1)-(3) (1953).

       Z.      The Internal Revenue Code of 1954

       In 1954, Congress recodified the federal tax laws as the Internal
Revenue Code of 1954, ch. 736, 68A Stat. 3. Section 45 of the Internal
Revenue Code of 1939, as amended by section 128(b) and (c) of the
Revenue Act of 1943, was recodified as section 482 of the Internal
Revenue Code of 1954, 68A Stat. at 162. The only difference between
the two provisions was nonsubstantive: Congress replaced the words
“the Commissioner is authorized to” with the words “the Secretary or
his delegate may”. Thus, section 482 of the Internal Revenue Code of
1954, provided:

               In any case of two or more organizations, trades, or
       businesses (whether or not incorporated, whether or not
       organized in the United States, and whether or not
       affiliated) owned or controlled directly or indirectly by the
       same interests, the Secretary or his delegate may
       distribute, apportion, or allocate gross income, deductions,
       credits, or allowances between or among such
       organizations, trades, or businesses, if he determines that
       such distribution, apportionment, or allocation is
       necessary in order to prevent evasion of taxes or clearly to
       reflect the income of any of such organizations, trades, or
       businesses.

       Section 482 of the Internal Revenue Code of 1954 applied only to
tax years that began after December 31, 1953, and ended after August
16, 1954. Internal Revenue Code of 1954, sec. 7851(a)(1)(A), 68A Stat.
at 919, 929. 107 Thus for calendar-year taxpayers, 1954 was the first year
for which section 482 of the Internal Revenue Code of 1954 was effective.
This is relevant to Commissioner v. First Sec. Bank, 405 U.S. at 399-
400, which involved the tax years 1955-59 of a calendar-year taxpayer.
These years were governed by section 482 of the Internal Revenue Code
of 1954.

        107 With respect to these same tax years, sec. 45 of the Internal Revenue Code

of 1939 was repealed. Internal Revenue Code of 1954, sec. 7851(a)(1)(A), 68A Stat. at
919.
                                            116

       Section 7805(a) of the Internal Revenue Code of 1954, 68A Stat.
at 917, was the provision in the Internal Revenue Code of 1954 that was
analogous to section 62 of the Internal Revenue Code of 1939. Section
7805(a) of the Internal Revenue Code of 1954 provided: “[T]he Secretary
or his delegate shall prescribe all needful rules and regulations for the
enforcement of this title, including all rules and regulations as may be
necessary by reason of any alteration of law in relation to internal
revenue.” 108

      Section 7805(b) of the Internal Revenue Code of 1954, 68A Stat.
at 917, was the provision in the Internal Revenue Code of 1954 that was
analogous to section 3791(b) of the Internal Revenue Code of 1939.
Section 7805(b) of the Internal Revenue Code of 1954 provided: “The
Secretary or his delegate may prescribe the extent, if any, to which any
ruling or regulation, relating to the internal revenue laws, shall be
applied without retroactive effect.” 109

       Section 7807(a) of the Internal Revenue Code of 1954, 68A Stat.
at 917, in conjunction with Treasury Decision 6091, 19 Fed. Reg. 5167
(Aug. 17, 1954), addressed the applicability of regulations promulgated
under the Internal Revenue Code of 1939. Those regulations continued
to be effective with respect to the Internal Revenue Code of 1954 until
they were superseded. Interstate Drop Forge Co. v. Commissioner, 326
F.2d 743, 745 (7th Cir. 1964), aff’g T.C. Memo. 1963-149. 110 Thus section

        108   “[T]his title” referred to the Internal Revenue Code of 1954. Id. (a)(1), 68A
Stat. at 3.
        109In 1976, Congress made a nonsubstantive change to sec. 7805(a) and (b) of
the Internal Revenue Code of 1954, substituting “Secretary” for “Secretary or his
delegate” in both provisions. Tax Reform Act of 1976, Pub. L. No. 94-455, sec.
1906(b)(13)(A), 90 Stat. at 1834.
        110   Sec. 7807(a) of the Internal Revenue Code of 1954, 68A Stat. at 917,
provided:
        Until regulations are promulgated under any provision of this title
        which depends for its application on the promulgation of regulations
        (or which is to be applied in such manner as may be prescribed by
        regulations) all instructions, rules or regulations which are in effect
        immediately prior to the enactment of this title shall, to the extent such
        instructions, rules, or regulations could be prescribed as regulations
        under authority of such provision, be applied as if promulgated as
        regulations under such provision.
       Treasury Decision 6091, 19 Fed. Reg. 5167 (Aug. 17, 1954), provided in
relevant part:
                                          117

39.45-1 of Regulations 118 (26 C.F.R. sec. 39.45-1 (1953)), which related
to section 45 of the Internal Revenue Code of 1939, continued to be
effective as to section 482 of the Internal Revenue Code of 1954 until
section 39.45-1 of Regulations 118 was superseded by new
regulations. 111

      It took time for the Treasury Department to promulgate
regulations relating to the provisions of the Internal Revenue Code of
1954. See 26 C.F.R. v (1954). When these regulations were eventually
promulgated, they were published in the Federal Register. A new title
of the Code of Federal Regulations was created, named “Title 26--
Internal Revenue, 1954”, for the purpose of covering these regulations.
See 26 C.F.R. v (1954). 112 Because the new title continued in use until

        All regulations (including all Treasury decisions) prescribed by, or
        under authority duly delegated by, the Secretary of the Treasury, or
        jointly by the Secretary and the Commissioner of Internal Revenue, or
        by the Commissioner of Internal Revenue with the approval of the
        Secretary of the Treasury, * * * applicable under any provision of law
        in effect on the date of enactment of the Code, to the extent such
        provision of law is repealed by the Code, are hereby prescribed under
        and made applicable to the provisions of the Code corresponding to the
        provision of law so repealed insofar as any such regulation is not
        inconsistent with the Code. Such regulations shall become effective as
        regulations under the various provisions of the Code as of the dates the
        corresponding provisions of law are repealed by the Code, until
        superseded by regulations issued under the Code.
        111As explained later, regulations related to sec. 482 of the Internal Revenue
Code of 1954 were promulgated in 1962. Regulation sec. 1.482-1, T.D. 6595, 27 Fed.
Reg. 3597-3598 (Apr. 14, 1962), 1962-1 C.B. 43, 49-51, reprinted in 26 C.F.R. sec. 1.482-
1 (1961 ed. 1965 Cum. Supp.).
          The temporal scope of “Title 26--Internal Revenue, 1954” of the Code of
        112

Federal Regulations and its revisions is set forth in the table below:
  Title or revision                                 Scope

Title 26--Internal    Regulations promulgated during 1954, and effective as to facts
Revenue, 1954         arising on and after Jan. 1, 1955. 26 C.F.R. v (1954).
1955 revision         Regulations promulgated during 1954-55, and effective as to
                      facts arising on and after Jan. 1, 1956. 26 (pts. 1-220) C.F.R. v
                      (1955).
1956 revision         Regulations promulgated during 1954-56, and effective as to
                      facts arising on and after Jan. 1, 1957. 26 (pts. 1-169) C.F.R. v
                      (1956).
                                          118

1961 (with revisions), the new title (and its revisions) ended up
containing all of the 1954 Code regulations promulgated in the 1950s.
However, no regulations related to section 482 of the Internal Revenue
Code of 1954 were published in the 1950s. So “Title 26--Internal
Revenue, 1954” and its revisions did not contain any regulations related
to section 482 of the Internal Revenue Code of 1954.

       The preface to the new title “Title 26--Internal Revenue, 1954”
gave the following explanation of the reasons for the creation of the new
title:

               The enactment of the Internal Revenue Code of
        1954, August 16, 1954, gave rise to a unique problem in the
        codification of the rules and regulations of the Internal
        Revenue Service. To accommodate rules and regulations
        implementing the new Internal Revenue Code, a new title
        was established in the Code of Federal Regulations entitled
        “Internal Revenue, 1954”, designed to replace “Title 26--
        Internal Revenue” contained in the 1949 Edition.
        However, since many of the regulations implementing the
        Internal Revenue Code of 1954 had not been issued by the
        end of 1954, it was decided to publish both titles as of
        January 1, 1955.

              This book, therefore, contains all of the rules and
        regulations constituting Title 26--Internal Revenue, 1954,
        including temporary rules relating to income tax and
        administrative matters, issued pursuant to the Internal

revised as of Jan. 1, Regulations promulgated during 1954-57, and effective as to
1958                  facts arising on and after Jan. 1, 1958. 26 (pts. 1-19) C.F.R. v
                      (1958).
revised as of Jan. 1., Regulations promulgated during 1954-58, and effective as to
1959                   facts arising on and after Jan. 1, 1959. 26 (pts. 1-19) C.F.R. v
                       (1959).
revised as of Jan. 1, Regulations promulgated during 1954-59, and effective as to
1960                  facts arising on and after Jan. 1, 1960. 26 (pt. 1 (secs. 1.01-
                      1.499)) v (1960).

The revision dates in the left-hand column reflect the revision dates set forth on the
title pages of the volumes.
                                        119

       Revenue Code of 1954, fully promulgated during 1954, and
       effective as to facts arising on and after January 1, 1955.

              In addition to this book, pocket supplements have
       been published for the existing volumes of Title 26--
       Internal Revenue, containing changes and additions to the
       regulations issued pursuant to the Internal Revenue Code
       of 1939 which were in force and effect on December 31,
       1954. Eventually, Title 26--Internal Revenue, 1954 will be
       published in permanent form, replacing the five volumes of
       Title 26--Internal Revenue containing regulations issued
       pursuant to the Internal Revenue Code of 1939.

26 C.F.R. v (1954). The preface quoted above explains that the title of
the Code of Federal Regulations related to the Internal Revenue Code of
1939 named “Title 26--Internal Revenue” would be published “as of
January 1, 1955” and that pocket supplements for that title had already
been published for changes and additions “which were in force and effect
on December 31, 1954.” “Title 26--Internal Revenue” of the Code of
Federal Regulations was published in 1954 and included regulations
that (1) were published in the Federal Register on or before December
31, 1953, and (2) were effective as to facts arising on or after January 1,
1954. 26 C.F.R. v (1954). Pocket supplements to “Title 26--Internal
Revenue” of the Code of Federal Regulations were published in 1955,
1956, and 1957. 26 C.F.R. (Supp. 1955); 26 C.F.R. (Supp. 1956); 26
C.F.R. (Supp. 1957). Added pocket parts to be used in conjunction with
the 1957 pocket supplement were published in 1958, 1959, and 1960. 26
C.F.R. (Supp. 1957 & added pocket part 1958); 26 C.F.R. (Supp. 1957 &
added pocket part 1959); 26 C.F.R. (Supp. 1957 & added pocket part
1960).

       AA.     The 1960 notice of proposed rulemaking

      On December 10, 1960, a notice of proposed rulemaking was
published in the Federal Register. 25 Fed. Reg. 12703. It proposed
regulation section 1.482-1, which, according to the notice was
“prescribed under” section 482 of the Internal Revenue Code of 1954. 25
Fed. Reg. at 12704. 113

        113 The 1960 proposed regulations are identical to final regulations

promulgated in 1962. T.D. 6595, 27 Fed. Reg. 3597-3598 (Apr. 14, 1962), 1962-1 C.B.
43, 49-51, reprinted in 26 C.F.R. sec. 1.482-1(b) (1961 ed. 1965 Cum. Supp.). We will
discuss the substance of the 1962 regulations shortly.
                                    120

      BB.    The creation of a new title of the Code of Federal
             Regulations

        In 1961 the Government Printing Office issued a new title in the
Code of Federal Regulations, “Title 26--Internal Revenue, Revised as of
January 1, 1961”, which replaced “Title 26--Internal Revenue, 1954”.
See 26 (part 1 (secs. 1.401 to 1.860)) C.F.R. v (1961). The new title
contained all regulations related to the Internal Revenue Code of 1954
that had been promulgated on or before December 31, 1960, and
effective as to facts arising on or after January 1, 1961. Id. No final
regulations related to section 482 of the Internal Revenue Code of 1954
were promulgated on or before December 31, 1960. Therefore, the new
title did not contain any regulations related to section 482 of the Internal
Revenue Code of 1954. The new title contained the following heading to
act as a placemarker for future regulations under section 482 of the
Internal Revenue Code of 1954: “§1[.]482 [Reserved]”. 26 C.F.R. 140
(1961).

      CC.    The 1962 final regulations

      On April 14, 1962, a final version of regulation section 1.482-1,
which was identical to the 1960 proposed version, was published in the
Federal Register. T.D. 6595, 27 Fed. Reg. 3597-3598 (published Apr. 14,
1962; filed Apr. 13, 1962), 1962-1 C.B. 43, 49-51. As with the 1960
proposed regulations, the Treasury Department said that the final 1962
regulations were “prescribed under” section 482 of the Internal Revenue
Code of 1954. T.D. 6565, 27 Fed. Reg. 3595. Three years after the final
1962 regulations were published in the Federal Register, they were
published in the Code of Federal Regulations. 26 C.F.R. sec. 1.482-1
(1961 ed. 1965 Cum. Supp.).

       The final 1962 regulations under section 482 of the Internal
Revenue Code of 1954 contained only one section, section 1.482-1, which
was divided into three paragraphs: (a), (b), and (c). The entire section is
set forth below:

      Sec. 1.482-1 Determination of the taxable income of a
      controlled taxpayer.

             (a) Definitions. When used in this section--

            (1) The term “organization” includes                any
      organization of any kind, whether it be a                 sole
                             121

proprietorship, a partnership, a trust, an estate, an
association, or a corporation (as each is defined or
understood in the Internal Revenue Code or the
regulations thereunder), irrespective of the place where
organized, where operated, or where its trade or business
is conducted, and regardless of whether domestic or
foreign, whether exempt, whether affiliated, or whether a
party to a consolidated return.

      (2) The term “trade” or “business” includes any trade
or business activity of any kind, regardless of whether or
where organized, whether owned individually or otherwise,
and regardless of the place where carried on.

       (3) The term “controlled” includes any kind of
control, direct or indirect, whether legally enforceable, and
however exercisable or exercised. It is the reality of the
control which is decisive, not its form or the mode of its
exercise. A presumption of control arises if income or
deductions have been arbitrarily shifted.

      (4) The term “controlled taxpayer” means any one of
two or more organizations, trades, or businesses owned or
controlled directly or indirectly by the same interests.

      (5) The terms “group” and “group of controlled
taxpayers” mean the organizations, trades, or businesses
owned or controlled by the same interests.

        (6) The term “true taxable income” means, in the
case of a controlled taxpayer, the taxable income (or, as the
case may be, any item or element affecting taxable income)
which would have resulted to the controlled taxpayer, had
it in the conduct of its affairs (or, as the case may be, in the
particular contract, transaction, arrangement, or other act)
dealt with the other member or members of the group at
arm’s length. It does not mean the income, the deductions,
the credits, the allowances, or the item or element of
income, deductions, credits, or allowances, resulting to the
controlled taxpayer by reason of the particular contract,
transaction, or arrangement, the controlled taxpayer, or
the interests controlling it, chose to make (even though
                            122

such contract, transaction, or arrangement be legally
binding upon the parties thereto).

       (b) Scope and purpose. (1) The purpose of section
482 is to place a controlled taxpayer on a tax parity with
an uncontrolled taxpayer, by determining, according to the
standard of an uncontrolled taxpayer, the true taxable
income from the property and business of a controlled
taxpayer. The interests controlling a group of controlled
taxpayers are assumed to have complete power to cause
each controlled taxpayer so to conduct its affairs that its
transactions and accounting records truly reflect the
taxable income from the property and business of each of
the controlled taxpayers. If, however, this has not been
done, and the taxable incomes are thereby understated, the
district director shall intervene, and, by making such
distributions, apportionments, or allocations as he may
deem necessary of gross income, deductions, credits, or
allowances, or of any item or element affecting taxable
income, between or among the controlled taxpayers
constituting the group, shall determine the true taxable
income of each controlled taxpayer. The standard to be
applied in every case is that of an uncontrolled taxpayer
dealing at arm’s length with another uncontrolled
taxpayer.

       (2) Section 482 and this section apply to the case of
any controlled taxpayer, whether such taxpayer makes a
separate or a consolidated return. If a controlled taxpayer
makes a separate return, the determination is of its true
separate taxable income. If a controlled taxpayer is a party
to a consolidated return, the true consolidated taxable
income of the affiliated group and the true separate taxable
income of the controlled taxpayer are determined
consistently with the principles of a consolidated return.

       (3) Section 482 grants no right to a controlled
taxpayer to apply its provisions at will, nor does it grant
any right to compel the district director to apply such
provisions. It is not intended (except in the case of the
computation of consolidated taxable income under a
consolidated return) to effect in any case such a
distribution, apportionment, or allocation of gross income,
                                   123

      deductions, credits, or allowances, or any item of gross
      income, deductions, credits, or allowances, as would
      produce a result equivalent to a computation of
      consolidated taxable income under subchapter A, chapter
      6 of the Code.

             (c) Application. Transactions between one controlled
      taxpayer and another will be subjected to special scrutiny
      to ascertain whether the common control is being used to
      reduce, avoid, or escape taxes. In determining the true
      taxable income of a controlled taxpayer, the district
      director is not restricted to the case of improper accounting,
      to the case of a fraudulent, colorable, or sham transaction,
      or to the case of a device designed to reduce or avoid tax by
      shifting or distorting income, deductions, credits, or
      allowances. The authority to determine true taxable
      income extends to any case in which either by inadvertence
      or design the taxable income, in whole or in part, of a
      controlled taxpayer, is other than it would have been had
      the taxpayer in the conduct of his affairs been an
      uncontrolled taxpayer dealing at arm’s length with another
      uncontrolled taxpayer.

26 C.F.R. sec. 1.482-1 (1961 ed. 1965 Cum. Supp.). We refer to 26 C.F.R.
sec. 1.482-1 (1961 ed. 1965 Cum. Supp.) as the 1962 regulations.

       There were differences between section 1.482-1 of the 1962
regulations and section 39.45-1 of Regulations 118 (26 C.F.R. sec. 39.45-
1(b)(1) (1953)). One difference was that in the third sentence of section
1.482-1(b)(1) of the 1962 regulations, the phrase “the district director
shall intervene” replaced the phrase “the statute contemplates that the
Commissioner shall intervene” in Regulation 118. Another difference
was that the term “true net income”, which was used in several places
in section 39.45-1 of Regulations 118 (1953), was changed to “true
taxable income” each time it was used in the 1962 regulations. Neither
of these differences, nor any other difference between the 1962
regulations and Regulation 118 (1953), appears relevant to the effect of
legal restrictions on allocations of income under section 482 of the
Internal Revenue Code of 1954. The portion of the 1962 regulations
most relevant to such legal restrictions was the “complete power”
passage found in the second and third sentences of 26 C.F.R. sec. 1.482-
1(b)(1) (1961 ed. 1965 Cum. Supp.). These sentences in the 1962
regulations (which are quoted in the excerpt above) were not
                                   124

substantively different from these sentences in the 1953 regulations. In
the 1953 regulations, these two sentences had been written as follows:

      The interests controlling a group of controlled taxpayers
      are assumed to have complete power to cause each
      controlled taxpayer so to conduct its affairs that its
      transactions and accounting records truly reflect the net
      income from the property and business of each of the
      controlled taxpayers. If, however, this has not been done,
      and the taxable net incomes are thereby understated, the
      statute contemplates that the Commissioner shall
      intervene, and, by making such distributions,
      apportionments, or allocations as he may deem necessary
      of gross income, deductions, credits, or allowances, or of
      any item or element affecting net income, between or
      among the controlled taxpayers constituting the group,
      shall determine the true net income of each controlled
      taxpayer. * * *

26 C.F.R. sec. 39.45-1(b)(1) (1953).

       The 1962 regulations (i.e., the 1962 version of regulation section
1.482-1) had no effective-date provision. This raises the question of
whether the 1962 regulations were applicable retroactively for the same
tax years for which section 482 of the Internal Revenue Code of 1954
applied, i.e., to tax year 1954 and later years for calendar-year
taxpayers. If they did apply retroactively, that would mean the 1962
version of regulation section 1.482-1 superseded section 39.45-1 of
Regulations 118 (1953) for tax year 1954 and later years. The
proposition that the 1962 regulatory provisions applied retroactively for
the same years for which section 482 of the Internal Revenue Code of
1954 applied finds support in Pollack v. Commissioner, 47 T.C 92, 110
(1966), aff’d, 392 F.2d 409 (5th Cir. 1968), which held that “unless the
Commissioner otherwise specifies, regulations are retroactive to the
date on which the statute was enacted”. (Citations omitted.) However,
Pollack alone might not resolve the question of whether the 1962
regulatory provisions applied retroactively for the same years for which
section 482 of the Internal Revenue Code of 1954 applied. Two other
principles potentially bear on this question. First, the Treasury
Department cannot give a regulation retroactive effect if to do so would
be an abuse of discretion. See Anderson, Clayton & Co. v. United States,
562 F.2d 972, 980-981 (5th Cir. 1977). Thus, if the 1962 regulatory
provisions were otherwise construed as having retroactive effect, there
                                         125

might be an additional step of determining whether it would be an abuse
of discretion for the Treasury Department to attempt to give the 1962
regulations retroactive effect. Second, section 4(c) of the APA 114
provided that substantive rules must generally be published not less
than 30 days before their effective date. Section 4(c) of the APA 115 has
been interpreted as prohibiting retroactive regulations. See Georgetown
Univ. Hosp., 821 F.2d at 757 n.11. However, some caselaw suggests that
section 4(c) of the APA 116 does not bar retroactive tax regulations, under
the theory that such regulations are permitted by section 7805(b) of the
Internal Revenue Code of 1954. See Redhouse v. Commissioner, 728
F.2d 1249, 1253 (9th Cir. 1984), aff’g Wendland v. Commissioner, 79
T.C. 355 (1982); Wing v. Commissioner, 81 T.C. 17, 29 n.16 (1983). We
will discuss in greater detail the question of retroactivity when we
discuss First Security Bank, which made repeated references to 26
C.F.R. sec. 1.482-1 (1971). See infra part II.FF. The short answer is
that it does not matter whether the 1962 regulations were applicable for
the same tax years for which section 482 of the Internal Revenue Code
of 1954 applied, including the 1955-59 tax years at issue in First
Security Bank, because there is no relevant difference between the 1962
regulations and the 1953 regulations as to the portions of the regulatory
text cited and quoted by Commissioner v. First Sec. Bank, 405 U.S. at
400 & nn.8 & 10, 404 & n.18, 407 & n.25.

      DD.         The 1965 and 1966 notices of proposed rulemaking

       On April 1, 1965, a notice of proposed rulemaking, which proposed
regulations related to section 482 of the Internal Revenue Code of 1954,
was published in the Federal Register. 30 Fed. Reg. 4256 (filed Mar. 31,
1965). Under the proposal a new paragraph (d) would be added to
section 1.482-1 of the 1962 regulations, which had only three
paragraphs: (a), (b), and (c). The proposed paragraph (d) would be
entitled “Method of allocation”. The 1965 proposal would also add new
regulation section 1.482-2, entitled “Determination of taxable income in
specific situations”. The proposal would leave unchanged the text of
section 1.482-1(a), (b), and (c), except that it would make a technical
change to section 1.482-1(a) by making the definitions in paragraph (a)
applicable to proposed regulation section 1.482-2. No changes in the
regulations were proposed in the 1965 notice of proposed rulemaking

      114   Codified as amended at 5 U.S.C. sec. 553(d).
      115   Codified as amended at 5 U.S.C. sec. 553(d).
      116   Codified as amended at 5 U.S.C. sec. 553(d).
                                   126

other than those we have discussed here, i.e., the addition of section
1.482-1(d), the addition of section 1.482-2, and the technical change.

       Of the provisions in the 1965 proposed regulations, it is important
to discuss here only section 1.482-1(d)(5), which addressed the use of a
deferred-income method of accounting for payments that would be
barred by foreign legal restrictions. Section 1.482-1(d)(5) provided:

             (5) If payment or reimbursement for the sale,
      exchange, or use of property, the rendition of services, or
      the advance of other consideration among members of a
      group of controlled entities was prevented, or would have
      been prevented, at the time of the transaction because of
      currency or other restrictions imposed under the laws of
      any foreign country, any distributions, apportionments, or
      allocations which may be made under section 482 with
      respect to such transactions may be treated as deferable
      income or deductions, providing the taxpayer has, for the
      year to which the distributions, apportionments, or
      allocations relate, requested and received permission to
      use a method of accounting in which the reporting of
      deferable income is deferred until the income ceases to be
      deferable income. Such method of accounting is referred to
      in this section as the deferred income method of
      accounting. If such method has been approved, any
      payments or reimbursements which were prevented or
      would have been prevented, and any deductions
      attributable to such payments or reimbursements, shall be
      deferred until they cease to be deferable under such
      method of accounting. The principles of this subparagraph
      may be illustrated by the following example in which it is
      assumed that D, a domestic corporation, and F, a foreign
      corporation, are members of the same group of controlled
      entities:

             Example: D, which, is in the business of rendering
      services to unrelated parties, renders services for the
      benefit of F in 1965, which cost $60,000 and have a fair
      value of $100,000. Assume that the district director
      proposes to increase D’s income by $100,000, but that the
      country in which F is located would have blocked payment
      in 1965 for such services. If D has received permission with
      respect to its 1965 return to use the deferred income
                                   127

      method of accounting, the $100,000 allocation and the
      $60,000 costs are deferable until such amounts cease to be
      deferable under D’s method of accounting.

30 Fed. Reg. 4257.

       On August 2, 1966, the Treasury Department withdrew the 1965
proposed regulations under section 482 of the Internal Revenue Code of
1954. 31 Fed. Reg. 10394 (filed Aug. 1, 1966). In their place, the
Treasury Department issued new proposed regulations, which were
published in a new notice of proposed rulemaking. 31 Fed. Reg. 10394
(Aug. 2, 1966). The basic features of the 1966 proposed regulations were
the same as the 1965 proposed regulations: there was to be added new
regulation section 1.482-1(d), entitled “Method of allocation”; there was
to be added new regulation section 1.482-2, entitled “Determination of
taxable income in specific situations”; and the text of section 1.482-1(a),
(b), and (c), was to be unchanged except for the same technical change
to section 1.482-1(a) that had been proposed in 1965 (i.e., making the
definitions in paragraph (a) applicable to proposed regulation section
1.482-2).

       Section 1.482-1(d)(6) of the 1966 proposed regulations, 31 Fed.
Reg. 10395, addressed the use of a deferred-income method of
accounting for payments that would be barred by foreign legal
restrictions. These provisions of the 1966 proposed regulations were
similar to section 1.482-1(d)(5) of the 1965 proposed regulations, except
that the 1966 proposed regulations placed a time limit on the taxpayer’s
ability to elect the method of accounting. Section 1.482-1(d)(6) of the
1966 proposed regulations provided:

             (6) If payment or reimbursement for the sale,
      exchange, or use of property, the rendition of services, or
      the advance of other consideration among members of a
      group of controlled entities was prevented, or would have
      been prevented, at the time of the transaction because of
      currency or other restrictions imposed under the laws of
      any foreign country, any distributions, apportionments, or
      allocations which may be made under section 482 with
      respect to such transactions may be treated as deferrable
      income or deductions, providing the taxpayer has, for the
      year to which the distributions, apportionments, or
      allocations relate, elected to use a method of accounting in
      which the reporting of deferrable income is deferred until
                             128

the income ceases to be deferrable income. Under such
method of accounting, referred to in this section as the
deferred income method of accounting, any payments or
reimbursements which were prevented or would have been
prevented, and any deductions attributable directly or
indirectly to such payments or reimbursements, shall be
deferred until they cease to be deferrable under such
method of accounting. If such method of accounting has
not been elected with respect to the taxable year to which
the allocations under section 482 relate, the taxpayer may
elect such method with respect to such allocations (but not
with respect to other deferrable income) at any time before
the first occurring of the following events with respect to
the allocations:

      (i) Execution of Form 870 (Waiver of Restrictions on
Assessment and Collection of Deficiency in Tax and
Acceptance of Overassessment);

       (ii) Expiration of the period ending 30 days after the
date of a letter by which the district director transmits an
examination report notifying the taxpayer of proposed
adjustments reflecting such allocations; or

     (iii) Execution of a closing agreement or offer-in-
compromise.

The principles of this subparagraph may be illustrated by
the following example in which it is assumed that D, a
domestic corporation, and F, a foreign corporation, are
members of the same group of controlled entities:

         Example. D, which is in the business of rendering a
certain type of service to unrelated parties, renders such
services for the benefit of F in 1965. The direct and indirect
costs allocable to such services are $60,000, and an arm’s
length charge for such services is $100,000. Assume that
the district director proposes to increase D’s income by
$100,000, but that the country in which F is located would
have blocked payment in 1965 for such services. If, prior
to the first occurring of the events described in subdivisions
(i), (ii), or (iii) of this subparagraph, D elects to use the
deferred income method of accounting with respect to such
                                        129

       allocation, the $100,000 allocation and the $60,000 of costs
       are deferrable until such amounts cease to be deferrable
       under D’s method of accounting.

31 Fed. Reg. 10395.

       While the 1966 proposed regulations were in proposed form, the
1962 regulation remained in effect. 26 C.F.R. sec. 1.482-1 (1961 ed. 1965
Cum. Supp.). Meanwhile, two successive new editions of the Code of
Federal Regulations were published in 1967 and 1968. Each reprinted
the 1962 regulations. 26 C.F.R. sec. 1.482-1 (1967); 26 C.F.R. sec. 1.482-
1 (1968). The 1967 revision to the Code of Federal Regulations
contained regulations promulgated on or before December 31, 1966. 26
(part 1 (secs. 1.401-1.500)) C.F.R. v (1967). The 1968 revision to the
Code of Federal Regulations contained regulations promulgated on or
before December 31, 1967. 26 C.F.R. (part 1 (secs. 1.401-1.500)) v (1968).

       EE.     The 1968 final regulations

       On April 16, 1968, Treasury Decision 6952, which contained final
amendments to the 1962 regulations was published. 33 Fed. Reg. 5848
(published Apr. 16, 1968; filed Apr. 15, 1968). Treasury Decision 6952
stated that the amendments were adopted “under” section 482 of the
Internal Revenue Code of 1954. 33 Fed. Reg. 5848. Tracking the 1966
proposed regulations, the amendments that were made by Treasury
Decision 6952 did the following: they added section 1.482-1(d), entitled
“Method of allocation”; they added section 1.482-2, entitled
“Determination of taxable income in specific situations”; and they left
unchanged the existing text of section 1.482-1(a), (b), and (c) except for
a technical change to section 1.482-1(a) (which made the definitions in
paragraph (a) applicable to new regulation section 1.482-2). The 1968
regulatory amendments left in place the provisions containing the
“complete power” passage. See 26 C.F.R. sec. 1.482-1(b)(1) (1969) (part
of section 1.482-1, after its 1968 amendment by T.D. 6952). 117

        117 The “complete power” passage was in the 1962 regulations. 26 C.F.R. sec.

1.482-1(b)(1) (1968) (1962 regulations). The “complete power” passage appeared in the
1934 regulations and then appeared in the 1936, 1939, 1940, 1943, and 1953
regulations. For citations of the regulations in which the “complete power” passage
appeared, see the bullet points supra note 38. Neither the 1965 proposed regulations
nor the 1966 proposed regulations would have changed the “complete power” passage
in the 1962 regulations. 30 Fed. Reg. 4256 (Apr. 1, 1965); 31 Fed. Reg. 10394 (Aug. 2,
1966).
                                         130

       We use the phrase “the 1968 regulations” to refer to the
regulations related to section 482 of the Internal Revenue Code of 1954,
as the regulations were amended in 1968, even including the portions of
the 1962 regulations related to section 482 of the Internal Revenue Code
of 1954 that were not affected by the 1968 amendments. This
convention has been used elsewhere. See, e.g., T.D. 8552, 59 Fed. Reg.
34972 (July 8, 1994) (preamble to 1994 final regulations); Thomas E.
Jenks, “Section 482 and the Non-Recognition Provisions: The Transfer
of Intangible Assets”, 32 Tax Law. 775, 783 (1979); Edward Albert
Purnell, “The Net Present Value Approach to Intangible Transfer
Pricing Under Section 482: An Economic Model Takes the BALRM
Floor”, 45 Tax Law. 647, 650 n.13 (1992). Note that when we refer to
the 1968 regulations, we will not cite the 1968 edition of the Code of
Federal Regulations. This edition included only regulations that were
promulgated on or before December 31, 1967. 26 (part 1 (secs. 1.401-
1.500)) v (1968). 118 The 1968 amendments were filed on, and therefore
were promulgated on, April 15, 1968. 33 Fed. Reg. 5857 (Apr. 16, 1968).
Therefore the 1968 edition of the Code of Federal Regulations does not
reflect the 1968 amendments.

       One of the provisions of the 1968 regulations that was not in the
1962 regulations was section 1.482-1(d)(6). Section 1.482-1(d)(6) of the
1968 regulations was almost identical to section 1.482-1(d)(6) of the 1966
proposed regulations. 31 Fed. Reg. 10395 (Aug. 2, 1966). The provision
allowed the use of a deferred-income method of accounting for payments
that would be barred by foreign legal restrictions. Subparagraph (6) of
section 1.482-1(d) of the 1968 regulations provided:

               (6) If payment or reimbursement for the sale,
        exchange, or use of property, the rendition of services, or
        the advance of other consideration among members of a
        group of controlled entities was prevented, or would have
        been prevented, at the time of the transaction because of
        currency or other restrictions imposed under the laws of
        any foreign country, any distributions, apportionments, or
        allocations which may be made under section 482 with
        respect to such transactions may be treated as deferrable
        income or deductions, providing the taxpayer has, for the

        118 When referring to the 1968 regulations, we will refer variously to the 1969,

1971, or 1992 editions of the Code of Federal Regulations. Although the 1992 edition
reflects some post-1968 amendments to the regulations, see 26 C.F.R. sec. 1.482-2
(1992) (historical notes), these amendments are not relevant.
                             131

year to which the distributions, apportionments, or
allocations relate, elected to use a method of accounting in
which the reporting of deferrable income is deferred until
the income ceases to be deferrable income. Under such
method of accounting, referred to in this section as the
deferred income method of accounting, any payments or
reimbursements which were prevented or would have been
prevented, and any deductions attributable directly or
indirectly to such payments or reimbursements, shall be
deferred until they cease to be deferrable under such
method of accounting. If such method of accounting has
not been elected with respect to the taxable year to which
the allocations under section 482 relate, the taxpayer may
elect such method with respect to such allocations (but not
with respect to other deferrable income) at any time before
the first occurring of the following events with respect to
the allocations:

      (i) Execution by the taxpayer of Form 870 (Waiver of
Restrictions on Assessment and Collection of Deficiency in
Tax and Acceptance of Overassessment);

(ii) Expiration of the period ending 30 days after the date
of a letter by which the district director transmits an
examination report notifying the taxpayer of the proposed
adjustments reflecting such allocations or before July 16,
1968, whichever is later; or

     (iii) Execution of a closing agreement or offer-in-
compromise.

The principles of this subparagraph may be illustrated by
the following example in which it is assumed that X, a
domestic corporation, and Y, a foreign corporation, are
members of the same group of controlled entities:

       Example. X, which is in the business of rendering a
certain type of service to unrelated parties, renders such
services for the benefit of Y in 1965. The direct and indirect
costs allocable to such services are $60,000, and an arm’s
length charge for such services is $100,000. Assume that
the district director proposes to increase X’s income by
$100,000, but that the country in which Y is located would
                                   132

      have blocked payment in 1965 for such services. If, prior
      to the first occurring of the events described in subdivisions
      (i), (ii), or (iii) of this subparagraph, X elects to use the
      deferred income method of accounting with respect to such
      allocation, the $100,000 allocation and the $60,000 of costs
      are deferrable until such amounts cease to be deferrable
      under X’s method of accounting.

33 Fed. Reg. 5849 (Apr. 16, 1968), 26 C.F.R. sec. 1.482-1(d)(6) (1969).

       Section 1.482-2 of the 1968 regulations, 33 Fed. Reg. 5849 (Apr.
16, 1968), a new provision not found in the 1962 regulations, addressed
the methods for allocating income in the case of specific types of
transactions. See also 33 Fed. Reg. 5848, 26 C.F.R. sec. 1.482-1(d)(1)
(1969). These types of transactions were loans, sec. 1.482-2(a), services,
id. para. (b), use of tangible property, id. para. (c), transfer or use of
intangible property, id. para. (d), and sales of tangible property, id.
para. (e). 33 Fed. Reg. 5849-5857.

       For transfers or use of intangible property, here are the major
rules in the 1968 regulations: an appropriate allocation may be made to
reflect an arm’s-length consideration, sec. 1.482-2(d)(1)(i), 33 Fed. Reg.
5852 (Apr. 16, 1968); the amount of arm’s-length consideration is best
indicated by comparable transactions, id. subpara. (2)(ii), 33 Fed. Reg.
5853; and in the absence of comparable transactions, the amount of
arm’s-length consideration may be arrived at through 12 factors, id.
subpara. (2)(iii). Section 1.482-2(d)(4) of the 1968 regulations related to
cost-sharing agreements for the development of intangible property. 33
Fed. Reg. 5854.

      The preamble to the 1968 amendments to the section 482
regulations observed that a notice of proposed rulemaking had been
made in 1965 and that those proposed amendments had been withdrawn
and replaced with new proposals in 1966. 33 Fed. Reg. 5848. The
preamble then stated: “After consideration of all such relevant matter
as was presented by interested persons regarding the rules proposed,
the amendment under section 482 is hereby adopted to read as set forth
below.” Id.

       The 1968 regulatory amendments did not have an effective-date
provision. As with the 1962 regulations, there is a question as to
whether the 1968 regulations applied retroactively. Caselaw suggests
that a regulation without an effective-date provision is generally
                                          133

applicable for the same tax years as the statutory provisions to which
the regulation relates. See Pollack v. Commissioner, 47 T.C. at 110. 119
The statutory provision to which the 1968 regulatory amendments
related was section 482 of the Internal Revenue Code of 1954, 33 Fed.
Reg. 5848, which was effective beginning with tax year 1954 for
calendar-year taxpayers.        Internal Revenue Code of 1954, sec.
7851(a)(1)(A), 68A Stat. at 919. Therefore, the caselaw suggests that for
these taxpayers the 1968 amendment would be effective for tax year
1954 and subsequent years. However, this does not entirely answer the
question of whether the 1968 amendments were applicable for the tax
year 1954 and subsequent years. Two other principles may be relevant.
First, there is caselaw holding that the Treasury Department cannot
give a regulation retroactive effect if to do so would be an abuse of
discretion. See Anderson, Clayton & Co., 562 F.2d at 980-981. Thus,
even if the 1968 amendments were otherwise construed as having
retroactive effect, there may be an additional step of determining
whether it would be an abuse of discretion for the Treasury Department
to attempt to give the 1968 amendments retroactive effect. Second,
section 4(c) of the APA 120 provided that substantive rules must generally
be published not less than 30 days before their effective date. This APA
antiretroactivity rule might arguably trump section 7805(b) of the
Internal Revenue Code of 1954. However, some caselaw suggests it does
not.    See Redhouse v. Commissioner, 728 F.2d 1253; Wing v.
Commissioner, 81 T.C. at 29 n.16. We consider this retroactivity
question later when we discuss First Security Bank, which repeatedly
referred to 26 C.F.R. sec. 1.482-1 (1971). See infra part II.FF. The short
answer is that it does not matter whether the 1968 regulations have
retroactive effect as to the 1955-59 tax years at issue in First Security
Bank because there is no relevant difference between the 1968
regulations and earlier regulations as to the portion of the regulations
cited and quoted by First Security Bank.

      On April 16, 1968, the same day that Treasury Decision 6952 was
published in the Federal Register, a proposed amendment to section
1.482-2(b)(3) and the proposed addition of section 1.482-2(b)(7) were also
published. 33 Fed. Reg. 5858. These proposals are not relevant to the

       119This case interpreted sec. 7805(b) of the Internal Revenue Code of 1954,
which granted the Treasury Department authority to prescribe the extent, if any, to
which a tax regulation may be applied without retroactive effect. Sec. 7805(b) of the
Internal Revenue Code of 1954 governed the 1968 regulatory amendments.
       120   Codified as amended at 5 U.S.C. sec. 553(d).
                                     134

effect of legal restrictions on allocations of income under section 482 of
the Internal Revenue Code of 1954.

       On April 25, 1968, a correction of an error in section 1.482-
2(e)(3)(i) of the 1968 regulations was published. 33 Fed. Reg. 6290 (Apr.
25, 1968). This correction is not relevant to the effect of legal restrictions
on allocations of income under section 482 of the Internal Revenue Code
of 1954.

       On July 25, 1968, an amendment to section 1.482-2(d)(4) of the
1968 regulations was published. 33 Fed. Reg. 10569 (July 25, 1968). 121
This amendment does not appear relevant to the effect of legal
restrictions on allocations of income under section 482 of the Internal
Revenue Code of 1954.

       The 1969 revision to the Code of Federal Regulations contained
regulations promulgated on or before December 31, 1968. See 26 (part
1 (secs. 1.401-1.500)) C.F.R. v (1969). Included in the 1969 revision was
section 1.482-1, which consisted of the following provisions:

       ●      section 1.482-1(a), (b), and (c), with section 1.482-1(a)
              reflecting the technical change to section 1.482-1(a) made
              by the Treasury Decision 6952 amendment on April 16,
              1968; and

       ●      section 1.482-1(d), which had been added by the Treasury
              Decision 6952 amendment on April 16, 1968.

26 C.F.R. sec. 1.482-1 (1969). Also included in the 1969 revision was
section 1.482-2, which was the Treasury Decision 6952 text promulgated
on April 16, 1968, 33 Fed. Reg. 5849, as amended on April 25, 1968, 33
Fed. Reg. 6290, and on July 25, 1968, 33 Fed. Reg. 10569. 26 C.F.R.
sec. 1.482-2 (1969).

      On January 22, 1969, an amendment to section 1.482-2(b)(3) and
the addition of section 1.482-2(b)(7) were published. These changes
were the final version of the changes proposed on April 16, 1968. 34 Fed.
Reg. 933 (Jan. 22, 1969). These changes are not relevant to the effect of

        121 The preamble stated that the notice-and-comment procedure was not

followed because the amendment “liberalized” the regulations. 33 Fed. Reg. 10569
(July 25, 1968).
                                        135

legal restrictions on allocations of income under section 482 of the
Internal Revenue Code of 1954.

       On January 29, 1969, a minor correction to section 1.482-2(b)(3)
was published. 34 Fed. Reg. 1380 (Jan. 29, 1969). This correction is not
relevant to the effect of legal restrictions on allocations of income under
section 482 of the Internal Revenue Code of 1954.

       The 1970 revision of the Code of Federal Regulations contained
regulations promulgated on or before December 31, 1969. See 26 (part
1 (secs. 1.401-1.500)) C.F.R. v (1970). The 1970 revision contained the
same text of section 1.482-1 that had been printed in the 1969 revision.
26 C.F.R. sec. 1.482-1 (1970). Section 1.482-2 in the 1970 revision was
identical to the version of section 1.482-2 published in the 1969 revision,
except that it included the amendments made on January 22 and 29,
1969. 26 C.F.R. sec. 1.482-2 (1970).

       The 1971 revision of the Code of Federal Regulations codified
regulations as of January 1, 1971, including amendments published
during 1970. See 26 (part 1 (secs. 1.401-1.500)) C.F.R. i, v (1971). This
1971 revision contained the same text of sections 1.482-1 and -2 that
appeared in the 1970 revision. 26 C.F.R. secs. 1.482-1, -2 (1971). The
text of section 1.482-1 appears at 288-292 of the relevant volume of the
1971 revision to the Code of Federal Regulations. 26 C.F.R. sec. 1.482-
1 (1971).

       FF.     Commissioner v. First Security Bank, 405 U.S. 394 (1972)
               (a case involving tax years 1955 to 1959)

      In Commissioner v. First Sec. Bank, 405 U.S. at 396, a holding
company 122 owned two banks 123 and an insurance company. 124
Customers of the two banks sometimes wanted to buy credit-life
insurance; the banks would refer these customers to an unrelated
insurance company that had agreed to reinsure the referred business

        122 The holding company was First Security Corp., which the Supreme Court

referred to as “Holding Company”. Commissioner v. First Sec. Bank, 405 U.S. at 396.
       123The two banks were First Security Bank of Utah, N.A., and First Security
Bank of Idaho, N.A., which the Supreme Court referred to collectively as “the Banks”.
Commissioner v. First Sec. Bank, 405 U.S. at 396.
       124 The insurance company was First Security Life Insurance Company of

Texas, which the Supreme Court referred to as “Security Life”. Commissioner v. First
Sec. Bank, 405 U.S. at 396.
                                           136

with the insurance company that was owned by holding company. Id.
at 398. 125 The unrelated insurance company wrote the policies and bore
the insurance risks. Id. 126 The two banks did not receive any
commissions. Id. Pursuant to section 482 of the Internal Revenue Code
of 1954, 127 respondent allocated insurance commission income to the two
banks for tax years 1955, 1956, 1957, 1958, and 1959. Id. at 399-400.
These tax years were based on calendar years. First Sec. Bank of Utah,
N.A. v. Commissioner, T.C. Memo. 1967-256, 26 T.C.M. (CCH) 1320,
1321 (1967), rev’d and remanded, 436 F.2d 1192 (10th Cir. 1971), aff’d,
405 U.S. 394 (1972). The amount respondent sought to allocate to the
two banks was 40% of the premiums that had been received by the
reinsurer from the unrelated insurance company. Commissioner v.
First Sec. Bank, 405 U.S. at 400. The allocation was improper, the Court
held, because the two banks were prohibited from receiving insurance
commission income by section 92 of the National Bank Act. Id. at 402.
This is a provision of the federal banking laws that authorizes national
banks to act as insurance agents in places with a population of 5,000 or
fewer. The provision has been interpreted by the courts to implicitly
prohibit national banks from acting as insurance agents in places with
a population of more than 5,000. Id. at 401 n.13 (citing Saxon v. Ga.
Ass’n of Indep. Ins. Agents, Inc., 399 F.2d 1010 (5th Cir. 1968), and
Commissioner v. Morris Tr., 367 F.2d 794, 795 (4th Cir. 1966), aff’g 42
T.C. 779 (1964)). The two banks were national banks. Id. at 396. Thus
they were implicitly prohibited by section 92 of the National Bank Act
from acting as insurance agents in places with a population of more than
5,000. The Court assumed that because the two banks could not act as
insurance agents, they could not legally receive insurance commission
income. Id. at 402. The Court also assumed that because the two banks
received no compensation for referring their customers to the unrelated
insurance company they did not violate section 92 of the National Bank
Act. Id. n.16. 128 The upshot of these assumptions was that the two
banks were in compliance with the law but would have been in violation
of the law had they received insurance commissions.

       125 The unrelated insurance company was American National Insurance
Company of Galveston, Texas, which the Supreme Court referred to as “American
National”. Commissioner v. First Sec. Bank, 405 U.S. at 398.
        126 Although the unrelated insurance company bore the risks, it hedged this

risk through the reinsurance arrangement.
       127   Recall that this provision can be found at 68A Stat. at 162.
       128 First Security Bank held that it could make these assumptions because the

government had failed to contest their validity. Commissioner v. First Sec. Bank of
Utah, 405 U.S. at 402 & n.16.
                                          137

      The opinion first gave a one-sentence introduction to the case, id.
at 394 & n.1 and then described the relevant facts, id. at 396-399. The
opinion then described respondent’s position as follows:

       Pursuant to his § 482 power to allocate gross income among
       controlled corporations in order to reflect the actual
       incomes of the companies, the Commissioner determined
       that 40% of Security Life’s premium income [Security Life
       was the unrelated insurance company] was allocable to the
       Banks as compensation for originating and processing the
       credit life insurance. * * * It is the Commissioner’s view
       that the 40% of the premium income so allocated is the
       equivalent of commissions that the Banks earned and must
       be included in their “true taxable income.”8
               8 See   26 CFR § 1.482-1(a)(6) (1971).

Id. at 399-400 & n.8. The opinion in First Security Bank then explained
the purpose of section 482 of the Internal Revenue Code of 1954:

               The parties agree that § 482 is designed to prevent
       “artificial shifting, milking, or distorting of the true net
       incomes of commonly controlled enterprises.”9 Treasury
       Regulations provide:

       “The purpose of section 482 is to place a controlled taxpayer
       on a tax parity with an uncontrolled taxpayer, by
       determining[129] according to the standard of an
       uncontrolled taxpayer, the true taxable income from the
       property and business of a controlled taxpayer. * * * The
       standard to be applied in every case is that of an
       uncontrolled taxpayer dealing at arm’s length with another
       uncontrolled taxpayer.”10

              The question we must answer is whether there was
       a shifting or distorting of the Banks’ true net income
       resulting from the receipt and retention by Security Life
       [the unrelated insurance company] of the premiums above
       described. [Footnote omitted.]

       129 The First Security Bank opinion failed to include the comma after the word

“determining” in 26 C.F.R. sec. 1.482-1(b)(1) (1971).
                                       138
             9 B. Bittker & J. Eustice, Federal Income Taxation of
      Corporations and Shareholders p. 15-21 (3d ed. 1971).

              10 26 CFR § 1.482-1(b)(1) (1971).         The first regulations
      interpreting this section of the statute were issued in 1934. They have
      remained virtually unchanged. Jenks, Treasury Regulations Under
      Section 482, 23 Tax Lawyer 279 (1970).

Commissioner v. First Sec. Bank, 405 U.S. at 400 & nn.9 &10, 401.

       The next relevant portion of the First Security Bank opinion
contains the reasoning for the Supreme Court’s holding that respondent
cannot allocate income to a taxpayer who did not receive the income and
could not legally receive the income. Id. at 394-407. Petitioner and
respondent have competing interpretations of the Supreme Court’s
reasoning. Petitioner contends that “First Security Bank found section
482 [of the Internal Revenue Code of 1954] to be clear in light of the
longstanding and consistent interpretation of the concept of income”.
Respondent argues that First Security Bank did not determine that the
text of section 482 of the Internal Revenue Code of 1954 was clear. In
respondent’s view, First Security Bank relied on the text of a regulation,
26 C.F.R. sec. 1.482-1 (1971). Because of this dispute regarding the
reasoning of First Security Bank, we quote the Supreme Court’s
reasoning in full below:

             We know of no decision of this Court wherein a
      person has been found to have taxable income that he did
      not receive and that he was prohibited from receiving. In
      cases dealing with the concept of income, it has been
      assumed that the person to whom the income was
      attributed could have received it.         The underlying
      assumption always has been that in order to be taxed for
      income, a taxpayer must have complete dominion over it.
      “The income that is subject to a man’s unfettered command
      and that he is free to enjoy at his own option may be taxed
      to him as his income, whether he sees fit to enjoy it or not.”
      Corliss v. Bowers, 281 U.S. 376, 378 (1930).

             It is, of course, well established that income assigned
      before it is received is nonetheless taxable to the assignor.
      But the assignment-of-income doctrine assumes that the
      income would have been received by the taxpayer had he
      not arranged for it to be paid to another. In Harrison v.
      Schaffner, 312 U.S. 579, 582 (1941), we said:
                             139

   “[O]ne vested with the right to receive income [does]
   not escape the tax by any kind of anticipatory
   arrangement, however skillfully devised, by which
   he procures payment of it to another, since, by the
   exercise of his power to command the income, he
   enjoys the benefit of the income on which the tax is
   laid.”17

       One of the Commissioner’s regulations for the
implementation of § 482 expressly recognizes the concept
that income implies dominion or control of the taxpayer. It
provides as follows:

   “The interests controlling a group of controlled
   taxpayers are assumed to have complete power to
   cause each controlled taxpayer so to conduct its
   affairs that its transactions and accounting records
   truly reflect the taxable income from the property
   and business of each of the controlled taxpayers.”18

This regulation is consistent with the control concept
heretofore approved by this Court, although in a different
context. The regulation, as applied to the facts in this case,
contemplates that Holding Company--the controlling
interest--must have “complete power” to shift income
among its subsidiaries. It is only where this power exists,
and has been exercised in such a way that the “true taxable
income” of a subsidiary has been understated, that the
Commissioner is authorized to reallocate under § 482. But
Holding Company had no such power unless it acted in
violation of federal banking laws. The “complete power”
referred to in the regulations hardly includes the power to
force a subsidiary to violate the law.

       Apart from the inequity of attributing to the Banks
taxable income that they have not received and may not
lawfully receive, neither the statute nor our prior decisions
require such a result. We are not faced with a situation
such as existed in those cases, urged by the Commissioner,
in which we held the proceeds of criminal activities to be
taxable.19 Those cases concerned situations in which the
taxpayer had actually received funds. Moreover, the
illegality involved was the act that gave rise to the income.
                             140

Here the originating and referring of the insurance, a
practice widely followed, is acknowledged to be legal. Only
the receipt of insurance commissions or premiums thereon
by national banks is not. Had the Banks ignored the
banking laws, thereby risking the loss of their charters and
subjecting their officers to personal liability,20 the illegal-
income cases would be relevant. But the Banks from the
inception of their use of credit life insurance in 1948 were
careful never to place themselves in that position. We
think that fairness requires the tax to fall on the party that
actually receives the premiums rather than on the party
that cannot.21

       In L.E. Shunk Latex Products, Inc. v. Commissioner,
18 T.C. 940 (1952), the Tax Court considered a closely
analogous situation. The same interest controlled a
manufacturer and a distributor of rubber prophylactics.
The OPA Price Regulations of World War II became
effective on December 1, 1941. Prior thereto the distributor
had raised its prices to retailers, but the manufacturer had
not increased the prices charged to its affiliated distributor.
The Commissioner, acting under § 482, attempted to
allocate some of the distributor’s income to the
manufacturer on the ground that a portion of the
distributor’s profits was in fact earned by the
manufacturer, even though the manufacturer was
prohibited by the OPA regulations from increasing its
prices. In holding that the Commissioner had acted
improperly, the Tax Court said that he had “no authority
to attribute to petitioners income which they could not
have received.” 18 T.C., at 961.22

       It is argued, finally, that the “services” rendered by
the Banks in making credit insurance available to
customers “would have been compensated had the
corporations been dealing with each other at arm’s
length.”23 The short answer is that the proscription
against acting as insurance agent and receiving
compensation therefor applies to all national banks located
in places with population in excess of 5,000 inhabitants. It
applies equally to such banks whether or not they are
controlled by a holding company. If these Banks had been
independent of any such control--as most banks are--no
                                    141

commissions or premiums could have been received
lawfully and there would have been no taxable income.24
As stated in the Treasury Regulations, the “purpose of
section 482 is to place a controlled taxpayer on a tax parity
with an uncontrolled taxpayer . . . .”25 We think our holding
comports with such parity treatment.

      We conclude that the premium income received by
Security Life could not be attributable to the Banks.
Holding Company did not utilize its control over the Banks
and Security Life to distort their true net incomes. The
Commissioner’s exercise of his § 482 authority was
therefore unwarranted in this case. * * *
        17See Helvering v. Horst, 311 U.S. 112 (1940) (assignment of
interest coupons attached to bonds owned by taxpayer); Lucas v. Earl,
281 U.S. 111 (1930) (taxpayer assigned to wife one-half interest in his
earnings). See generally Commissioner v. Sunnen, 333 U.S. 591
(1948), and cases discussed therein at 604-610.
        18 26   CFR § 1.482-1(b)(1) (1971).

         James v. United States, 366 U.S. 213 (1961); Rutkin v.
        19

United States, 343 U.S. 130 (1952).
        20 12   U.S.C. § 93.
        21 Thus, in Commissioner v. Lester, 366 U.S. 299 (1961), in
determining that a taxpayer should not be taxed on alimony payments
to his divorced wife, the Court determined that it was more consistent
with the basic precepts of income tax law that the wife, who received
and had power to spend the payments, should be taxed rather than the
husband who actually earned the money.
        22 As noted at the outset of this opinion, certiorari was granted

to resolve the conflict between the decision below and that in Local
Finance Corp. v. Commissioner, 407 F.2d 629 (CA7 1969). The Tax
Court in this case felt bound to follow Local Finance Corp., which was
decided subsequently to L.E. Shunk Latex Products, Inc. v.
Commissioner, 18 T.C. 940 (1952). For the reasons stated in the
opinion above, we think Local Finance Corp. was erroneously decided
and that the earlier views of the Tax Court were correct.

        See Teschner v. Commissioner, 38 T.C. 1003, 1009 (1962):

        “In the case before us, the taxpayer, while he had no power to
dispose of income, had a power to appoint or designate its recipient.
Does the existence or exercise of such a power alone give rise to taxable
income in his hands? We think clearly not. In Nicholas A. Stavroudis,
27 T.C. 583, 590 (1956), we found it to be settled doctrine that a power
                                             142

       to direct the distribution of trust income to others is not alone sufficient
       to justify the taxation of that income to the possessor of such a power.
                 23 See   dissenting opinion of MR. JUSTICE BLACKMUN, post,
       at 422.
                 24 If
                  an unaffiliated bank were able to provide the insurance at
       a cheaper rate because no commissions were paid, this would benefit
       the customers but would result in no taxable income.
                 25 26   CFR § 1.482-1(b)(1) (1971).

Commissioner v. First Sec. Bank, 405 U.S. at 403-407.

       The statutory provision referred to in First Security Bank was
section 482 of the Internal Revenue Code of 1954. The regulation
referred to in First Security Bank was 26 C.F.R. sec. 1.482-1 (1971).

       When citing and quoting the regulations related to section 482 of
the Internal Revenue Code of 1954, First Security Bank referred to the
1971 edition of the Code of Federal Regulations. Commissioner v. First
Sec. Bank of Utah, 405 U.S. at 400 & nn.8&10, 404 & n.18, 407 & n.25.
The text of the regulations related to section 482 of the Internal Revenue
Code of 1954 that were printed in the 1971 edition of the Code of Federal
Regulations had appeared in various forms in the 1953, 1962, and 1968
regulations. 26 C.F.R. sec. 39.45-1 (1953) (1953 regulations); 26 C.F.R.
sec. 1.482-1 (1961 ed. 1965 Cum. Supp.) (1962 regulations); 26 C.F.R.
secs. 1.482-1 and -2 (1969) (1968 regulations). First Security Bank did
not expressly say which of these sets of regulations governed the tax
years at issue in that case (1955-59). 130 Looking at the text of First
Security Bank, and comparing the text of the various regulations, we
make the following conclusions:

       ●         Of the regulatory provisions quoted and cited in First
                 Security Bank, each provision appears in both the 1962 and
                 1968 regulations.

        130 Commissioner v. First Sec. Bank, 405 U.S. at 400 & nn.8&10, 404 & n.18,

407 & n.25, referred to the 1971 edition of the Code of Federal Regulations, an edition
that contained the 1968 regulations. One might infer from this that the Supreme
Court thought that the 1968 regulations governed the case. On the other hand
Commissioner v. First Sec. Bank, 405 U.S. at 400 n.10, also stated that the regulations
related to sec. 482 of the Internal Revenue Code of 1954 had been virtually unchanged
since 1934. Because these regulations were changed significantly in 1968, T.D. 6952,
33 Fed. Reg. 5848-5857 (Apr. 16, 1968), this might be taken to suggest that the
Supreme Court thought the 1968 regulations did not govern the case.
                                143

     ●     Of the regulatory provisions quoted and cited in First
           Security Bank, the provisions do not appear in the 1953
           regulations in the form quoted or cited by the opinion with
           one exception.

We now explain these conclusions. We first repeat the following
relevant regulatory history regarding the 1953, 1962, and 1968
regulations:

     ●     In 1953, the Treasury Department issued a comprehensive
           set of income-tax regulations related to the Internal
           Revenue Code of 1939. 26 C.F.R. secs. 39-1 to 39.6000-1
           (1953).    These regulations were Regulations 118.
           Regulations 118 included section 39.45-1, which related to
           section 45 of the Internal Revenue Code of 1939. Section
           39.45-1 of Regulations 118 included the “complete power”
           passage. 26 C.F.R. sec. 39.45-1(b)(1) (1953).

     ●     In 1954, Congress replaced the Internal Revenue Code of
           1939 with the Internal Revenue Code of 1954. The
           regulations that were related to the Internal Revenue Code
           of 1939 were applied to the relevant provisions of the
           Internal Revenue Code of 1954 until they were superseded
           by new regulations. Internal Revenue Code of 1954, sec.
           7807(a); T.D. 6091, 19 Fed. Reg. 5167 (Aug. 17. 1954).

     ●     In 1962 the Treasury Department promulgated
           comprehensive regulations related to section 482 of the
           Internal Revenue Code of 1954. Title 26 C.F.R. sec. 1.482-
           1 (1961 ed. 1965 Cum. Supp.) (the 1962 regulations)
           replaced section 39.45-1 of Regulations 118 (26 C.F.R. sec.
           39.45-1 (1953)) (the 1953 regulations). There were some
           differences between the 1962 regulations and the parallel
           provisions in the 1953 regulations, but none of the
           differences matter in relation to allocations of income the
           payment of which is barred by legal restrictions.

     ●     In 1968, the Treasury Department made amendments to
           the 1962 regulations. T.D. 6952, 33 Fed. Reg. 5848 (Apr.
           16, 1968). These amendments included a new regulation
           section 1.482-2, which related to particular types of
           transactions. 26 C.F.R. sec. 1.482-2 (1969). The 1968
           amendment also included a provision allowing the
                                        144

               deferred-income method of accounting for income the
               payment of which is barred by foreign legal restrictions. 26
               C.F.R. sec. 1.482-1(d)(6) (1969). The 1968 amendment
               retained the “complete power” passage which had appeared
               in the 1953 and the 1962 regulations. 26 C.F.R. sec. 1.482-
               1(b)(1) (1969).

       With this regulatory history in mind, we can explain our
conclusions that each regulatory provision, as quoted and cited in First
Security Bank, appears in both the 1962 and 1968 regulations but not
(with one exception) the 1953 regulations. We discuss below each of the
four instances in which First Security Bank referred to regulations
related to section 482 of the Internal Revenue Code of 1954.

       The first regulatory reference in Commissioner v. First Security
Bank of Utah, 405 U.S. at 400 & n.8, is the citation of 26 C.F.R. sec.
1.482-1(a)(6) (1971) after the following sentence: “It is the
Commissioner’s view that the 40% of the premium income so allocated
is the equivalent of commissions that the Banks earned and must be
included in their ‘true taxable income.’” The term “true taxable income”
was defined by 26 C.F.R. sec. 1.482-1(a)(6) (1971). This term was first
defined in the 1962 regulations, 26 C.F.R. sec. 1.482-1(a)(6) (1961 ed.
1965 Supp.), and appeared again unchanged in the 1968 regulations, 26
C.F.R. sec. 1.482-1(a)(6) (1969). 131 The definition of “true taxable
income” was not in the 1953 regulations, which used and defined a
different term--“true net income”. 26 C.F.R. sec. 39.45-1(a)(6) (1953).

      The second regulatory reference in Commissioner v. First
Security Bank of Utah, 405 U.S. at 400 & n.10, is the quotation of the
portion of 26 C.F.R. sec. 1.482-1(b)(1) (1971) that stated:

       The purpose of section 482 is to place a controlled taxpayer
       on a tax parity with an uncontrolled taxpayer, by
       determining, according to the standard of an uncontrolled
       taxpayer, the true taxable income from the property and
       business of a controlled taxpayer . . . . The standard to be
       applied in every case is that of an uncontrolled taxpayer
       dealing at arm’s length with another uncontrolled
       taxpayer.

        131 In other words, the 1962 definition of “true taxable income” was unchanged

by the 1968 regulatory amendments.
                                     145

(Ellipsis in original opinion.) 132 This same text quoted in First Security
Bank is found in the 1962 regulations, 26 C.F.R. sec. 1.482-1(b)(1) (1961
ed. 1965 Cum. Supp.), and in the 1968 regulations, 26 C.F.R. sec. 1.482-
1(b)(1) (1969), but is slightly different from the 1953 regulations, 26
C.F.R. sec. 39.45-1(b)(1) (1953), which refer to “true net income” instead
of “true taxable income”.

       The third regulatory reference in Commissioner v. First Security
Bank of Utah, 405 U.S. at 404 & n.18, is the quotation of the portion of
26 C.F.R. sec. 1.482-1(b)(1) (1971) that stated: “The interests controlling
a group of controlled taxpayers are assumed to have complete power to
cause each controlled taxpayer so to conduct its affairs that its
transactions and accounting records truly reflect the taxable income
from the property and business of each of the controlled taxpayers.” This
text is found in the 1962 regulations, 26 C.F.R. sec. 1.482-1(b)(1) (1961
ed. 1965 Supp.), and in the 1968 regulations, 26 C.F.R. sec. 1.482-1(b)(1)
(1969), but is slightly different from the 1953 regulations, 26 C.F.R. sec.
39.45-1(b)(1) (1953), which refer to “net income” instead of “taxable
income”.

       The fourth regulatory reference in Commissioner v. First Security
Bank of Utah, 405 U.S. at 407 & n.25, is the citation of 26 C.F.R. sec.
1.482-1(b)(1) (1971) for this proposition: “As stated in the Treasury
Regulations, the ‘purpose of section 482 is to place a controlled taxpayer
on a tax parity with an uncontrolled taxpayer . . . .” (Ellipsis in original
opinion.) The text quoted in the Supreme Court opinion appears in the
1962 regulations and the 1968 regulations. 26 C.F.R. sec. 1.482-1(b)(1)
(1961 ed. 1965 Supp.) (1962 regulations); 26 C.F.R. sec. 1.482-1(b)(1)
(1969) (1968 regulations). It also appears in the 1953 regulations. 26
C.F.R. sec. 39.45-1(b)(1) (1953).

       We will now discuss the significance of which version of the
regulations was relied on by First Security Bank. Recall that the
regulatory provisions cited and quoted by First Security Bank contain
textual differences from the 1953 regulations. Therefore a plausible
case can be made that the First Security Bank opinion indicated that
the 1953 regulation was not the version it relied on. Whether this is
correct (i.e., whether First Security Bank relied on the 1953 version) is
not significant. This is because there is no relevant difference between
the 1953 regulations, on the one hand, and the 1962 and 1968

      132 When the Supreme Court quoted the text, the Supreme Court omitted the

comma after the word “determining”.
                                         146

regulations, on the other, as to those portions of the regulations cited
and quoted by First Security Bank.

       First Security Bank did not cite or quote 26 C.F.R. sec. 1.482-
1(d)(6) (1969). 133 This provision, which appeared in the 1968 regulations
but not the 1953 regulations or the 1962 regulations, allowed taxpayers
to elect the deferred-income method of accounting regarding income the
payment of which would be barred by foreign legal restrictions. In First
Security Bank, respondent did not argue that the availability of the
deferred-income method of accounting in the regulations meant that the
regulations did not prohibit respondent from allocating income under
section 482 of the Internal Revenue Code of 1954 that could not be paid
to the taxpayer because of legal restrictions. 134           Indeed, the
government’s briefs in First Security Bank did not make any reference
to 26 C.F.R. sec. 1.482-1(d)(6) (1969). Therefore there is no need for us
to determine whether 26 C.F.R. sec. 1.482-1(d)(6) (1969) applied for the
1955-59 taxable years at issue in First Security Bank. Such a
determination would not inform our understanding of the holding or
reasoning of First Security Bank.

       GG.     The Tax Reform Act of 1976

       In 1976, Congress amended section 482 of the Internal Revenue
Code of 1954 to replace “the Secretary or his delegate” with “the
Secretary”. 26 U.S.C. sec. 482 (1976), as amended by the Tax Reform
Act of 1976, Pub. L. No. 94-455, sec. 1906(b)(13)(A), 90 Stat. at 1834.
The change was effective for tax years beginning after December 31,
1976. Tax Reform Act of 1976 sec. 1906(d)(2), 90 Stat. at 1835. Neither
petitioner nor respondent contends that this change is significant.

       133This provision was the same in the 1969 edition of the Code of Federal
Regulations and the 1971 edition of the Code of Federal Regulations.
      134 The government made such an argument in Procter & Gamble Co. v.

Commissioner, 95 T.C. 324, 341 (1990), aff’d, 961 F.2d 1255, 1259-1260 (6th Cir. 1992).
                                    147

      HH.    Procter & Gamble Co. v. Commissioner, 95 T.C. 323 (1990)
             (a case involving tax years ending June 30, 1978, and June
             30, 1979), aff’d, 961 F.2d 1255 (6th Cir. 1992); and Exxon
             Corp. v. Commissioner, T.C. Memo. 1993-616, 66 T.C.M.
             (CCH) 1707 (a case involving tax years 1979, 1980, and
             1981), aff’d sub nom. Texaco, Inc. v. Commissioner, 98 F.3d
             825 (5th Cir. 1996)

       In Procter & Gamble Co. v. Commissioner, 95 T.C. 323, 324, 326
(1990), aff’d, 961 F.2d 1255 (6th Cir. 1992), a U.S. company owned a
Swiss company, which in turn owned a Spanish company. The Swiss
company paid royalties to the U.S. company for the right of the Swiss
company and the Spanish company to use the U.S. company’s
intellectual property. Id. at 324, 330. Pursuant to this arrangement,
the Spanish company used the U.S. company’s intellectual property. Id.
at 330. The Spanish company paid no compensation to the Swiss
company even though the Swiss company had paid the U.S. company for
the Spanish company’s right to use the U.S. company’s intellectual
property. Id. Respondent made an allocation of royalty income under
section 482 of the Internal Revenue Code of 1954 (26 U.S.C. sec. 482
(1982)) from the Spanish company to the Swiss company for the Spanish
company’s use of intellectual property. Procter & Gamble Co. v.
Commissioner, 95 T.C. at 330-331. To include this royalty income in the
income of the Swiss company would increase the subpart F income of
the Swiss company, which in turn would trigger an inclusion in the gross
income of the U.S. company under section 951(a)(1)(A) of the Internal
Revenue Code of 1954 (26 U.S.C. sec. 951(a)(1)(A)). Procter & Gamble
Co. v. Commissioner, 95 T.C. at 331. The tax years to which these
allocations related were the U.S. company’s tax years ending June 30,
1978 and 1979. Id. at 323, 330-331.

       The Spanish government had issued a series of letters over 10
years stating that the Spanish company was prohibited from paying
royalties to the Swiss company. Id. at 326-327. The existence of such a
prohibition also found support in an order of the Spanish Ministry of
Industry and in Spanish Decree 3099/1976. Id. at 328-329. The Tax
Court concluded that Spanish law prohibited the payment of royalties
by the Spanish company to its Swiss parent. Id. at 336-337. The Court
held that because the prohibition was applied consistently “there is no
need to identify a specific constitutional or statutory provision codifying
the prohibition in order to treat the prohibition as law.” Id. at 337 (citing
U.S. Padding Corp. v. Commissioner, 88 T.C. 177, 187-188 (1987), aff’d,
865 F.2d 750 (6th Cir. 1989)).
                                  148

      The Tax Court in Procter & Gamble Co. v. Commissioner, 95 T.C.
at 335-336, then held that the allocation under section 482 of the
Internal Revenue Code of 1954 was not permissible:

             We find First Security Bank and Salyersville
      National Bank [613 F.2d 650, 655-656 (6th Cir. 1980), a
      case applying First Security Bank] compelling with respect
      to the issue before the Court. As we understand these
      cases, section 482 simply does not apply where restrictions
      imposed by law, and not the actions of the controlling
      interest, serve to distort income among the controlled
      group. * * *

Thus, the Tax Court’s holding in Procter & Gamble rested on First
Security Bank. In the following passage, the Tax Court recognized that
the reasoning of First Security Bank relied on the idea that the
“complete power” to shift include “hardly includes the power to force a
subsidiary to violate the law”:

             In concluding that the Commissioner’s allocation
      was unwarranted, the Supreme Court emphasized that
      there was no shifting or distorting of income because the
      banks simply could not receive insurance premium income.
      The Court stated that section 1.482-1(b)(1), Income Tax
      Regs., as applied to the facts--

         contemplates that [First Security Corp.]--the
         controlling interest--must have “complete power” to
         shift income among its subsidiaries. It is only where
         this power exists, and has been exercised in such a
         way that the “true taxable income” of a subsidiary
         has been understated, that the Commissioner is
         authorized to reallocate under sec. 482. But [First
         Security Corp.] had no such power unless it acted in
         violation of federal banking laws. The “complete
         power” referred to in the regulations hardly includes
         the power to force a subsidiary to violate the law.
         [Commissioner v. First Security Bank of Utah, 405
         U.S. at 404-405.]

Procter & Gamble Co. v. Commissioner, 95 T.C. at 334-335 (alteration
in original) (footnote omitted) (quoting Commissioner v. First Sec. Bank,
405 U.S. at 404-405).
                                  149

       The Tax Court in Procter & Gamble Co. v. Commissioner, 95 T.C.
at 339, rejected respondent’s argument that First Security Bank was
distinguishable because it involved a domestic legal restriction, not a
foreign legal restriction. The Tax Court explained that First Security
Bank held that no section 482 allocation is appropriate where “the
controlling interest has not utilized its power to shift income” and thus
the First Security Bank holding did not hinge on whether the legal
restriction was foreign or domestic.         Procter & Gamble Co. v.
Commissioner, 95 T.C. at 339.

      The Tax Court also rejected respondent’s argument that a
prohibition on making payments is distinguishable from a prohibition
on receiving payments. Id. The Spanish company in Procter & Gamble
was prohibited from making payments. Id. at 326. The two national
banks in First Security Bank were prohibited from receiving payments.
See Procter & Gamble Co. v. Commissioner, 95 T.C. at 339. The Tax
Court held that the distinction between a prohibition on making
payments and a prohibition on receiving payments is a “distinction
without a difference”. Id. It reasoned that if the Spanish company was
prohibited from making payments to the Swiss company, the Swiss
company was prohibited from receiving them. Id.

      The Tax Court’s Procter & Gamble opinion rejected respondent’s
argument that the Spanish prohibition on payment of royalties was
merely an administrative decision that the Spanish company could have
appealed. Id. at 333, 337. The Tax Court reasoned that the Spanish
subsidiary had informally communicated with the Spanish government
and had concluded that an appeal would be unsuccessful and
detrimental to the company’s relationship with the government. Id. at
337.

       Additionally, the Tax Court’s Procter & Gamble opinion
considered whether it was significant that the Spanish prohibition on
royalty payments affected only royalty payments to a commonly owned
company. Id. at 339-340. It held that First Security Bank had
established the general principle that a section 482 allocation cannot be
made unless “control was utilized to shift income”. Procter & Gamble
Co. v. Commissioner, 95 T.C. at 339-340. The Tax Court held that the
U.S. company did not use its control to shift income from the Spanish
company to the Swiss company and that therefore no section 482
allocation was proper. Id. at 340.
                                   150

        Finally, the Tax Court in Procter & Gamble Co. v. Commissioner,
95 T.C. at 340-341, addressed the significance of section 1.482-1(d)(6),
which was added in 1968. 33 Fed. Reg. 5849, 26 C.F.R. sec. 1.482-1(d)(6)
(1969). The regulation provided that if intercompany payments were
restricted by foreign law, the taxpayer could elect to defer the
corresponding income that would otherwise be allocated to the taxpayer
under section 482 of the Internal Revenue Code of 1954 until the
restriction was lifted. Id. The Tax Court held that because section 482
of the Internal Revenue Code of 1954 does not apply, the regulations
under section 482 of the Internal Revenue Code of 1954 do not apply.
Procter & Gamble Co. v. Commissioner, 95 T.C. at 340-341. Excerpted
in full below is the Tax Court’s discussion of 26 C.F.R. sec. 1.482-1(d)(6)
(1969):

              Finally, respondent suggests that if section 482 does
      not apply under the circumstances presented, the Court
      has effectively rendered section 1.482-1(d)(6), Income Tax
      Regs., meaningless. Respondent references Rev. Rul. 74-
      245, 1974-1 C.B. 124, which provides that section 1.482-
      1(d)(6), Income Tax Regs., will be liberally administered to
      allow a taxpayer relief from a section 482 allocation, by
      permitting deferral of the allocated income, where the
      payments allocated could not be effected under foreign law.
      Respondent emphasizes that the regulation contemplates
      that if the taxpayer elects to defer the allocated income, the
      taxpayer must likewise defer expenses relating to that
      income so as to ultimately match income and expense. In
      this case, petitioner did not elect to proceed under the
      regulation and claims that the regulation does not apply in
      the face of a Spanish law prohibiting payment of specific
      income.

             By virtue of our holding that section 482 does not
      apply, the regulations underlying section 482 likewise do
      not apply. We note that section 1.482-1(d)(6), Income Tax
      Regs., was prescribed by Treasury Decision 6952 on April
      15, 1968, prior to the First Security Bank decision. See
      1968-1 C.B. 218. Thus, no consideration was given to the
      effect of First Security Bank on the scope of the regulation.
      Notwithstanding the foregoing, our ruling does not render
      section 1.482-1(d)(6), Income Tax Regs., meaningless.
      Rather, we only limit the application of the regulation
      within the narrow confines of the facts presented in this
                                         151

       case. Specifically, section 482 does not apply where the
       taxpayer’s legitimate business purposes subject it to legal
       restraints effectively blocking receipt of income. We do not
       have before us, and therefore do not address, whether a
       section 482 allocation may be appropriate where legitimate
       business purposes are lacking.

Procter & Gamble Co. v. Commissioner, 95 T.C. at 340-341 (footnote
omitted).

       In the excerpt above, Procter & Gamble Co. v. Commissioner, 95
T.C. at 340-341, referred to “section 1.482-1(d)(6), Income Tax Regs.”
This provision of the regulations, which allows the deferred-income
method of accounting, was not promulgated until the 1968 regulatory
amendments. 33 Fed. Reg. 5849 (Apr. 16, 1968); 26 C.F.R. sec. 1.482-
1(d)(6) (1969) (1968 regulations). Although the 1968 amendments had
no effective date, see T.D. 6952, 33 Fed. Reg. 5848, they related to
section 482 of the Internal Revenue Code of 1954, which was effective
for tax years that began after December 31, 1953, and ended after
August 16, 1954. Internal Revenue Code of 1954, sec. 7851(a)(1)(A), 68A
Stat. at 919, 929. Thus, the 1968 regulations were effective for the tax
years at issue in Procter & Gamble Co. v. Commissioner, 95 T.C. at 323,
which were the tax years ending June 30, 1978 and 1979. 135

       The U.S. Court of Appeals for the Sixth Circuit affirmed the Tax
Court’s decision in Procter & Gamble Co. v. Commissioner, 961 F.2d
1255 (6th Cir. 1992). The Sixth Circuit’s primary holding was that First
Security Bank controlled Procter & Gamble even though the restriction
in First Security Bank was a domestic law and the restriction in Procter
& Gamble was a foreign law. Procter & Gamble Co. v. Commissioner,
961 F.2d at 1258-1259. The Sixth Circuit reasoned that the U.S.
company in Procter & Gamble did not have the “complete power” (within
the meaning of regulation section 1.482-1(b)(1)) to shift income from the
Swiss company to the Spanish company because Spanish law prohibited
the Spanish company to make payments to the Swiss company. Id.

        135 Pollack v. Commissioner, 47 T.C. at 110, held that “unless the

Commissioner otherwise specifies, regulations are retroactive to the date on which the
statute was enacted.” Although to apply the 1968 regulations retroactively might have
been challenged as an abuse of discretion, see Anderson, Clayton & Co., 562 F.2d at
980-981, or as an arguable violation of the Administrative Procedure Act’s
antiretroactivity provision, 5 U.S.C. sec. 553(d) (codifying sec. 4(c) of the APA, as
amended), the 1968 regulations were not retroactive as applied to the tax years at issue
in Procter & Gamble, which were after 1968.
                                   152

Excerpted below is the Sixth Circuit’s main holding and the reasons
given for it:

      The purpose of section 482 is “to place a controlled taxpayer
      on a tax parity with an uncontrolled taxpayer.” Treas. Reg.
      § 1.482-1(b)(1).

             It is P&G’s [the U.S. company’s] position that section
      482 requires that any distortion of income of a controlled
      party result from the existence and exercise of control.
      P&G argues that where governing law, and not the
      controlling party or interests, causes a distortion of income,
      section 482 is unavailable to allocate income. P&G argues
      that the regulations promulgated under section 482 and
      the Supreme Court’s decision in Commissioner v. First
      Security Bank, 405 U.S. 394, 92 S. Ct. 1085, 31 L. Ed. 2d
      318 (1972), support this position.

            The term “controlled” is defined in Treas. Reg. §
      1.482-1(a)(3) to include:

         any kind of control, direct or indirect. . . . It is the
         reality of the control which is decisive, not its form
         or the mode of its exercise.

      Treas. Reg. § 1.482-1(b)(1) states the level of control that is
      presumed to justify making a section 482 allocation:

         The interests controlling a group of controlled
         taxpayers are assumed to have complete power to
         cause each controlled taxpayer so to conduct its
         affairs that its transactions and accounting records
         truly reflect the taxable income from the property
         and business of each of the controlled taxpayers.

      Further, Treas. Reg. § 1.482-1(c) states:

         Transactions between one controlled taxpayer and
         another will be subjected to special scrutiny to
         ascertain whether the common control is being used
         to reduce, avoid, or escape taxes.
                            153

       The foregoing regulations recognize that in order for
the Commissioner to have authority to make a section 482
allocation, a distortion in a controlled taxpayer’s income
must be caused by the exercise of such control. In the
present case there is no evidence that P&G or AG [the
Swiss company] used its control over España [the Spanish
company] to manipulate or shift income. Indeed, the Tax
Court held that the failure of España to make royalty
payments was a result of the prohibition against royalty
payments under Spanish law and was not due to the
exercise of control by P&G. The Spanish prohibition is
expressly found in the letter approving España’s
organization and in the letters permitting capital increases
for España. In addition, Decrees 2343/1973 ad 3099/1976
made it clear that payments for transfers of technology
from Spanish entities to controlling foreign entities would
be restricted.

        The Supreme Court held in First Security that the
Commissioner is authorized to allocate income under
section 482 only where a controlling interest has complete
power to shift income among its subsidiaries and has
exercised that power. In First Security, two related banks
offered credit life insurance to their customers. The banks
were prohibited by federal law from acting as insurance
agents and receiving premiums, and they referred
customers to an unrelated insurance company to purchase
this insurance. The insurance company retained 15
percent of the premiums for actuarial and accounting
services, and transferred 85 percent of the premiums
through a reinsurance agreement to an insurance company
affiliated with the banks. The insurance affiliate reported
the entire amount it received as reinsurance premiums as
its income. The Commissioner determined that 40 percent
of the affiliate’s income was allocable to the banks as
compensation for originating and processing the insurance.
The Supreme Court set aside the Commissioner’s
allocation. The Court found that the holding company that
controlled the banks and the insurance affiliate did not
have the power to shift income among its subsidiaries
unless it operated in violation of federal banking law. The
Court stated that the “complete power” referred to in
Treas. Reg. § 1.482-1(b)(1) does not include the power to
                                   154

      force a subsidiary to violate the law. So here, P&G did not
      have the power to shift income between España and its
      other interests unless it violated Spanish law. The
      payment or non-payment of royalties in no way depended
      on P&G’s control of the various entities. The same result--
      no royalties--would exist in the case of unrelated entities.

             The Commissioner argues that First Security is not
      controlling in this case because the Supreme Court’s
      analysis is limited to instances in which allocation under
      section 482 is contrary to federal law. We are not
      persuaded. The Supreme Court focused on whether the
      controlling interests utilized their control to distort income.
      We see no reason to alter this analysis because foreign law,
      as opposed to federal law, prevented payment of royalties.
      The purpose of section 482 is to prevent artificial shifting
      of income between related taxpayers. Because Spanish law
      prohibited royalty payments, P&G could not exercise the
      control that section 482 contemplates, and allocation under
      section 482 is inappropriate. That foreign law is involved
      may require a heightened scrutiny to be sure the taxpayer
      is not responsible for the restriction on payment. But that
      is not suggested in the case of the Spanish law here which
      was in effect long before España was created.

Id.

       In Procter & Gamble Co. v. Commissioner, 961 F.2d at 1259, the
government also argued before the Sixth Circuit that the Spanish
company could have paid the Swiss company a dividend, even if it could
not have paid it a royalty. The Sixth Circuit rejected this argument. Id.
The Sixth Circuit reasoned that (1) the Spanish company had no
obligation to arrange its affairs so as to maximize taxes, (2) payment of
a royalty by the Spanish company to its Swiss parent in the guise of a
dividend would be an evasion of Spanish law, and (3) the Spanish
company did not have sufficient earnings from which to pay a dividend.
Id.

      Finally, the Sixth Circuit in Procter & Gamble held that section
1.482-1(b)(6) did not apply. Here is the Sixth Circuit’s full reasoning:

            The Commissioner argues that the Tax Court erred
      by refusing to apply Treas. Reg. § 1.482-1(b)(6), the
                           155

“blocked income” regulation. Treas. Reg. § 1.482-1(b)(6)
provides in pertinent part:

       If payment or reimbursement for the sale,
   exchange, or use of property, the rendition of
   services, or the advance of other consideration
   among members of a group of controlled entities was
   prevented, or would have been prevented, at the
   time of the transaction because of currency or other
   restrictions imposed under the laws of any foreign
   country, any distributions, apportionments, or
   allocations which may be made under section 482
   with respect to such transactions may be treated as
   deferrable income.

This regulation recognizes the problem posed by
restrictions placed on payments in a foreign currency.
Income allocated under section 482 may be deferred if
payments have been blocked by currency or other
restrictions under the laws of a foreign country. The Tax
Court determined that because section 482 did not apply to
the present case, the regulations promulgated under
section 482 likewise did not apply.

       The Commissioner argues that this regulation is
designed to remedy the situation presented in this case.
We disagree. Treas. Reg. § 1.482-1(b)(6) contemplates the
situation where a temporary restriction under foreign law
prevents payments, and defers the allocation of income
until such time as the payments are no longer restricted.
This case does not present a situation in which payments
to P&G were temporarily restricted; rather, Spanish law
prohibited payment of royalties altogether.            This
prohibition cannot be viewed as temporary because it was
ultimately repealed in 1987. At the time in question, there
was no reason for P&G to believe that the Spanish
government would lift this ban; therefore, the payments
that España was prohibited by law from making cannot be
viewed as temporarily blocked payments.

      The Commissioner also argues that the prohibition
on royalty payments was temporary and that P&G could
have deferred royalty payments under this regulation and
                                   156

      then at some future time P&G could have liquidated
      España and taken its capital out of Spain.            Upon
      liquidation, the Commissioner argues, the temporary
      prohibition on payment of pesetas would end. We find this
      argument to be meritless because P&G need not organize
      its subsidiaries in such a way as to maximize its tax
      liabilities. There is no question that P&G may legally
      structure its affairs in its own best interest. Salyersville,
      613 F.2d at 653. We agree with the Tax Court that Treas.
      Reg. § 1.482-1(b)(6) does not apply to this case.

Id. at 1259-1260.

        In Exxon Corp. v. Commissioner, T.C. Memo. 1993-616, 66 T.C.M.
(CCH) 1707, 1716-1721, 1739-1752, aff’d sub nom. Texaco, Inc. v.
Commissioner, 98 F.3d 825 (5th Cir. 1996), the Tax Court addressed the
effect of a restriction imposed by Saudi Arabia whereby companies
which bought oil from Saudi Arabia at a below-market price could not
resell the oil at a greater price. A U.S. subsidiary of Texaco (which was
a type of company referred to as an “offloader”) had purchased oil from
Saudi Arabia at a below-market price and resold the oil to foreign
affiliates at the same price. Id. at 1710, 1733, 1752-1760. Respondent
determined in Exxon that income should be allocated from the foreign
affiliates to the U.S. subsidiary under section 482 of the Internal
Revenue Code of 1954 (26 U.S.C. sec. 482) to reflect that the price at
which the U.S. subsidiary sold the oil to the foreign affiliates was below
the market price. Id. at 1733. The tax years at issue were the calendar
years 1979-81. Id. at 1708. Respondent also determined that the
allocation of income was justified under section 61 of the Internal
Revenue Code of 1954 and under the principle that income is taxed to
the taxpayer who earns it. Id. at 1733, 1738.

      The Tax Court in Exxon held that respondent’s allocations in that
case were improper under First Security Bank and Procter & Gamble.
Exxon Corp. v. Commissioner, 66 T.C.M (CCH) at 1734-1739. Exxon
explained that First Security Bank established the principle that section
482 cannot be used to allocate income to a taxpayer if receipt of the
income is prohibited by law:

      In Commissioner v. First Security Bank, supra, certain
      affiliated banks referred their customers to an independent
      insurance company for purposes of obtaining credit life
      insurance. Credit life insurance policies were written by
                           157

the independent insurance company, which then reinsured
the policies with an affiliate of the banks pursuant to a
“treaty of reinsurance”.        The independent insurance
company retained 15 percent of the premiums for providing
actuarial and accounting services, and the affiliated
insurance company retained 85 percent of the premiums
for assuming the risk under the policies. No sales
commissions or referral fees were paid to the affiliated
banks.     These banks could not legally receive such
commissions pursuant to a Federal law which prohibited
banks from acting as insurance agents in locations with a
population in excess of 5,000 inhabitants. During the years
at issue, 85 percent of the premiums paid by the customers
were reported by the affiliated life insurance company on
its tax returns. The Commissioner allocated 40 percent of
the affiliated life insurance company’s net premium income
to the banks as compensation for originating and
processing the credit life insurance. The Tax Court upheld
the Commissioner’s allocation, but the Court of Appeals for
the Tenth Circuit reversed. The Supreme Court affirmed
the Court of Appeals on the ground that, since the banks
could not legally receive the commissions under Federal
law, the Commissioner could not reallocate them to the
banks. The Court stated that it had never found a taxpayer
to have income “that he did not receive and that he was
prohibited from receiving” and premised this on the
underlying assumption that, “in order to be taxed for
income, a taxpayer must have complete dominion over it.”
Commissioner v. First Security Bank, 405 U.S. at 403. The
Court further observed that one of the Commissioner’s
regulations under section 482 also recognized the concept
that “income implies dominion or control” by providing:

   “The interests controlling a group of controlled
   taxpayers are assumed to have complete power to
   cause each controlled taxpayer so to conduct its
   affairs that its transactions and accounting records
   truly reflect the taxable income from the property
   and business of each of the controlled taxpayers.”

Id. at 404 (emphasis added) (quoting sec. 1.482-1(b)(1),
Income Tax Regs.). The Court concluded therefrom that
the parent holding company
                                  158

         must have ‘complete power’ to shift income among
         its subsidiaries. It is only where this power exists,
         and has been exercised in such a way that the ‘true
         taxable income’ of a subsidiary has been
         understated, that the Commissioner is authorized to
         reallocate under § 482. But Holding Company had
         no such power unless it acted in violation of federal
         banking laws. The ‘complete power’ referred to in
         the regulations hardly includes the power to force a
         subsidiary to violate the law.

      Id. at 404-405. Thus, the Supreme Court has indicated
      that, where the receipt of income is prohibited by law, the
      Commissioner is prohibited from allocating such income
      pursuant to section 482.

Exxon Corp. v. Commissioner, 66 T.C.M. (CCH) at 1735 (footnotes
omitted). It is important to note that in the excerpt above Exxon
recognized that First Security Bank relied upon the “complete power”
regulatory provision.

      Next, Exxon Corp. v. Commissioner, 66 T.C.M (CCH) at 1735-
1736, observed that in Procter & Gamble the Tax Court “took the
holding of First Security and applied it in the context of a foreign--as
opposed to a domestic Federal or State--law.”

       The Tax Court in Exxon next addressed respondent’s reliance on
section 61 of the Internal Revenue Code of 1954 for his theory that
income in question should be allocated to Texaco’s U.S. subsidiary.
Exxon Corp. v. Commissioner, 66 T.C.M. (CCH) at 1738-1739. Under
the section 61 assignment-of-income doctrine, income is attributable to
the taxpayer who earned the income even if the earner had agreed to
assign the income to another taxpayer. Lucas v. Earl, 281 U.S. 111
(1930), cited in Exxon Corp. v. Commissioner, 66 T.C.M. (CCH) at 1738.
The Tax Court in Exxon stated that First Security Bank had held that
the assignment-of-income doctrine does not apply to income that a
taxpayer is legally prohibited from receiving:

            The Supreme Court also has recognized that a legal
      prohibition against a taxpayer’s receipt of income
      precludes an assignment of such income to the taxpayer by
      the Commissioner. In First Security (a section 482 case),
                                          159

        the Court discussed the interplay between section 482 and
        the assignment of income cases as follows:

                We know of no decision of this Court wherein a
            person has been found to have taxable income that
            he did not receive and that he was prohibited from
            receiving. In cases dealing with the concept of
            income, it has been assumed that the person to
            whom the income was attributed could have received
            it. The underlying assumption always has been that
            in order to be taxed for income, a taxpayer must have
            complete dominion over it.

        Commissioner v. First Security Bank, 405 U.S. 394, 403
        (1972). Thus, according to the above-quoted language, a
        taxpayer who is legally prohibited from receiving income
        and who does not in fact receive such income, cannot be
        said to have “earned” the income under a section 61
        analysis.

Exxon Corp. v. Commissioner, 66 T.C.M. (CCH) at 1738-1739. Thus,
Exxon rejected two theories, under sections 482 and 61 of the Internal
Revenue Code of 1954, respectively, why Texaco’s foreign affiliates
should be allocated income. 136

      Next the Tax Court in Exxon held that the resale price restriction
was a valid and binding prohibition because it was authorized by the
King of Saudi Arabia, it was consistently applied, compliance with it was
mandatory, and it was in effect during the years at issue. Id. at 1739-
1752. Next the Tax Court held that Texaco did not ignore or circumvent
the restriction. Id. at 1752-1760. Finally the Tax Court concluded:
“Under the rule of Commissioner v. First Security Bank, 405 U.S. 394
(1972), its assignment of income predecessors, and its progeny, we hold
that the 1979 restriction precluded a section 61 or section 482

        136 That the two theories are distinct from each other is evidenced by the way

Exxon summarized its holding near the end of the opinion. In the summary, Exxon
stated that first, “the offtakers did not ‘earn’ the income occasioned by the low cost of
the Saudi crude within the meaning of section 61 because they did not receive it and
were prohibited from receiving it”, and second, they “were deprived of the requisite
power to control the location of income” and so “respondent’s allocation under section
482 is not warranted.” Exxon Corp. & Affiliated Cos. v. Commissioner, T.C. Memo.
1993-616, 66 T.C.M. (CCH) 1707, 1739 (1993), aff’d sub nom. Texaco, Inc. & Subs. v.
Commissioner, 98 F.3d 825 (5th Cir. 1996).
                                   160

adjustment to the income of petitioners’ offtakers in this case.” Id. at
1760.

        In Texaco, Inc. v. Commissioner, 98 F.3d 825 (5th Cir. 1996), the
Fifth Circuit affirmed the decision of the Tax Court in Exxon. The Fifth
Circuit opinion can be divided into four parts. In the first part it agreed
with the Tax Court’s conclusion that the resale price restriction had the
effect of law. Texaco, Inc. v. Commissioner, 98 F.2d at 828. In the second
part the Fifth Circuit agreed that the Tax Court properly applied First
Security Bank. The second part of the Fifth Circuit’s opinion is
excerpted below:

             We also agree with the Tax Court’s legal conclusion
      that the teaching of Commissioner v. First Security Bank,
      405 U.S. 394, 92 S. Ct. 1085, 31 L. Ed. 2d 318 (1972), bars
      the Commissioner from allocating income to Textrad
      [Texaco’s U.S. subsidiary] on its sales of Saudi crude under
      § 482. Because the sales price of the crude is governed by
      Letter 103/z, Texaco did not have the power to control the
      sales price of the oil.

               Section 482 of the Internal Revenue Code authorizes
      the Secretary to apportion or allocate income between
      organizations controlled by the same interests “if he
      determines that such distribution, apportionment, or
      allocation is necessary in order to prevent evasion of taxes
      or clearly to reflect the income of any such organizations
      . . . .” 26 U.S.C. § 482 (1994). The relevant IRS regulation
      explains that the purpose of § 482 is “to place a controlled
      taxpayer on a tax parity with an uncontrolled taxpayer”
      and to ensure that controlling entities conduct their
      subsidiaries’ transactions in such a way as to reflect the
      “true taxable income” of each controlled taxpayer. 26
      C.F.R. § 1.482-1A(b)(1) (1996).4 The regulation further
      explains that “[t]he standard to be applied in every case is
      that of an uncontrolled taxpayer dealing at arm’s length
      with another uncontrolled taxpayer.” Id.

             In First Security, the Court held that § 482 did not
      authorize the Commissioner to allocate income to a party
      prohibited by law from receiving it. 405 U.S. at 404. In
      that case, two related banks offered credit life insurance to
      their customers. Federal law prohibited the banks from
                             161

acting as insurance agents and receiving premiums or
commissions on the sale of insurance. The banks referred
their customers to an unrelated insurance company to
purchase this insurance. The insurance company retained
a small percent of the premiums for administrative
services and transferred the bulk of the premiums through
a reinsurance agreement to an insurance company
affiliated with the banks, which reported all of the
reinsurance premiums it received as income.           The
Commissioner reallocated 40 percent of the related
insurance company’s income from these reinsurance
premiums to the banks as compensation for originating
and referring the insurance business. Id. at 396-99.

       The Court concluded that due to the restrictions of
federal banking law, the holding company that controlled
the banks and the insurance affiliate did not have the
power to shift income among its subsidiaries. In so holding,
the Court emphasized that the Commissioner’s authority
to allocate income under § 482 presupposes that the
taxpayer has the power to control its income: “The
underlying assumption always has been that in order to be
taxed for income, a taxpayer must have complete dominion
over it.” Id. at 403. Indeed, as the Court noted, the
Commissioner’s own regulations for implementing § 482
contemplate that the controlling interest “must have
‘complete power’ to shift income among its subsidiaries.”
Id. at 404-05, 92 S. Ct. at 1091-92 (quoting 26 C.F.R.
§ 1.482-1(b)(1) (1971)).

       Moreover, the regulations and First Security make
clear that this standard is not limited to cases where the
government contends the taxpayer attempted to evade
taxes. Rather, the Court explicitly extends its reasoning to
circumstances where the government contends that the
organization’s “true taxable income” has not been
reflected.5 After explaining that the right to control the
allocation of income is critical, the Court stated: “It is only
where this power exists, and has been exercised in such a
way that the ‘true, taxable income’ of a subsidiary has been
understated, that the Commissioner is authorized to
reallocate under § 482 . . . . The ‘complete power’ referred
to in the regulations hardly includes the power to force a
                                   162

subsidiary to violate the law.” Id. (emphasis added).
Because the holding company in First Security could not
have allocated the income to the banks unless it acted in
violation of the law, the Court concluded that the banks’
true income was not understated and the Commissioner’s
allocation under § 482 was improper.

        The Sixth Circuit decision in Procter & Gamble Co.
v. Commissioner, 961 F.2d 1255 (6th Cir. 1992), also
supports the Tax Court’s conclusion. In that case, the court
held that a Spanish law prohibiting a foreign affiliate from
paying royalties for the use of patents was sufficient to
preclude the Commissioner from reallocating income to
account for a reasonable royalty. The court stated that “the
purpose of § 482 is to prevent artificial shifting of income
between related taxpayers.” Id. at 1259 (emphasis added).
Again the deciding issue was one of control: “Because
Spanish law prohibited royalty payments, [the controlling
company] could not exercise the control that § 482
contemplates, and allocation under § 482 is inappropriate.”
Id. at 1259. See also L.E. Shunk Latex Products, Inc. v.
Commissioner, 18 T.C. 940, 1952 WL 188 (1952) (holding
that Commissioner could not allocate additional income to
condom manufacturer where manufacturer sold condoms
to its affiliate at price set by Office of Price Administration,
even though affiliate made substantial profits on the
transactions).

       It is precisely this ability to control the flow of its
income that Texaco lacked. The Tax Court found, and we
agree, that Letter 103/z had the force and effect of law, that
Textrad was obligated to comply with its requirements,
and that it did so comply. Because Textrad lacked the
power to sell Saudi crude above the OSP, reallocation
under § 482 is inappropriate.

       426   C.F.R. § 1.482-1A(b)(1) reads in full:

   The purpose of section 482 is to place a controlled taxpayer on
   a tax parity with an uncontrolled taxpayer, by determining,
   according to the standard of an uncontrolled taxpayer, the true
   taxable income from the property and business of a controlled
   taxpayer. The interests controlling a group of controlled
   taxpayers are assumed to have complete power to cause each
                                       163

          controlled taxpayer so to conduct its affairs that its
          transactions and accounting records truly reflect the taxable
          income from the property and business of each of the controlled
          taxpayers. If, however, this has not been done, and the taxable
          incomes are thereby understated, the district director shall
          intervene, and, by making such distributions, apportionments,
          or allocations as he may deem necessary of gross income,
          deductions, credits, or allowances, or of any item or element
          affecting taxable income, between or among the controlled
          taxpayers constituting the group, shall determine the true
          taxable income of each controlled taxpayer. The standard to be
          applied in every case is that of an uncontrolled taxpayer
          dealing at arm’s length with another uncontrolled taxpayer.
               5We find no indication from the facts and contentions of the

      parties in First Security that the government contended that the banks
      or the holding company sought to evade taxes. Rather, First Security
      explains in general terms the type case § 482 is designed to reach
      without distinguishing between claims of evasion and other claims that
      the true income of the taxpayer has not been reflected: “The question
      we must answer is whether there was a shifting or distorting of the
      [taxpayers] true net income.” Id. at 400-401 (emphasis added); see also
      id. at 407 (concluding that because the holding company “did not utilize
      its control over the [banks and the affiliated insurance company] to
      distort their true net incomes,” the Commissioner could not exercise
      his § 482 authority) (emphasis added). This is consistent with the
      approach and structure of the regulation, which also does not
      distinguish between evasion and other conduct that fails to reflect the
      true taxable income of the taxpayer. See 26 C.F.R. § 1.482-1A(b)(1)
      (1996).

Texaco, Inc. v. Commissioner, 98 F.3d at 828-830.

      In the third part of its opinion in Texaco, the Fifth Circuit rejected
the government’s reliance on the assignment-of-income doctrine to
support its allocation of income:

            The Commissioner tries to justify the allocation by
      analogizing Texaco’s conduct to an “assignment of income”
      and places much reliance on the Supreme Court’s decision
      in United States v. Basye, 410 U.S. 441, 93 S. Ct. 1080, 35
      L. Ed. 2d 412 (1973). However, nothing in Basye is
      contrary to the principles discussed above, and the
      Commissioner’s reliance on this case is misplaced.

              In Basye, the Court relied on familiar principles
      “that income is taxed to the party who earns it and that
      liability may not be avoided through an anticipatory
                                   164

      assignment of that income” to hold that a group of doctors’
      failure to actually receive a portion of their compensation
      that was instead placed in a retirement trust did not
      preclude the Commissioner from allocating that income to
      them. Id. at 457, 93 S. Ct. at 1089. The Court found that
      the sole reason the doctors could not receive the challenged
      portion of their income was because their medical
      partnership had agreed with a health plan foundation to
      service the foundation’s members for free in exchange for
      contributions to a retirement trust. Id. at 449, 93 S. Ct. at
      1085.

             The Court’s holding in Basye turned on the
      consensual nature of the agreement and is entirely
      consistent with the principles of control expressed in the
      regulations adopted under § 482 and in First Security. As
      the regulations make clear, the goal of inquiring into the
      transactions of controlled taxpayers under § 482 is “to
      ascertain whether the common control is being used to
      reduce, avoid or escape taxes.” 26 C.F.R. § 1.482-1A(c)
      (1996). The Court in Basye agreed with the Commissioner
      that the doctors’ compensation scheme was entirely
      voluntary--that the medical partnership possessed
      common control and used it to reduce, avoid, or escape
      taxes. That the doctors exercised that control prior to their
      actual possession of the income was irrelevant.

              But where, as here, the taxpayer lacks the power to
      control the allocation of the profits, reallocation under
      § 482 is inappropriate. As stated above, we fully agree with
      the Tax Court that Letter 103/z deprived Textrad of the
      power to sell Saudi crude to its foreign refining affiliates
      for a price that exceeded the OSP. Because Texaco lacked
      the ability to control the allocation of the income in
      question, it follows that it could not have used its control to
      evade taxes or artificially shift its income to its foreign
      affiliates so that its true taxable income was not reflected.

Id. at 830.

       In the fourth part of its opinion in Texaco, the Fifth Circuit
rejected the government’s argument that respondent’s proposed
allocation in that case would be consistent with the goal of tax parity:
                                           165

              Nor would the Commissioner’s proposed allocation
       be consistent with § 482’s goal of achieving tax parity
       between controlled and uncontrolled taxpayers. As the
       First Security Court and the regulations make clear, the
       “‘purpose of § 482 is to place a controlled taxpayer on a tax
       parity with an uncontrolled taxpayer.’” 405 U.S. at 407
       (citing 26 C.F.R. § 1.482-1(b)(1) (1971)). Thus, “[t]he
       standard to be applied in every case is that of an
       uncontrolled taxpayer dealing at arm’s length with another
       uncontrolled taxpayer.” 26 C.F.R. § 1.482-1A(b)(1) (1996).

               The record evidence fully supports the Tax Court’s
       findings that Textrad sold significant amounts of Saudi
       crude to unrelated customers at the same OSP it sold to its
       affiliates, that the volume of Textrad’s sales of Saudi crude
       to unrelated customers during this period remained
       generally consistent with historic levels, and that any
       changes in Textrad’s sales to its affiliates and its unrelated
       customers during this period had no nexus with the
       restrictions imposed by Letter 103/z. Therefore, the Tax
       Court did not err in concluding that the Commissioner
       failed to demonstrate any disparity between Texaco’s
       treatment of its affiliates and its unrelated customers as a
       result of the Saudi price restrictions. Thus, under the
       regulation’s tax parity standard, the Commissioner’s
       allocation of Texaco’s income under § 482 is improper.

Id. at 830-831 (alteration in original).

      The Fifth Circuit’s opinion in Texaco, Inc. v. Commissioner, 98
F.3d at 828 & n.4, 829 n.5, 830, cited 26 C.F.R. sec. 1.482-1A (1996),
multiple times. This regulation was created in 1993 when Treasury
Decision 8470, 58 Fed. Reg. 5271 (Jan. 21, 1993), redesignated the 1968
regulations137 as 26 C.F.R. secs. 1.482-1A and 2A (1994), effective for tax
years beginning on or before April 21, 1993. 138 The redesignated
regulations were printed in the 1996 edition of the Code of Federal

       137 The 1968 regulations, including subsequent amendments, were at 26 C.F.R.
secs. 1.482-1 and -2 (1992).
       138   The 1993 redesignation is described in greater detail infra part II.LL.
                                  166

Regulations. Therefore, when the Fifth Circuit cited 26 C.F.R. sec.
1.482-1A (1996), it was citing the 1968 regulations.

      II.   The 1986 amendment to section 482

      Recall that section 482 of the Internal Revenue Code of 1954 had
one sentence:

              In any case of two or more organizations, trades, or
      businesses (whether or not incorporated, whether or not
      organized in the United States, and whether or not
      affiliated) owned or controlled directly or indirectly by the
      same interests, the Secretary may distribute, apportion, or
      allocate gross income, deductions, credits, or allowances
      between or among such organizations, trades, or
      businesses, if he determines that such distribution,
      apportionment, or allocation is necessary in order to
      prevent evasion of taxes or clearly to reflect the income of
      any of such organizations, trades, or businesses.

Internal Revenue Code of 1954 sec. 482 (as amended in 1976), 26 U.S.C.
sec. 482 (1982). The sentence was the same as the text of section 45 of
the Revenue Act of 1928, 45 Stat. at 806, as that text was altered by
three subsequent statutory changes: (1) in 1943 “gross income or
deductions” was replaced with “gross income, deductions, credits, or
allowances”, (2) in 1954 “the Commissioner is authorized to” was
replaced with “the Secretary or his delegate may”, and (3) in 1976 “the
Secretary or his delegate may” was replaced with “the Secretary may”.
Revenue Act of 1943 sec. 128(b) and (c); Internal Revenue Code of 1954
sec. 482; Tax Reform Act of 1976 sec. 1906(b)(13)(A). Because these
statutory changes were relatively insignificant, it has been observed
that section 482 of the Internal Revenue Code of 1954 was “essentially
the same” as section 45 of the Revenue Act of 1928. See G.D. Searle &
Co. v. Commissioner, 88 T.C. at 356 (comparing section 45 of the
Revenue Act of 1928 to section 482 of the Internal Revenue Code of 1954
before the 1976 amendment).

      The Tax Reform Act of 1986, Pub. L. No. 99-514, sec. 2(a), 100
Stat. at 2095, redesignated the Internal Revenue Code of 1954 (as
amended) as the Internal Revenue Code of 1986. The Tax Reform Act
of 1986 simultaneously added a second sentence to section 482 of the
Internal Revenue Code of 1986. This sentence is:
                                   167

      In the case of any transfer (or license) of intangible
      property (within the meaning of section 936(h)(3)(B)), the
      income with respect to such transfer or license shall be
      commensurate with the income attributable to the
      intangible.

Tax Reform Act of 1986, sec. 1231(e)(1), 100 Stat. at 2562-2563. The
second sentence cross-references section 936(h)(3)(B), which provides
that the term “intangible property” means any

            (i) patent, invention, formula, process, design,
      pattern, or know-how;

           (ii) copyright,      literary,   musical,   or   artistic
      composition;

            (iii) trademark, trade name, or brand name;

            (iv) franchise, license, or contract;

             (v) method, program, system, procedure, campaign,
      survey, study, forecast, estimate, customer list, or technical
      data; or

            (vi) any similar item,

      which has substantial value independent of the services of
      any individual.

The text of section 482 after the 1986 amendment can be found at 26
U.S.C. sec. 482 (1988). The text of section 482 of the Internal Revenue
Code of 1954 before the 1986 amendment can be found at 26 U.S.C. sec.
482 (1982).

       The portion of the Tax Reform Act of 1986 that added the second
sentence to section 482 was section 1231(e)(1). The effective-date
provision for section 1231(e) of the Tax Reform Act of 1986 (including
section 1231(e)(1) is as follows:

      The amendments made by subsection (e) shall apply to
      taxable years beginning after December 31, 1986, but only
      with respect to transfers after November 16, 1985, or
      licenses granted after such date (or before such date with
                                       168

       respect to property not in existence or owned by the
       taxpayer on such date).

Id. sec. 1231(g)(2)(A), 100 Stat. at 2563.

       In 2006, 3M Brazil used patents owned by 3M IPC. 3M Brazil’s
use of patents was not governed by a license. In 2006, 3M Brazil also
used nonpatented technology owned by 3M IPC. This use was not
governed by a license. Neither petitioner nor respondent contends that
the amendment by the Tax Reform Act of 1986 to section 482 did not
govern the use of 3M IPC’s patents and nonpatented technology by 3M
Brazil during the 2006 tax year.

       Respondent contends that the second sentence of section 482
applies to the intangibles transactions at issue, which are (1) the use by
3M Brazil of trademarks owned by 3M Company pursuant to the 1998
trademark licenses, (2) the use by 3M Brazil of patents owned by 3M
IPC, and (3) the transfer of technology from 3M IPC to 3M Brazil.
Petitioner does not argue that the effective-date provision makes the
second sentence of section 482 inapplicable for the case. Rather,
petitioner argues that neither sentence of section 482 governs the
intangibles transactions because of the effect of the Brazilian legal
restrictions. 139

      The House Ways & Means Committee issued a report describing
the House bill that preceded the Tax Reform Act of 1986. H.R. Rept. No.
99-426 (1985), 1986-3 C.B. (Vol. 2) 1. The House bill contained the
sentence in section 482 of the Internal Revenue Code of 1954. H.R. 3838,
99th Cong., sec. 641(e) (1985). The House bill also contained a new
sentence similar to the second sentence in section 482 of the Internal
Revenue Code of 1986. H.R. 3838, 99th Cong., sec. 641(e). However, the
new sentence in the House bill affected only transfers of intangible
property by United States persons to a foreign corporation; that is, it
applied only to outbound transfers. Id. Excerpted below is most of the
Ways & Means Committee report that related to the provision in the
House bill:

                             Reasons for Change

      139 Petitioner argues: “Since the Commissioner has no authority under section

482 when a legal restriction exists, the arm’s length standard as modified by the
commensurate with income language does not come into play in such a case.”
                             169

       There is a strong incentive for taxpayers to transfer
intangibles to related foreign corporations or possessions
corporations in a low tax jurisdiction, particularly when
the intangible has a high value relative to manufacturing
or assembly costs. Such transfers can result in indefinite
tax deferral or effective tax exemption on the earnings,
while retaining the value of the earnings in the related
group.

       The committee is concerned that the provisions of
sections 482, 367(d), and 936 that allocate income to a U.S.
transferor of intangibles may not be operating to assure
adequate allocations to the U.S. taxable entity of income
attributable to intangibles in these situations.

                        Section 482

       Many observers have questioned the effectiveness of
the “arm’s length” approach of the regulations under
section 482. A recurrent problem is the absence of
comparable arm’s length transactions between unrelated
parties, and the inconsistent results of attempting to
impose an arm’s length concept in the absence of
comparables.

       A fundamental problem is the fact that the
relationship between related parties is different from that
of unrelated parties.        Observers have noted that
multinational companies operate as an economic unit, and
not “as if” they were unrelated to their foreign subsidiaries.
In addition, a parent corporation that transfers potentially
valuable property to its subsidiary is not faced with the
same risks as if it were dealing with an unrelated party.
Its equity interest assures it of the ability ultimately to
obtain the benefit of future anticipated or unanticipated
profits, without regard to the price it sets. The relationship
similarly would enable the parent to adjust its
arrangement each year, if it wished to do so, to take
account of major variations in the revenue produced by a
transferred item.

      The problems are particularly acute in the case of
transfers of high-profit potential intangibles. Taxpayers
                                         170

       may transfer such intangibles to foreign related
       corporations or to possession corporations at an early
       stage, for a relatively low royalty, and take the position
       that it was not possible at the time of the transfers to
       predict the subsequent success of the product. Even in the
       case of a proven high-profit intangible, taxpayers
       frequently take the position that intercompany royalty
       rates may appropriately be set on the basis of industry
       norms for transfers of much less profitable items.

              Certain judicial interpretations of section 482
       suggest that pricing arrangements between unrelated
       parties for items of the same apparent general category as
       those involved in the related party transfer may in some
       circumstances be considered a “safe harbor” for related
       party pricing arrangements, even though there are
       significant differences in the volume and risks involved, or
       in other factors. See, e.g., United States Steel Corporation
       v. Commissioner, 617 F.2d 942 (2d Cir. 1980).[140] While
       the committee is concerned that such decisions may unduly
       emphasize the concept of comparables even in situations
       involving highly standardized commodities or services, it
       believes that such an approach is sufficiently troublesome
       where transfers of intangibles are concerned that a
       statutory modification to the intercompany pricing rules
       regarding transfers of intangibles is necessary.

              In many cases firms that develop high profit-
       potential intangibles tend to retain their rights or transfer
       them to related parties in which they retain an equity
       interest in order to maximize their profits. The transferor
       may well be looking in part to the value of its direct or
       indirect equity interest in the related party transferee as

        140 In United States Steel Corp. v. Commissioner, 617 F.2d 942, 945 (2d Cir.

1980), rev’g T.C. Memo. 1977-140, a U.S. company (i.e., United States Steel) owned a
Liberian shipping subsidiary. The Liberian company shipped ore for the U.S. company
at the same rate that it charged to unrelated parties. Id. The Second Circuit held that
the rates the Liberian company charged the U.S. company were arm’s-length rates
because they were the same rates charged to unrelated customers. Id. at 947. The
government had contended that the unrelated-party transactions were infrequent,
low-volume transactions that were not comparable to the transactions between the
Liberian company and the U.S. company. Id. at 948, 949, 951. The Second Circuit
held that the transactions were “similar enough”. Id. at 947.
                             171

part of the value to be received for the transfer, rather than
to “arm’s length” factors. Industry norms for transfers to
unrelated parties of less profitable intangibles frequently
are not realistic comparables in these cases.

       Transfers between related parties do not involve the
same risks as transfers to unrelated parties. There is thus
a powerful incentive to establish a relatively low royalty
without adequate provisions for adjustment as the
revenues of the intangible vary. There are extreme
difficulties in determining whether the arm’s length
transfers between unrelated parties are comparable. The
committee thus concludes that it is appropriate to require
that the payment made on a transfer of intangibles to a
related foreign corporation or possessions corporation be
commensurate with the income attributable to the
intangible. The committee believes, therefore, that this is
the measure that should be used under section 367 and
section 482 in the case of transfers to a foreign corporation.

           *     *      *     *     *     *      *

                 Explanation of Provisions

       The basic requirement of the bill is that payments
with respect to intangibles that a U.S. person transfers to
a related foreign corporation or possessions corporation
must be commensurate with the income attributable to the
intangible.    This approach applies both to outright
transfers of the ownership of the intangibles (whether by
sale, contribution to capital, or otherwise), and to licenses
or other arrangements for the use of intangibles.

       In making this change, the committee intends to
make it clear that industry norms or other unrelated party
transactions do not provide a safe-harbor minimum
payment for related party intangibles transfers. Where
taxpayers transfer intangibles with a high profit potential,
the compensation for the intangibles should be greater
than industry averages or norms. In determining whether
the taxpayer could reasonably expect that projected profits
would be greater than the industry norm, the committee
intends that there should be taken into account any
                                   172

      established pattern of transferring relatively high profit
      intangibles to Puerto Rico or low tax foreign locations.

             The committee does not intend, however, that the
      inquiry as to the appropriate compensation for the
      intangible be limited to the question of whether it was
      appropriate considering only the facts in existence at the
      time of the transfer.        The committee intends that
      consideration also be given the actual profit experience
      realized as a consequence of the transfer. Thus, the
      committee intends to require that the payments made for
      the intangible be adjusted over time to reflect changes in
      the income attributable to the intangible. The bill is not
      intended to require annual adjustments when there are
      only minor variations in revenues. However, it will not be
      sufficient to consider only the evidence of value at the time
      of the transfer. Adjustments will be required when there
      are major variations in the annual amounts of revenue
      attributable to the intangible.

H.R. Rept. No. 99-426, at 423-426, 1986-3 C.B. (Vol. 2) 1, 423-426
(footnotes omitted). We have added emphasis to the particular portions
of the report referred to by petitioner.

       The conference committee recommended that Congress add the
sentence that was eventually added to section 482 by the Tax Reform
Act of 1986. H.R. Conf. Rept. No. 99-841 (Vol. I), at I-504 (1986). The
conference committee’s report explained this recommendation as
follows:

                              Present Law

             Transfers to related foreign corporations as licenses
      or sales are subject to an “arm’s-length” price standard.
      Uncertainty exists regarding what transfers are
      appropriate to treat as “arm’s-length” comparables and
      regarding the significance of profitability, including major
      changes in profitability of the intangible after the transfer.

                     *    *    *    *    *    *    *

                               House Bill
                             173

       Payments with respect to intangibles transferred to
a foreign related party must be commensurate with the
income attributable to the intangible. * * *

               *    *    *    *    *    *    *

                    Senate Amendment

      No provision.

                   Conference Agreement

       The conference agreement follows the House bill.
The concerns addressed in the House bill originated in
connection with transfers of intangibles from U.S. parties
to foreign affiliates, particularly those operating in low-tax
foreign countries. Consequently, the provisions of the
House bill only were applied to transfers of intangibles
from U.S. persons to their foreign affiliates. In view of the
fact that the objective of these provisions--that the division
of income between related parties reasonably reflect the
relative economic activity undertaken by each--applies
equally to inbound transfers, the conferees concluded that
it would be appropriate for these principles to apply to
transfers between related parties generally if income must
otherwise be taken into account.

       The conferees do not intend to affect present law
concepts of what constitutes a single “license”, to the extent
those concepts are not inconsistent with the purposes of the
new provision. Thus, for example, in the case of continuous
transfers of technology under a continuing license
agreement, the adequacy of the royalty may, in appropriate
cases, be determined by applying the appropriate
standards under the conference agreement on an aggregate
basis with respect to the profitability and other relevant
features of the transferred intangibles as a whole.

        Similary [sic], the conferees do not intend to change
principles that would permit offsets or other adjustments
to reflect the tax impact of the taxpayer’s transactions as a
whole.
                                         174

              The conferees are also aware that many important
       and difficult issues under section 482 are left unresolved
       by this legislation.     The conferees believe that a
       comprehensive study of intercompany pricing rules by the
       Internal Revenue Service should be conducted and that
       careful consideration should be given to whether the
       existing regulations could be modified in any respect.

H.R. Conf. Rept. No. 99-841 (Vol. II), at II-637 to II-638 (1986), 1986-3
C.B. (Vol. 4) 1, 637-638. We have emphasized the three sentences of the
conference committee report on which petitioner relies. The first
sentence was quoted by petitioner. The second sentence was cited by
petitioner and paraphrased by petitioner. The third sentence was
indirectly referred to by petitioner through its quotation of a passage of
the Blue Book that alludes to the third sentence. 141
       In the passage excerpted above, the conference committee report
acknowledged that “many important and difficult issues under section
482 are left unresolved by this legislation” and stated that “a
comprehensive study of intercompany pricing rules by the Internal
Revenue Service should be conducted” and “careful consideration should
be given to whether the existing regulations could be modified in any
respect.” H.R. Conf. Rept. No. 99-841 (Vol. II), at II-638, 1986-3 C.B.
(Vol. 4), at 638. We discuss the resulting study shortly.

       141 The so-called Blue Book for the Tax Reform Act of 1986 was a postenactment
description of that law by the staff of the Joint Committee on Taxation. Staff of J.
Comm. on Taxation, General Explanation of the Tax Reform Act of 1986 (J. Comm.
Print 1987). Petitioner quotes the following sentence from the Blue Book: “Congress
believed that a comprehensive study of intercompany pricing rules by the Internal
Revenue Service should be conducted and that careful consideration should be given
to whether the existing regulations could be modified in any respect.” Id. at 1017. This
sentence from the Blue Book is evidently a reference to the third sentence that we have
emphasized in the excerpt from the conference report.
       While we are on the topic of the Blue Book, we observe that petitioner quotes
two other sentences from the Blue Book in support of its argument. These are the two
sentences:
                Congress intended that consideration also be given to the
        actual profit experience realized as a consequence of the transfer.
        Thus, Congress intended to require that the payments made for the
        intangible be adjusted over time to reflect changes in the income
        attributable to the intangible. * * *
Id. at 1016. A similar statement is found in the House Ways & Means Committee
report that we excerpted earlier in this Opinion. H.R. Rept. No. 99-426, at 425-426
(1985), 1986-3 C.B. (Vol. 2) 1, 425-426.
                                          175

       The 1968 regulations--which related to section 482 of the Internal
Revenue Code of 1954--seemingly carried over to section 482 of the
Internal Revenue Code of 1986. 142 The first sentence of section 482 of
the Internal Revenue Code of 1986 was the same as section 482 of the
Internal Revenue Code of 1954. Thus, it would make sense that the
1968 regulations would be valid as to section 482 of the Internal
Revenue Code of 1986, unless such regulations were inconsistent with
the second sentence of section 482 of the Internal Revenue Code of
1986. 143 Our (admittedly limited) research does not reveal any
successful challenge to the validity of the 1968 regulations on grounds
that they were inconsistent with the second sentence of section 482 of
the Internal Revenue Code of 1986.

       As the conference committee report suggested, the Treasury
Department and the IRS conducted a study of intercompany pricing
rules. This study, which was published as Notice 88-123, 1988-2 C.B.
458, is also known as the “White Paper”. Altera Corp. & Subs. v.
Commissioner, 145 T.C. 91, 98 (2015), rev’d, 926 F.3d 1061 (9th Cir.
2019). The White Paper discussed various transfer-pricing problems
involving services, tangible property, and intangible property. Notice
88-123, 1988-2 C.B. at 468. However, it did not discuss the effect of
foreign legal restrictions on transfer pricing. With respect to intangible
property, the White Paper observed that under the 1968 regulations
(1) the best indication of arm’s-length consideration was comparable
transactions and (2) in the absence of comparable transactions, 12
factors were to be taken into account in determining arm’s-length
consideration. Id., 1988-2 C.B. at 460. The White Paper stated that the
1968 final regulations provided little or no guidance on the relative
importance of particular factors. Id. The White Paper stated that for a
transfer price for intangible property to meet the commensurate-with-
income standard, adjustment must generally be made to the transfer
price to reflect changes to the income stream, economic activities

        142 As explained in greater detail later, in 1992 the Treasury Department
issued proposed regulations under sec. 482 of the Internal Revenue Code of 1986. 57
Fed. Reg. 3571 (Jan. 30, 1992). See infra part II.KK. The notice of proposed
rulemaking referred to the 1968 regulations, with amendments, as “the existing
regulations”, 57 Fed. Reg. 3572, thus implying that the 1968 regulations had carried
over to sec. 482 of the Internal Revenue Code of 1986.
        143 If a statute is amended so as to be inconsistent with a prior regulation, the

regulation is no longer binding. See Zeta Beta Tau Fraternity, Inc. v. Commissioner,
87 T.C. 421, 433 (1986).
                                         176

performed, assets employed, and economic costs and risks borne. Id. at
477. The White Paper also recommended that methods of pricing
intangible property should include, in the absence of comparable
transactions, a rate-of-return-on-assets analysis and a profit-split
analysis. Id. at 485-493. The White Paper discussed the legislative
history of the commensurate-with-income sentence added to section 482
in 1986. Id. at 472. In its briefs, petitioner quotes one of the paragraphs
from the White Paper’s discussion of legislative history of the
commensurate-with-income sentence. This is the quoted paragraph:

             The 1986 Act amended section 482 to require that
      payments to a related party with respect to a licensed or
      transferred intangible be “commensurate with the
      income”122 attributable to the intangible. The provision
      applies to both manufacturing and marketing
      intangibles.123 The legislative history clearly indicates
      Congressional concern that the arm’s length standard as
      interpreted in case law has failed to allocate to U.S. related
      parties appropriate amounts of income derived from
      intangibles.124 The amendment is a clarification of prior
      law. Accordingly, it should not be assumed that the Service
      will cease taking positions that it may have taken under
      prior law.
             122 (e)   Treatment of Certain Royalty Payments.--

          (1) In General.--Section 482 (relating to allocation of income
          and deductions among taxpayers) is amended by adding at the
          end thereof the following new sentence: “In the case of any
          transfer (or license) of intangible property (within the meaning
          of section 936(h)(3)(B)), the income with respect to such
          transfer or license shall be commensurate with the income
          attributable to the intangible.”

          (2) Technical Amendment.--Subparagraph (A) of section
          367(d)(2) (relating to transfers of intangibles treated as
          transfer pursuant to sale for contingent payments) is amended
          by adding at the end thereof the following new sentence: “The
          amounts taken into account under clause (ii) shall be
          commensurate with the income attributable to the intangible.”

      Sec. 1231(e)(1), Tax Reform Act of 1986, 100 Stat. 2085 (1986).
             123 For this purpose, intangibles are broadly defined by
      reference to section 936(h)(3)(B) under which intangible property
      includes any:
                                          177

           (i) patent, invention, formula, process, design, pattern, or
           know-how;

           (ii) copyright, literary, musical, or artistic composition;

           (iii) trademark, trade name, or brand name;

           (iv) franchise, license, or contract;

           (v) method, program, system, procedure, campaign, survey,
           study, forecast, estimate, customer list, or technical data; or

           (vi) any similar item,

       which has substantial value independent of the services of any
       individual. See also Treas. Reg. § 1.482-2(d)(3)(ii) and Rev. Rul. 64-56,
       1964-1 C.B. 113, regarding the treatment of know-how as property in
       a section 351 transfer.
                124 1985 House Rep., supra n.47, at 420-427; 1986 Conf. Rep.,

       supra n.2, at II-637 to II-638. Several commentators have suggested
       that the phrase “commensurate with income” derives from Nestle Co.,
       Inc. v. Comm’r, T.C. Memo. 1963-14, where the Tax Court sanctioned
       a taxpayer’s post-agreement increase in royalties paid by an affiliate
       for a very profitable intangible license. The opinion states that “[s]o
       long as the amount of the royalty paid was commensurate with the
       value of the benefits received and was reasonable, we would not be
       inclined to, nor do we think we would be justified to, conclude that the
       increased royalty was something other than what it purported to be.”
       (Emphasis in White Paper). There is, however, nothing in the
       legislative record to indicate that this is the case or to indicate
       Congressional approval or disapproval of the result in Nestle.

Notice 88-123, 1988-2 C.B. at 472. 144 The White Paper also stated that
the “commensurate with income” sentence added to section 482 in 1986
“requires that changes be made to the transfer payments to reflect
substantial changes in the income stream attributable to the intangible
as well as substantial changes in the economic activities performed,
assets employed, and economic costs and risks borne by related entities.”

       144 There is another portion of the White Paper that discusses the purpose of

the commensurate-with-income sentence. This portion of the White Paper, which is
not quoted or cited by petitioner, states:
       Looking at the income related to the intangible and splitting it
       according to relative economic contributions is consistent with what
       unrelated parties do. The general goal of the commensurate with
       income standard is, therefore, to ensure that each party earns the
       income or return from the intangible that an unrelated party would
       earn in an arm’s length transfer of the intangible.
Notice 88-123, 1988-2 C.B. 458, 472.
                                         178

Id. at 477. The White Paper stated that the 1986 amendment was a
“Congressional directive to the Service to make adjustments to
intangible returns that reflect the actual profit experience” and that the
amendment was in part a legislative rejection of R.T. French Co. v.
Commissioner, 60 T.C. 836 (1973), a case the White Paper said had
“endorsed the view that a long-term, fixed rate royalty agreement could
not be adjusted under section 482 based on subsequent events that were
not known to the parties at the original contract date.” Notice 88-123,
1988-2 C.B. at 477. 145

        JJ.      The 1988 amendment to section 7805 regarding temporary
                 regulations

        In 1988, Congress added section 7805(e), which provided:

        SEC. 7805(e). Temporary Regulations.--

                    (1) Issuance.--Any temporary regulation
              issued by the Secretary shall also be issued as a
              proposed regulation.

                     (2)   3-year     duration.--Any    temporary
              regulation shall expire within 3 years after the date
              of issuance of such regulation.

Sec. 7805(e), as amended by the Technical and Miscellaneous Revenue
Act of 1988 (TAMRA), Pub. L. No. 100-647, sec. 6232(a), 102 Stat. at
3734. The 1988 amendment applied to “any regulation issued after”
November 20, 1988. TAMRA sec. 6232(b), 102 Stat. at 3735.

        KK.      The 1992 notice of proposed rulemaking

       On January 30, 1992 the Federal Register published a notice of
proposed rulemaking that proposed income tax regulations related to
intercompany transfer pricing under section 482 of the Internal
Revenue Code of 1986. 57 Fed. Reg. 3571 (Jan. 30, 1992).

       The 1992 notice of proposed rulemaking discussed the legislative
history of the commensurate-with-income sentence that had been added
to section 482 by the Tax Reform Act of 1986. 57 Fed. Reg. 3571.

        145 For a discussion of R.T. French Co. v. Commissioner, 60 T.C. 836 (1973), see

Reuven S. Avi-Yonah, “The Rise and Fall of Arm’s Length: A Study in the Evolution of
U.S. International Taxation”, 15 Va. Tax Rev. 89, 113-114 (1995).
                                        179

Initially, the 1992 notice of proposed rulemaking made the following
statement:

       The legislative history of the Act states that this change
       was intended to assure that the division of income between
       related parties reasonably reflects the economic activities
       each undertakes. See H.R. Rep. 99-281, 99th Cong., 2d
       Sess. (1986) at II-637.

Id. The citation of “H.R. Rep. 99-281, 99th Cong., 2d Sess. (1986) at II-
637” was apparently an error. The cited report, H.R. Rept. No. 99-281,
appears to be unrelated to tax law. 146 The House report that was related
to the Tax Reform Act of 1986 was H.R. Rept. No. 99-426, a report
written by the House Ways & Means Committee. However, nothing in
H.R. Rept. No. 99-426 appears to correspond to the content attributed to
“H.R. Rep. 99-281, 99th Cong., 2d Sess. (1986) at II-637” in the 1992
notice of proposed rulemaking. Instead, the 1992 notice of proposed
rulemaking probably meant to cite H.R. Conf. Rept. No. 99-841 (Vol. II),
at II-637. This is the conference committee report that was related to
the Tax Reform Act of 1986. Its content corresponds to the discussion of
“H.R. Rep. 99-281, 99th Cong., 2d Sess. (1986) at II-637” in the 1992
notice of proposed rulemaking. This discussion refers to dividing income
so as to reflect economic activities. 147
       The 1992 notice of proposed rulemaking stated that the
legislative history of the commensurate-with-income sentence “also
expresses concern” about the improper use of comparables, including
with respect to intangible property with high profit potential. 57 Fed.
Reg. 3571 (citing the House Ways & Means Committee report, H.R.
Rept. No. 99-426, at 424).

      The 1992 notice of proposed rulemaking stated that the
“Conference Committee report” also had recommended that the IRS
study the question of whether the regulations under section 482 should

       146 However, we acknowledge that some secondary sources discussing sec. 482
of the Internal Revenue Code of 1986 have also referred to “H.R. 99-281, 99th Cong.,
2d Sess. (1986).” Yariv Brauner, “Cost Sharing and the Acrobatics of Arm’s Length
Taxation”, 38 Intertax 544, 557 (2010); Joel B. Rosenberg & Barbara N. McLennan,
“Technology, Licensing, and Economic Issues in Transfer Pricing”, 3 Corp. Bus. Tax’n
Monthly 10, 19-20 (January 2002).
          147 The conference committee report stated that “the objective of these

provisions” is “that the division of income between related parties reasonably reflect
the relative economic activity undertaken by each”. H.R. Conf. Rept. No. 99-841 (Vol.
II), at II-637 (1986), 1986-3 C.B. (Vol. 4) 1, 637.
                                          180

be modified. 57 Fed. Reg. 3571. This was obviously a reference to H.R.
Conf. Rept. No. 99-841 (Vol. II), at II-637 to II-638, the conference
committee report related to the Tax Reform Act of 1986.

       The 1992 proposed regulations contained no change to section
1.482-1(d)(6) of the 1968 regulations relating to the deferred-income
method of accounting for payments that would be barred by foreign legal
restrictions, 33 Fed. Reg. 5849 (Apr. 16, 1968), 26 C.F.R. sec. 1.482-
1(d)(6) (1969); 26 C.F.R. sec. 1.482-1(d)(6) (1992) (same as 1969 edition).

      The 1992 proposed regulations made no change to the “complete-
power” sentence, or the sentence thereafter, in the 1968 regulations. 57
Fed. Reg. 3578. These two sentences in the 1968 regulation were:

        The interests controlling a group of controlled taxpayers
        are assumed to have complete power to cause each
        controlled taxpayer so to conduct its affairs that its
        transactions and accounting records truly reflect the
        taxable income from the property and business of each of
        the controlled taxpayers. If, however, this has not been
        done, and the taxable incomes are thereby understated, the
        district director shall intervene, and, by making such
        distributions, apportionments, or allocations as he may
        deem necessary of gross income, deductions, credits, or
        allowances, or of any item or element affecting taxable
        income, between or among the controlled taxpayers
        constituting the group, shall determine the true taxable
        income of each controlled taxpayer. * * *

26 C.F.R. sec. 1.482-1(b)(1) (1969) (1968 regulations); 148 26 C.F.R. sec.
1.482-1(b)(1) (1992) (same as 1969 edition). Similar sentences had been
in the regulations since 1934. See art. 45-1(b), Regulations 86 (1934). 149

       The 1992 proposed regulations made no changes to the definition
of “controlled” in the 1968 regulations. 26 C.F.R. sec. 1.482-1(a)(3)

        148 No changes were made to sec. 1.482-1 of the 1968 regulations from (1) the
promulgation of the 1968 amendments to sec. 1.482-1 of the regulations by Treasury
Decision 6952, 33 Fed. Reg. 5848, on April 16, 1968, to (2) the publication of the 1969
edition of 26 C.F.R. See 26 C.F.R. sec. 1.482-1 (1969) (historical notes).
         149 Before 1962 the phrase “the district director shall intervene” had been “the

statute contemplates that the Commissioner shall intervene”. 26 C.F.R. sec. 39.45-
1(b)(1) (1953).
                                   181

(1969); 26 C.F.R. sec. 1.482-1(a)(3) (1992) (same as 1969 edition). This
definition had been in the regulations since 1934. See art. 45-1(a)(3),
Regulations 86 (1934).

       The 1992 proposed regulations made no changes to the definition
of “true taxable income” in the 1968 regulations. 26 C.F.R. sec. 1.482-
1(a)(6) (1969); 26 C.F.R. sec. 1.482-1(a)(6) (1992) (same as 1969 edition).
A similar term--with a similar definition--had been in the regulations
since 1934. See art. 45-1(a)(6), Regulations 86 (1934) (defining “true net
income”).

       The 1992 proposed regulations made no changes to the tax-parity
sentence in the 1968 regulations. This 1968 sentence was: “The purpose
of section 482 is to place a controlled taxpayer on a tax parity with an
uncontrolled taxpayer, by determining, according to the standard of an
uncontrolled taxpayer, the true taxable income from the property and
business of a controlled taxpayer.” 26 C.F.R. sec. 1.482-1(b)(1) (1969);
26 C.F.R. sec. 1.482-1(b)(1) (1992) (same as 1969 edition). A similar
sentence regarding tax-parity had been in the regulations since 1934.
See art. 45-1(b), Regulations 86 (1934).

       The 1992 proposed regulations made no changes to the sentence
in the 1968 regulations that imposed the arm’s-length standard. This
sentence was: “The standard to be applied in every case is that of an
uncontrolled taxpayer dealing at arm’s length with another uncontrolled
taxpayer.” 26 C.F.R. sec. 1.482-1(b)(1) (1969); 26 C.F.R. sec. 1.482-
1(b)(1) (1992) (same text as 1969 edition). This sentence had been in the
regulations since 1934. Art. 45-1(b), Regulations 86 (1934).

       The 1992 proposed regulations contained the following addition
relating to the arm’s-length standard and the commensurate-with-
income standard:

      In determining whether controlled taxpayers have dealt
      with each other at arm’s length, the general principle to be
      followed is whether uncontrolled taxpayers, each
      exercising sound business judgment on the basis of
      reasonable levels of experience (or, if greater, the actual
      level of experience of the controlled taxpayer) within the
      relevant industry and with full knowledge of the relevant
      facts, would have agreed to the same contractual terms
      under the same economic conditions and other
      circumstances. * * * In the case of any transfer of an
                                         182

        intangible between or among controlled taxpayers, the true
        taxable income of the transferor with respect to such
        transfer must be commensurate with the income
        attributable to the intangible. See § 1.482-2(d).

Sec. 1.482-1(b)(1), Proposed Income Tax Regs., 57 Fed. Reg. 3578-3579
(Jan. 30, 1992).

       The 1992 proposed regulations also contained proposed
replacements to the transfer-pricing rules applicable to intangible
property in section 1.482-2(d) of the 1968 regulations. 33 Fed. Reg. 5852
(Apr. 16, 1968); 26 C.F.R. sec. 1.482-2(d) (1992) (1968 regulations at the
time of the 1992 proposed regulations); 150 sec. 1.482-2(d), Proposed
Income Tax Regs., 57 Fed. Reg. 3579-3585 (Jan. 30, 1992) (1992
proposed regulations); 57 Fed. Reg. 3572 (Jan. 30, 1992) (explanation of
1992 proposed regulations). Under the 1992 proposed regulations, one
of three methods would be used to determine the transfer price of
intangible property: the matching-transaction method, the comparable-
adjustable-transaction method, or the comparable-profit-interval
method. Sec. 1.482-2(d)(3), (4), and (5), Proposed Income Tax Regs., 57
Fed. Reg. 3580-3584 (Jan. 30, 1992). The 1992 proposed regulations also
proposed the following rule regarding annual adjustments: “If an
intangible is transferred under an arrangement with a term covering
more than one taxable year, the consideration charged in each taxable
year may be adjusted to assure that it is commensurate with the income
attributable to the intangible.” Sec. 1.482-2(d)(6)(i), Proposed Income
Tax Regs., 57 Fed. Reg. 3584. The 1992 proposed regulations included
a paragraph on cost-sharing agreements. Sec. 1.482-2(g), Proposed
Income Tax Regs., 57 Fed. Reg. 3595-3601.              This paragraph’s
counterpart in the 1968 regulations was section 1.482-2(d)(4). 33 Fed.
Reg. 5854 (Apr. 16, 1968); 26 C.F.R. sec. 1.482-2(d)(4) (1992) (1968
regulations at the time of the 1992 proposed regulations).

      The 1992 proposed regulations also proposed modifications to the
rules with regard to tangible property in section 1.482-2(e) of the 1968
regulations. 33 Fed. Reg. 5854-5857 (Apr. 16, 1968) (1968 regulations),

         150 Between the 1968 promulgation of sec. 1.482-2 of the regulations related to

sec. 482 of the Internal Revenue Code of 1954 and the publication of the 1992 edition
of title 26 of the Code of Federal Regulations, ten amendments were made to section
1.482-2 of the regulations. See 26 C.F.R. sec. 1.482-2 (1992) (historical notes). Some
of the amendments were made before sec. 482 of the Internal Revenue Code of 1954
was redesignated sec. 482 of the Internal Revenue Code of 1986. Some were made
after the redesignation.
                                      183

26 C.F.R. sec. 1.482-2(e) (1992) (1968 regulations at the time of the 1992
proposed regulations); sec. 1.482-2(e), Proposed Income Tax Regs., 57
Fed. Reg. 3585-3586 (1992 proposed regulations); 57 Fed. Reg. 3574
(explanation of the 1992 proposed regulations). Under the proposed
modifications, a comparable-profit-interval method would serve as a
check on methods other than the comparable-uncontrolled-price
method. Sec. 1.482-2(e), Proposed Income Tax Regs., 57 Fed. Reg. 3585-
3586 (1992 proposed regulations); 57 Fed. Reg. 3574 (explanation of the
1992 proposed regulations). It has been said that the “most significant”
change proposed in the 1992 proposed regulations was the introduction
of the comparable-profit-interval method for transfers of intangible and
tangible property. Bobbe Hirsch, Alan S. Lederman, & John M. Hughes,
“Final Transfer Pricing Regulations Restate Arm’s Length Principle”, 72
Taxes 587, 588 (1994).

      The 1992 proposed regulations were proposed to be effective--as a
general rule--for tax years beginning after December 31, 1992. 57 Fed.
Reg. 3601. The 1992 notice of proposed rulemaking invited the public
to send comments on the 1992 proposed regulations to respondent. 57
Fed. Reg. 3578. It also invited the public to request a public hearing on
the proposed regulations and stated that if such a request was received,
a public hearing would be held and advance notice of the hearing would
be published in the Federal Register. 57 Fed. Reg. 3578. The parties
have not directed us to any record of a public hearing regarding the 1992
proposed regulations.

       LL.    The 1993 temporary regulations                 and    the    1993
              redesignation of the 1968 regulations

       On January 21, 1993, the Treasury Department issued Treasury
Decision 8470, which was published in the Federal Register at 58 Fed.
Reg. 5263. Treasury Decision 8470 did two things. First, it created
temporary regulations under section 482 of the Internal Revenue Code
of 1986 (26 C.F.R. secs. 1.482-1T through -7T (1994)) which were
generally effective for tax years beginning after April 21, 1993. Id. sec.
-1T(h) (1994) (effective date). 151 Second, it redesignated the 1968
regulations (including subsequent amendments) and made them
effective for tax years beginning on or before April 21, 1993. 26 C.F.R.
secs. 1.482-1A and -2A (1994); T.D. 8470, para. 1a, 58 Fed. Reg. 5271
(employing the heading “Regulations Applicable for Taxable Years

       151 As explained later, 26 C.F.R. sec. 1.482-6T (1994) had no text. It was

reserved for future regulations.
                                      184

Beginning on or Before April 21, 1993” for sections 1.482-1A and -2A);
58 Fed. Reg. 17775 (Apr. 6, 1993) (“The temporary regulations are
generally effective for taxable years beginning after April 21, 1993.
Regulations §§ 1.482-1 and 1.482-2, promulgated in 1968, were
redesignated as §§ 1.482-1A and 1.482-2A, and are effective for taxable
years beginning on or before April 21, 1993.”).

       Treasury Decision 8470 contained errors that were later corrected
in the Federal Register in three sets of corrections. 58 Fed. Reg. 17775
(Apr. 6, 1993); 58 Fed. Reg. 28446 (May 13, 1993); 58 Fed. Reg. 28921
(May 18, 1993). The first set of corrections related to both the 1993
temporary regulations and the redesignation of the 1968 regulations. 58
Fed. Reg. 17775 (Apr. 6, 1993). The second and third sets of corrections
related only to the 1993 temporary regulations. 58 Fed. Reg. 28446
(May 13, 1993); 58 Fed. Reg. 28921 (May 18, 1993).

       The changes to the section 482 regulations made by Treasury
Decision 8470 (as corrected) were reflected in codified regulations
published in the 1994 edition of the Code of Federal Regulations. 152 In
explaining the changes made by Treasury Decision 8470 (and its
corrections), we will refer to the codified regulations that were published
in the 1994 edition of the Code of Federal Regulations (which reflected
the changes made by Treasury Decision 8470 and its corrections) rather
than the text of Treasury Decision 8470 (and its corrections) printed in
the Federal Register.

        152 Recall that the changes made by Treasury Decision 8470 to the sec. 482

regulations include both the creation of the 1993 temporary regulations and the
redesignation of the 1968 regulations.
                                    185

       Whereas the 1992 proposed regulations would have modified
some parts of the 1968 regulations and would have left some parts of the
1968 regulations intact, the 1993 temporary regulations were a
comprehensive set of regulations replacing the 1968 regulations in their
entirety. See T.D. 8552, 59 Fed. Reg. 34972 (July 8, 1994) (preamble to
final 1994 regulations). Section 1.482-1T set forth general transfer-
pricing rules governing all types of transactions. 26 C.F.R. sec. 1.482-
1T (1994).      Specific types of transactions were dealt with in
sections -2T(a) (loans); -2T(b) (services); -2T(c) (use of tangible property);
-3T (transfers of tangible property); -4T (transfers of intangible
property); -5T (comparable-profits method relating to transfer of
tangible and intangible property); and -7T (cost-sharing agreements).
26 C.F.R. secs. 1.482-2T, 3T, -4T, -5T, -7T (1994). Section 1.482-6T was
marked as reserved for future regulations regarding the profit-split
method. 26 C.F.R. sec. 1.482-6T (1994).

       Recall that section 1.482-2 of the 1968 regulations had been
divided into the following five paragraphs: (a) loans, (b) services, (c) use
of tangible property, (d) transfer or use of intangible property, and
(e) sales of tangible property. 26 C.F.R. sec. 1.482-2 (1992). The first
three paragraphs ((a), (b), and (c)) were copied verbatim to the 1993
temporary regulations. 26 C.F.R. sec. 1.482-2T(a) through (c) (1994)
(1993 temporary regulations).

       Paragraph (d) of section 1.482-2 of the 1968 regulations had dealt
with the transfer or use of intangible property. 26 C.F.R. sec. 1.482-2(d)
(1992). Paragraph (d) included subparagraph (4) regarding cost-sharing
agreements. 26 C.F.R. sec. 1.482-2(d)(4) (1992). The counterparts to
paragraph (d) of section 1.482-2 of the 1968 regulations were sections
1.482-4T (transfer of intangible property) and -7T (cost-sharing
agreements) of the 1993 temporary regulations. 26 C.F.R. secs. 1.482-
4T, -7T (1994). Section 1.482-7T of the 1993 temporary regulations
regarding cost-sharing agreements was substantively the same as
section 1.482-2(d)(4) of the 1968 regulations. 26 C.F.R. sec. 1.482-7T
(1994) (1993 temporary regulations); 26 C.F.R. sec. 1.482-2(d)(4) (1992)
(1968 regulations); see 58 Fed. Reg. 17775 (Apr. 6, 1993) (“[T]he 1968
regulations cost sharing provisions * * * will continue to apply as
§ 1.482-7T during the period before further action is taken on the 1992
proposed cost sharing regulations.”); 59 Fed. Reg. 34987 (July 8, 1994)
(stating that the 1993 temporary regulations relating to cost sharing
incorporated the text of the 1968 regulations). However, the 1993
provisions were different from the 1992 proposed regulations on cost-
                                   186

sharing agreements. Sec. 1.482-2(g), Proposed Income Tax Regs., 57
Fed. Reg. 3595-3601 (Jan. 30, 1992).

       Paragraph (e) of section 1.482-2 of the 1968 regulations dealt with
sales of tangible property. 26 C.F.R. sec. 1.482-2(e) (1992) (1968
regulations). Its counterpart in the 1993 temporary regulations was
section 1.482-3T. 26 C.F.R. sec. 1.482-3T (1994) (1993 temporary
regulations).

       The 1993 temporary regulations replaced the passage containing
the “complete-power” sentence in the 1968 regulations, a passage that
had existed in various forms in the regulatory scheme since 1934. This
passage in the 1968 regulations had been:

      The interests controlling a group of controlled taxpayers
      are assumed to have complete power to cause each
      controlled taxpayer so to conduct its affairs that its
      transactions and accounting records truly reflect the
      taxable income from the property and business of each of
      the controlled taxpayers. If, however, this has not been
      done, and the taxable incomes are thereby understated, the
      district director shall intervene, and, by making such
      distributions, apportionments, or allocations as he may
      deem necessary of gross income, deductions, credits, or
      allowances, or of any item or element affecting taxable
      income, between or among the controlled taxpayers
      constituting the group, shall determine the true taxable
      income of each controlled taxpayer. * * *

26 C.F.R. sec. 1.482-1(b)(1) (1992) (1968 regulations). In the 1993
temporary regulations, the passage was replaced by the following
provision: “If a controlled taxpayer has not reported its true taxable
income, the district director may make allocations between or among the
members of a controlled group. In such cases, the district director may
allocate income, deductions, credits, allowances, basis, or any other item
or element affecting taxable income (referred to as “allocations”). 26
C.F.R. sec. 1.482-1T(a)(2) (1994) (1993 temporary regulations). The
complete-power sentence was therefore eliminated in the 1993
temporary regulations.

      The 1993 temporary regulations replaced the definition of
“controlled” in the 1968 regulations with a similar definition. See 26
                                  187

C.F.R. sec. 1.482-1(a)(3) (1992) (1968 regulations). The 1993 temporary
regulations provided:

      Controlled includes any kind of control, direct or indirect,
      whether legally enforceable, and however exercisable or
      exercised. It is the reality of the control that is decisive,
      not its form or the mode of its exercise. A presumption of
      control arises if income or deductions have been arbitrarily
      shifted as a result of the actions of two or more taxpayers
      acting in concert or with a common goal or purpose.

26 C.F.R. sec. 1.482-1T(g)(4) (1994) (1993 temporary regulations).

       The 1993 temporary regulations defined a “group of controlled
taxpayers” as “the taxpayers owned or controlled directly or indirectly
by the same interests.” 26 C.F.R. sec. 1.482-1T(g)(6) (1994) (1993
temporary regulations); cf. 26 C.F.R. sec. 1.482-1(a)(5) (1992) (1968
regulations) (defining a “group of controlled taxpayers” as “the
organizations, trades, or businesses owned or controlled directly or
indirectly by the same interests”).

      The 1993 temporary regulations created the concept of a
“controlled transaction”. A “controlled transaction” was defined as “any
transaction * * * between two or more members of the same group of
controlled taxpayers.” 26 C.F.R. sec. 1.482-1T(g)(8) (1994) (1993
temporary regulations).

      The 1993 temporary regulations replaced the definition of “true
taxable income” in the 1968 regulations. See 26 C.F.R. sec. 1.482-1(a)(6)
(1992) (1968 regulations). The 1993 temporary regulations provided:
“True taxable income means, in the case of a controlled taxpayer, the
taxable income that would have resulted had it dealt with the other
member or members of the group at arm’s length.” 26 C.F.R. sec. 1.482-
1T(g)(9) (1994) (1993 temporary regulations).

       The 1993 temporary regulations modified the tax-parity sentence
in the 1968 regulations. The 1968 regulations had stated: “The purpose
of section 482 is to place a controlled taxpayer on a tax parity with an
uncontrolled taxpayer, by determining, according to the standard of an
uncontrolled taxpayer, the true taxable income from the property and
business of a controlled taxpayer.” 26 C.F.R. sec. 1.482-1(b)(1) (1992)
(1968 regulations). By contrast, the 1993 temporary regulations stated:
“The purpose of section 482 is to ensure that taxpayers clearly reflect
                                   188

income attributable to controlled transactions, and to prevent the
avoidance of taxes with respect to such transactions. Section 482 places
a controlled taxpayer on a tax parity with an uncontrolled taxpayer by
determining the true taxable income of the controlled taxpayer in a
manner that reasonably reflects the relative economic activity
undertaken by each taxpayer.” 26 C.F.R. sec. 1.482-1T(a)(1) (1994)
(1993 temporary regulations).

       The 1993 temporary regulations replaced the following sentence
in the 1968 regulations imposing the arm’s-length standard: “The
standard to be applied in every case is that of an uncontrolled taxpayer
dealing at arm’s length with another uncontrolled taxpayer.” 26 C.F.R.
sec. 1.482-1(b)(1) (1992) (1968 regulations). The new sentence in the
1993 temporary regulations was: “In determining the true taxable
income of a controlled taxpayer, the standard to be applied in every case
is that of a taxpayer dealing at arm’s length with an uncontrolled
taxpayer.” 26 C.F.R. sec. 1.482-1T(b)(1) (1994) (1993 temporary
regulations).

       The 1993 temporary regulation did not adopt the additional text
in the 1992 proposed regulation relating to the arm’s-length standard
and the commensurate-with-income standard.            Sec. 1.482-1(b)(1),
Proposed Income Tax Regs., 57 Fed. Reg. 3578-3579 (Jan. 30, 1992).
Instead, the 1993 temporary regulation adopted the following sentence:
“A controlled transaction meets the arm’s length standard if the results
of that transaction are consistent with the results that would have been
realized if uncontrolled taxpayers had engaged in a comparable
transaction under comparable circumstances.” 26 C.F.R. sec. 1.482-
1T(b)(1) (1994) (1993 temporary regulations).

       The         matching-transaction   and      comparable-adjustable-
transaction methods for determining the transfer prices of intangible
property in the 1992 proposed regulations were combined into a single
comparable-uncontrolled-transaction method in the 1993 temporary
regulations. See T.D. 8470, 58 Fed. Reg. 5269 (Jan. 21, 1993) (preamble
to 1993 temporary regulations); 26 C.F.R. 1.482-4T(c) (1994) (1993
temporary regulations); 26 C.F.R. sec. 1.482-2(d)(2)(iii), Proposed
Income Tax Regs., 57 Fed. Reg. 3580 (Jan. 30, 1992). Instead of the
comparable-profit-interval method for tangible and intangible property
described in the 1992 proposed regulations (sec. 1.482-2(d)(5), Proposed
Income Tax Regs., 57 Fed. Reg. 3583-3584 (Jan. 30, 1992); sec. 1.482-
2(e)(1)(iii), (f), Proposed Income Tax Regs., 57 Fed. Reg. 3586-3595 (Jan.
30, 1992)), the 1993 temporary regulations described a comparable-
                                         189

profit method that was broadly similar to the comparable-profit-interval
method. 26 C.F.R. sec. 1.482-5T (1994) (1993 temporary regulations);
T.D. 8552, 59 Fed. Reg. 34974 (July 8, 1994) (preamble to 1994 final
regulations). The comparable-profit method, unlike the comparable-
profit-interval method in the 1992 proposed regulations, did not serve
as a mandatory check on other methods. 26 C.F.R. sec. 1.482-3T(a)(1)
(1994) (1993 temporary regulations); sec. 1.482-2(e)(1)(iii), Proposed
Income Tax Regs., 57 Fed. Reg. 3586 (Jan. 30, 1992); Hirsch et al., supra,
at 588 (“The mandatory CPI check was deleted, while a comparable
profits method (CPM), similar to the CPI, was introduced as a specified
method for transfer of either tangible or intangible property.”).

       Section 1.482-4T(e)(2)(i) of the 1993 temporary regulations had
the following provision: “If an intangible is transferred under an
arrangement that covers more than one year, the consideration charged
in each taxable year may be adjusted to ensure that it is commensurate
with the income attributable to the intangible. Adjustments made
pursuant to this paragraph (e)(2) shall be consistent with the arm’s
length standard and the provisions of § 1.482-1T.” 26 C.F.R. sec. 1.482-
4T(e)(2)(i) (1994) (1993 temporary regulations). The first sentence of the
provision was similar to a sentence in the 1992 proposed regulations.
Sec. 1.482-2(d)(6)(i), Proposed Income Tax Regs., 57 Fed. Reg. 3584 (Jan.
30, 1992). The second sentence of the provision had no counterpart in
the 1992 proposed regulations. Id. The preamble to the 1993 temporary
regulations explained the provision as follows: “Section 1.482-4T(e)(2)(i)
provides that if an intangible is transferred for a period in excess of one
year, the consideration charged is generally subject to annual
adjustment to ensure that it is commensurate with the income
attributable to the intangible. This provision is required by the 1986
amendment to section 482.” 58 Fed. Reg. 5270 (Jan. 21, 1993).

       The 1993 temporary regulations did not contain any rules
comparable to section 1.482-1(d)(6) of the 1968 regulations (26 C.F.R.
sec. 1.482-1(d)(6) (1969)), which governed the deferred-income method
of accounting for payments prevented by foreign legal restrictions. 153
The 1993 temporary regulations did not contain any rules regarding the
effect of foreign legal restrictions on section 482 allocations. The 1993

        153 Under the structure imposed by Treasury Decision 8470, sec. 1.482- 1(d)(6)

of the 1968 regulations (26 C.F.R. sec. 1.482-1(d)(6) (1969)) had been redesignated 26
C.F.R. sec 1.482-1A(d)(6) (1994), and applied only for tax years beginning on or before
April 21, 1993. T.D. 8470, para. 1a, 58 Fed. Reg. 5271 (Jan. 21, 1993); 58 Fed. Reg.
17775 (Apr. 6, 1993).
                                         190

temporary regulations contained a placeholder for such rules in section
1.482-1T(f)(2), which had the heading “Effect of Foreign legal
restrictions” and the text “[Reserved]”. 26 C.F.R. sec. 1-482-1T(f)(2)
(1994) (1993 temporary regulations).

      The preamble to the 1993 temporary regulations, T.D. 8470, 58
Fed. Reg. 5264 (Jan. 21, 1993), stated that the 1993 temporary
regulations were needed immediately to provide guidance to the public
and that therefore it was impractical and contrary to the public interest
to comply with section 4(a) of the APA. 154

       The preamble to the 1993 temporary regulations contained a
discussion of the legislative history of the commensurate-with-income
sentence that had been added to section 482 by the Tax Reform Act of
1986. 58 Fed. Reg. 5264 (Jan. 21, 1993). This discussion was similar to
the discussion of the legislative history in the 1992 notice of proposed
rulemaking. 57 Fed. Reg. 3571 (Jan. 30, 1992).

       Treasury Decision 8470, published on January 21, 1993,
redesignated the 1968 regulations and provided that they applied only
for earlier years, i.e., those tax years beginning on or before April 21,
1993. Until the 1993 redesignation, the 1968 regulations had two
sections: 26 C.F.R. secs. 1.482-1 and -2 (1992). Section 1.482-2 of the
1968 regulations was divided into five paragraphs:

      26 C.F.R. sec. 1.482-2(a) (1992)         loans

      26 C.F.R. sec. 1.482-2(b) (1992)         services

      26 C.F.R. sec. 1.482-2(c) (1992)         use of tangible property

      26 C.F.R. sec. 1.482-2(d) (1992)         transfer or use of intangible property

      26 C.F.R. sec. 1.482-2(e) (1992)         sales of tangible property

Treasury Decision 8470 redesignated section 1.482-1 of the 1968
regulations as section 1.482-1A and made section 1.482-1A applicable
for tax years beginning on or before April 21, 1993. 26 C.F.R. sec. 1.482-
1A (1994); see T.D. 8470, 58 Fed. Reg. 5271 (Jan. 21, 1993); 58 Fed. Reg.
17775 (Apr. 6, 1993). For those years, Treasury Decision 8470 also
created section 1.482-2A(a) through (c), which provided: “For applicable
rules, see § 1.482-2T(a) through (c).” As noted before, section 1.482-2T(a)
through (c) of the 1993 temporary regulations (regarding loans, services,

      154   Codified as amended at 5 U.S.C. sec. 553(b).
                                   191

and use of tangible property, respectively) are verbatim copies of section
1.482-2(a) through (c) of the 1968 regulations, respectively. In addition,
Treasury Decision 8470 created section 1.482-2A(d), which consisted of
a verbatim copy of section 1.482-2(d) of the 1968 regulations (regarding
transfer or use of intangible property, including subparagraph (4)
regarding cost-sharing agreements). 26 C.F.R. sec. 1.482-2(d) (1992); 26
C.F.R. sec. 1.482-2A(d) (1994). Treasury Decision 8470 also created
section 1.482-2A(e), which was a verbatim copy of section 1.482-2(e) of
the 1968 regulations (regarding sales of tangible property). 26 C.F.R.
sec. 1.482-2(e) (1992); 26 C.F.R. sec. 1.482-2A(e) (1994). In summary,
sections -1 and -2 of the 1968 regulations (26 C.F.R. secs. 1.482-1 and -2
(1992)) were transformed into sections -1A and -2A (26 C.F.R. secs.
1.482-1A, -2A (1994)) and made applicable for tax years beginning on or
before April 21, 1993.

      MM. The 1993 notice of proposed rulemaking

       On January 21, 1993, the same day it issued Treasury Decision
8470, the Treasury Department published a notice of proposed
rulemaking in the Federal Register. 58 Fed. Reg. 5310. The notice of
proposed rulemaking withdrew the 1992 proposed regulations with the
exception of section 1.482-2(g), Proposed Income Tax Regs., 57 Fed. Reg.
3595 (Jan. 30, 1992), which related to cost-sharing agreements. See 58
Fed. Reg. 5310. Thus, paragraph 2(g) of the 1992 proposed regulations
remained a proposal by the Treasury Department. 58 Fed. Reg. 17775
(Apr. 6, 1993) (“The 1992 proposed cost sharing regulations will be the
basis of the final regulations that will be promulgated as § 1.482-7, and
therefore, are the provisions on which comments are solicited.”); see also
59 Fed. Reg. 34987 (July 8, 1994).

       The 1993 notice of proposed rulemaking explained that the
Treasury Department proposed that sections -1T through -5T of the
1993 temporary regulations (26 C.F.R. secs. 1.482-1T through -5T
(1994)) eventually be made final. 58 Fed. Reg. 5310; T.D. 8470, 58 Fed.
Reg. 5272. This meant that sections -1T through -5T of the 1993
temporary regulations had the status of both (1) temporary regulations
and (2) proposed regulations. See 59 Fed. Reg. 34972 (July 8, 1994)
(referring to regulations as both temporary and proposed).

      Recall that section 1.482-6T of the 1993 temporary regulations
was merely a placeholder for future regulations regarding the profit-
split method. 26 C.F.R. sec. 1.482-6T (1994). The 1993 notice of
proposed rulemaking contained the text of proposed regulations related
                                   192

to the profit-split method. This text was section 1.482-6T, Proposed
Income Tax Regs., 58 Fed. Reg. 5313 (Jan. 21, 1993). Although the text
bore the identifier “T”, for temporary, the regulation was not a
temporary regulation, but a proposal for a final regulation. 58 Fed. Reg.
5310 (“In addition to the text of the temporary regulations, the final
regulations that will result from the regulations proposed in this notice
will be based on the text of proposed §§ 1.482-1T(f)(2) and 1.482-6T
contained in this notice. These provisions are proposed to take the place
of reserved sections of the temporary regulations.”). Therefore, for years
governed by the 1993 temporary regulations (i.e., generally tax years
beginning after April 21, 1993), no applicable regulatory provision
related to the profit-split method.

       Recall that section 1.482-7T of the 1993 temporary regulations
related to cost-sharing agreements. 26 C.F.R. sec. 1.482-7T (1994) (1993
temporary regulations); 58 Fed. Reg. 17776 (Apr. 6, 1993); 58 Fed. Reg.
28921 (May 18, 1993). Recall that section 1.482-2(g) of the 1992
proposed regulations (Proposed Income Tax Regs., 57 Fed. Reg. 3595-
3601 (Jan. 30, 1992)) also related to cost-sharing agreements.

       Recall that a passage from the 1993 temporary regulations
related to the purpose and scope of section 482 but omitted the complete-
power sentence found in the 1968 regulations. 26 C.F.R. sec. 1.482-
1T(a)(1) (1994). The 1993 notice of proposed rulemaking proposed that
this passage be made final through the effect of its general proposal that
there be made final sections 1.482-1T to -5T of the 1993 temporary
regulations, 26 C.F.R. secs. 1.482-1T through -5T (1994). 58 Fed. Reg.
5310; T.D. 8470, 58 Fed. Reg. 5272.

       Recall that the 1993 temporary regulations had a provision
(-4T(e)(2)(i)) permitting annual adjustments in the compensation for the
long-term use of intangible property. 26 C.F.R. sec. 1.482-4T(e)(2)(i)
(1994). The 1993 notice of proposed rulemaking proposed that this
provision be made final through the effect of its general proposal that
there be made final sections 1.482-1T to -5T of the 1993 temporary
regulations, 26 C.F.R. secs. 1.482-1T through -5T (1994). 58 Fed. Reg.
5310; T.D. 8470, 58 Fed. Reg. 5272.

       Recall that section 1.482-1T(f)(2) of the 1993 temporary
regulations contained a placeholder for future provisions regarding the
“Effect of foreign legal restrictions”. The 1993 notice of proposed
rulemaking included, as proposed regulations, section 1.482-1T(f)(2),
Proposed Income Tax Regs., 58 Fed. Reg. 5312, headed “Effect of foreign
                                   193

legal restrictions”. Although this proposed provision was identified with
a “T”, for temporary, the provision was not a temporary regulation, but
a proposal for a final regulation. See 58 Fed. Reg. 5310. Here is the text
of section 1.482-1T(f)(2), Proposed Income Tax Regs., 58 Fed. Reg. 5312:

      (i) In general. The district director may make an allocation
      under section 482 without regard to the effect of any
      foreign legal restriction, except as provided in paragraph
      (f)(2)(iv) of this section. However, an allocation under
      section 482 will be treated as deferrable if the following
      requirements are met:

             (A) The taxpayer must establish to the satisfaction
      of the district director that the payment or receipt of part
      or all of the arm’s length amount that would otherwise be
      required under section 482 was prevented because of a
      foreign legal restriction and circumstances described in
      paragraph (f)(2)(ii) of this section.

             (B) The taxpayer whose U.S. tax liability may be
      affected by the foreign legal restrictions must elect the
      deferred income method of accounting, as described in
      paragraph (f)(2)(iii) of this section, on a written statement
      attached to a timely U.S. income tax return (or an amended
      return) filed before the Internal Revenue Service first
      contacts any member of the controlled group concerning an
      examination of the return for the taxable year to which the
      foreign restriction applies. A written statement furnished
      by a taxpayer subject to the Coordinated Examination
      Program will be considered an amended return for
      purposes of this paragraph (f)(2)(i) if it satisfies the
      requirements of a qualified amended return for purposes of
      § 1.6662-5(j)(1) as set forth in those regulations or as the
      Commissioner may prescribe by applicable revenue
      procedures. The election statement must identify the
      affected transactions, the parties to the transactions, and
      the applicable foreign legal restrictions.

             (ii) Applicable legal restrictions. Foreign legal
      restrictions (whether temporary or permanent) will be
      taken into account for purposes of this paragraph (f)(2) only
      if the conditions set forth in paragraphs (f)(2)(ii)(A)
      through (D) of this section are met.
                             194

       (A) The restrictions are publicly promulgated,
generally applicable to all similarly situated persons (both
controlled and uncontrolled), and not imposed as part of a
commercial transaction between the taxpayer and the
foreign sovereign.

       (B) The taxpayer (or other member of the controlled
group with respect to which the restrictions apply) has
exhausted all effective and practical remedies prescribed
by foreign law or practice for obtaining a waiver of such
restrictions (other than remedies that would have a
negligible prospect of success if pursued).

       (C) The restrictions expressly prevented the
payment or receipt of part or all of the arm’s length amount
that would otherwise be required under section 482; a
restriction that applies only to the deductibility of an
expense for tax purposes is not a restriction on payment or
receipt for this purpose.

       (D) The related parties subject to the restriction did
not engage in any transaction with controlled or
uncontrolled parties that had the effect of circumventing
the restriction, and have not otherwise violated the
restriction in any material respect.

       (iii) Deferred income method of accounting. If the
requirements of paragraph (f)(2)(i) of this section are
satisfied, any allocation that may be made under section
482 with respect to such transaction will be treated as
deferrable until payment or receipt of the relevant item
ceases to be prevented by the foreign legal restriction. For
purposes of the deferred income method of accounting
under this paragraph (f)(2)(iii), deductions (including the
cost or other basis of inventory and other assets sold or
exchanged) and credits properly chargeable against any
amount so deferred, are subject to deferral under the
provisions of § 1.461-1(a)(4).

        (iv) Exception for arm’s length transactions.
Regardless of whether the election described in paragraph
(f)(2)(i)(B) of this section has been made, an allocation will
                                        195

       not be made under section 482 with respect to a controlled
       transaction if the taxpayer establishes the following to the
       satisfaction of the district director--

             (A) Payment or reimbursement for the controlled
       transaction was prevented at the time of the transaction
       because of a foreign legal restriction and circumstances
       described in paragraph (f)(2)(ii) of this section; and

              (B) Uncontrolled transactions that establish a
       comparable uncontrolled price under § 1.482-3T(b) (in the
       case of tangible property) or a comparable uncontrolled
       transaction under § 1.482-4T(c) (in the case of intangible
       property) demonstrate that, taking into account the foreign
       legal restriction, the controlled transaction was at arm’s
       length.

              (v) Examples. The following examples, in which Sub
       is a Country FC subsidiary of U.S. corporation, Parent,
       illustrate this paragraph (f)(2).

              Example 1. (i) Parent licenses an intangible to Sub.
       FC law prohibits Sub from paying a royalty to Parent. The
       requirements of paragraphs (f)(2)(ii)(A), (B), and (C) of this
       section are satisfied. Parent attached to its timely filed
       U.S. income tax return a written statement that satisfies
       the requirements of paragraph (f)(2)(i)(B) of this section,
       electing the deferred income method of accounting under
       paragraph (f)(2)(iii) of this section. The arm’s length
       royalty rate for the use of the intangible property in the
       absence of the foreign restriction is 10% of its sales in
       country FC.[155]

       155 This sentence appeared in the copy of the notice of proposed rulemaking
published in the Federal Register. 58 Fed. Reg. 5313 (Jan. 21, 1993). However, the
copy of the notice of proposed rulemaking published in the Cumulative Bulletin
contained instead the following two sentences:
              The arm’s length royalty rate for the use of the intangible
       property in the absence of the foreign restriction is 10% of Sub’s sales
       in country FC. Sub pays no a royalty to Parent but does distribute to
       Parent an amount equal to 10% of its sales in country FC.
      1993-1 C.B. 825, 828.       In the stipulation, petitioner and respondent
acknowledged that the notice of proposed rulemaking was “published in the Federal
                                          196

               (ii) The district director makes an allocation of
        royalty income to Parent, based on the arm’s length royalty
        rate of 10%. Further, the district director determines that
        because the distribution from Sub to Parent had the effect
        of circumventing the FC law, the requirements of
        paragraph (f)(2)(ii)(D) of this section are not satisfied.
        Thus, Parent did not validly elect the deferred income
        method of accounting, and the allocation of royalty income
        cannot be treated as deferrable.            In appropriate
        circumstances, the district director may permit the amount
        of the distribution to be treated as payment by Sub of the
        royalty allocated to Parent, under the provisions of § 1.482-
        1T(e)(4).

               Example 2. The facts are the same as in Example 1,
        except that Sub distributes an amount equal to 8% of its
        sales in country FC. Because the distribution has the effect
        of circumventing the FC law within the meaning of
        paragraph (f)(2)(ii)(D) of this section, the deferred income
        method of accounting was not validly elected, and does not
        apply, with respect to the amount of the distribution.
        However, the election was properly made, and does apply,
        with respect to the 2% difference between the arm’s length
        royalty rate and the amount of the distribution.
        Accordingly, of the 10% royalty allocated to Parent, 2%
        may be treated as deferrable.                In appropriate
        circumstances, the district director may permit the 8% that
        was distributed to be treated as payment by Sub of the
        royalty allocated to Parent, under the provisions of § 1.482-
        1T(e)(4).
               Example 3. The facts are the same as in Example 1,
        except that Country FC law permits the payment of a
        royalty, but limits the amount to 5% of sales, and Sub pays
        the 5% royalty to Parent. Parent demonstrates the
        existence of comparable uncontrolled transactions in which

Register”. However, petitioner and respondent stipulated that Exhibit 36-J “is a copy
of” the notice of proposed rulemaking. Exhibit 36-J is the text of the notice of proposed
rulemaking that was published in the Cumulative Bulletin. For these purposes, the
Federal Register is the authoritative source. See sec. 4(a) of the APA, codified as
amended at 5 U.S.C. sec. 553(b) (requiring a notice of proposed rulemaking to be
published in the Federal Register). Therefore, we disregard any apparent acquiescence
by petitioner and respondent to the proposition that text published in the Cumulative
Bulletin should be considered the text of the notice of proposed rulemaking.
                                   197

      an uncontrolled parties accepted a royalty rate of 5%, even
      though an arm’s length royalty would otherwise have
      equaled 10%. Because the requirements of paragraph
      (f)(2)(iv) of this section are satisfied, the district director
      does not make an allocation of royalty income to Parent
      under section 482.

The 1993 notice of proposed rulemaking gave the following explanation
of section 1.482-1T(f)(2), Proposed Income Tax Regs., 58 Fed. Reg. 5312:

             Section 1.482-1T(f)(2) provides guidance on the
      extent to which foreign legal restrictions on payments
      between controlled taxpayers will be respected for
      purposes of section 482. In general, 1.482-1T(f)(2)(i)
      provides that a foreign legal restriction will be recognized
      for this purpose if the taxpayer demonstrates that the
      receipt of an arm’s length payment was prevented by a
      foreign legal restriction, and the taxpayer elects the
      deferred income method of accounting with respect to such
      payments.

             Section 1.482-1T(f)(2)(ii) defines an applicable
      foreign legal restriction as a restriction that is publicly
      promulgated and generally applicable, with respect to
      which the controlled taxpayer has exhausted all
      practicable legal remedies afforded under foreign law for
      obtaining a waiver, expressly prevents the payment of an
      arm’s length amount within the meaning of section 482,
      and was not circumvented through other transactions
      between the controlled taxpayers.

             Section 1.482-1T(f)(2)(iii) provides that if the
      restriction meets the definition of an applicable foreign
      legal restriction and the taxpayer has elected the deferred
      income method of accounting, any section 482 allocation
      connected with the transaction will be deferrable until the
      restriction is removed. Deductions and credits chargeable
      against a deferred amount are subject to deferral under
      section 461.

             Section 1.482-1T(f)(2)(iv) provides an exception from
      the election requirement in cases in which the taxpayer can
      demonstrate, based on a comparable uncontrolled
                                  198

      transaction, that the transaction as structured was at
      arm’s length.

58 Fed. Reg. 5310. The 1993 notice of proposed rulemaking also made
the following general statement:

             Before adopting these regulations, consideration
      will be given to any written comments that are timely
      submitted (preferably a signed original and eight copies) to
      the Commissioner of Internal Revenue. All comments will
      be available for public inspection and copying. A public
      hearing will be held upon written request by any person
      who submits timely written comments on the proposed
      rules. Notice of the time, place and date for the hearing
      will be published in the Federal Register.

Id. Respondent received comments pertaining to section 1.482-1T(f)(2),
Proposed Income Tax Regs., 58 Fed. Reg. 5312-5313, from the following
four organizations:

      ●     The American Petroleum Institute, which submitted
            “Comments by the American Petroleum Institute on the
            Temporary and Proposed Regulations on Intercompany
            Transfer Pricing under Code section 482,” dated July 20,
            1993.

      ●     Tax Executives Institute, Inc. (“Tax Executives Institute”),
            which submitted a letter dated August 6, 1993, enclosing
            “Comments of Tax Executives Institute, Inc. On
            Temporary and Proposed Regulations under Section 482 of
            the Internal Revenue Code, T.D. 8470, IL-401-88,
            submitted to the Internal Revenue Service.”

      ●     TRW, Inc. (“TRW”), which submitted a letter dated July 16,
            1993.

      ●     United States Council for International Business, which
            submitted a letter dated July 21, 1993, enclosing
            “Statement of the United States Council for International
            Business on Proposed Regulation Section 1.482(f)(2) Issued
            Pursuant to the Internal Revenue Code.”
                                   199

       All four organizations that submitted comments on section 1.482-
1T(f)(2), Proposed Income Tax Regs., 58 Fed. Reg. 5312, stated that the
proposed regulations were inconsistent with the holding in First
Security Bank. The American Petroleum Institute stated that the
proposed regulation “apparently ignores” First Security Bank’s holding,
which, in the view of the American Petroleum institute, was that “an
allocation of income is inappropriate where a government restriction
negates the ‘complete power’ of a taxpayer to control the distribution of
income among affiliates.” All four commentators stated that the
proposed regulations were inconsistent with the reasoning of the Tax
Court and the Sixth Circuit in Procter & Gamble, which involved the
effect of a foreign legal restriction.

       Two commentators--the Tax Executives Institute and TRW--
argued against the requirement of section 1.482-1T(f)(2)(ii)(A), Proposed
Income Tax Regs., 58 Fed. Reg. 5312, that, for a foreign legal restriction
to be taken into account, it would have to be “generally applicable to all
similarly situated persons (both controlled and uncontrolled).” The Tax
Executives Institute explained that “[a] legal restriction should not have
to apply to all businesses in the foreign jurisdiction in order to trigger
First Security Bank’s limitation on section 482.” The Tax Executives
Institute added: “Some countries in Latin America, for example, apply
such restrictions only to payments between related parties.” TRW also
opposed the “both controlled and uncontrolled” clause, arguing that it
was inconsistent with the Sixth Circuit opinion in Procter & Gamble.

       Two commentators--the American Petroleum Institute and
TRW---questioned the requirement of section 1.482-1T(f)(2)(ii)(D),
Proposed Income Tax Regs., 58 Fed. Reg. 5312, that “related parties
subject to the restriction did not engage in any transaction with
controlled or uncontrolled parties that had the effect of circumventing
the restriction”. Specifically, they expressed concern that the proposed
rule could be interpreted to mean that the payment of dividends, or
(according to the American Petroleum Institute) even just the ability to
pay dividends, might be considered a way to circumvent a legal
restriction.

       Two commentators--the American Petroleum Institute and the
Tax Executives Institute--addressed the requirement in section 1.482-
1T(f)(2)(ii)(B), Proposed Income Tax Regs., 58 Fed. Reg. 5312, that the
taxpayer must have “exhausted all effective and practical remedies
prescribed by foreign law or practice for obtaining a waiver of such
restrictions (other than remedies that would have a negligible prospect
                                  200

of success if pursued).” The American Petroleum Institute stated that
the exhaustion-of-remedies requirement “will be difficult to establish
with developing nations where the effectiveness of various avenues of
appeal is subject to question and a vigorous pursuit of an appeal may
place the taxpayer’s business interests in that county at risk.” The Tax
Executives Institute merely requested clarification: “The regulations
should also clarify (perhaps in an example) when taxpayers will be
considered to have exhausted their remedies under foreign law. The
requirement should not compel taxpayers to pursue futile, costly
actions.”

       The American Petroleum Institute challenged the proposed
regulation’s requirement that a restriction imposed by foreign law be
publicly promulgated. The American Petroleum Institute stated that,
even in the industrialized world, “restrictions which have the practical
force and effect of law may not necessarily be traceable to a specific
published statutory or regulatory source.”

       Two commentators--the American Petroleum Institute and the
Tax Executives Institute--argued that taxpayers should continue to be
allowed to make the deferral election within the time limits that had
been permitted by the 1968 regulations. Recall that the 1968
regulations required that the election be made before any of the
following events occurred: (1) the taxpayer’s waiver of the period for
assessment, (2) 30 days after the examination report, or (3) the closing
agreement or offer-in-compromise. 26 C.F.R. sec. 1.482-1A(d)(6) (1994).
The 1993 proposed regulation would have required the election to be
made before the IRS first contacted the taxpayer about an examination.
Sec. 1.482-1T(f)(2)(i)(B), Proposed Income Tax Regs., 58 Fed. Reg. 5312.

       Following the receipt of written comments relating to the 1993
notice of proposed rulemaking, the Treasury Department and
respondent held a public hearing on August 16, 1993. Although several
witnesses testified at the hearing, none testified regarding section
1.482-1T(f)(2), Proposed Income Tax Regs., 58 Fed. Reg. 5312, which
related to foreign legal restrictions.

      NN.    The 1994 final regulations

      On July 8, 1994, Treasury Decision 8552 was published in the
Federal Register. 59 Fed. Reg. 34971. Treasury Decision 8552 did two
things. First, it promulgated final regulations under section 482 of the
Internal Revenue Code of 1986. T.D. 8552, para. 3, 59 Fed. Reg. 34988.
                                        201

These 1994 final regulations were comprehensive: They comprised all
regulations related to section 482 for the tax years and transactions to
which they applied. Second, it removed the 1993 temporary regulations.
T.D. 8552, para. 2, 59 Fed. Reg. 34988.

       The effective dates of the 1994 final regulations were specified in
section 1.482-1(j) of the 1994 final regulations, which is printed below:

             (1) The regulations in this are generally effective for
       taxable years beginning after October 6, 1994.

              (2) Taxpayers may elect to apply retroactively all of
       the provisions of these regulations for any open taxable
       year. Such election will be effective for the year of the
       election and all subsequent taxable years.

              (3) Although these regulations are generally
       effective for taxable years as stated, the final sentence of
       section 482 (requiring that the income with respect to
       transfers or licenses of intangible property be
       commensurate with the income attributable to the
       intangible) is generally effective for taxable years
       beginning after December 31, 1986. For the period prior to
       the effective date of these regulations, the final sentence of
       section 482 must be applied using any reasonable method
       not inconsistent with the statute. The IRS considers a
       method that applies these regulations or their general
       principles to be a reasonable method.

              (4) These regulations will not apply with respect to
       transfers made or licenses granted to foreign persons
       before November 17, 1985, or before August 17, 1986, for
       transfers or licenses to others. Nevertheless, they will
       apply with respect to transfers or licenses before such dates
       if, with respect to property transferred pursuant to an
       earlier and continuing transfer agreement, such property
       was not in existence or owned by the taxpayer on such
       date.[156]

       156 The quoted text is found in Treasury Decision 8552, 59 Fed. Reg. 35002
(July 8, 1994). In 2003, sec. 1.482-1(j)(5) of the regulation was added. T.D. 9088, 68
Fed. Reg. 51177 (Aug. 26, 2003). Subparagraph (5) was included in the 2006 edition
                                         202

       Petitioner does not argue that any provision of section 1.482-1(j)
of the 1994 final regulations results in the 1994 final regulations’ not
being effective for the 2006 tax year of the 3M consolidated group.

       The 2006 edition of the Code of Federal Regulations contains the
regulations generally applicable for the 2006 tax year for taxpayers,
such as the 3M consolidated group, who use the calendar year as the tax
year. Therefore, when we wish to cite the regulations that are effective
for this case, we cite the 2006 edition of the Code of Federal Regulations.
Between the promulgation of the 1994 final regulations and the
publication of the 2006 edition of the Code of Federal Regulations, some
amendments had been made to the 1994 final regulations. 157 However,
neither petitioner nor respondent relies on these amendments. In this
Opinion we do not refer to portions of the regulations that were amended
after the 1994 final regulations.

        As mentioned before, the second change effected by Treasury
Decision 8552 was the removal of temporary regulation 1.482-1T
to -6T. 158 T.D. 8552, para. 2, 59 Fed. Reg. 34988 (July 8, 1994). Treasury
Decision 8552 provided that the effective date for the removal of the
1993 temporary regulations was October 6, 1994. T.D. 8552, 59 Fed.
Reg. 34971 (sections 1.482-1T to -6T of the 1993 regulations “are
removed effective October 6, 1994”). This effective-date provision for the
removal of the 1993 temporary regulations was not expressed in terms
of tax years. However, the new 1994 final regulations were generally
effective for the tax years beginning after October 6, 1994. See section
1.482-1(j)(1) of the 1994 final regulations, 59 Fed. Reg. 35002 (July 8,
1994). Therefore it would be sensible to consider the temporary
regulations to be removed generally for the tax years beginning after
October 6, 1994. If this interpretation is placed on the effective-date
provision regarding the removal of the 1993 temporary regulations, then

of title 26 of the Code of Federal Regulations. This edition generally contains the
regulations applicable for the 2006 tax year (for taxpayers, such as the 3M consolidated
group, who use calendars years as tax years). However, 26 C.F.R. sec. 1.482-1(j)(5)
does not appear relevant to any of the regulatory provisions affecting this case.
       157 One such amendment was the 1995 addition of final regulations regarding
cost-sharing agreements. T.D. 8632, 60 Fed. Reg. 65553 (Dec. 20, 1995) (adding sec.
1.482-7).
        158 As explained before, sec. 1.482-6T of the 1993 temporary regulations (26

C.F.R. sec. 1.482-6T (1994)) was merely a placeholder.
                                    203

the general scope of the section 482 regulations from this era can be
described thus:

     Beginning date of tax year   Regulations generally applicable for tax year

 On or before Apr. 21, 1993       1968 regulations, redesignated in 1993

 After Apr. 21, 1993, and on or   1993 temporary regulations
 before Oct. 6, 1994

       The preamble to the 1994 final regulations contained a discussion
of the legislative history of the commensurate-with-income sentence
that had been added to section 482 by the Tax Reform Act of 1986. 59
Fed. Reg. 34972 (July 8, 1994). This 1994 discussion of legislative
history is similar to the discussions of legislative history in the 1992
notice of proposed rulemaking, 57 Fed. Reg. 3571 (Jan. 30, 1992), and in
the preamble to the 1993 temporary regulations, 58 Fed. Reg. 5264 (Jan.
21, 1993); see supra part II.KK (discussing 1992 notice of proposed
rulemaking) and LL (discussing preamble to the 1993 temporary
regulations).

       The preamble to the 1994 final regulations also explained that
“[w]ritten comments responding to the notice of proposed rulemaking
were received, and a public hearing was held on August 16, 1993”; and
that “[a]fter consideration of all the comments”, the proposed
regulations under the 1993 notice of proposed rulemaking, as revised by
Treasury Decision 8552, were adopted and the 1993 temporary
regulations were removed. T.D. 8552, 59 Fed. Reg. 34972, 34988.

       The preamble to the 1994 final regulations made the following
general comparison to the 1993 temporary regulations (which were also
proposed regulations): “While the final regulations reflect numerous
modifications in response to the comments received on the 1993
regulations, both the format and substance of the final regulations are
generally consistent with the 1993 regulations. The changes adopted
are intended to clarify and refine those provisions of the 1993
regulations that required improvement, without fundamentally altering
the basic policies reflected in the 1993 regulations.” T.D. 8552, 59 Fed.
Reg. 34975.
       The 1994 final regulations included a finalized version of the 1993
temporary regulations (which were also proposed regulations) regarding
the comparable-profits method. Sec. 1.482-5, 59 Fed. Reg. 35021 (text
of section 1.482-5, the portion of the 1994 final regulations relating to
                                         204

the comparable-profits method); 26 C.F.R. sec. 1.482-5T (1994) (1993
temporary regulations). The 1994 final regulations included a finalized
version of the 1993 proposed regulations regarding the profit-split
method. Sec. 1.482-6, 59 Fed. Reg. 35025 (text of section 1.482-6, the
portion of the 1994 final regulations relating to the profit-split method);
59 Fed. Reg. 34986 (preamble describing history of section 1.482-6 of
1994 final regulations); sec. 1.482-6T, Proposed Income Tax Regs., 58
Fed. Reg. 5313-5316 (Jan. 21, 1993) (text of proposed regulation on
profit-split method in 1993 notice of proposed rulemaking).

      The 1994 final regulations had no provisions regarding cost-
sharing agreements. 59 Fed. Reg. 34987. Thus, the provisions in the
1993 temporary regulations continued to apply. Id.; 26 C.F.R. sec. 1.482-
7T (1994) (1993 temporary regulations).

       Like the 1993 temporary regulations, the 1994 final regulations
had a provision permitting the consideration charged for an intangible
to be periodically adjusted to be commensurate with the income
attributable to the intangible. 26 C.F.R. sec. 1.482-4(f)(2) (2006) (1994
final regulations); 26 C.F.R. sec. 1.482-4T(e)(2)(i) (1994) (1993
temporary regulations). 159 The preamble to the 1994 final regulations
explained the provision as follows: “Section 1.482-4(f)(2) provides that if
an intangible is transferred for a period in excess of one year, the
consideration charged is generally subject to an annual adjustment to
ensure that it is commensurate with the income attributable to the
intangible. This provision is required by the 1986 amendment to section
482.” 59 Fed. Reg. 34984. 160

       159  The provision in the 1994 final regulations, which was substantially
identical to the provision in the 1993 temporary regulations, was:
               If an intangible is transferred under an arrangement that
       covers more than one year, the consideration charged in each taxable
       year may be adjusted to ensure that it is commensurate with the
       income attributable to the intangible. Adjustments made pursuant to
       this paragraph (f)(2) shall be consistent with the arm’s length standard
       and the provisions of § 1.482-1. * * *
       26 C.F.R. sec. 1.482-4(f)(2) (2006) (1994 final regulations); see 26 C.F.R. sec.
1.482-4T(e)(2)(i) (1994) (1993 temporary regulations).
        160 The preamble also discussed the parallel provision in the 1992 proposed

regulations (sec. 1.482-2(d)(6)(i), Proposed Income Tax Regs., 57 Fed. Reg. 3584 (Jan.
30, 1992)):
               In addition to providing new methods for transfers of
       intangibles, the 1992 regulations implemented the “commensurate
                                       205

       Recall that before the 1994 final regulations were promulgated,
the regulatory provisions containing the “complete power” sentence
were in effect only for tax years beginning on or before April 21, 1993.
As we have explained, the section 482 regulations before the
promulgation of the 1994 final regulations had consisted of two separate
tracks. Tax years beginning on or before April 21, 1993, were generally
governed by the 1968 regulations as redesignated in 1993. T.D. 8470
para. 1, 58 Fed. Reg. 5271 (Jan. 21, 1993); 58 Fed. Reg. 17775 (Apr. 6,
1993).    This redesignated set of regulations had the provisions
containing the “complete power” sentence. 26 C.F.R. sec. 1.482-1A(b)(1)
(1994). Tax years beginning after April 21, 1993, were governed by the
1993 temporary regulations. 26 C.F.R. sec. 1.482-1T(a), (h) (1994). The
1993 temporary regulations did not have the provisions containing the
“complete power” sentence. 26 C.F.R. sec. 1.482-1T(a)(1) (1994) (1993
temporary regulations).

      Like the 1993 temporary regulations, the 1994 final regulations
did not have the passage containing the “complete power” sentence that
had existed in various forms from 1934 to 1993. Instead of this passage,
the 1993 temporary regulations had provided:

       If a controlled taxpayer has not reported its true taxable
       income, the district director may make allocations between
       or among the members of a controlled group. In such cases,
       the district director may allocate income, deductions,
       credits, allowances, basis, or any other item or element
       affecting taxable income (referred to as “allocations”).
       * * *

26 C.F.R. sec. 1.482-1T(a)(2) (1994) (1993 temporary regulations). The
1994 final regulations had similar provisions:

       The district director may make allocations between or
       among the members of a controlled group if a controlled
       taxpayer has not reported its true taxable income. In such
       case, the district director may allocate income, deductions,

       with income” standard by providing that these methods could be
       applied to adjust the consideration charged in the year of examination
       (periodic adjustments) unless one of three narrow exceptions applied.
59 Fed. Reg. 34972 (July 8, 1994).
                                    206

      credits, allowances, basis, or any other item or element
      affecting taxable income (referred to as allocations). * * *

26 C.F.R. sec. 1.482-1(a)(2) (2006) (1994 final regulations).

      The 1994 final regulations’ definition of the word “controlled”,
which was similar to the definition in the 1993 temporary regulations,
was as follows:

      Controlled includes any kind of control, direct or indirect,
      whether legally enforceable or not, and however
      exercisable or exercised, including control resulting from
      the actions of two or more taxpayers acting in concert or
      with a common goal or purpose. It is the reality of the
      control that is decisive, not its form or the mode of its
      exercise. A presumption of control arises if income or
      deductions have been arbitrarily shifted.

26 C.F.R. sec. 1.482-1(i)(4) (2006) (1994 final regulations); see 26 C.F.R.
sec. 1.482-1T(g)(4) (1994) (1993 temporary regulations).

      Like the 1993 temporary regulations, the 1994 final regulations
defined a “group of controlled taxpayers” as “the taxpayers owned or
controlled directly or indirectly by the same interests.” 26 C.F.R. sec.
1.482-1(i)(6) (2006) (1994 final regulations); 26 C.F.R. sec. 1.482-1T(g)(6)
(1994) (1993 temporary regulations).

       The 1994 final regulations, like the 1993 temporary regulations,
defined a “controlled transaction” as “any transaction * * * between two
or more members of the same group of controlled taxpayers.” 26 C.F.R.
sec. 1.482-1(i)(8) (2006) (1994 final regulations); 26 C.F.R. sec. 1.482-
1T(g)(8) (1994) (1993 temporary regulations).

     The 1994 final regulations’ definition of the term “true taxable
income” was similar to the definition in the 1993 temporary regulations:

      True taxable income means, in the case of a controlled
      taxpayer, the taxable income that would have resulted had
      it dealt with the other member or members of the group at
      arm’s length. * * *

26 C.F.R. sec. 1.482-1(i)(9) (2006) (1994 final regulations); 26 C.F.R. sec.
1.482-1T(g)(9) (1994) (1993 temporary regulations).
                                   207

      The 1994 final regulations contained provisions regarding the
purpose of section 482, which included a reference to the tax-parity goal.
The purpose provisions in the 1994 final regulations were:

      The purpose of section 482 is to ensure that taxpayers
      clearly reflect income attributable to controlled
      transactions, and to prevent the avoidance of taxes with
      respect to such transactions.     Section 482 places a
      controlled taxpayer on a tax parity with an uncontrolled
      taxpayer by determining the true taxable income of the
      controlled taxpayer. * * *

26 C.F.R. sec. 1.482-1(a) (2006) (1994 final regulations). These
provisions were the same as the provisions in the 1993 temporary
regulations, except that the 1994 final regulations omitted the clause “in
a manner that reasonably reflects the relative economic activity
undertaken by each taxpayer.” 26 C.F.R. sec. 1.482-1T(a)(1) (1994)
(1993 temporary regulations).        The preamble to the 1994 final
regulations explained this omission.

      The definition of true taxable income in § 1.482-1(i)(9)
      already incorporates the notion that, under section 482, the
      controlled taxpayer should earn the amount of income that
      would have resulted had it dealt with other controlled
      taxpayers at arm’s length. Because a transaction at arm’s
      length naturally would reflect the ‘relative economic
      activity undertaken,’ this definition incorporates that
      concept, and it is unnecessary to include the additional
      language in this provision.

T.D. 8552, 59 Fed. Reg. 34976.

      The 1994 final regulations contained a sentence similar to the
sentence in the 1993 temporary regulations that imposed the arm’s-
length standard. 26 C.F.R. sec. 1.482-1(b)(1) (2006) (1994 final
regulations); 26 C.F.R. sec. 1.482-1T(b)(1) (1994) (1993 temporary
regulations). The sentence in the 1994 final regulations was this: “In
determining the true taxable income of a controlled taxpayer, the
standard to be applied in every case is that of a taxpayer dealing at arm’s
length with an uncontrolled taxpayer.” 26 C.F.R. sec. 1.482-1(b)(1)
(2006) (1994 final regulations).
                                   208

       As explained before, the 1993 temporary regulation adopted the
following sentence: “A controlled transaction meets the arm’s length
standard if the results of that transaction are consistent with the results
that would have been realized if uncontrolled taxpayers had engaged in
a comparable transaction under comparable circumstances.” 26 C.F.R.
sec. 1.482-1T(b)(1) (1994) (1993 temporary regulations). The parallel
sentence in the 1994 final regulations was this: “A controlled transaction
meets the arm’s length standard if the results of the transaction are
consistent with the results that would have been realized if uncontrolled
taxpayers had engaged in the same transaction under the same
circumstances (arm’s length result).” 26 C.F.R. sec. 1.482-1(b)(1) (2006)
(1994 final regulations).

       The 1994 final regulations under section 482, which were
promulgated by Treasury Decision 8552, included 26 C.F.R. sec. 1.482-
1(h)(2) (2006) (1994 final regulations). Subparagraph (2), headed “Effect
of foreign legal restrictions”, provides:

             (i) In general. The district director will take into
      account the effect of a foreign legal restriction to the extent
      that such restriction affects the results of transactions at
      arm’s length. Thus, a foreign legal restriction will be taken
      into account only to the extent that it is shown that the
      restriction affected an uncontrolled taxpayer under
      comparable circumstances for a comparable period of time.
      In the absence of evidence indicating the effect of the
      foreign legal restriction on uncontrolled taxpayers, the
      restriction will be taken into account only to the extent
      provided in paragraphs (h)(2)(iii) and (iv) of this section
      (Deferred income method of accounting).

             (ii) Applicable legal restrictions. Foreign legal
      restrictions (whether temporary or permanent) will be
      taken into account for purposes of this paragraph (h)(2)
      only if, and so long as, the conditions set forth in
      paragraphs (h)(2)(ii)(A) through (D) of this section are met.
             (A) The restrictions are publicly promulgated,
      generally applicable to all similarly situated persons (both
      controlled and uncontrolled), and not imposed as part of a
      commercial transaction between the taxpayer and the
      foreign sovereign;
                            209

       (B) The taxpayer (or other member of the controlled
group with respect to which the restrictions apply) has
exhausted all remedies prescribed by foreign law or
practice for obtaining a waiver of such restrictions (other
than remedies that would have a negligible prospect of
success if pursued);

       (C) The restrictions expressly prevented the
payment or receipt, in any form, of part or all of the arm’s
length amount that would otherwise be required under
section 482 (for example, a restriction that applies only to
the deductibility of an expense for tax purposes is not a
restriction on payment or receipt for this purpose); and

       (D) The related parties subject to the restriction did
not engage in any arrangement with controlled or
uncontrolled parties that had the effect of circumventing
the restriction, and have not otherwise violated the
restriction in any material respect.

      (iii) Requirement for electing the deferred income
method of accounting. If a foreign legal restriction
prevents the payment or receipt of part or all of the arm’s
length amount that is due with respect to a controlled
transaction, the restricted amount may be treated as
deferrable if the following requirements are met—

       (A) The controlled taxpayer establishes to the
satisfaction of the district director that the payment or
receipt of the arm’s length amount was prevented because
of a foreign legal restriction and circumstances described
in paragraph (h)(2)(ii) of this section; and

       (B) The controlled taxpayer whose U.S. tax liability
may be affected by the foreign legal restriction elects the
deferred income method of accounting, as described in
paragraph (h)(2)(iv) of this section, on a written statement
attached to a timely U.S. income tax return (or an amended
return) filed before the IRS first contacts any member of
the controlled group concerning an examination of the
return for the taxable year to which the foreign legal
restriction applies. A written statement furnished by a
taxpayer subject to the Coordinated Examination Program
                             210

will be considered an amended return for purposes of this
paragraph (h)(2)(iii)(B) if it satisfies the requirements of a
qualified amended return for purposes of § 1.6664-2(c)(3)
as set forth in those regulations or as the Commissioner
may prescribe by applicable revenue procedures. The
election statement must identify the affected transactions,
the parties to the transactions, and the applicable foreign
legal restrictions.

       (iv) Deferred income method of accounting. If the
requirements of paragraph (h)(2)(ii) of this section are
satisfied, any portion of the arm’s length amount, the
payment or receipt of which is prevented because of
applicable foreign legal restrictions, will be treated as
deferrable until payment or receipt of the relevant item
ceases to be prevented by the foreign legal restriction. For
purposes of the deferred income method of accounting
under this paragraph (h)(2)(iv), deductions (including the
cost or other basis of inventory and other assets sold or
exchanged) and credits properly chargeable against any
amount so deferred, are subject to deferral under the
provisions of § 1.461-1(a)(4). In addition, income is
deferrable under this deferred income method of
accounting only to the extent that it exceeds the related
deductions already claimed in open taxable years to which
the foreign legal restriction applied.

       (v) Examples. The following examples, in which Sub
is a Country FC subsidiary of U.S. corporation, Parent,
illustrate this paragraph (h)(2).

              Example 1. Parent licenses an intangible to
      Sub. FC law generally prohibits payments by any
      person within FC to recipients outside the country.
      The FC law meets the requirements of paragraph
      (h)(2)(ii) of this section. There is no evidence of
      unrelated parties entering into transactions under
      comparable circumstances for a comparable period
      of time, and the foreign legal restrictions will not be
      taken into account in determining the arm’s length
      amount. The arm’s length royalty rate for the use of
      the intangible property in the absence of the foreign
      restriction is 10% of Sub’s sales in country FC.
                       211

However, because the requirements of paragraph
(h)(2)(ii) of this section are satisfied, Parent can elect
the deferred income method of accounting by
attaching to its timely filed U.S. income tax return a
written statement that satisfies the requirements of
paragraph (h)(2)(iii)(B) of this section.

      Example 2. (i) The facts are the same as in
Example 1, except that Sub, although it makes no
royalty payment to Parent, arranges with an
unrelated intermediary to make payments equal to
an arm’s length amount on its behalf to Parent.

        (ii) The district director makes an allocation
of royalty income to Parent, based on the arm’s
length royalty rate of 10%. Further, the district
director determines that because the arrangement
with the third party had the effect of circumventing
the FC law, the requirements of paragraph
(h)(2)(ii)(D) of this section are not satisfied. Thus,
Parent could not validly elect the deferred income
method of accounting, and the allocation of royalty
income cannot be treated as deferrable.             In
appropriate circumstances, the district director may
permit the amount of the distribution to be treated
as payment by Sub of the royalty allocated to Parent,
under the provisions of § 1.482-1(g) (Collateral
adjustments).

       Example 3. The facts are the same as in
Example 1, except that the laws of FC do not prevent
distributions    from    corporations     to    their
shareholders. Sub distributes an amount equal to
8% of its sales in country FC. Because the laws of
FC did not expressly prevent all forms of payment
from Sub to Parent, Parent cannot validly elect the
deferred income method of accounting with respect
to any of the arm’s length royalty amount. In
appropriate circumstances, the district director may
permit the 8% that was distributed to be treated as
payment by Sub of the royalty allocated to Parent,
under the provisions of § 1.482-1(g) (Collateral
adjustments).
                                   212

                    Example 4. The facts are the same as in
             Example 1, except that Country FC law permits the
             payment of a royalty, but limits the amount to 5% of
             sales, and Sub pays the 5% royalty to Parent. Parent
             demonstrates the existence of a comparable
             uncontrolled transaction for purposes of the
             comparable uncontrolled transaction method in
             which an uncontrolled party accepted a royalty rate
             of 5%. Given the evidence of the comparable
             uncontrolled transaction, the 5% royalty rate is
             determined to be the arm’s length royalty rate.

       The preamble to Treasury Decision 8552 explains the final 1994
regulations. The portion of the preamble related to 26 C.F.R. sec. 1.482-
1(h)(2) (2006) states:

             The rules on foreign legal restrictions were
      originally issued in proposed form in the 1993 regulations.
      Section 1.482-1(h)(2) modifies and finalizes that provision.
      It provides that a foreign legal restriction will be taken into
      account to the extent that such restriction affects the
      results of transactions at arm’s length. If there is no
      evidence that the restriction affected uncontrolled
      taxpayers the restriction will be disregarded in
      determining an arm’s length result, and it will be taken
      into account only to the extent provided in §§ 1.482-
      1(h)(2)(iii) and (iv), relating to the deferred income method
      of accounting. A foreign legal restriction is generally
      defined under § 1.482-1(h)(2)(ii) as a restriction that is
      publicly promulgated and generally applicable, not
      imposed as part of a commercial transaction between the
      taxpayer and the foreign government, with respect to
      which the taxpayer has exhausted all practicable legal
      remedies afforded under foreign law, expressly prevents
      the payment, in any form, of an arm’s length amount
      within the meaning of section 482, and was not otherwise
      circumvented by the controlled taxpayers.

            Section 1.482-1(h)(2)(iii) provides that if a provision
      meets the definition of a foreign legal restriction and the
      taxpayer has elected the deferred income method of
      accounting, any section 482 allocation connected with the
                                  213

      transaction will be deferrable until the restriction is
      removed.

            Section 1.482-1(h)(2)(iv) provides that if the
      requirements of § 1.482-1(h)(2)(iii) are satisfied, the
      amount subject to the restriction will be treated as
      deferrable until payment or receipt of the relevant item
      ceases to be prevented by the foreign legal restriction.
      Deductions and credits incurred in open years and that are
      chargeable against a deferred amount are subject to
      deferral under § 1.461-1(a)(4).

59 Fed. Reg. 34981.

      OO.    Stipulations regarding the 1994 final regulations

       Petitioner and respondent have stipulated that the
“administrative record pertaining to the adoption of subparagraph (h)(2)
of Treas. Reg. § 1.482-1 consists of the following documents”:

      ●      The 1992 notice of proposed rulemaking, dated January 30,
             1992. 57 Fed. Reg. 3571 (Jan. 30, 1992).

      ●      “1993 Temporary Income Tax Regulations (T.D. 8470; 58
             FR 5263-02), dated January 21, 1993.” Note that the
             stipulation here cites only Treasury Decision 8470, and
             fails to acknowledge the three later corrections to Treasury
             Decision 8470 relating to errors in the 1993 temporary
             regulations. The three corrections are 58 Fed. Reg. 17775
             (Apr. 6, 1993); 58 Fed. Reg. 28446 (May 13, 1993); and 58
             Fed. Reg. 28921 (May 18, 1993). As noted in the fourth
             bullet point below, the stipulation later mistakenly says
             the corrections are to the 1993 notice of proposed
             rulemaking. These anomalies in the stipulation appear to
             be to be insignificant.

      ●      The 1993 notice of proposed rulemaking, dated January 21,
             1993. 58 Fed. Reg. 5310 (Jan. 21, 1993).

      ●      “Corrections to the 1993 Notice of Proposed Rulemaking,
             dated April 6, 1993 (58 Fed. Reg. 17775), dated May 13,
             1993 (58 Fed. Reg. 28446), dated May 18, 1993 (58 Fed.
             Reg. 28921).” In our view, while the first correction related
                                    214

             to both the 1993 temporary regulation and the 1993 notice
             of proposed rulemaking, the second and third corrections
             related only to the 1993 temporary regulations. They did
             not relate to the 1993 notice of proposed rulemaking.

      ●      Public comments:

             ○      American Petroleum Institute, dated June 20, 1993,
             ○      Tax Executives Institute, dated August 6, 1993,
             ○      TRW, dated July 16, 1993, and
             ○      United States Council for International Business,
                    dated July 21, 1993.

      ●      The 1994 final regulations, T.D. 8552, dated July 8, 1994.
             59 Fed. Reg. 34971 (July 8, 1994).

       Petitioner and respondent stipulated that the fixed ceilings on the
amounts payable as royalties for the licensing of patents, unpatented
technology, and trademarks are Brazilian legal restrictions that apply
only to payments made by a Brazilian company to a controlling foreign
company. Petitioner and respondent stipulated that therefore, at all
relevant times, including during the 2006 tax year, there is no evidence
that these legal restrictions affected “an uncontrolled taxpayer under
comparable circumstances for a comparable period of time” within the
meaning of 26 C.F.R. sec. 1.482-1(h)(2)(i) (2006).

       Petitioner and respondent have stipulated that petitioner did not
elect the deferred income method of accounting described in 26 C.F.R.
sec. 1.482-1(h)(2)(iv) (2006), and that petitioner does not assert that it is
entitled to use that method.

      PP.    The 1996 amendment to section 7805(a) regarding
             regulations relating to post-1996 provisions of the Internal
             Revenue Code

      When the section 482 regulations were adopted in 1994, section
7805 could be summarized as follows:

      ●      Section 7805(a) authorized the Treasury Department to
             prescribe all “needful” regulations for the enforcement of
             the Internal Revenue Code. 26 U.S.C. sec. 7805(a) (1994).
                                         215

        ●       Section 7805(b) authorized the Treasury Department to
                determine the extent, if any, to which such regulations
                would apply without retroactive effect. 26 U.S.C. sec.
                7805(b) (1994). 161

       In 1996, however, Congress amended section 7805(b) to provide
as follows:

               (1) In general.--Except as otherwise provided in this
        subsection, no temporary, proposed, or final regulation
        relating to the internal revenue laws shall apply to any
        taxable period ending before the earliest of the following
        dates:

                      (A) The date on which such regulation is filed
                with the Federal Register.

                      (B) In the case of any final regulation, the
                date on which any proposed or temporary regulation
                to which such final regulation relates was filed with
                the Federal Register.

                      (C)      The date on which any notice
                substantially describing the expected contents of
                any temporary, proposed, or final regulation is
                issued to the public.

              (2) Exception for promptly issued regulations.--
        Paragraph (1) shall not apply to regulations filed or issued
        within 18 months of the date of the enactment of the
        statutory provision to which the regulation relates.

               (3) Prevention of abuse.--The Secretary may provide
        that any regulation may take effect or apply retroactively
        to prevent abuse.

               (4) Correction of procedural defects.--The Secretary
        may provide that any regulation may apply retroactively to
        correct a procedural defect in the issuance of any prior
        regulation.

        161 A similar provision had been in the tax laws since 1934. See supra part II.F

(discussing sec. 62 of the Revenue Act of 1934).
                                   216

            (5)    Internal regulations.--The limitation of
      paragraph (1) shall not apply to any regulation relating to
      internal Treasury Department policies, practices, or
      procedures.

             (6) Congressional authorization.--The limitation of
      paragraph (1) may be superseded by a legislative grant
      from Congress authorizing the Secretary to prescribe the
      effective date with respect to any regulation.

            (7) Election to apply retroactively.--The Secretary
      may provide for any taxpayer to elect to apply any
      regulation before the dates specified in paragraph (1).

             (8) Application to rulings.--The Secretary may
      prescribe the extent, if any, to which any ruling (including
      any judicial decision or any administrative determination
      other than by regulation) relating to the internal revenue
      laws shall be applied without retroactive effect.

Sec. 7805(b), as amended by the Taxpayer Bill of Rights 2, Pub. L. No.
104-168, sec. 1101(a), 110 Stat. at 1468 (1996).

       So, before the 1996 amendment section 7805(b) gave the Treasury
Department the discretion to make regulations without retroactive
effect. See TBL Licensing LLC v. Commissioner, 158 T.C. ___ (slip op.
at 25 n.10 (Jan. 31, 2022) (stating that under pre-1996 section 7805(b),
“regulations generally applied retroactively unless the Secretary of the
Treasury exercised his discretion to apply them prospectively”). But
after the 1996 amendment section 7805(b) generally imposed an
antiretroactivity rule that was keyed to when the public received notice
of the content of the regulation.

       Under the effective-date provision of the 1996 amendment, the
1996 amendment applied “with respect to regulations which relate to
statutory provisions enacted on or after the date of the enactment of this
Act [July 30, 1996].” Taxpayer Bill of Rights 2, sec. 1101(b), 110 Stat. at
1469. Would the 1994 final regulations (including 26 C.F.R. sec. 1.482-
1(h)(2) (2006)) be considered “regulations which relate to statutory
provisions enacted on or after the date of the enactment of this Act [July
30, 1996]”?
                                   217

       The effective-date provision of the 1996 amendment has been
interpreted to mean that the phrase “enacted on or after the date of the
enactment of this Act” modifies the term “statutory provisions.”
Grapevine Imp., Ltd. v. United States, 636 F.3d 1368, 1381 n.6 (Fed.
Cir. 2011), vacated and remanded, 566 U.S. 971 (2012); Esden v. Bank
of Bos., 229 F.3d 154, 171 n.21 (2d Cir. 2000); TBL Licensing LLC v.
Commissioner, 158 T.C. at ___ (slip op. at 25 n.10); Intermountain Ins.
Serv. of Vail, LLC v. Commissioner, 134 T.C. 211, 229 n.3 (2010)
(Halpern & Holmes, JJ., concurring in result only), rev’d and remanded,
650 F.3d 691 (D.C. Cir. 2011), vacated and remanded, 566 U.S. 972
(2012); Steve R. Johnson, “Preserving Fairness in Tax Administration
in the Mayo Era”, 32 Va. Tax Rev. 269, 312 (2012). Under this view, the
1996 amendment to section 7805(b) would not govern the 1994 final
regulations. The 1994 final regulations related to section 482, which
was enacted before 1996. Therefore, the pre-1996 version of section
7805(b) would govern the 1994 final regulations. But pre-1996 section
7805(b) would have no effect on whether the 1994 final regulations are
applicable for the 2006 tax year. The pre-1996 version of section 7805(b)
generally provided that tax regulations are applied retroactively, but
that is irrelevant to the 1994 final regulations as applied for the 2006
tax year, as that is a prospective application.

       Another interpretation of the effective-date provision of the 1996
amendment to section 7805(b) is that the phrase “enacted on or after”
modifies the word “regulations” and not the phrase “statutory
provisions”.      John Bunge, “Statutory Protection From IRS
Reinterpretation of Old Tax Laws”, 144 Tax Notes 1177 (2014). Under
this view, the 1996 amendment to section 7805(b) would govern the 1994
regulations because these regulations could not be said to have been
“enacted” after 1996; they were promulgated in 1994. If the 1996
amendments to section 7805(b) govern the 1994 final regulations, then
section 7805(b) does not prevent the 1994 final regulations from being
applicable for the 2006 tax year of the 3M consolidated group. The post-
1996 version of section 7805(b) is essentially a prohibition on retroactive
regulations, see sec. 7805(b)(1), with certain exceptions. But the 1994
final regulations are prospective, not retroactive, with respect to the
2006 tax year.

      The bottom line is that neither version of section 7805(b) would
preclude the 1994 final regulations from being applicable for the 2006
tax year.
                                   218

      QQ.    Post-2006 amendments to section 482

      After 2006, the tax year at issue, section 482 was affected by
several amendments.

      A 2017 law amended section 482 to add a third sentence:

      For purposes of this section, the Secretary shall require the
      valuation of transfers of intangible property (including
      intangible property transferred with other property or
      services) on an aggregate basis or the valuation of such a
      transfer on the basis of the realistic alternatives to such a
      transfer, if the Secretary determines that such basis is the
      most reliable means of valuation of such transfers.

Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, sec. 14221(b)(2), 131
Stat. at 2219 (codified at 26 U.S.C. sec. 482 (2018)). The amendment
was applicable for transfers in tax years beginning after December 31,
2017. Id. subsec. (c)(1).

       The same 2017 law indirectly affected the second sentence of
section 482. As it was enacted in 1986, the sentence referred to
“intangible property (within the meaning of section 936(h)(3)(B))”. 26
U.S.C. sec. 482 (Supp. IV 1987). Section 936(h)(3)(B) then provided:

             The term “intangible property” means any--

            (i) patent, invention, formula, process, design,
         pattern, or know-how;

            (ii) copyright, literary, musical, or artistic
         composition;
            (iii) trademark, trade name, or brand name;

             (iv) franchise, license, or contract;

            (v) method, program, system, procedure, campaign,
         survey, study, forecast, estimate, customer list, or
         technical data; or

             (vi) any similar item,
                                   219

      which has substantial value independent of the services of
      any individual.

26 U.S.C. sec. 936(h)(3)(B) (1982). In 2017, the definition of intangible
property in section 936(h)(3)(B) was amended. Tax Cuts and Jobs Act
of 2017, sec. 14221(a), 131 Stat. at 2218. After the 2017 amendment,
section 936(h)(3)(B) provided:

             The term “intangible property” means any--

             (i) patent, invention, formula, process, design,
          pattern, or know-how;

             (ii) copyright,    literary,   musical,   or   artistic
          composition;

             (iii) trademark, trade name, or brand name;

             (iv) franchise, license, or contract;

             (v) method, program, system, procedure, campaign,
          survey, study, forecast, estimate, customer list, or
          technical data;

             (vi) any goodwill, going concern value, or workforce
          in place (including its composition and terms and
          conditions (contractual or otherwise) of its
          employment); or

             (vii) any other item the value or potential value of
          which is not attributable to tangible property or the
          services of any individual.
26 U.S.C. sec. 936(h)(3)(B) (2012 ed. & Supp. V 2018). This amendment
too was applicable for transfers in tax years beginning after December
31, 2017. Tax Cuts and Jobs Act of 2017, sec. 14221(c)(1).

      In 2018, section 482 was amended to replace the words
“intangible property (within the meaning of section 936(h)(3)(B))” with
the words “intangible property (within the meaning of section
367(d)(4))”. Consolidated Appropriations Act, 2018, Pub. L. No. 115-141,
div. U, sec. 401(d)(1)(D)(viii)(III), 132 Stat. at 1207. Section 367(d)(4)
provides:
                                   220

            For purposes of this subsection, the term “intangible
      property” means any--

                   (A) patent, invention,       formula,   process,
             design, pattern, or know-how,

                  (B) copyright, literary, musical, or artistic
             composition,

                    (C) trademark, trade name, or brand name,

                    (D) franchise, license, or contract,

                   (E) method, program, system, procedure,
             campaign, survey, study, forecast, estimate,
             customer list, or technical data,

                   (F) goodwill, going concern value, or
             workforce in place (including its composition and
             terms and conditions (contractual or otherwise) of its
             employment), or

                    (G) other item the value or potential value of
             which is not attributable to tangible property or the
             services of any individual.

Consolidated Appropriations Act, 2018, sec. 401(d)(1)(D)(viii)(I), 132
Stat. at 1207 (codified at 26 U.S.C. sec. 367(d)(4) (2018)). The 2018
amendment had retroactive effect only to the extent the 2018 version of
section 482 would result in the same tax liability as the pre-2018
version, i.e., only if the 2018 amendment would have no effect.
Consolidated Appropriations Act, 2018, div. U, sec. 401(e), 132 Stat. at
1212-1213.

       In summary, the 2017 amendments to section 482 and section
936(h)(3)(B) added a third sentence to section 482 and altered the
section 936(h)(3)(B) definition of intangible property.             These
amendments had prospective effect only and therefore did not affect the
2006 tax year at issue in this case. The 2018 amendment to section 482
changed the cross-reference in the definition of intangible property to
the section 367(d)(4) definition of intangible property. But the 2018
amendment does not apply retroactively to past years such as 2006 to
the extent it would affect tax liabilities. Therefore, for the purposes of
                                   221

the 3M consolidated group’s 2006 tax year, the operative text of section
482 is the text before the 2017 and 2018 amendments, which is:

              In any case of two or more organizations, trades, or
      businesses (whether or not incorporated, whether or not
      organized in the United States, and whether or not
      affiliated) owned or controlled directly or indirectly by the
      same interests, the Secretary may distribute, apportion, or
      allocate gross income, deductions, credits, or allowances
      between or among such organizations, trades, or
      businesses, if he determines that such distribution,
      apportionment, or allocation is necessary in order to
      prevent evasion of taxes or clearly to reflect the income of
      any of such organizations, trades, or businesses. In the
      case of any transfer (or license) of intangible property
      (within the meaning of section 936(h)(3)(B)), the income
      with respect to such transfer or license shall be
      commensurate with the income attributable to the
      intangible.

26 U.S.C. sec. 482 (Supp. IV 1987). And the operative text of section
936(h)(3)(B) is:

      The term “intangible property means any--

             (i) patent, invention, formula, process, design,
             pattern, or know-how;

             (ii) copyright,    literary,   musical,   or   artistic
             composition;

             (iii) trademark, trade name, or brand name;

             (iv) franchise, license, or contract;

             (v)  method,       program,    system, procedure,
             campaign, survey, study, forecast, estimate,
             customer list, or technical data; or

             (vi) any similar item,

      which has substantial value independent of the services of
      any individual.
                                            222

26 U.S.C. sec. 936(h)(3)(B) (1982).

III.    Whether the Brazilian legal restrictions satisfy the seven
        requirements of 26 C.F.R. sec. 1.482-1(h)(2) (2006) for taking into
        account foreign legal restrictions

       Title 26 C.F.R. sec. 1.482-1(h)(2) (2006) provides that a foreign
legal restriction is taken into account in making allocations under
section 482 if seven 162 requirements are met: (1) the restriction affected
uncontrolled taxpayers under comparable circumstances for a
comparable period of time, (2) the restriction was publicly promulgated,
(3) the restriction was generally applicable to all similarly situated
persons (both controlled and uncontrolled), (4) the restriction was not
imposed as part of a commercial transaction between the taxpayer and
the foreign government, (5) the taxpayer exhausted all remedies
prescribed by foreign law or practice for obtaining a waiver of the
restriction (other than remedies that would have a negligible prospect
of success), (6) the restriction expressly prevented the payment or
receipt, in any form, of all or part of the arm’s-length amount, and (7) the
taxpayer and related parties did not engage in any arrangement with
controlled or uncontrolled parties that circumvented the restriction, and
did not materially violate the restriction. 26 C.F.R. sec. 1.482-1(h)(2)(i)
and (ii) (2006). 163     Petitioner contends that the Brazilian legal
restrictions met some of these seven requirements. 164 We discuss

        162Title 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006) requires that the foreign legal
restriction be “publicly promulgated, generally applicable to all similarly situated
persons (both controlled and uncontrolled), and not imposed as part of a commercial
transaction between the taxpayer and the foreign sovereign.” As petitioner recognizes,
this requirement consists of three conjunctive parts. Thus, each part must be
independently satisfied for the foreign legal restriction to be taken into account. Our
Opinion refers to the three parts of 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006) as the
second requirement, the third requirement, and the fourth requirement, respectively,
of 26 C.F.R. sec. 1.482-1(h)(2) (2006).
        163 The regulation also takes a foreign legal restriction into account if the

taxpayer elects to defer the restricted income, 26 C.F.R. sec. 1.482-1(h)(2)(i), (iv) (2006),
but the 3M consolidated group did not make such an election. Furthermore, the
election is available only with respect to foreign legal restrictions that meet the last
six requirements. Id. subdiv. (iv).
        164 Although all seven requirements must be met for the Brazilian legal
restrictions to be taken into account under 26 C.F.R. sec. 1.482-1(h)(2) (2006), from
petitioner’s perspective it is not futile to argue that only some of the requirements are
                                        223

whether each of the seven requirements of 26 C.F.R. sec. 1.482-1(h)(2)
(2006) is met below in part III.A, B, C, D, E, F, and G, respectively.

       A.      Effect on uncontrolled taxpayers

       The first requirement, which is set forth in 26 C.F.R. sec. 1.482-
1(h)(2)(i) (2006), is that “a foreign legal restriction will be taken into
account only to the extent that it is shown that the restriction affected
an uncontrolled taxpayer under comparable circumstances for a
comparable period of time.” The stipulation states that the Brazilian
restrictions fail the first requirement:

              The parties agree that the fixed ceilings on the
       amounts payable as royalties for the licensing of patents,
       unpatented technology, and trademarks are Brazilian legal
       restrictions that apply only to payments made by a
       Brazilian company to a controlling foreign company.
       Therefore, at all relevant times, including during the 2006
       year, there is no evidence that these legal restrictions
       affected “an uncontrolled taxpayer under comparable
       circumstances for a comparable period of time” within the
       meaning of Treas. Reg. § 1.482-1(h)(2)(i).

And in its briefs, petitioner does not dispute that the Brazilian
restrictions fail the first requirement. We therefore hold that the
Brazilian restrictions fail the first requirement.

met. This is because petitioner argues that the remaining requirements are invalid.
In particular, petitioner challenges the validity of

       •       the first requirement, see infra part V.A,

       •       the second requirement, see infra parts V.B, VI.B.3

       •       the third requirement, see infra part V.C,

       •       the fifth requirement, see infra part VI.B.4,

       •       the sixth requirement, see infra part V.F, and

       •       the seventh requirement, see infra parts V.G, VI.B.5.
        A table infra part VII illustrates the relationship between (1) petitioner’s
arguments that particular requirements are met and (2) petitioner’s arguments that
particular requirements are invalid.
        Additionally, petitioner makes challenges to the validity of the regulation
unrelated to any individual requirement of the regulation. See infra parts IV, VI.A,
VI.B.1, VI.B.2, and VI.B.6.
                                          224

        B.      Publicly promulgated

       The second requirement, which is set forth in 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(A) (2006), is that the foreign legal restriction be “publicly
promulgated”. As part of their dispute over whether the second
requirement is met, petitioner and respondent disagree on the meaning
of the term “publicly promulgated”. Respondent contends that to be
publicly promulgated a foreign legal restriction must be in writing.
Petitioner disagrees. It contends that a foreign legal restriction need
not be in writing to be publicly promulgated. 165

        In favor of its position that a foreign legal restriction need not be
in writing, petitioner contends that the restrictions at issue in
Commissioner v. First Security Bank, 405 U.S. 394, Texaco, Inc. v.
Commissioner, 98 F.3d 825, and Procter & Gamble Co. v. Commissioner,
95 T.C. 323, were not in writing. We disagree. The restrictions at issue
in all three cases were in writing:

        ●       First Security Bank concerned a federal statute, section 92
                of the National Bank Act, which authorized national banks
                “doing business in any place the population of which does
                not exceed five thousand inhabitants * * * [to] act as the
                agent for any fire, life, or other insurance company”. Act of
                Sept. 7, 1916, ch. 461, 39 Stat. at 753. Commissioner v.
                First Security Bank, 405 U.S. at 401, explained that this
                statute had been interpreted as implicitly prohibiting
                national banks from acting as insurance agents in places
                populated by more than 5,000 inhabitants: “Although § 92
                does not explicitly prohibit banks in places with a
                population of over 5,000 from acting as insurance agents,
                courts have held that it does so by implication.” As support
                for this statement, Commissioner v. First Security Bank,
                405 U.S. at 401 n.13, cited the following two judicial
                opinions: “Saxon v. Georgia Association of Independent

         165 Petitioner makes an alternative argument that if the public-promulgation

requirement means that a foreign legal restriction must be in writing, then the public-
promulgation requirement is an unreasonable interpretation of sec. 482 that is invalid
under Chevron step two. We analyze this Chevron-step-two argument in a different
part of this Opinion. See infra part V.B. In the present part of this Opinion (i.e., part
III.B) we consider whether the public-promulgation requirement of 26 C.F.R. sec.
1.482-1(h)(2) (2006) is met assuming that requirement is valid under Chevron step
two.
                                      225

              Insurance Agents, Inc., 399 F.2d 1010 (CA5 1968). See
              Commissioner v. Morris Trust, 367 F.2d 794, 795 (CA4
              1966).” These two opinions were in writing and were
              published in the Federal Reporter. The statutory provision
              itself was also in writing, e.g., it was published in the
              Statutes at Large, although it had been omitted from the
              United States Code. U.S. Nat’l Bank of Or. v. Indep. Ins.
              Agents of Am., 508 U.S. 439 (1993); Commissioner v. First
              Security Bank, 405 U.S. at 401 n.12. 166

       ●      In Procter & Gamble Co. v. Commissioner, 95 T.C. at 336,
              the restrictions in question were reflected in letters from
              the Spanish government, an order by the Spanish Ministry
              of Industry, and Decree 3099/1976. These were written
              documents.

       ●      In Texaco, Inc. v. Commissioner, 98 F.3d at 827, the
              restrictions in question were “authorized by the King [of
              Saudi Arabia] and communicated to Aramco by
              [Petroleum] Minister Yamani in Letter 103/z, dated
              January 23, 1979.” Letter 103/z was a written document.

Thus, all three cases concerned legal restrictions that were in writing.
Although the courts held that the legal restrictions must be accounted
for in making transfer-pricing determinations, the courts did not
address the question of whether an unwritten legal restriction must be
accounted for.
       Furthermore, the three cases did not construe the public-
promulgation requirement imposed by 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A)
(2006) because the transactions at issue were not governed by that
provision. See supra part II.FF (describing the transactions at issue in
First Security Bank), HH (describing the transactions at issue in Procter
& Gamble and Texaco, Inc.), and NN (discussing the effective-date
provisions of the 1994 final regulations). Because the three cases did
not interpret this regulatory requirement, they did not address the
meaning of the term “publicly promulgated”. In particular, they did not
address the issue of whether a “publicly promulgated” restriction must
be in writing.

        166 We have previously observed that the Supreme Court in Commissioner v.

First Security Bank, 405 U.S. at 402, held that the prohibition on national banks’
acting as insurance agents could be assumed to be a prohibition on national banks’
receiving insurance commission income. See supra part II.FF.
                                   226

       In our view, a foreign legal restriction is “publicly promulgated”
within the meaning of 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006) only if
the restriction is in writing. Taking unwritten restrictions into account
in determining section 482 allocations would foster disputes between
taxpayers and the Internal Revenue Service as to the substance of
unwritten rules made by foreign governments. Furthermore, there
would be uncertainty in the computation of federal tax liabilities to the
extent such liabilities were potentially affected by such rules. We are
reluctant to assign a meaning to the words of the regulation that would
foster tax disputes and result in uncertainty about tax liabilities. See
Mayo Found. for Med. Educ. & Res. v. United States, 562 U.S. 44, 59
(2011) (holding that it is reasonable to interpret a statute in such a way
as to avoid “continuing uncertainty” and “wasteful litigation”). The
regulation in question was written by the agency charged with “the
administration and enforcement” of the federal tax laws. Sec. 7801(a)(1)
(setting forth powers and duties of Secretary of the Treasury). We hold
that the regulation’s reference to a “publicly promulgated” restriction is
meant to include only a written restriction. With this interpretation of
the term “publicly promulgated” in 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A)
(2006) in mind, we now consider whether the Brazilian legal restrictions
at issue in this case were publicly promulgated.

       Printed below is petitioner’s initial argument that the Brazilian
legal restrictions were publicly promulgated:

             In this case, a statute--the Brazilian Foreign Capital
      Law (Law No. 4131/1962)--required Brazilian companies
      wanting to remit royalties abroad to submit evidence of the
      licensing agreement to the Brazilian Central Bank. Stip.
      ¶ 74. The Brazilian Central Bank issued formal written
      guidance--Circular-Letter No. 2795--that required a
      Brazilian licensee wanting to submit royalties abroad to
      produce evidence that the licensing agreement had been
      recorded by the BPTO. Stip. ¶ 75.b.

             Another statute--Law No. 3470/1958--imposed fixed
      ceilings on the tax deductibility of royalties that could be
      adjusted by the Brazilian Ministry of Finance. Stip. ¶ 87.
      The Ministry of Finance issued regulations establishing
      the deduction ceilings (Portaria No. 436/58, 113/59, 314/70,
      and 60/94). Stip. ¶ 88. Yet another statute--Law No.
      8383/1991--permitted “a Brazilian company to remit
                                      227

       royalties to its controlling foreign company to the extent
       such payments were made deductible for Brazilian tax
       purposes ....” Stip. ¶ 82.a. Thus, a statute restricted
       payment of royalties by imposing rate ceilings, and a
       regulation said what the rate ceilings were. These legal
       rules ought to satisfy any public promulgation
       requirement.

And respondent’s position is this:

       [A]t least a portion of the restrictions upon which 3M relies
       were not publicly promulgated. The pricing restrictions
       under Law No. 8383/1991 do not expressly apply to
       technology transfer payments for unpatented technology
       (such as trade secrets).           Nonetheless, the BPTO
       administratively extends these restrictions to unpatented
       technology by way of an unwritten interpretation. Stip.
       ¶ 90.

As to respondent’s position quoted above, petitioner concedes that “the
pricing restrictions for royalties on unpatented technology were
unwritten.” However, petitioner contends that these restrictions on
technology-transfer payments were publicly promulgated by the BPTO
because the stipulation states that (1) that the restrictions exist and
(2) penalties would apply if 3M Brazil violated the restrictions.

       The Brazilian restrictions on technology-transfer payments are
described in paragraph 90 of the stipulation, stating that “[u]nder” the
BPTO’s interpretation of Law Nos. 4131/1962 and 8382/1991 the BPTO
applies the same fixed ceilings that apply to patent or trademark
royalties to technology-transfer payments. 167 Paragraph 90 further
states that this interpretation was applied by the BPTO during 2006
and that it was not “published”. As we noted before, petitioner concedes
that the Brazilian restrictions on payments for technology transfers
were unwritten. So, in short, the Brazilian legal restrictions on
payments for technology transfers consist of the BPTO’s unwritten
interpretation of law described in paragraph 90. Therefore, the question
to consider is whether the BPTO’s unwritten interpretation described in
paragraph 90 of the stipulation is publicly promulgated.

       167   These fixed ceilings apply only to payments to controlling foreign
companies.
                                           228

       Petitioner contends that the BPTO’s interpretation should be
considered to have been publicly promulgated because the
interpretation exists. 168 But 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006)
requires not just that the foreign legal restriction exist. The restriction
must also be “publicly promulgated.” To be “publicly promulgated” the
restriction must be in writing, as we have explained. Petitioner
concedes that the BPTO’s interpretation is unwritten. This concession
is consistent with the stipulation, which says that the BPTO’s
interpretation is “unpublished.” Given petitioner’s concession that the
BPTO’s interpretation is unwritten, and given our interpretation of the
public-promulgation regulatory requirement, it follows that the BPTO’s
interpretation has not been publicly promulgated. 169

       Because we conclude that the restrictions on technology-transfer
payments were not publicly promulgated, we cannot conclude that the
relevant Brazilian legal restrictions were publicly promulgated. The
relevant Brazilian legal restrictions include both limits on technology-
transfer payments and limits on patent royalties. We know only the
cumulative effect of these limits. Paragraph 126 of the stipulation
establishes that the relevant Brazilian legal restrictions prohibited 3M
Brazil from paying more than $9,387,909 for patent royalties and for
technology transfers. 170 But the stipulation does not show how much of

        168 Petitioner states: “The Commissioner points out that the pricing restrictions

for royalties on unpatented technology were unwritten (i.e., they were applied by
analogy to the written rules applicable to patents)”. Resp. Br. 70.
      Although these rules were unwritten, they nonetheless were publicly
promulgated by the BPTO. They were not secret rules.
        169 Still another aspect of the Brazilian legal restrictions is that if a product is

covered by a patent license or by a technology-transfer agreement between a Brazilian
company and a controlling foreign company, then any trademark license between the
Brazilian company and the controlling foreign company for the same product must be
granted royalty-free. As to products covered by patent licenses, this requirement
would seem to be publicly promulgated. But as to products covered by technology-
transfer agreements, this requirement is found only in an unwritten BPTO policy
described in paragraph 94a of the stipulation.
        170The $9,387,909 amount was calculated before subtracting $5,104,756 of
trademark royalties actually paid by 3M Brazil, a subtraction required by the Brazilian
prohibition on a Brazilian company’s paying trademark royalties to its controlling
foreign company for a product covered by a patent license or technology-transfer
agreement. The $9,387,909 amount was also calculated before subtracting the
$4,117,370 R&D offset, a subtraction required by paragraph 128 of the stipulation.
When both the trademark royalty payment and the R&D offset are taken into account,
the sec. 482 adjustment would be $165,785. This adjustment assumes that the
                                      229

this maximum payment is attributable to the restrictions on patent
royalties. Petitioner, bearing the burden of proof, is required to show
how much the restrictions on patent royalties, standing alone, would
affect the appropriate section 482 allocation. Petitioner has not made
such a showing.

       We hold that the Brazilian legal restrictions at issue are not
publicly promulgated.

       C.     Generally applicable

       The third requirement, which is set forth in 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(A) (2006), is that the foreign legal restriction be generally
applicable to all similarly situated persons (both controlled and
uncontrolled). Petitioner does not contend that the Brazilian legal
restrictions are generally applicable. We hold that the Brazilian legal
restrictions do not meet the general-applicability requirement.

       D.     Not part of commercial transaction

       The fourth requirement, which is set forth in 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(A) (2006), is that the foreign legal restriction not have been
imposed as part of a commercial transaction between the taxpayer and
the foreign government. Although respondent broadly contends that the
Brazilian legal restrictions are not “publicly promulgated, generally
applicable to all similarly situated persons (both controlled and
uncontrolled) and not imposed as part of a commercial transaction
between the taxpayer and the foreign sovereign”, respondent does not
specifically contend that the Brazilian legal restrictions were imposed
as part of commercial transactions between the 3M consolidated group
and the government of Brazil. As a result, we hold that the Brazilian
legal restrictions were not imposed as part of commercial transactions
between the 3M consolidated group and the government of Brazil.

       E.     Exhaustion of remedies

        The fifth requirement, which is set forth in 26 C.F.R. sec. 1.482-
1(h)(2)(ii)(B) (2006), is that a foreign legal restriction is taken into
account only if the taxpayer has exhausted all remedies prescribed by
foreign law or practice for obtaining a waiver of the restriction (other

Brazilian restrictions on patent royalties and on technology-transfer payments are
taken into account (and therefore reflects petitioner’s position).
                                    230

than remedies that would have a negligible prospect of success if
pursued). Respondent contends that 3M Company did not exhaust its
remedies for obtaining a waiver of the relevant Brazilian restrictions.
Petitioner disagrees.

       It is not necessary for us to resolve the question of whether 3M
Company exhausted the remedies for obtaining a waiver of the Brazilian
legal restrictions. As we have explained, the Brazilian legal restrictions
at issue fail to meet the first, second, and third requirements of 26 C.F.R.
sec. 1.482-1(h)(2) (2006). See supra part III.A, B, and C. And as we
explain below, the Brazilian legal restrictions do not meet the sixth
requirement. See infra part III.F.

       F.     Restriction on payment in any form

        The sixth requirement, which is set forth in 26 C.F.R. sec 1.482-
1(h)(2)(ii)(C) (2006), is that a foreign legal restriction will be taken into
account only if it “expressly prevented the payment or receipt, in any
form, of part or all of the arm’s length amount that would be otherwise
be required under section 482 (for example, a restriction that applies
only to the deductibility of an expense for tax purposes is not a
restriction on payment or receipt for this purpose)”. Respondent
contends that the Brazilian legal restrictions do not meet the “any form”
requirement described above because, respondent contends, “Brazilian
law does not restrict 3M Brazil’s ability to pay dividends or interest-on-
net-equity out of its earnings and profits, including out of the additional
profits generated by reason of 3M Brazil’s failure to pay arm’s length
compensation.” Petitioner agrees that the Brazilian legal restrictions
fail this requirement.

       G.     Circumvention or violation of restriction

       The seventh requirement, which is set forth in 26 C.F.R. sec.
1.482-1(h)(2)(ii)(D) (2006), is that a foreign legal restriction is taken into
account only if the related parties did not engage in an arrangement
that had the effect of circumventing the restriction and did not violate
the restriction in a material respect. Respondent contends that 3M
Brazil materially violated the Brazilian legal restrictions. Petitioner
contends that 3M Brazil did not materially violate the Brazilian legal
restrictions. We need not determine whether 3M Brazil materially
violated the Brazilian legal restrictions, because we have held supra
part III.A, B, C, E, and F, that five other requirements of 26 C.F.R. sec.
1.482-1(h)(2) (2006) are not met.
                                         231

IV.    Chevron step one

       In determining whether to defer to an agency’s interpretation of
a statute, courts employ the two-step test articulated in Chevron,
U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-843
(1984). 171 Under Chevron step one, a court must, “applying the ordinary
tools of statutory construction, * * * determine ‘whether Congress has
directly spoken to the precise question at issue.’” City of Arlington, Tex.
v. FCC, 569 U.S. 290, 296 (2013) (quoting Chevron, 467 U.S. at 842).
And “[i]f the intent of Congress is clear, that is the end of the matter; for
the court, as well as the agency, must give effect to the unambiguously
expressed intent of Congress.” Chevron, 467 U.S. at 842-843. But if the
statute is ambiguous, then under Chevron step two a court must defer
to the agency’s interpretation of the statute if the interpretation is
reasonable. Mayo Found. for Med. Educ. & Research v. United States,
562 U.S. 44, 58 (2011); Chevron, 467 U.S. at 843-844. An agency’s
interpretation that satisfies Chevron step two must be deferred to by a
court even if the interpretation conflicts with a prior judicial
interpretation of the statute. See Nat’l Cable & Telecomms. Ass’n v.
Brand X Internet Servs., 545 U.S. 967, 982 (2005). However, if the prior
judicial precedent had held that the statute was unambiguous, then the
prior judicial interpretation controls over the agency interpretation. See
id. (“A court’s prior judicial construction of a statute trumps an agency
construction otherwise entitled to Chevron deference only if the prior

       171 In Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44,
50, 55-58 (2011), the Supreme Court held that the Chevron test, not the test under
National Muffler Dealers Ass’n, Inc. v. United States, 440 U.S. 472 (1979), required
the Court to defer to 26 C.F.R. sec. 31.3121(b)(10)-2(d)(3)(iii) (2005), a regulation
which, like 26 C.F.R. sec. 1.482-1(h)(2) (2006), was promulgated pursuant to sec.
7805(a). The National Muffler test was a multifactor test, as can be seen by the
following text from National Muffler Dealers Assn., 440 U.S. at 477:
                In determining whether a particular regulation carries out the
       congressional mandate in a proper manner, we look to see whether the
       regulation harmonizes with the plain language of the statute, its
       origin, and its purpose. A regulation may have particular force if it is
       a substantially contemporaneous construction of the statute by those
       presumed to have been aware of congressional intent. If the regulation
       dates from a later period, the manner in which it evolved merits
       inquiry. Other relevant considerations are the length of time the
       regulation has been in effect, the reliance placed on it, the consistency
       of the Commissioner’s interpretation, and the degree of scrutiny
       Congress has devoted to the regulation during subsequent re-
       enactments of the statute. * * *
                                   232

court decision holds that its construction follows from the unambiguous
terms of the statute and thus leaves no room for agency discretion.”); id.
at 982-983 (“Only a judicial precedent holding that the statute
unambiguously forecloses the agency’s interpretation, and therefore
contains no gap for the agency to fill, displaces a conflicting agency
construction.”).

       Petitioner argues that 26 C.F.R. sec. 1.482-1(h)(2) (2006) is
invalid under Chevron step one because, in petitioner’s view, judicial
precedents have held that predecessors to section 482 unambiguously
provided that there can be no allocation of unreceived income under
these statutes if receiving the income is prohibited by legal restrictions.
The judicial precedents relied on by petitioner for this argument are L.E.
Shunk Latex, First Security Bank, Procter & Gamble, and Exxon.

       Of these four cases, petitioner primarily relies on First Security
Bank. Petitioner argues that in First Security Bank the Supreme Court
held that the “plain meaning” of the predecessor to section 482 was that
respondent cannot allocate to a taxpayer income that the taxpayer was
prevented from receiving by a legal restriction.

      However, petitioner’s interpretation of First Security Bank is
inconsistent with the portion of the opinion explaining the reasons for
the holding. In that portion, there is an initial passage discussing the
general principle that a taxpayer has income only to the extent the
taxpayer has control over the income. Commissioner v. First Sec. Bank,
405 U.S. at 403-404. The next part of the First Security Bank opinion,
405 U.S. at 404-407, focused specifically on section 482 of the Internal
Revenue Code of 1954. This portion explained that a regulation related
to section 482 of the Internal Revenue Code embraced the control
concept discussed in the initial passage. 26 C.F.R. sec. 1.482-1(b)(1)
(1971). We now analyze in greater depth the two portions of the First
Security Bank opinion, i.e., (1) the initial passage and (2) the section-
482-specific portion.

       The initial passage of First Security Bank stated that no decision
of the Supreme Court had found that a person had “taxable income that
he did not receive and that he was prohibited from receiving”; that it
had long been assumed that “the person to whom the income was
attributed could have received it”; that it has also been assumed that “in
order to be taxed for income, a taxpayer must have complete dominion
over it”; and that “the assignment-of-income doctrine assumes that the
income would have been received by the taxpayer had he not arranged
                                           233

for it to be paid to another” (an assumption articulated in Corliss v.
Bowers, 281 U.S. 376, 378 (1930): “The income that is subject to a man’s
unfettered command and that he is free to enjoy at his own option may
be taxed to him as his income”.). Commissioner v. First Sec. Bank, 405
U.S. at 403-404. Petitioner places great weight on First Security Bank’s
identification (in the initial passage) of the principle that a taxpayer
does not have taxable income the taxpayer cannot legally receive. 172

       Significantly the initial passage in First Security Bank involved
the interpretation of the predecessors of section 61, not the predecessors
of section 482. First, the principle identified in the initial passage was
an application of the proposition that “[t]he income that is subject to a
man’s unfettered command and that he is free to enjoy at his own option
may be taxed to him as his income”. Commissioner v. First Sec. Bank,
405 U.S. at 403 (quoting Corliss, 281 U.S. at 378). This proposition is a
judicial interpretation of section 61 and its predecessors.            See
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 427-431 (1955)
(holding that recovery of punitive damages for fraud and antitrust
violations was gross income under section 22(a) of the Internal Revenue
Code of 1939, 53 Stat. at 9, because the taxpayer had complete dominion
over the recovery); Foley v. Commissioner, 87 T.C. 605, 608 (1986)
(specifying section 61 of the Internal Revenue Code of 1954, 68A Stat. at
17, as the source of the proposition that income is an accession to wealth
over which a taxpayer has complete dominion). 173 Second, the initial
passage also explained that the assignment-of-income doctrine
concerned situations in which a taxpayer was taxed on income over
which the taxpayer had control. Commissioner v. First Sec. Bank, 405
U.S. at 403-404.       The assignment-of-income doctrine too is an
interpretation of the predecessors of section 61, not the predecessors of
section 482. See Sargent v. Commissioner, 929 F.2d 1252, 1258 (8th Cir.

        172The principle was identified in the following sentence in Commissioner v.
First Sec. Bank, 405 U.S. at 403:
                We know of no decision of this Court wherein a person has been
        found to have taxable income that he did not receive and that he was
        prohibited from receiving. * * *
The sentence addresses the situation in which (1) the income was not received and
(2) it was illegal to receive the income. Under sec. 61, there is no taxable income in
that situation. Cf. James v. United States, 366 U.S. 213 (1961) (stating that under sec.
61, there is taxable income if (1) the income was received and (2) it was illegal to receive
the income).
      173 Sec. 61 provides that gross income generally means all income from

whatever source derived.
                                         234

1991), rev’g 93 T.C. 572 (1989); Wilson v. United States, 530 F.2d 772,
778-779 (8th Cir. 1976). Indeed, the cases cited in the initial passage as
examples of the application of the assignment-of-income doctrine were
resolved under the predecessors of section 61, not the predecessors of
section 482. Commissioner v. First Sec. Bank, 405 U.S. at 403-404 &
n.17; Harrison v. Schaffner, 312 U.S. 579, 581 (1941) (section 22(a) of
the Revenue Act of 1928, 45 Stat. at 797); Helvering v. Horst, 311 U.S.
112, 114 (1940) (section 22 of the Revenue Act of 1934, 48 Stat. at 686);
Lucas v. Earl, 281 U.S. at 114 (1930) (section 213(a) of the Revenue Act
of 1918, ch. 18, 40 Stat. at 1065). But the ultimate question in
Commissioner v. First Sec. Bank, 405 U.S. at 400, involved respondent’s
authority under the predecessors of section 482, not section 61. Thus,
the initial passage does not constitute the complete explanation of First
Security Bank’s holding. Such an explanation must necessarily involve
the predecessors of section 482, since that was the statute supporting
respondent’s position in First Security Bank.

      The following sentence was the transition between (1) First
Security Bank’s discussion of section 61 principles and (2) its
interpretation of the predecessors of section 482:

               One of the Commissioner’s regulations for the
        implementation of § 482 expressly recognizes the concept
        that income implies dominion or control of the taxpayer.
        ***

Commissioner v. First Sec. Bank, 405 U.S. at 404. 174 First Security
Bank then quoted the “complete power” sentence from 26 C.F.R. sec.
1.482-1(b)(1) (1971), 175 explaining that the “complete-power” sentence
“is consistent with the control concept heretofore approved by this Court,
although in a different context.”

        174 Petitioner’s description of this sentence in the First Security Bank opinion

omits the Supreme Court’s reference to the regulation. Here is how petitioner
describes the sentence:
        As the Supreme Court stated in First Security, section 482 “recognizes
        the concept that income implies dominion or control of the taxpayer.”
        405 U.S. 404.
       175 “The interests controlling a group of controlled taxpayers are assumed to

have complete power to cause each controlled taxpayer so to conduct its affairs that its
transactions and accounting records truly reflect the taxable income from the property
and business of each of the controlled taxpayers.”
                                          235

     The First Security Bank opinion next stated that the allocation of
income under section 482 of the Internal Revenue Code of 1954 was
improper under the “complete power” regulation:

        The regulation, as applied to the facts in this case,
        contemplates that Holding Company--the controlling
        interest--must have “complete power” to shift income
        among its subsidiaries. It is only where this power exists,
        and has been exercised in such a way that the “true taxable
        income” of a subsidiary has been understated, that the
        Commissioner is authorized to reallocate under § 482. But
        Holding Company had no such power unless it acted in
        violation of federal banking laws. The “complete power”
        referred to in the regulations hardly includes the power to
        force a subsidiary to violate the law.

Id. at 404-405. This passage, which holds the section 482 allocation to
the banks was not authorized under 26 C.F.R. sec. 1.482-1(b)(1) (1971),
is in our view the core reasoning of First Security Bank. The passage
indicated that 26 C.F.R. sec. 1.482-1(b)(1) (1971) limited transfer-pricing
allocations to those situations in which the income to be allocated could
legally have been paid.

       That First Security Bank relied on a regulation rather than the
text of the relevant statute indicates that First Security Bank did not
hold that the statute was “unambiguous”. 176 Had it thought the statute
to be unambiguous, the Supreme Court would not have had to rely on a
regulation. See Barnhart v. Sigmon Coal Co., 534 U.S. 438, 462 (2002)
(“In the context of an unambiguous statute, we need not contemplate
deferring to the agency’s interpretation. See Chevron U.S.A. Inc. v.
Natural Resources Defense Council, Inc., 467 U.S. 837, 842-843
(1984).”); Andrade-Zamora v. Lynch, 814 F.3d 945, 951 (8th Cir. 2016)
(“If the statute is unambiguous, we simply apply the statute.” (citing
Hawkins v. Cmty. Bank of Raymore, 761 F.3d 937, 940 (8th Cir. 2014))).

         176 It is relevant whether First Security Bank held that the terms of the statute

were unambiguous. Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545
U.S. 967, 982 (2005) (“A court’s prior judicial construction of a statute trumps an
agency construction otherwise entitled to Chevron deference only if the prior court
decision holds that its construction follows from the unambiguous terms of the statute
and thus leaves no room for agency discretion.”); id. at 982-983 (“Only a judicial
precedent holding that the statute unambiguously forecloses the agency’s
interpretation, and therefore contains no gap for the agency to fill, displaces a
conflicting agency construction.”).
                                    236

The statute in question in First Security Bank was section 482 of the
Internal Revenue Code of 1954. Nothing indicates that First Security
Bank thought that the unambiguous words of the statute justified its
holding about the effect of legal restrictions. Although First Security
Bank quoted the one-sentence statute in full, this quotation was
relegated to a footnote to the first sentence of the opinion. The first
sentence of the opinion was simply an introduction to the opinion:

            This case presents for review a determination by the
      Commissioner of Internal Revenue (Commissioner),
      pursuant to § 482 of the Internal Revenue Act [footnote
      quoting section 482 of the Internal Revenue Code of 1954],
      that the income of taxpayers within a controlled group
      should be reallocated to reflect the true taxable income of
      each.

Commissioner v. First Sec. Bank, 405 U.S. at 395 & n.1. This
introductory sentence merely framed the issue in the case as one arising
under the predecessors of section 482 as opposed to some other provision
of the Internal Revenue Code of 1954. Neither the footnote containing
the text of this statute nor any other part of the First Security Bank
opinion parsed the text of the statute so as to link the text of the statute
to the principle that income cannot be attributed to a taxpayer who
cannot legally receive it. That link was supplied by a regulation, 26
C.F.R. sec. 1.482-1(b)(1) (1971), which, First Security Bank explained,
embodied the concept that “income implies dominion or control of the
taxpayer”. Id. at 404.

        In our view, First Security Bank did not hold that the predecessor
of section 482 of the Internal Revenue Code of 1954 unambiguously
precluded an allocation of income that could not be legally received. See
Nat’l Cable & Telecomms. Ass’n, 545 U.S. at 982 (“A court’s prior judicial
construction of a statute trumps an agency construction otherwise
entitled to Chevron deference only if the prior court decision holds that
its construction follows from the unambiguous terms of the statute and
thus leaves no room for agency discretion.”); id. at 982-983 (“Only a
judicial precedent holding that the statute unambiguously forecloses the
agency’s interpretation, and therefore contains no gap for the agency to
fill, displaces a conflicting agency construction.”). We therefore reject
petitioner’s argument that “the Supreme Court in First Security
determined that the plain meaning of section 482 precludes the
interpretation adopted by the Commissioner in Treas. Reg. § 1.482-
                                       237

1(h)(2).” In other words, we hold that First Security Bank was not a
Chevron step one opinion. 177

       Petitioner also argues that L.E. Shunk Latex was a Chevron step
one opinion. In L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C.
at 961, the court held that section 45 of the Internal Revenue Code of
1939 did not authorize the allocation of income to a taxpayer who could
not legally receive the income. Section 45 of the Internal Revenue Code
of 1939 was essentially the same as the first sentence of section 482. So
if L.E. Shunk Latex had held that section 45 of the Internal Revenue
Code of 1939 unambiguously precluded respondent from making an
income allocation, as petitioner argues it held, then L.E. Shunk Latex is
a precedent that arguably precludes the allocation respondent has made
of income to 3M IPC in this case. 178 In our view, though, L.E. Shunk
Latex is not a Chevron step one opinion. It held that respondent’s
allocation under section 45 of the Internal Revenue Code of 1939 cannot
disregard a legal restriction on the receipt of income but did not suggest
that this holding stems from unambiguous statutory text. See Nat’l
Cable & Telecomms. Ass’n, 545 U.S. at 982 (stating that prior judicial
construction controls if “the prior court decision holds that its
construction follows from the unambiguous terms of the statute”). The
statute authorized respondent to allocate income among businesses “in
order to clearly * * * reflect the income” of the businesses but did not
refer to the effect of legal restrictions on the receipt of income. 179

       Furthermore, recall that Commissioner v. First Sec. Bank, 405
U.S. at 404-405, expressly relied on the “complete power” sentence in
the regulation. As explained before, First Security Bank’s reliance on a
regulation suggests that First Security Bank did not hold the statute to
be unambiguous. Petitioner contends that L.E. Shunk Latex, which was
written in 1952, could not have relied on the regulation containing the
“complete power” sentence because, petitioner contends, the regulation

        177 Of course, First Security Bank (1971) was written before Chevron (1984)

and therefore would not have found it necessary to classify its reasoning as Chevron
step one or Chevron step two. See United States v. Home Concrete & Supply, Inc., 566
U.S. 478, 488-489 (2012) (plurality opinion).
       178   Remember though that sec. 482 now contains “commensurate-with-
income”, which also serves to distinguish our case from L.E. Shunk Latex. We discuss
the significance of this phrase later on.
       179 Unlike 26 C.F.R. sec. 1.482-2(h)(2) (2006) (giving rules for taking into

account the effect of a “foreign legal restriction”).
                                     238

was promulgated only in 1962. Petitioner’s contention is reflected in the
following passage in its brief:

      The Supreme Court in First Security Bank said that the
      “views of the Tax Court [in L.E. Shunk] were correct. 405
      U.S. at 406, n.22. The decision in L.E. Shunk did not
      depend on the “complete power” regulation, which was
      adopted later13 and neither did the decision in First
      Security.

             13The  regulation was promulgated in 1962. T.D. 6595, 1962-1
      C.B. 43, 1962 IRB LEXIS 321, at *20 (July, 1962)

(Alleration in original.) At oral argument, petitioner also pressed the
contention that L.E. Shunk Latex was decided before the promulgation
of the regulation containing the “complete power” sentence:

      [A]ll this says is that the interest controlling a group of
      controlled taxpayers are assumed to have complete power
      to cause--basically it caused them to have their records
      truly reflect income. * * * Just one more thing on that
      point--L.E. Shunk was decided before this regulation by the
      Tax Court and so, obviously, this regulation had no effect
      on the L.E. Shunk decision and the Supreme Court in First
      Security said it agreed with L.E. Shunk.

(Emphasis added.) We reject petitioner’s theory that the “complete
power” sentence first arose in 1962 and that therefore L.E. Shunk Latex
could not have relied on the “complete power” sentence. The “complete
power” sentence first appeared in 1934 with the promulgation of
Regulations 86. Art. 45-1(b), Regulations 86 Relating to the Income Tax
Under the Revenue Act of 1934, at 123. The “complete power” sentence
also appeared in section 29.45-1(b) of Regulations 111, which had been
published in the Federal Register in 1943 and in the Cumulative
Supplement to the Code of Federal Regulations in 1944. 8 Fed. Reg.
14882 (Nov. 3, 1943). Significantly, Regulations 111 was effective for
tax years beginning after December 31, 1941. Sec. 29.1-1, Regulations
111 relating to the Income Tax Under the Internal Revenue Code 1. The
years at issue in L.E. Shunk Latex were 1942, 1943, and 1945. L.E.
Shunk Latex Prods., Inc. v. Commissioner, 18 T.C. at 955. Although
Regulations 111 was amended in 1944, see T.D. 5426, 10 Fed. Reg. 23
(Jan. 2, 1945), 26 C.F.R. sec. 29.45-1 (1944 Supp.), and this amendment
was seemingly effective starting with the 1944 tax year and thus would
                                 239

seem to have been effective with respect to the 1945 tax year in L.E.
Shunk Latex, the 1944 amendment did not appreciably change the
“complete power” sentence or the passage containing it. To wit, before
the 1944 amendment the “complete power” passage was:

      The interests controlling a group of controlled taxpayers
      are assumed to have complete power to cause each
      controlled taxpayer so to conduct its affairs that its
      transactions and accounting records truly reflect the net
      income from the property and business of each of the
      controlled taxpayers. If, however, this has not been done,
      and the taxable net incomes are thereby understated, the
      statute contemplates that the Commissioner shall
      intervene, and, by making such distributions,
      apportionments, or allocations as he may deem necessary
      of gross income or deductions, or of any item or element
      affecting net income, between or among the controlled
      taxpayers constituting the group, shall determine the true
      net income of each controlled taxpayer. * * *

26 C.F.R. sec. 29.45-1(b) (Cum. Supp. 1944). After the 1944 amendment,
the “complete power” passage was:

      The interests controlling a group of controlled taxpayers
      are assumed to have complete power to cause each
      controlled taxpayer so to conduct its affairs that its
      transactions and accounting records truly reflect the net
      income from the property and business of each of the
      controlled taxpayers. If, however, this has not been done,
      and the taxable net incomes are thereby understated, the
      statute contemplates that the Commissioner shall
      intervene, and, by making such distributions,
      apportionments, or allocations as he may deem necessary
      of gross income[,] deductions, credits, or allowances or of
      any item or element affecting net income, between or
      among the controlled taxpayers constituting the group,
      shall determine the true net income of each controlled
      taxpayer. * * *

26 C.F.R. sec. 29.45-1 (1949). As can be seen, the 1944 amendment to
the “complete power” passage in Regulations 111 was insignificant.
Regulations 111 was not superseded until the 1953 promulgation of
                                        240

Regulations 118, a series of regulations which also contained the
complete-power passage. 26 C.F.R. sec. 39.45-1(b)(1) (1953).

       In 1962, the Treasury Department promulgated regulations
under section 482 of the Internal Revenue Code of 1954. T.D. 6595, 27
Fed. Reg. 3597 (Apr. 13, 1962), codified at 26 C.F.R. sec. 1.482-1 (1961
ed. 1965 Cum. Supp.). These 1962 regulations included the passage
containing the “complete power” sentence. 26 C.F.R. sec. 1.482-1(b)(1)
(1961 ed. 1965 Cum. Supp.). However, the same passage was in section
29.45-1 of Regulations 111, which was in effect for the three tax years
at issue in L.E. Shunk Latex. 26 C.F.R. sec. 29.45-1(b) (Cum. Supp.
1944) (before 1944 amendment); 26 C.F.R. sec. 29.45-1(b) (1949) (after
1944 amendment).

       There were some irregularities in the official publication of
section 29.45-1 of Regulations 111. Regulations 111 should seemingly
have been published in the 1943 Supplement to the Code of Federal
Regulations, not just the Cumulative Supplement to the Code of Federal
Regulations. 180 And in the Federal Register, section 29.45-1 of
Regulations 111 was inexplicably published with the prefix “9.” instead
of “29.” Although these discrepancies may make it difficult for today’s
researchers to find section 29.45-1 of Regulations 111, they do not
detract from the proposition that section 29.45-1 of Regulations 111 was
effective as to the transactions at issue in L.E. Shunk Latex. That
section 29.45-1 of Regulations 111 was effective as to the transactions at
issue in L.E. Shunk Latex is supported by the fact that the opinion cited
section 29.45-1 of Regulations 111 three times. L.E. Shunk Latex
Prods., Inc. v. Commissioner, 18 T.C. at 956, 958.

        Consequently, we are not persuaded by petitioner’s view that the
regulation containing the “complete power” sentence was not effective
for, or in existence for, the years at issue in L.E. Shunk Latex.

      Although the “complete power” sentence was in effect for the
years at issue in L.E. Shunk Latex Prods., Inc. v. Commissioner, 18 T.C.
at 956, the opinion did not quote that sentence. 181 By contrast,
Commissioner v. First Sec. Bank, 405 U.S. at 404, quoted the “complete
power” sentence, and also explained that this sentence led to its

         And Regulations 111 erroneously stated that it was part of the 1943
       180

Supplement to the Code of Federal Regulations.
       181 L.E. Shunk Latex quoted the tax-parity sentence, which, like the “complete

power” sentence, was in subparagraph (1) of sec. 29.45-1(b) of Regulations 111.
                                         241

conclusion that section 482 could not result in the allocation of income
to a taxpayer for whom receipt of the income was illegal. As
Commissioner v. First Sec. Bank, 405 U.S. at 404-405, explained:

       The regulation, as applied to the facts in this case,
       contemplates that Holding Company--the controlling
       interest--must have “complete power” to shift income
       among its subsidiaries. It is only where this power exists,
       and has been exercised in such a way that the “true taxable
       income” of a subsidiary has been understated, that the
       Commissioner is authorized to reallocate under § 482. But
       Holding Company had no such power unless it acted in
       violation of federal banking laws. The “complete power”
       referred to in the regulations hardly includes the power to
       force a subsidiary to violate the law.

By contrast, no textual link can be found in the L.E. Shunk Latex
opinion between (1) the “complete power” sentence and (2) its holding
that “the Commissioner had no authority to attribute to * * * [the two
manufacturers] income which they could not have received.” L.E. Shunk
Latex Prods., Inc. v. Commissioner, 18 T.C. at 961. 182
       Because First Security Bank cited L.E. Shunk Latex with favor,
and because L.E. Shunk Latex did not expressly rely on the complete-
power sentence, petitioner argues that First Security Bank did not rely
on the complete-power regulation. We reject this argument. It is
speculative to assume that L.E. Shunk Latex would not have been
decided differently in the absence of the complete-power sentence. More
importantly, Commissioner v. First Sec. Bank, 405 U.S. at 404-405,
expressly stated that its result followed from the complete-power
sentence.

     Petitioner alternatively suggests that we could set First Security
Bank aside and rely entirely on L.E. Shunk Latex 183 for the proposition

       182 Commissioner v. First Sec. Bank, 405 U.S. at 406, observed that L.E. Shunk
Latex’s statement that the Commissioner “had no authority to attribute to petitioners
income which they could not have received” constituted the holding of L.E. Shunk
Latex and stated that L.E. Shunk Latex was a “closely analogous situation” to First
Security Bank.
        183 L.E. Shunk Latex is an Opinion of the Tax Court of the United States. We

are a continuation of that court. Tax Reform Act of 1969, Pub. L. No. 91-172, sec. 961,
83 Stat. at 735-736 (“The United States Tax Court * * * is a continuation of the Tax
Court of the United States as it existed prior to the date of enactment of this Act”.).
                                         242

that no income can be allocated to a taxpayer under section 482 that a
taxpayer could not receive. Even if petitioner were correct that L.E.
Shunk Latex concluded that the statute was unambiguous, 184 that
holding would conflict with First Security Bank, for First Security Bank
held the same statute to be ambiguous. In such a conflict, the Supreme
Court’s view should prevail over a lower court’s. We would therefore
reject petitioner’s argument that we should adopt L.E. Shunk Latex’s
interpretation of a statute over First Security Bank’s.

       Petitioner also argues that the Tax Court’s Procter & Gamble
opinion was a Chevron step one opinion. The holding of Procter &
Gamble Co. v. Commissioner, 95 T.C. at 335-336, can be found in the
following passage: “We find First Security Bank and Salyersville
National Bank compelling with respect to the issue before the Court. As
we understand these cases, section 482 simply does not apply where
restrictions imposed by law, and not the actions of the controlling
interest, serve to distort income among the controlled group.” The term
“these cases” referred to First Security Bank and to Salyersville
National Bank v. United States, 613 F.2d 650 (6th Cir. 1980), which was
a Sixth Circuit opinion that followed directly from First Security Bank.
Procter & Gamble Co. v. Commissioner, 95 T.C. at 335. The holding of
Procter & Gamble did not encompass a view that the text of section 482
of the Internal Revenue Code of 1954 was unambiguous. Rather,
Procter & Gamble relied on First Security Bank’s interpretation of
section 482 of the Internal Revenue Code of 1954. Procter & Gamble Co.
v. Commissioner, 95 T.C. at 335-336. First Security Bank in turn did
not state that its holding followed from the unambiguous text of section
482 of the Internal Revenue Code of 1954. Instead, Commissioner v.
First Sec. Bank, 405 U.S. at 405, relied on the “complete power”
regulatory sentence to interpret section 482. See 26 C.F.R. sec. 1.482-
1(b)(1) (1971). Indeed, the Tax Court’s opinion in Procter & Gamble, 95
T.C. at 334-335, recognized that First Security Bank had relied on the
“complete power” sentence. 185 Furthermore, the Sixth Circuit’s opinion,

       184We emphasize that we do not think that L.E. Shunk Latex held that the
statute was unambiguous.
        185 Addressing the significance of the deferred-income method of accounting in

the 1968 regulations, 26 C.F.R. sec. 1.482-1(d)(6) (1971), the Tax Court stated that the
regulations under sec. 482 of the Internal Revenue Code of 1954 “do not apply” because
of “our holding that section 482” does not apply. Procter & Gamble Co. v.
Commissioner, 95 T.C. at 341. However, as we have just explained, the holding that
the statute did not apply was not reasoned from the statutory text, but from First
Security Bank, which in turn relied on the “complete power” regulatory sentence.
                                        243

affirming the Tax Court, also relied on First Security Bank. Procter &
Gamble Co. v. Commissioner, 961 F.2d at 1259. The Sixth Circuit
observed that First Security Bank had in turn relied on the “complete
power” sentence: “The [First Security Bank] Court stated that the
‘complete power’ referred to in Treas. Reg. § 1.482-1(b)(1) does not
include the power to force a subsidiary to violate the law.” Procter &
Gamble Co. v. Commissioner, 961 F.2d at 1259. 186 Thus, both the Tax
Court and the Sixth Circuit relied ultimately on the “complete power”
sentence in the 1934 regulation. They did not hold that the statute was
unambiguous. They are not Chevron step-one opinions.

        Petitioner also argues that Texaco, Inc. v. Commissioner, 98 F.3d
825, was a Chevron step-one opinion. In Texaco, the Fifth Circuit held
that the First Security Bank opinion prevented respondent from making
an allocation of income to Textrad, a U.S. company, because Textrad was
prevented by Saudi law from charging a full market price when selling
oil to its foreign refining affiliates. Id. at 828 (“We also agree with the
Tax Court’s legal conclusion that the teaching of Commissioner v. First
Sec. Bank, 405 U.S. 394, 92 S. Ct. 1085, 31 L.Ed.2d 318 (1972), bars the
Commissioner from allocating income to Textrad on its sales of Saudi
crude under § 482.”). The Fifth Circuit Texaco opinion did not state that
its holding was based on the unambiguous text of section of 482 of the
Internal Revenue Code of 1954. Rather, the Fifth Circuit relied on the
First Security Bank opinion. Texaco, Inc. v. Commissioner, 98 F.3d at
828. The Fifth Circuit observed in Texaco, Inc. v. Commissioner, 98 F.3d
at 829, that the First Security Bank opinion had in turn relied on the
“complete power” regulation:

       Indeed, as the Court noted, the Commissioner’s own
       regulations for implementing § 482 contemplate that the
       controlling interest “must have ‘complete power’ to shift
       income among its subsidiaries.” Id. at 404-05, 92 S. Ct. at
       1091-92 (quoting 26 C.F.R. § 1.482-1(b)(1) (1971)).

The Fifth Circuit had earlier observed that the complete-power sentence
was in the then-current volume of the Code of Federal Regulations, 26
C.F.R. sec. § 1.482-1A(b)(1) (1996). Id. at 828 n.4; see supra part II.HH

        186 Directly analyzing the meaning of the “complete power” sentence, the Sixth

Circuit’s opinion stated that the “complete power” sentence recognized that respondent
is authorized to make a transfer-pricing allocation only when the distortion of income
results from the exercise of common control, not when the distortion of income results
from a legal restriction. Procter & Gamble Co. v. Commissioner, 961 F.2d at 1258.
                                          244

(the last paragraph, which discusses what version of the section 482
regulations was referred to in the Fifth Circuit’s Texaco opinion). The
Fifth Circuit’s observation about the existence of the regulation, and its
reliance on First Security Bank, causes us to conclude that Texaco is not
a Chevron step-one opinion.

       Another aspect of the four opinions we have discussed (First
Security Bank, 405 U.S. 394, L.E. Shunk Latex, 18 T.C. 940, Procter &
Gamble Co., 95 T.C. 323, and Texaco, 98 F.3d 825) is that each opinion
interpreted the one-sentence version of the statute. In 1986, Congress
added a second sentence to the effect that when there is a license or
transfer of intangible property, the income with respect to such a license
or transfer must be commensurate with the income attributable to the
intangible. Tax Reform Act of 1986, sec. 1231(e)(1), 100 Stat. at 2562-
2563. 187 3M IPC allowed 3M Brazil to use its patents; it also transferred
unpatented technology to 3M Brazil. Respondent seeks to allocate
income to 3M IPC for the use of the patents and for the transfer of
unpatented technology in amounts that correlate with the income
earned by 3M Brazil from its use of the patents and the transfer to it of
unpatented technology. The proposed allocation is consistent with the
1986 statutory amendment. The income respondent seeks to allocate to
3M IPC is commensurate with the income attributable to the intangible
property. Therefore, the four opinions are distinguishable because they

          The statutory text that is effective for the 2006 year of the 3M consolidated
        187

group is sec. 482 of the Internal Revenue Code of 1986. Sec. 482 of the Internal
Revenue Code of 1954 had contained the following single sentence:
                In any case of two or more organizations, trades, or businesses
        (whether or not incorporated, whether or not organized in the United
        States, and whether or not affiliated) owned or controlled directly or
        indirectly by the same interests, the Secretary or his delegate [in 1976,
        the term “Secretary or his delegate” was replaced with the term
        “Secretary”, Pub. L. No. 94-455, sec. 1906(b)(13)(A), 90 Stat. at 1834,
        an inconsequential change] may distribute, apportion, or allocate gross
        income, deductions, credits, or allowances between or among such
        organizations, trades, or businesses, if he determines that such
        distribution, apportionment, or allocation is necessary in order to
        prevent evasion of taxes or clearly to reflect the income of any of such
        organizations, trades, or businesses.
68A Stat. at 162. Sec. 482 of the Internal Revenue Code of 1986, however, contained
the following additional sentence: “In the case of any transfer (or license) of intangible
property (within the meaning of section 936(h)(3)(B)), the income with respect to such
transfer or license shall be commensurate with the income attributable to the
intangible.” This sentence had been added by the Tax Reform Act of 1986, sec.
1231(e)(1), 100 Stat. at 2562-2563.
                                    245

construed the pre-1986 statutory           provision   that    lacked   the
commensurate-with-income sentence.

       But petitioner argues that the 1986 statutory change is irrelevant
to the effect of legal restrictions on section 482 allocations because, in
petitioner’s view, the scope of the 1986 amendment is limited to the
purpose attributed to it by the report of the House Ways & Means
Committee. Petitioner observes that that report stated that the
committee intended the 1986 amendment to “make it clear that industry
norms or other unrelated party transactions do not provide a safe-harbor
minimum payment for related party intangibles transfers” and that
“consideration * * * be given the actual profit experience realized as a
consequence of the transfer.” H.R. Rept. No. 99-426, at 425, 1986-3 C.B.
(Vol. 2), at 425. Thus, petitioner contends that the legislative intent for
the 1986 amendment was to require that “income from intangibles be
commensurate with income over an extended timeframe.” Petitioner
also observes that the Blue Book stated that the 1986 statutory
amendment had been intended to ensure that “consideration also be
given to the actual profit experience realized as a consequence of the
transfer” of intangibles and that “payments made for the intangible be
adjusted over time to reflect changes in the income attributable to the
intangible.” Staff of J. Comm. on Taxation, General Explanation of the
Tax Reform Act of 1986, at 1016 (J. Comm. Print 1987). Petitioner
further notes that neither the House report, the conference committee
report, nor the Blue Book mentions legal restrictions on the payment or
receipt of income and that none of these publications refers to First
Security Bank or L.E. Shunk Latex. Respondent responds that the
congressional intent behind the 1986 amendment is documented by the
conference committee report, H.R. Conf. Rept. No. 99-841 (Vol. II), at II-
637, 1986-3 C.B. (Vol. 4) at 637, which stated that the object of the
amendment was to ensure that “the division of income between related
parties reasonably reflect the relative economic activity undertaken by
each”. In respondent’s view, the way respondent has applied 26 C.F.R.
sec. 1.482-1(h)(2) (2006) in this case is consistent with the 1986 statutory
change because the change was designed to “address a growing concern
that multinational companies, such as 3M, were transferring valuable
intangibles offshore for less than arm’s length consideration”. First
Security Bank and the other three cases, according to respondent, are
distinguishable because they had not “addressed allocation of income
subject to foreign legal restrictions under section 482 as amended by the
Tax Reform Act of 1986.”
                                        246

       We do not agree with petitioner that the scope of the
commensurate-with-income sentence added in 1986 is limited to the
narrow “timeframe” purpose identified in the House report and the
Bluebook. Even if that could be said to be Congress’ purpose for the
1986 amendment, Congress used remarkably broad wording in the
commensurate-with-income sentence. It was the text of the 1986
amendment that was enacted by Congress, not the purpose behind the
amendment. See Oncale v. Sundowner Offshore Servs., Inc., 523 U.S.
75, 79 (1998) (“[I]t is ultimately the provisions of our laws rather than
the principal concerns of our legislators by which we are governed.”) As
we explained supra part II.K, a portion of the 1994 final regulations
addressed the “timeframe” concern identified in the House report and
the Blue Book.        26 C.F.R. sec. 1.482-4(f)(2) (2006) (1994 final
regulations). If petitioner is right that the scope of the commensurate-
with-income sentence of section 482 is limited to remedying the
“timeframe” concern, then only this small portion of the vast 1994 final
regulations was authorized by the second sentence of section 482. The
rest of the 1994 final regulations would be unauthorized, including the
comparable-profits method, 26 C.F.R. sec. 1.482-5 (2006), and the profit-
split method, 26 C.F.R. sec. 1.482-6 (2006). These methods have a strong
conceptual tie to the commensurate-with-income standard. 188

        188 The comparable-profits method is strongly linked to the commensurate-

with-income standard. The 1988 White Paper proposed a rate-of-return approach for
determining the proper charge for an intangible property under the commensurate
with income standard. See 57 Fed. Reg. 3572 (Jan. 30, 1992) (1992 notice of proposed
rulemaking) (explaining that the basic arm’s-length rate of return method described
in the White Paper was an “approach[] for determining the proper charge for an
intangible under the commensurate with income standard”). The comparable-profit-
interval method in the 1992 proposed regulations was based on the rate-of-return
approach. See 57 Fed. Reg. 3572-3573 (1992 notice of proposed rulemaking)
(explaining that the methods put forward for pricing intangible property in the 1992
proposed regulations, which were, in order of priority, the matching-transaction
method, the comparable-adjustable-transaction method, and the comparable-profit-
interval method, were formulated in response to the criticism of the prominent role
accorded in the White Paper to the basic arm’s-length rate of return method). The
comparable-profits method, adopted in the 1993 temporary regulations and the 1994
final regulations, was “broadly similar” to the comparable-profit interval method from
the 1992 proposed regulations. T.D. 8552, 59 Fed. Reg. 34974 (preamble to the 1994
final regulations).
       The profit-split method is also strongly linked to the commensurate-with-
income standard. See G. Michael Tilton, U.S. International Tax Forms Manual:
Compliance & Reporting, para. 9.08 (2020) (“The 1986 amendment to the statute
created legislative sanction to use a profit-split analysis, at least in part. That
amendment, which added just one sentence to the statute, was limited by its terms to
                                         247

       Furthermore, Congress was likely aware that by the time of the
1986 amendment, much of the interpretation of predecessors of section
482 had been made through regulations promulgated by the Treasury
Department. T.D. 6595, 27 Fed. Reg. 3595 (Apr. 14, 1962) (1962
regulations); T.D. 6952, 33 Fed. Reg. 5848 (Apr. 16, 1968) (1968
regulations). It is reasonable to think that Congress would have
expected that the interpretive questions posed by section 482 as
amended in 1986 would be resolved by subsequent regulations, not by
pre-amendment legislative history. Indeed, the conference committee
report urged the Treasury Department to adopt new regulations.
Specifically, the conference committee report stated that the committee
was aware that “many important and difficult issues under section 482
are left unresolved by this legislation”, that the committee believed that
the executive branch should conduct a comprehensive study of the 1968
regulations, and that the executive branch should carefully consider
whether the 1968 regulations should be modified “in any respect.” H.R.
Conf. Rept. No. 99-841 (Vol. II), at II-638, 1986-3 C.B. (Vol. 4) at 638.

       Petitioner has a contention that bears on the proposition that
Congress intended the Treasury Department to promulgate regulations
to interpret section 482 after the 1986 amendment. Petitioner contends
that the Treasury Department never indicated that there was a link
between the 1986 amendment and the 1994 regulations regarding
foreign legal restrictions. 189 To evaluate the merits of this contention
we will review the various administrative pronouncements made by the
Treasury Department from 1986 to 1994. We begin with the 1988 White
Paper, which was the comprehensive Treasury Department and IRS
study of section 482 requested by the 1986 conference committee report.
Notice 88-123, 1988-2 C.B. 458. The White Paper discussed the
commensurate-with-income sentence that was added to the statute in
1986 but did not discuss foreign or domestic legal restrictions on the
receipt of income. Id., 1988-2 C.B. at 472-475, 478-480. The preamble
to the 1992 proposed regulations discussed the commensurate-with-
income sentence, 57 Fed. Reg. 3571, 3574 (Jan. 30, 1992), but the 1992

transfer prices for intangible property, but the 1994 final regulations provide that the
profit-split method may be used as a check on another method or as a separate
method.”).
       189 Petitioner argues: “But the Commissioner is wrong when he asserts that

the TRA 1986 amendment modified the holding of First Security. * * * The
Commissioner made no such claim in the White Paper. Nor did Treasury cite TRA
1986 as one of its reasons for adopting Treas. Reg. § 1.482-1(h)(2) anywhere in the
administrative record”.
                                   248

proposed regulations did not involve legal restrictions on the receipt of
income, id. at 3578-3601. On January 21, 1993, the Treasury
Department published two documents that were related to each other:
Treasury Decision 8470, 58 Fed. Reg. 5263, and a notice of proposed
rulemaking, 58 Fed. Reg. 5310. Treasury Decision 8470 contained the
text of the 1993 temporary regulations. The preamble to Treasury
Decision 8470 had a section labeled “Introduction” that discussed the
1986 commensurate-with-income amendment. 58 Fed. Reg. 5264. The
preamble to Treasury Decision 8470 also had a section labeled
“Provisions of the Temporary Regulations” that addressed particular
provisions in the 1993 temporary regulations. The 1993 temporary
regulations did not involve legal restrictions on the receipt of income
except for creating a placeholder for rules involving foreign legal
restrictions. 26 C.F.R. sec. 1.482-1T(f)(2) (1994) (1993 temporary
regulations). The 1993 notice of proposed rulemaking, issued on the
same day as the Treasury Decision, proposed that the 1993 temporary
regulations be made final. 58 Fed. Reg. 5310, 5312-5313. The 1993
notice of proposed rulemaking also proposed that rules regarding foreign
legal restrictions be added at regulation section 1.482-1T(f)(2). 58 Fed.
Reg. 5312-5313. The preamble to the 1993 notice of proposed
rulemaking did not contain an “Introduction” section like Treasury
Decision 8470. It contained a section titled “Explanation of Proposed
Regulations” discussing particular provisions of the proposed
regulations. This section did not refer to the commensurate-with-
income sentence added to the statute in 1986. But if one views the two
January 21, 1993 documents as related to each other, then the
discussion of the commensurate-with-income sentence in the preamble
to Treasury Decision 8470 explained not just Treasury Decision 8470
but also the proposed regulations in the notice of proposed rulemaking.
In 1994, the Treasury Department published Treasury Decision 8552,
59 Fed. Reg. 34971 (July 8, 1994), which contained the 1994 final
regulations. The 1994 final regulations consisted of final versions of
(1) the 1993 temporary regulations, which had also been proposed
regulations, and (2) the 1993 proposed regulation regarding foreign legal
restrictions. The preamble to Treasury Decision 8552 discussed
Treasury Decision 8470 (Jan. 21, 1993) and the notice of proposed
rulemaking (Jan. 21, 1993) as if the two documents were integral to each
other. 59 Fed. Reg. 34972. Furthermore, the preamble to Treasury
Decision 8552 had a section titled “Introduction” that discussed the 1986
addition of the commensurate-with-income sentence to the statute. 59
Fed. Reg. 34972. So to summarize, the Treasury Department did draw
a link between the commensurate-with-income statutory change and the
rules regarding foreign legal restrictions in 26 C.F.R. sec. 1.482-1(h)(2)
                                         249

(2006) (1994 final regulations). First, the 1986 statutory change was
discussed in the “Introduction” portion of the preamble to Treasury
Decision 8470. 58 Fed. Reg. 5264. Treasury Decision 8470 was issued
the same day as the notice of proposed rulemaking, January 21, 1993,
setting forth the proposed regulations on foreign legal restrictions. T.D.
8470, 58 Fed. Reg. 5310; sec. 1.482-1T(f)(2), Proposed Income Tax Regs.,
58 Fed. Reg. 5312-5313. The two documents were related to each other.
See T.D. 8552, 59 Fed. Reg. 34972. Second, the 1986 statutory change
was discussed in the preamble to Treasury Decision 8552 under the
heading “Introduction”. 59 Fed. Reg. 34972. Treasury Decision 8552
contained the 1994 final regulations, including the rules in section
1.482-1(h)(2) of the 1994 final regulations which addressed foreign legal
restrictions. 59 Fed. Reg. 35000-35001; 26 C.F.R. sec. 1.482-1(h)(2)
(2006) (1994 final regulations). Petitioner is therefore incorrect to
suggest that there is no link between the 1986 statutory change and 26
C.F.R. sec. 1.482-1(h)(2) (2006) (1994 final regulations). 190
       Petitioner invokes the 2012 Supreme Court opinion of Home
Concrete in support of its argument that 26 C.F.R. sec. 1.482-1(h)(2)
(2006) is invalid. But applying the analysis of Home Concrete reaffirms
our conclusion that the prior caselaw does not resolve this case. In
United States v. Home Concrete & Supply, LLC, 566 U.S. 478, 480, 486
(2012) (plurality opinion), the Supreme Court resolved a conflict
between (1) its 1958 opinion in Colony, Inc. v. Commissioner, 357 U.S.
28 (1958), and (2) a Treasury regulation promulgated in 2010. 26 C.F.R.
sec. 301.6501(e)-1(a)(1)(iii) (2011). Colony had interpreted a provision
of the Internal Revenue Code of 1939. Home Concrete & Supply, 566
U.S. at 481. According to Home Concrete, the opinion in Colony had
held that Congress “had ‘directly spoken to the question at hand’” and
therefore “left ‘[no] gap for the agency to fill’.” Id. at 489 (plurality
opinion) (citing Chevron, 467 U.S. at 842-843). Significantly Home
Concrete also explained that the “operative language” of the statute
interpreted by the 2010 regulation was not different from the provision

         190 Although we have directly addressed petitioner’s argument on its face by

explaining that the Treasury Department linked the 1986 statutory change to the 1994
regulations regarding foreign legal restrictions, we are skeptical that the Treasury
Department was actually required to draw such a link. At this stage in the analysis,
the question is whether First Security Bank is binding precedent as to this case.
Respondent’s argument is that First Security Bank is not binding precedent as to this
case because First Security Bank interpreted the statute before it was changed in 1986.
The validity of respondent’s view that First Security Bank is distinguishable because
it interpreted the pre-1986 version of the statute does not appear to hinge on whether
the Treasury Department articulated a link between the 1986 statutory change and
the 1994 regulations regarding foreign legal restrictions.
                                           250

of the Internal Revenue Code of 1939 interpreted by Colony. Id. at 483-
484. Although there had been changes to portions of the tax laws other
than the provision interpreted by Colony, the Supreme Court in Home
Concrete explained that these changes failed “to exert an interpretive
force sufficiently strong to affect our conclusion.” Id. at 485. Home
Concrete is distinguishable. Unlike Colony, First Security Bank did not
hold that Congress had “directly addressed the precise question at
issue”. See Home Concrete & Supply, 566 U.S. at 488 (plurality opinion)
(quoting Chevron, 467 U.S. at 843). Furthermore, compared to the
changed statutory text in Colony, the addition of the commensurate-
with-income sentence to the statute in 1986 has stronger “interpretive
force” because respondent’s position--of allocating income to 3M IPC
commensurate with income from intangibles--is supported by the text of
the 1986 amendment. Therefore, Home Concrete does not counsel the
invalidation of 26 C.F.R. sec. 1.482-1(h)(2) (2006) (1994 final
regulations) on the grounds of the regulation’s conflict with First
Security Bank.

       Having rejected petitioner’s argument that caselaw has already
held that section 482 is unambiguous, we next consider whether section
482 is actually unambiguous. 191 This is a Chevron step one question
that depends on whether Congress has “directly addressed the precise
question at issue”. Chevron, 467 U.S. at 843. In determining whether
Congress has “directly addressed the precise question at issue”, a court
is to consult the plain language of the statute, and, if the intent of
Congress is not clear, the legislative history. 192

       191  Petitioner’s arguments regarding Chevron step one hinge primarily on
judicial precedents that we have discussed above. However, petitioner also makes the
argument that “legislative history makes clear that the purpose of section 482 is to
prevent the arbitrary shifting of profits among related taxpayers through the exercise
of control” and that “3M did not exercise its control over 3M to shift profits to 3M
Brazil”.
       192   The U.S. Court of Appeals for the Eighth Circuit explained it this way:
               In the course of a Chevron analysis, a court must first consider
       the actual words of the statute. Chevron, 467 U.S. at 843 * * * (the
       starting point for the interpretation of a statute must be its plain
       language.) If the intent of Congress is clear from the plain language of
       the statutory provision, that will be the end of the judicial inquiry. Id.
       If analysis of the statutory language does not yield an unambiguous
       congressional intent, the court should then look to the legislative
       history. [Fn. Omitted.] If congressional intent is clearly discernable,
       the agency must act in accordance with that intent and the court need
       not defer to the agency’s interpretation of its mandate. K Mart Corp.
                                          251

       The “precise question at issue” is whether respondent is
precluded from making a section 482 allocation of income to 3M IPC that
could not be paid to 3M IPC under Brazilian law. 193 The first sentence
of section 482 authorizes respondent to make allocations of income
between related businesses if “necessary in order to prevent evasion of
taxes or clearly to reflect the income of any of such * * * businesses.” We
do not see in these words an unambiguous expression of Congress’ intent
on how to account for legal restrictions that prevent the receipt of
income. Chevron, 467 U.S. at 842-843. And, as we explained earlier,
the second sentence of section 482 is consistent with the allocation of
income proposed by respondent because respondent seeks to allocate
income to 3M IPC for the use of the patents and for the transfer of
unpatented technology in amounts that are proportionate to the income
earned by 3M Brazil from its use of the patents and the transfer to it of
unpatented technology. In conclusion, the actual words of section 482
do not reveal that Congress unambiguously intended to prevent
respondent from making the allocation at issue.

        We now turn to the legislative history of section 482 to see
whether it suggests that section 482 is unambiguous in this context. See
Chevron, 467 U.S. at 383 n.9 (explaining the principle subsequently
known as Chevron step one: “If a court, employing traditional tools of
statutory construction, ascertains that Congress had an intention on the
precise question at issue, that intention is the law and must be given
effect.”); Ark. AFL-CIO v. FCC, 11 F.3d 1430, 1440 n.9 (8th Cir. 1993)
(considering legislative history at Chevron step one). In favor of its
interpretation of section 482, petitioner points to the Senate Finance
Committee report that preceded the passage of the Revenue Act of 1921.
See supra part II.A (discussing the Revenue Act of 1921). That Senate
committee report suggested that section 240(d) of the Revenue Act of
1921 was designed to combat the “arbitrary shifting of profits among
related businesses”. S. Rept. No. 67-275, supra at 20, 1939-1 C.B. (Part
2) at 195. Petitioner argues that an “arbitrary shifting of profits” can

        v. Cartier Inc., 486 U.S. 281, 291 * * * (1988); see also Chevron, 467
        U.S. at 843 n.9 * * * (“the judiciary is the final authority on issues of
        statutory construction and must reject administrative constructions
        which are contrary to clear congressional intent.”)
Ark. AFL-CIO v. FCC, 11 F.3d 1430, 1440 (8th Cir. 1993).
        193 Sec. 482 also authorizes allocations of income between related businesses if

“necessary in order to prevent evasion of taxes”. Respondent does not argue that this
basis for allocating income justifies his allocation of income to 3M IPC.
                                      252

result only from the voluntary setting of intercompany prices by the
common owners of related companies.

       Even if the purpose of section 240(d) of the Revenue Act of 1921
were to prevent the voluntary shifting of profits, this does not mean that
section 482 of the Internal Revenue Code of 1986 had the same purpose.
Furthermore, we disagree with the premise that an “arbitrary shifting
of profits” among related businesses can result only from the voluntary
setting of intercompany prices. A legal restriction on intercompany
payments could also arbitrarily shift profits. Thus, even if section 482
should be narrowly interpreted to confine respondent to correcting
“arbitrary shifting of profits” (the phrase used in the 1921 Senate
committee report), a foreign legal restriction could arbitrarily shift
profits and therefore justify a section 482 allocation.

       Petitioner next points us to the report of the House Ways and
Means Committee, H.R. Rept. No. 70-2, supra at 16-17, 1939-1 C.B.
(Part 2) at 395, which related to section 45 of the Revenue Act of 1928.
Section 45 of the Revenue Act of 1928 is essentially identical to the first
sentence of the section 482 of the Internal Revenue Code of 1986. See
supra part II.D (discussing the Revenue Act of 1928); Avi-Yonah, supra,
at 96. The House committee report stated that section 45 of the Revenue
Act of 1928 would serve two purposes: to prevent tax evasion and to
clearly reflect correct tax liability. The sentence from the House
committee report quoted by petitioner was:

       The section of the new bill provides that the Commissioner
       may, in the case of two or more trades or businesses owned
       or controlled by the same interests, apportion, allocate, or
       distribute the income or deductions between or among
       them, as may be necessary in order to prevent evasion (by
       the shifting profits, the making of fictitious sales, and other
       methods frequently adopted for the purpose of “milking”),
       and in order clearly to reflect their true tax liability.

H.R. Rept. No. 70-2, supra at 16-17, 1939-1 C.B. (Part 2) at 395. 194 This
sentence merely summarizes the two bases for allocations found in the

       194 A similar statement is made in the Senate Finance Committee’s report

regarding section 45 of the Revenue Act of 1928. S. Rept. No. 70-960, supra at 24,
1939-1 C.B. (Part 2) at 426.
                                          253

plain text of section 45 of the Revenue Act of 1928. 195 The House
committee report does not show that Congress unambiguously
expressed its intent to bar respondent from making allocations of income
under section 482 when legal restrictions prevented the receipt of the
income. If anything is to be deduced from the existence of two types of
authorizations in section 45 of the Revenue Act of 1928 (the single
sentence of which was carried over as the first sentence of section 482 of
the Internal Revenue Code of 1986), it might be that taxpayer-caused
misallocations of income are not the sole object of section 482.

       There is also legislative history of the 1986 addition of the
commensurate-with-income sentence. Petitioner, in contending that
First Security Bank, L.E. Shunk Latex, Procter & Gamble, and Texaco,
should control this case even though they were decided before the
addition of the commensurate-with-income sentence, argues that the
commensurate-with-income sentence, was intended only to serve the
“timeframe” purpose identified in the House committee report and the
Blue Book. H.R. Rept. No. 99-426, supra at 425-426, 1986-3 C.B. (Vol.
2) at 425-426; General Explanation of the Tax Reform Act of 1986, supra
at 1016. But, as we have already explained, the commensurate-with-
income sentence is worded too broadly to support an interpretation
confining the operation of the sentence to such a purpose. We would add
here that the proposition that the scope of the commensurate-with-
income sentence is not confined to the “timeframe” purpose is supported
by the Conference Committee report. H.R. Conf. Rept. No. 99-841 (Vol.
II), supra at II-637 to II-638, 1986-3 C.B. (Vol. 4) at 637-638. The
conference committee report stated that the sentence was added to
ensure that “the division of income between related parties reasonably
reflect[s] the relative economic activity undertaken by each”; the report
also urged the Treasury Department to consider comprehensive
revisions to the 1968 regulations. Id. at II-637 to II-638.

        195   As we have explained:
                 As relevant here, this statute gives respondent broad authority
        to allocate gross income, deductions, credits, or allowances between or
        among commonly controlled corporations on two alternate bases; to
        prevent the evasion of taxes or in order clearly to reflect the income of
        such corporations. * * *
G.D. Searle & Co. v. Commissioner, 88 T.C. 252, 357 (1987) (referring to sec. 482 of the
Internal Revenue Code of 1954, 26 U.S.C. sec. 482 (1976), which is essentially identical
to section 45 of the Revenue Act of 1928).
                                           254

      We hold that section 482 does not “unambiguously” preclude
respondent from allocating income to 3M IPC. See Chevron, 467 U.S. at
843.

V.      Whether 26 C.F.R. sec. 1.482-1(h)(2) (2006) is reasonable under
        Chevron step two

       Having rejected petitioner’s argument that 26 C.F.R. sec. 1.482-
1(h)(2) (2006) is invalid under Chevron step one, we next consider
petitioner’s argument that portions of the regulation are invalid under
Chevron step two. A regulation satisfies Chevron step two if it is a
“reasonable interpretation” of the statute. Mayo Found. for Med. Educ.
& Research, 562 U.S. at 58; Chevron, 467 U.S. at 844. Here is a more
detailed explanation of this condition:

               Deference to an agency becomes an issue when the
        first part of a Chevron analysis does not yield a clear
        congressional intent. Chevron, 467 U.S. at 843 * * *. In
        such cases, Congress delegated the interpretation and
        development of the statutory provision to the discretion of
        the agency charged with enforcing the statute. Id.
        Therefore, Chevron requires that a reviewing court defer to
        the agency’s interpretation of an ambiguous statute if that
        interpretation is “permissible.” Good Samaritan Hosp. v.
        Shalala, * * * 113 S. Ct. 2151, 2157 * * * (1993). In order
        to be “permissible,” the agency’s construction of the statute
        must be reasonable. Chevron, 467 U.S. at 844 * * *. As
        long as the interpretation proposed by the agency is
        reasonable, a reviewing court cannot replace the agency’s
        judgment with its own. Therefore, we cannot balance
        policy considerations, or choose among competing interests
        when evaluating the reasonableness of an agency action.
        [Fn. Omitted.] See EEOC v. Commercial Office Products
        Co., 486 U.S. 107 * * * (1988).

Ark. AFL-CIO, 11 F.3d at 1441. Petitioner makes a number of
challenges under Chevron step two to the validity of the various
requirements imposed by 26 C.F.R. sec. 1.482-1(h)(2) (2006). 196 We
address these arguments below on a requirement-by-requirement basis.

        196 All of petitioner’s Chevron step two challenges to 26 C.F.R. sec. 1.482-1(h)(2)

(2006) are to specific requirements of 26 C.F.R. sec. 1.482-1(h)(2) (2006).
                                     255

       A.     Effect on uncontrolled taxpayers

        The first requirement of 26 C.F.R. sec. 1.482-1(h)(2) (2006), which
is set forth in subdivision (i), is this: “[A] foreign legal restriction will be
taken into account only to the extent that it is shown that the restriction
affected an uncontrolled taxpayer under comparable circumstances for
a comparable period of time.” The argument pressed by petitioner is
that this effect-on-uncontrolled-taxpayers requirement is incompatible
with the purpose of section 482, which, as described by 26 C.F.R. sec.
1.482-1(a)(1) (2006), “is to ensure that taxpayers clearly reflect income
attributable to controlled transactions, and to prevent the avoidance of
taxes with respect to such transactions.” Here is petitioner’s full
argument:

       Under the general rule [26 C.F.R. sec. 1.482-1(h)(2)(i)], in
       the absence of evidence indicating the effect of the foreign
       legal restriction on an uncontrolled taxpayer, the
       Commissioner will ignore the legal restriction--except that
       the Commissioner may (if the conditions set forth in clause
       (h)(2)(ii) are satisfied) allow the election of the deferred
       income method of accounting.

              The general rule apparently is an application of the
       principle that section 482 “places a controlled taxpayer on
       a tax parity with an uncontrolled taxpayer by determining
       the true taxable income of the controlled taxpayer.” Treas.
       Reg. § 1.482-1(a)(1). The general rule of Treas. Reg.
       § 1.482-1(h)(2)(i) is that if uncontrolled taxpayers are not
       subject to a foreign legal restriction, then controlled
       taxpayers, even if they are subject to the restriction, should
       be treated as if they were not subject to it.

              This is faulty logic. The purpose of section 482,
       according to the regulations, “is to ensure that taxpayers
       clearly reflect income attributable to controlled
       transactions and to prevent the avoidance of taxes with
       respect to such transactions.” Treas. Reg. § 1.482-1(a)(1)
       (emphasis added). When a legal restriction prevents the
       exercise of control, then the transaction is not a controlled
       transaction. This is so even if the legal restriction applies
       only to related party transactions. As the Supreme Court
       stated in First Security, section 482 “recognizes the concept
       that income implies dominion or control of the taxpayer.”
                                   256

      405 U.S. at 404. If such control cannot be exercised, then
      the Commissioner has no authority to allocate income
      under section 482. And as this Court said in Procter &
      Gamble (which involved a Spanish restriction on paying
      royalties to a controlling foreign parent), “we do not find it
      significant that Spanish law only precluded royalty
      payments among companies with common ownership.”
      The Court said that “the proper focus is whether control
      was utilized to shift income,” and [w]hen control cannot be
      exercised, the Commissioner has no authority to allocate
      income under section 482.” 95 T.C. at 339-40. Thus, the
      general rule of Treas. Reg. § 1.482-1(h)(2)(i) is not a
      reasonable implementation of the statute.

       Petitioner’s argument essentially consists of two parts. First,
petitioner argues that section 482 should be interpreted to address
misallocations of income attributable to controlled transactions.
Second, petitioner argues that a transaction is not a controlled
transaction to the extent that a legal restriction prevents a payment of
compensation with respect to the transaction.

       Applying this argument to the case at hand, petitioner’s position
is that 3M Company did not control the amounts that 3M Brazil paid to
3M IPC for the use of patents and for unpatented technology. That
control, petitioner argues, was exercised by the government of Brazil
through its legal restrictions.

       The first part of the argument--that section 482 is aimed at
controlled transactions--is based directly on regulations under section
482. 26 C.F.R. sec. 1.482-1(a)(1) (2006) (stating that the purpose of
section 482 is to clearly reflect income attributable to controlled
transactions). This part of the argument seems valid.

       The second part of the argument--that a transaction is a not a
controlled transaction if payment for the transaction is controlled by
law--is founded on a Supreme Court opinion, First Security Bank. The
problem with the second part of the argument is that First Security
Bank rested upon a regulatory provision from 1934 that is no longer in
effect. The history of regulations under section 482 and its predecessors
begins with the 1934 regulations that were related to section 45 of the
Revenue Act of 1934. Art. 45-1, Regulations 86. But the 1934
regulations did not limit respondent’s authority through the concept of
“controlled transactions”.     The 1934 regulations stated that the
                                         257

“interests controlling a group of controlled taxpayers are assumed to
have complete power to cause each controlled taxpayer so to conduct its
affairs that its transactions and accounting records truly reflect the net
income from the property and business of each of the controlled
taxpayers.” Art. 45-1(b), Regulations 86. This “complete power”
sentence was carried over to subsequent regulations. 197 This sentence
was recognized by First Security Bank as a limit on the scope of section
482 of the Internal Revenue Code of 1954, such that respondent could
not allocate income to a taxpayer who was barred from receiving the
income because of a legal restriction. Commissioner v. First Sec. Bank,
394 U.S. at 404-405 & n.18 (citing 26 C.F.R. sec. 1.482-1(b)(1) (1971)).
First Security Bank thus seemingly supports the second part of
petitioner’s argument discussed above, that essentially there can be no
control without legal control. But the “complete-power” sentence on
which First Security Bank relied is no longer in the regulatory scheme
for tax years beginning after April 21, 1993. 198 Therefore, the sentence
does not limit respondent’s authority to allocate the income of the 3M
consolidated group for the 2006 tax year.

       We are still left with the first part of petitioner’s argument--that
section 482 is aimed at controlled transactions. This proposition is valid
as far as it goes. But the proposition fails to defeat the section 482
allocation at issue in this case. The term “controlled transaction” was
introduced in the 1993 temporary (which were also proposed)
regulations and then adopted in the 1994 final regulations. 26 C.F.R.
sec. 1.482-1(i)(8) (2006) (1994 final regulations); 26 C.F.R. sec. 1.482-
1T(g)(8) (1994) (1993 temporary regulations). Under both sets of
regulations, the purpose of section 482 is to ensure the clear reflection
of income from controlled transactions. 26 C.F.R. sec. 1.482-1(a)(1)
(2006) (1994 final regulations); 26 C.F.R. sec. 1.482-1T(a)(1) (1994) (1993

       197Parts II.Y, II.CC, and II.EE, supra, discuss the history of the 1953, 1962,
and 1968 regulations.
       198 This point can be verified by looking at a single volume of the 2006 edition
of the Code of Federal Regulations. Compare

       •       26 C.F.R. sec. 1.482-1A(b)(1) (2006) (the redesignated regulation
               containing the “complete power” passage published under the heading
               “REGULATIONS        APPLICABLE        FOR     TAXABLE       YEARS
               BEGINNING ON OR BEFORE APRIL 21, 1993”)
       to

       •       26 C.F.R. sec. 1.482-1(a)(2), (b)(1) (2006) (1994 final regulations
               applicable for 2006 tax year).
                                            258

temporary regulations). A “controlled transaction” is defined as “any
transaction or transfer between two or more members of the same group
of controlled taxpayers.” 26 C.F.R. sec. 1.482-1(i)(8) (2006) (1994 final
regulations); 26 C.F.R. sec. 1.482-1T(g)(8) (1994) (1993 temporary
regulations). And a group of controlled taxpayers is defined as
“taxpayers owned or controlled directly or indirectly by the same
interests.” 26 C.F.R. sec. 1.482-1(i)(6) (2006) (1994 final regulations); 26
C.F.R. sec. 1.482-1T(g)(6) (1994) (1993 temporary regulations).
Petitioner does not contest that 3M IPC and 3M Brazil are owned or
controlled directly by the same interests. 199 It follows that 3M IPC and
3M Brazil are members of a group of controlled taxpayers, that all
transactions between them (including the use by 3M Brazil of 3M IPC’s
patents and including the transfer of technology from 3M IPC to 3M
Brazil), are “controlled transactions”, see 26 C.F.R. sec. 1.482-1(i)(8)
(2006) (1994 final regulations), and that therefore respondent’s section
482 adjustment to the income of the 3M consolidated group fits the
aforedescribed purpose of section 482 to achieve clear reflection of
income from controlled transactions. In short, the regulation’s focus on
a “controlled transaction”, i.e., the first part of petitioner’s argument, is
not inconsistent with the section 482 allocation at issue. We therefore
reject petitioner’s two-part argument.

       Although we have considered on its terms petitioner’s two-part
argument        challenging      the      effect-on-uncontrolled-taxpayers
requirement, we do not vouch that this two-part challenge implicates
the correct legal test for determining whether the requirement is valid
under Chevron step two. If we look to the words used by the Supreme
Court in Chevron, 467 U.S. at 844, this determination should be framed
as whether the effect-on-uncontrolled-taxpayers requirement is a
“reasonable interpretation” of section 482. Section 482 authorizes
respondent to allocate income among commonly controlled businesses if
the allocation is necessary to clearly reflect the income of the businesses.
But no text in section 482 addresses how the allocation should account
for legal restrictions on the payment of income. For example, section
482 does not mention legal restrictions on the payment of income. This

         199 There is an identical control test in the text of sec. 482. For an allocation of

income to be made, the statute requires that the two businesses be “owned or controlled
directly or indirectly by the same interests”. Sec. 482. Paragraph 25 of the stipulation
states that the operations of 3M Brazil were “owned or controlled” within the meaning
of sec. 482 by (1) 3M Company and (2) 3M IPC. Furthermore, it has been stipulated
that 3M Company ultimately owned 3M IPC and 3M Brazil in that it has been
stipulated that (1) 3M IPC was a wholly owned second-tier subsidiary of 3M Company
and (2) 3M Brazil was a wholly owned subsidiary of 3M IPC.
                                    259

omission is an implicit signal that the Treasury Department has
regulatory space to account for legal restrictions. See Chevron, 467 U.S.
at 844. Exercising that authority, the Treasury Department has
specified that foreign legal restrictions are taken into account only if
those restrictions affect uncontrolled taxpayers. 26 C.F.R. sec. 1.482-
1(h)(2)(i) (2006). In our view, this requirement is a reasonable
interpretation of section 482.        That statutory text--authorizing
respondent to allocate income between controlled businesses “in order
* * * clearly to reflect” their income--is broad enough to accommodate
the interpretation. See Springdale Mem’l Hosp. Ass’n, Inc. v. Bowen,
818 F.2d 1377, 1381 (8th Cir. 1987). The interpretation is reasonable.

       Our view that the effect-on-uncontrolled-taxpayers requirement
is a reasonable interpretation of section 482 is consistent with the way
in which the requirement supports two of the goals ascribed to section
482 by regulation. These goals are (1) tax parity and (2) arm’s-length
results.   26 C.F.R. sec. 1.482-1(a)(1), (b)(1) (2006) (1994 final
regulations).

       The effect-on-uncontrolled-taxpayers requirement is consistent
with the tax-parity goal in the regulations. The regulations state that
section 482 places a controlled taxpayer on a tax parity with an
uncontrolled taxpayer. 26 C.F.R. sec. 1.482-1(a)(1) (2006) (1994 final
regulations) (“Section 482 places a controlled taxpayer on a tax parity
with an uncontrolled taxpayer by determining the true taxable income
of the controlled taxpayer.”). It is consistent with this goal for income to
be allocated to a U.S. company from a related foreign company, despite
a foreign law barring the payment of the income, if the foreign law would
have allowed an unrelated foreign company to pay the income. The
allocation places the U.S. company receiving payments from a related
foreign company on par with a U.S. company receiving payments from
an unrelated foreign company.

       The effect-on-uncontrolled-taxpayers requirement is also
consistent with the arm’s-length standard. The regulations explain that
determinations under section 482 are to be made under the arm’s-length
standard and that the arm’s-length standard is met if “the results of the
[controlled] transaction are consistent with the results that would have
been realized if uncontrolled taxpayers had engaged in the same
transaction under the same circumstances (arm’s length result).” 26
C.F.R. sec. 1.482-1(b)(1) (2006) (1994 final regulations). If a foreign
restriction governs payments between controlled taxpayers but not
uncontrolled taxpayers, then allowing the restriction to affect the
                                    260

taxable income of controlled taxpayers would produce a non-arm’s-
length result that does not meet the arm’s-length standard. The effect-
on-uncontrolled-taxpayers requirement, 26 C.F.R. sec. 1.482-1(h)(2)(i)
(2006), disregards such a foreign legal restriction. The requirement thus
corrects the non-arm’s-length result and sets the controlled taxpayers
on the arm’s-length standard.

        Thus far we have been discussing whether the effect-on-
uncontrolled-taxpayers requirement reasonably interprets the first
sentence of section 482. But respondent also argues that the effect-on-
uncontrolled-taxpayers requirement is a reasonable interpretation of
the second sentence of section 482. Added in 1986, the second sentence
of section 482 provides that in the case of transfer or license of intangible
property, the income with respect to the transfer or license must be
commensurate with the income attributable to the intangible. In the
case of a foreign legal restriction that affects only controlled taxpayers,
the restriction would be disregarded by the effect-on-uncontrolled-
taxpayers requirement. If such a foreign legal restriction prevents
payment of compensation for the transfer or license of intangible
property, the effect of disregarding the restriction is that the transferor
or licensor of the intangible property could be allocated income
commensurate with the income from the intangible. In such an
instance, the commensurate-with-income goal of the second sentence of
section 482 is achieved by the effect-on-uncontrolled-taxpayers
requirement. The Brazilian legal restrictions at issue in this case are
an instance of foreign legal restrictions that prevent payment of
compensation for the transfer or license of intangible property.
Disregarding these restrictions achieves the goal of the second sentence
of section 482, which is to ensure that income with respect to the
transfer or license of intangibles is commensurate with the income
attributable to the intangibles. As applied to the facts of this case,
therefore, the effect-on-uncontrolled-taxpayers requirement of 26 C.F.R.
sec. 1.482-1(h)(2)(i) (2006) is a reasonable interpretation of the second
sentence of section 482.

       In conclusion, the effect-on-uncontrolled-taxpayers requirement
of 26 C.F.R. sec. 1.482-1(h)(2)(i) (2006) is a reasonable interpretation of
both sentences of section 482. We reject petitioner’s challenge to the
validity of the effect-on-uncontrolled-taxpayers requirement under
Chevron step two.
                                         261

       B.      Publicly promulgated

       Title 26 C.F.R. 1.482-1(h)(2)(ii)(A) (2006) provides that a foreign
legal restriction is taken into account under section 482 only if it is
“publicly promulgated”. We held supra part III.B that this means the
restriction must be in writing.

       The public-promulgation requirement is a reasonable
interpretation of section 482 because the requirement avoids
uncertainty about, and litigation over, the existence of a foreign legal
restriction. See Mayo Found., 562 U.S. at 59 (holding that a regulation
was valid under Chevron step two because, in part, the regulation
reduced litigation and uncertainty). It is difficult to discern the
existence and scope of a foreign legal restriction that is not publicly
promulgated. 200 It was not unreasonable for the Treasury Department
to require a foreign legal restriction to be publicly promulgated.

       Petitioner contends that the public-promulgation requirement is
an unreasonable interpretation of section 482 because it does not “take
into account the fact that many countries rely on unpromulgated
administrative guidance that is nonetheless considered binding.” Yet
the structure of 26 C.F.R. sec. 1.482-1(h)(2) (2006) shows that the
Treasury Department recognized that some foreign legal restrictions
were not publicly promulgated. Title 26 C.F.R. sec. 1.482-1(h)(2)(ii)(C)
(2006) provides that for foreign legal restrictions to affect a section 482
allocation they must “expressly prevent[] the payment or receipt, in any
form, of part or all of the arm’s length amount”. This (the sixth)
requirement is separate from the public-promulgation requirement
imposed by 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006). To require a
restriction to be publicly promulgated implies the recognition that some
restrictions are not publicly promulgated.

       200 As a factual matter, petitioner claims that the Brazilian legal restrictions
are “easily discoverable.” Petitioner does not cite any evidence for this proposition.
Instead petitioner directs us to a website that petitioner claims exemplifies the
“summaries of the rules on the Internet.” However, the website does not currently
contain any content regarding any Brazilian legal restrictions. Furthermore,
petitioner made this claim in its answering brief, so respondent did not have a chance
to respond to it.
       As respondent points out, the difficulty in discovering unwritten laws is
supported by the facts of this case. The stipulation recounts that in at least two
instances (described in paragraphs 64.b, 65, 94.b, and 94.c of the stipulation), 3M
Company’s attorneys misunderstood the BPTO’s unwritten policies.
                                    262

      We hold the requirement is valid under Chevron step two.

      C.     Generally applicable

       Title 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006) requires the foreign
legal restriction to be “generally applicable to all similarly situated
persons (both controlled and uncontrolled)”. Petitioner contends that
this requirement is an unreasonable interpretation of section 482.
Petitioner states that this requirement is similar to the effect-on-
uncontrolled-taxpayers requirement. Petitioner further states that its
arguments against the reasonableness of this general-applicability
requirement are similar to its arguments that the effect-on-
uncontrolled-taxpayers requirement is unreasonable. See supra part
III.A (holding that effect-on-uncontrolled-taxpayers requirement is
valid under Chevron step 2). We hold that the general-applicability
requirement is valid under Chevron step two.

      D.     Not part of commercial transaction

       Title 26 C.F.R. sec. 1.482-1(h)(2)(ii)(A) (2006) provides that the
foreign legal restriction must not have been imposed as part of a
commercial transaction between the taxpayer and the foreign
government. Petitioner does not contend that this requirement is
invalid under Chevron step two. For the purposes of this Opinion, we
conclude without further discussion that the requirement is valid under
Chevron step two.

      E.     Exhaustion of remedies

       Title 26 C.F.R. sec. 1.482-1(h)(2)(ii)(B) (2006) provides that a
foreign legal restriction will be taken into account only if the taxpayer
has exhausted all remedies prescribed by foreign law or practice for
obtaining a waiver of the restriction (other than remedies that would
have a negligible prospect of success if pursued). Petitioner concedes
that the exhaustion-of-remedies requirement is reasonable under
Chevron step two because the requirement does not impose on taxpayers
a duty to pursue remedies with a negligible prospect of success.

      F.     Restriction on payment in any form

       Title 26 C.F.R. sec 1.482-1(h)(2)(ii)(C) (2006) provides that a
foreign legal restriction will be taken into account only if the restriction
“expressly prevented the payment or receipt, in any form, of part or all
                                       263

of the arm’s length amount that would otherwise be required under
section 482 (for example, a restriction that applies only to the
deductibility of an expense for tax purposes is not a restriction on
payment or receipt for this purpose)”. Petitioner contends that the “any
form” requirement is invalid because it is an unreasonable
interpretation of section 482.

       We need not determine whether the “any form” requirement
satisfies Chevron step two because we have held that the Brazilian legal
restrictions fail three other requirements of 26 C.F.R. sec. 1.482-1(h)(2)
(2006). See Ramm v. Commissioner, 72 T.C. 671, 674-675 (1979)
(finding it unnecessary for the Court to evaluate the validity of a
requirement imposed by a regulation if the taxpayer did not satisfy the
other requirements imposed by the regulation).

       G.      Circumvention or violation of restriction

       Title 26 C.F.R. sec. 1.482-1(h)(2)(ii)(D) (2006) provides that a
foreign legal restriction will be taken into account only if the related
parties did not engage in an arrangement that had the effect of
circumventing the restriction and did not violate the restriction in a
material respect. Petitioner contends that this no-circumvention
requirement is invalid under Chevron step two. We need not determine
whether the no-circumvention requirement fails Chevron step two. This
is because we have held that three other requirements of 26 C.F.R. sec.
1.482-1(h)(2) (2006) have not been met. See Ramm v. Commissioner, 72
T.C. at 674-675.

VI.    The State Farm test for validity of regulations

      In Motor Vehicle Mfrs. Ass’n of the U.S., Inc. v. State Farm Mut.
Auto. Ins. Co. (State Farm), 463 U.S. 29, 34, 37 (1983), the Supreme
Court held that the Department of Transportation failed to present an
“adequate basis and explanation” for rescinding its regulatory
requirement that car manufacturers equip cars with either airbags or
automatic seatbelts. This failure meant that the requirement “may not
be abandoned”. Id. at 51. 201 In Altera Corp. & Subs. v. Commissioner,
145 T.C. at 106, 117-120, we held that the test employed in State Farm
should be applied to the 2003 amendments to the section 482 regulations

        201 The Supreme Court held that the matter should be remanded to the agency

for further consideration. Motor Vehicle Mfrs. Ass’n of the U.S., Inc. v. State Farm
Mut. Auto. Ins. Co. (State Farm), 463 U.S. 29, 57 (1983).
                                          264

regarding stock compensation in the context of cost-sharing
arrangements. 202 We held that the 2003 regulatory amendments failed
the State Farm test. Altera Corp. & Subs. v. Commissioner, 145 T.C. at
133. Therefore we held that the 2003 regulatory amendments were
invalid. Id. 203

       Petitioner contends that 26 C.F.R. sec. 1.482-1(h)(2) (2006)
regarding foreign legal restrictions is valid only if it satisfies the State
Farm test. Respondent disagrees. He contends that the State Farm test
is inapplicable to 26 C.F.R. sec. 1.482-1(h)(2) (2006). We need not
resolve whether 26 C.F.R. sec. 1.482-1(h)(2) (2006) must satisfy the
State Farm test. Even if 26 C.F.R. sec. 1.482-1(h)(2) (2006) is reviewable
under the State Farm test, this review would not result in a decision for
petitioner.

       Petitioner makes two types of challenges to 26 C.F.R. sec. 1.482-
1(h)(2) (2006) under State Farm: first, that the Treasury Department
did not “explain[] its choices with respect to Treas. Reg. § 1.482-1(h)(2)”;
and second, that the Treasury Department did not “respond[] to the
comments it received objecting to aspects thereof and requesting that
changes be made to the proposed regulations”. We consider both types

        202The Ninth Circuit reversed our decision in Altera, but did not disagree that
the 2003 regulatory amendments had to meet the State Farm test. Altera Corp. &
Subs. v. Commissioner, 926 F.3d 1061, 1075, 1079-1086 (9th Cir. 2019), rev’g 145 T.C.
91 (2015).
        203  As we explained supra part I.H., the 1992 proposed regulations had a
paragraph on cost-sharing agreements. Sec. 1.482-2(g), Proposed Income Tax Regs.,
57 Fed. Reg. 3595-3601 (Jan. 30, 1992). As we explained supra part II.LL and MM,
the 1993 temporary regulations also had a provision related to cost-sharing
agreements. 26 C.F.R. sec. 1.482-7T (1994) (1993 temporary regulations). As we
explained supra part II.NN, the 1994 final regulations had no provisions regarding
cost-sharing agreements. In 1995, the Treasury Department promulgated final
regulations regarding cost-sharing agreements. T.D. 8632, 60 Fed. Reg. 65553 (Dec.
20, 1995). In July 2002, the Treasury Department issued a notice of proposed
rulemaking with respect to a proposed amendment to the 1995 cost-sharing
regulations. 67 Fed. Reg. 48997 (July 29, 2002). In August 2003, the Treasury
Department promulgated a final rule amending the 1995 cost-sharing regulations.
T.D. 9088, 68 Fed. Reg. 51171 (Aug. 26, 2003). In Altera Corp. Subs. v. Commissioner,
145 T.C. at 117-120, we held that the final rule had to satisfy the State Farm test. We
held that the final rule did not satisfy the State Farm test because (1) it lacked a basis
in fact, (2) the Treasury Department failed to rationally connect the choice it made
with the facts it found, (3) the Treasury Department failed to adequately respond to
those who had commented on the proposed rulemaking, and (4) the final rule was
contrary to the evidence before the Treasury Department. Id. at 120-131.
                                         265

of challenges in the same sequence: (1) satisfactory explanation and
(2) and adequate response to comments.

       A.      Satisfactory explanation

       State Farm requires the agency to “articulate a satisfactory
explanation for its action, including a ‘rational connection between the
facts found and the choices made.’” State Farm, 463 U.S. at 43 (quoting
Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168
(1962)). 204 The agency’s explanation is satisfactory if the explanation is
“clear enough” that the agency’s “path may reasonably be discerned”.
Encino Motor Cars v. Navarro, 579 U.S. 211, 221 (2016) (quoting
Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419 U.S. 281, 286
(1974)).

       Petitioner argues that “Treasury provided no rationale
whatsoever for Treas. Reg. § 1.482-1(h)(2)”. We disagree. The first
requirement of 26 C.F.R. sec. 1.482-1(h)(2) (2006) is that the foreign
legal restriction affect uncontrolled taxpayers. The words of the
requirement itself express its rationale: “The district director will take
into account the effect of a foreign legal restriction to the extent that
such restriction affects the results of transactions at arm’s length. Thus,
a foreign legal restriction will be taken into account only to the extent
that it is shown that the restriction affected an uncontrolled taxpayer
under comparable circumstances for a comparable period of time.” 26
C.F.R. sec. 1.482-1(h)(2)(i) (2006). An “[u]ncontrolled taxpayer”--a term
used in the text of the requirement--is defined elsewhere in the 1994
final regulations as “any one of two or more taxpayers not owned or
controlled directly or indirectly by the same interests.” 26 C.F.R. sec.
1.482-1(i)(5) (2006). In our view, the regulatory text imposing the effect-
on--uncontrolled-taxpayers requirement, 26 C.F.R. sec. 1.482-1(h)(2)(i)
(2006), means that it is a specific application of two principles of section
482: (1) the arm’s-length standard and (2) the principle that section 482
should achieve tax parity between controlled and uncontrolled parties.
We explain this in greater detail below.

        204 The statutory source for this requirement has been identified as sec.

10(e)(B)(1) of the APA (codified as amended at 5 U.S.C. sec. 706(2)(A) (2018)), which
provides that a reviewing court will hold unlawful and set aside agency action that is
arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.
SIH Partners LLLP v. Commissioner, 150 T.C. 28, 42 (2018).
                                         266

       The arm’s-length standard has been recognized as a guiding
principle of allocations of income under section 482 and its predecessors
as far back as the 1934 regulations interpreting section 45 of the
Revenue Act of 1934. Art. 45-1(b), Regulations 86. The arm’s-length
standard is still recognized in the 1994 final regulations:

       In determining the true taxable income of a controlled
       taxpayer, the standard to be applied in every case is that
       of a taxpayer dealing at arm’s length with an uncontrolled
       taxpayer. A controlled transaction meets the arm’s length
       standard if the results of the transaction are consistent
       with the results that would have been realized if
       uncontrolled taxpayers had engaged in the same
       transaction under the same circumstances (arm’s length
       result). * * *

26 C.F.R. sec. 1.482-1(b)(1) (2006). Under the arm’s-length standard, a
section 482 allocation is based on the pricing of transactions between
unrelated parties--i.e., parties who deal with each other at arm’s length.
A foreign legal restriction that does not affect unrelated parties would
not affect the pricing of transactions between unrelated parties. See 26
C.F.R. sec. 1.482-1(h)(2)(i) (2006). Thus, the Treasury Department
satisfactorily explained that one of the reasons it promulgated section
1.482-1(h)(2) of the 1994 final regulations (26 C.F.R. sec. 1.482-1(h)(2)
(2006)) was to advance the goal of arm’s-length comparisons.

      Likewise, the tax-parity goal has long been recognized in the
regulatory scheme. 205 The 1994 final regulations state that section 482

       205 The regulations first adopted the goal of tax parity in 1934. Art. 45-1(b),
Regulations 86 (“The purpose of section 45 is to place a controlled taxpayer on a tax
parity with an uncontrolled taxpayer, by determining, according to the standard of an
uncontrolled taxpayer, the true net income from the property and business of a
controlled taxpayer.”). The 1993 temporary regulations contained a sentence
regarding tax parity: “Section 482 places a controlled taxpayer on a tax parity with an
uncontrolled taxpayer by determining the true taxable income of the controlled
taxpayer in a manner that reasonably reflects the relative economic activity
undertaken by each taxpayer.” 26 C.F.R. sec. 1.482-1T(a)(1) (1994) (1993 temporary
regulations). The preamble to the Treasury Department’s decision to promulgate the
1993 temporary regulations echoed the tax-parity goal: “Section 1.482-1T(a)(1)
reaffirms that the purpose of section 482 is to ensure that taxpayers clearly reflect
their income by placing a controlled taxpayer on a tax parity with an uncontrolled
taxpayer by determining the controlled taxpayer’s true taxable income.” T.D. 8470, 58
Fed. Reg. 5265 (Jan. 21, 1993). The preamble to the Treasury Department’s decision
                                         267

“places a controlled taxpayer on a tax parity with an uncontrolled
taxpayer by determining the true taxable income of the controlled
taxpayer”. 26 C.F.R. sec. 1.482-1(a)(1) (2006) (emphasis added). This
tax-parity goal is reflected in the 26 C.F.R. sec. 1.482-1(h)(2) (2006)
treatment of foreign legal restrictions. Subdivision (1) of that regulation
states that “a foreign legal restriction will be taken into account only to
the extent that it is shown that the restriction affected an uncontrolled
taxpayer”.     (Emphasis added.)       Thus, the effect-on-uncontrolled-
taxpayers requirement of section 1.482-1(h)(2)(i) of the 1994 final
regulations (26 C.F.R. sec. 1.482-1(h)(2)(i) (2006)) articulates a link to
the goal of tax parity between controlled and uncontrolled taxpayers
found in section 1.482-1(a)(1). 206          The Treasury Department
satisfactorily explained that one of the reasons it promulgated section
1.482-1(h)(2) of the 1994 final regulations was to advance the goal of tax
parity.

      We conclude that the regulation is not invalid for want of
explanation.

       B.      Adequate response to comments

      One aspect of the State Farm test is that an agency must
adequately respond to significant comments. See Altera Corp. & Subs.
v. Commissioner, 145 T.C. at 120, 130. 207 Significant comments are

to promulgate the 1994 final regulations explained that both the 1993 temporary
regulations and the 1994 final regulations contained the tax-parity sentence and
explained why the phrase “in a manner that reasonably reflects the relative economic
activity undertaken by each taxpayer” was omitted from the 1994 final regulation.
T.D. 8552, 59 Fed. Reg. 34976.
        206 Indeed, as part of its argument that the effect-on-uncontrolled-taxpayers

requirement fails the Chevron step-two test (an argument discussed supra part V.A),
petitioner concedes that the requirement “apparently is an application of the principle
that section 482 ‘places a controlled taxpayer on a tax parity with an uncontrolled
taxpayer by determining the true taxable income of the controlled taxpayer.’ Treas.
Reg. § 1.482-1(a)(1).”
       207 Altera suggested that the adequate-response-to-comments requirement was
part of the State Farm test but did not identify a specific portion of the State Farm
opinion that discussed this requirement. Instead Altera cited a U.S. Court of Appeals
opinion that held that an agency has an obligation to “respond[] to significant points
raised by the public”. Altera Corp. & Subs. v. Commissioner, 145 T.C. at 112 (quoting
Home Box Office, Inc. v. FCC, 567 F.2d 9, 35-36 (D.C. Cir. 1977)). “However,” Altera
observed, “[t]he failure to respond to comments is significant only insofar as it
demonstrates that the agency’s decision was not based on a consideration of the
                                       268

“those ‘comments which, if true, . . . would require a change in [the]
proposed rule.’” La. Fed. Land Bank Ass’n, FLCA v. Farm Credit
Admin., 336 F.3d 1075, 1080 (D.C. Cir. 2003) (quoting Am. Mining Cong.
v. EPA, 907 F.2d 1179, 1188 (D.C. Cir. 1990)). Petitioner has identified
six types of comments regarding section 1.482-1T(f)(2), Proposed Income
Tax Regs., 58 Fed. Reg. 5312 (Jan. 21, 1993), to which in its view the
Treasury Department did not give an adequate response. 208 We discuss
below each of the types of comments discussed by petitioner.

                 1.      Inconsistency with First Security Bank

      First, as petitioner points out, all four commentators (the
American Petroleum Institute, the Tax Executives Institute, TRW, and
the United States Council for International Business) explained to the
Treasury Department that section 1.482-1T(f)(2), Proposed Income Tax
Regs., 58 Fed. Reg. 5212-5314, was inconsistent with First Security
Bank and Procter & Gamble. Given the history of section 482, it is
apparent that the Treasury Department was already aware that the
proposed regulation was inconsistent with the caselaw. Indeed, one of
the commentators said that the proposed regulation was an “obvious
attempt” to “override” Procter & Gamble. Thus, these comments about
inconsistency with prior caselaw were not significant. Thompson v.
Clark, 741 F.2d 401, 409 (D.C. Cir. 1984) (stating that when comments
“brought to the attention of the agency nothing which it had not already
considered”, the agency need not respond).

                 2.      That some foreign legal restrictions apply only to
                         payments between related parties

       Second, petitioner points out that two commentators explained
that some foreign legal restrictions apply only to payments between
related persons. The structure of 26 C.F.R. sec. 1.482-1(h)(2) (2006)
shows that the Treasury Department was aware that some foreign legal
restrictions applied only to payments between related persons. Under
the general applicability requirement in 26 C.F.R. sec. 1.482-

relevant factors.” Altera Corp. & Subs. v. Commissioner, 145 T.C. at 112 (quoting
Sherley v. Sebelius, 689 F.3d 776, 784 (D.C. Cir. 2012)).
        208 To the extent it matters whether the Treasury Department considered the

public comments, petitioner has conceded that the Treasury Department considered
the public comments. First, paragraph 116 of the stipulation acknowledges that “all
the comments were considered”. Second, petitioner’s brief argues that the Treasury
Department did not “respond[]” to the comments, not that it failed to consider the
comments.
                                   269

1(h)(2)(ii)(A) (2006), a foreign legal restriction will be accounted for in
making a section 482 allocation only if the restriction applies to
controlled persons (which includes related persons) and uncontrolled
persons. Therefore, it is evident that the Treasury Department was
aware that some foreign legal restrictions apply only to payments
between related persons. Thus, these comments did not bring to the
Treasury Department’s attention something of which the Treasury
Department was not already aware and did not require a change to the
regulation. La. Fed. Land Bank Ass’n, FLCA, 336 F.3d at 1080;
Thompson v. Clark, 741 F.2d at 409.

                3.     That some foreign legal restrictions are
                       unpublished (comment related to the second
                       requirement)

       Third, petitioner points out that the American Petroleum
Institute explained that some foreign restrictions with the practical
force and effect of law may not be traceable to a specific published
source. On that ground, the American Petroleum Institute opposed the
requirement in section 1.482-1T(f)(2)(ii)(A), Proposed Income Tax Regs.,
58 Fed. Reg. 5312, that the foreign legal restriction be “publicly
promulgated”. The Treasury Department was aware that some legal
restrictions are not publicly promulgated, as is shown by its insistence
that only publicly promulgated restrictions be taken into account. Thus
the American Petroleum Institute’s comment is not significant. See
Thompson, 741 F.2d at 408.

                4.     Difficulty of establishing that the remedies were
                       exhausted (comment related to the fifth
                       requirement)

       Fourth, petitioner observes that commentators had expressed
concern that it would be difficult for a taxpayer to establish the
satisfaction of the requirement, in section 1.482-1T(f)(2)(ii)(B), Proposed
Income Tax Regs., 58 Fed. Reg. 5312, that the taxpayer exhaust all
remedies.     This requirement was made part of the 1994 final
regulations. 26 C.F.R. sec. 1.482-1(h)(2)(ii)(B) (2006). In this case
however, other requirements of 26 C.F.R. sec. 1.482-1(h)(2) (2006) are
not met: i.e., the effect-on-uncontrolled-taxpayers requirement, the
public-promulgation requirement, and the general-applicability
requirement. Therefore, any failure by the Treasury Department to
appropriately respond to comments regarding the exhaustion-of-
remedies requirement is irrelevant to the current case.
                                   270

                5.     Payment of dividends and the no-circumvention
                       requirement (comment related to the seventh
                       requirement)

       Fifth, petitioner observes that commentators expressed concern
that the no-circumvention requirement found in section 1.482-
1T(f)(2)(ii)(D), Proposed Income Tax Regs., 58 Fed. Reg. 5312, could be
interpreted to mean that the payment of dividends might be considered
a way to circumvent a legal restriction. In this case however, other
requirements are not met: i.e., the effect-on-uncontrolled-taxpayers
requirement, the public-promulgation requirement, and the general-
applicability requirement. Therefore, any failure by the Treasury
Department to appropriately respond to comments regarding the no-
circumvention requirement is irrelevant to the current case.

                6.     Time for making deferral election

       Petitioner observes that commentators had stated that they
preferred that taxpayers be allowed to continue to make the deferral
election within the timeframe permitted by the 1968 regulations. See
26 C.F.R. sec. 1.482-1(d)(6) (1969) (1968 regulations). However, the 3M
consolidated group did not elect the deferred income method of
accounting. Nor does petitioner assert that the group is entitled to use
that method. Therefore, any failure by the Treasury Department to
respond appropriately to comments regarding the timing of the deferral
election is irrelevant to the current case.

VII.   Conclusion

       As explained above, some of petitioner’s arguments involve a
general challenge to the entire regulation 26 C.F.R. sec. 1.482-1(h)(2)
(2006). This regulation was promulgated in 1994 to resolve questions
regarding foreign legal restrictions under section 482. As to petitioner’s
Chevron step-one challenge, we hold that judicial precedent has not
established that the plain language of section 482 is inconsistent with
the regulation. See supra part IV. We further hold that the plain text
of section 482 itself is not inconsistent with 26 C.F.R. sec. 1.482-1(h)(2)
(2006). See supra part IV. This further holding also relates to Chevron
step one.

       Petitioner’s State Farm challenge to 26 C.F.R. sec. 1.482-1(h)(2)
(2006) rests in part on the theory that the Treasury Department failed
to satisfactorily explain 26 C.F.R. sec. 1.482-1(h)(2) (2006). This is an
                                     271

attack on the entire regulation that we reject for reasons explained
supra part VI.A.

      Petitioner’s State Farm challenge also rests on the theory that the
Treasury Department failed to adequately respond to public comments
on the proposed form of the regulation. In part, this is a general attack
on the regulation, which we reject. See supra part VI.B.1, 2, and 6.

       That leaves petitioner’s arguments that are related to particular
requirements of the regulation, 26 C.F.R. sec. 1.482-1(h)(2) (2006).
Petitioner’s Chevron step-two challenge is particular to the first, second,
third, sixth, and seventh requirements of 26 C.F.R. sec. 1.482-1(h)(2)
(2006). We reject petitioner’s Chevron step-two challenge to the first,
second, and third requirements, see supra part V.A, B, and C, and we
leave unresolved its challenge to the sixth and seventh requirements.
See supra part V.F and G. Petitioner’s State Farm challenge based on
an adequate response to comments includes specific attacks on the
second, fifth, and seventh requirements. See supra part VI.B.3, 4, and
5. We reject the challenge to the second requirement, see supra part
VI.B.3, and leave unresolved the challenges to the fifth and seventh
requirements, see supra part VI.B.4 and 5. Petitioner also argues that
the second, fourth, fifth, and seventh requirements are satisfied. We
hold that the second requirement is not met, see supra part III.B, we
hold that the fourth requirement is met, see supra part III.D, but we
leave unresolved the question of whether the fifth and seventh
requirements are met, see supra part III.E and G.

       The table below illustrates petitioner’s contentions regarding the
validity of particular requirements of 26 C.F.R. sec. 1.482-1(h)(2) (2006):

                                                                 Does P contend
                                                                the requirement
                                             Does P contend    is invalid because
                                            the requirement       of insufficient
                           Does P contend   is invalid under       response to
                          the requirement     Chevron step      comments under
      Requirement              is met?            two?             State Farm?

 1. Restriction must            No                Yes                 No
 affect uncontrolled
 taxpayers

 2. Restriction must be        Yes                Yes                 Yes
 publicly promulgated
                                 272

3. Restriction must be     No             Yes             No
generally applicable

4. Restriction must not    Yes            No              No
be part of a commercial
transaction

5. Taxpayer must           Yes            No              No
exhaust remedies for
obtaining waiver of
restriction

6. Restrictions must       No             Yes             Yes
prohibit any form of
payment

7. Taxpayer did not        Yes            Yes             Yes
circumvent or violate
restriction

      The table below illustrates the Court’s holdings regarding the
particular requirements of 26 C.F.R. sec. 1.482-1(h)(2) (2006):
                                    273

                                                                 Is the
                                                             requirement
                                              Is the      invalid because of
                                           requirement        insufficient
                              Is the      invalid under       response to
                           requirement    Chevron step     comments under
      Requirement              met?            two?          State Farm?

 1. Restriction must           No              No                No
 affect uncontrolled
 taxpayers

 2. Restriction must be        No              No                No
 publicly promulgated

 3. Restriction must be        No              No                No
 generally applicable

 4. Restriction must not      Yes              No                No
 be part of a commercial
 transaction

 5. Taxpayer must          Unresolved          No                No
 exhaust remedies for
 obtaining waiver of
 restriction

 6. Restrictions must          No          Unresolved        Unresolved
 prohibit any form of
 payment

 7. Taxpayer did not       Unresolved      Unresolved        Unresolved
 circumvent or violate
 restriction

       As the table illustrates, the first, second, and third requirements
are valid and are not met with respect to the Brazilian legal restrictions.
Therefore the restrictions should not be taken into account in evaluating
respondent’s allocation of income to the 3M consolidated group. We
therefore sustain respondent’s determination.

       To reflect the foregoing,

       Decision will be entered under Rule 155.
                             274

    Reviewed by the Court.

    KERRIGAN, GALE, GUSTAFSON, NEGA, ASHFORD, and
MARSHALL, JJ., agree with this opinion of the Court.

    PARIS and COPELAND, JJ., concur in the result only.

    FOLEY, BUCH, PUGH, URDA, JONES, TORO, GREAVES, and
WEILER, JJ., dissent.
                                   275

       KERRIGAN, C.J., concurring: I agree with the outcome in the
opinion of the Court and write mainly in response to the dissents. The
opinion of the Court provides a thorough analysis of the issues under
consideration. I will focus solely on the arguments made against the
validity of Treasury Regulation § 1.482-1(h)(2) (blocked income
regulation).

       In the notice of deficiency, respondent made an adjustment under
section 482 “to clearly reflect the income of the entities.” Respondent
allocated royalty income to petitioner from its Brazilian subsidiary in
connection with the subsidiary’s use of intellectual property. At issue
here is a Brazilian law that precluded the subsidiary from paying any
royalties to petitioner other than a nominal amount.

       Petitioner contends that respondent’s allocation is improper
because the subsidiary was not legally permitted to make the payment
to petitioner. Respondent asserts that the Brazilian law should not be
considered because the blocked income regulation’s requirements are
not satisfied. Petitioner asserts—and the dissents agree—that the
blocked income regulation is invalid. I disagree on the basis of the
following.

       The thrust of Judge Buch’s dissent is that section 482, as
interpreted by the Supreme Court in Commissioner v. First Security
Bank of Utah, N.A., 405 U.S. 394, 404–05 (1972), is unambiguous,
thereby foreclosing the promulgation of regulations interpreting it. See
Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).
Under that interpretation, any regulation permitting the Commissioner
to allocate income in the face of a legal restriction would be invalid.
Judge Toro’s dissent goes further and asserts that the blocked income
regulation is invalid because Treasury failed to follow the
Administrative Procedure Act’s (APA) requirements. I disagree with
both assertions and will respond to each in turn.

       First, First Security Bank is distinguishable on its face and
therefore does not control this case. In Commissioner v. First Security
Bank, 405 U.S. at 401 n.13, the Court was interpreting a domestic
Federal banking law which implicitly prohibits national banks from
acting as insurance agents in places with a population of 5,000 or more.
Here the Tax Court is tasked with interpreting a foreign law.
Additionally, the law considered in First Security Bank was one of
general application whereas the blocked income regulation has a specific
use: It is aimed at restrictions that bar payments only to foreign
                                    276

companies affiliated with the local business. I find these factual
distinctions to be significant, confining First Security Bank’s holding to
the circumstances presented in that case.

       Furthermore, the version of section 482 that the Supreme Court
interpreted in First Security Bank differs significantly from the
statutory text that controls this case. In 1986 Congress amended section
482, making the first substantive change since 1954. The amendment
added the following new sentence to section 482: “In the case of any
transfer (or license) of intangible property . . . the income with respect
to such transfer or license shall be commensurate with the income
attributable to the intangible.”

       As a result of the sentence added to section 482, Treasury
promulgated new regulations in 1994. The new regulations made
changes to the section 482 regulations, including the elimination of the
complete power regulation provided in Treasury Regulation § 1.482-
1(b)(1) (complete power regulation). See Treas. Reg. § 1.482-1(b)(1)
(1971) (“The interests controlling a group of controlled taxpayers are
assumed to have complete power to cause each controlled taxpayer so to
conduct its affairs that its transactions and accounting records truly
reflect the taxable income . . . of each of the controlled taxpayers.”). The
holding in First Security Bank was grounded in this provision; it stated:
“The ‘complete power’ referred to in the regulations hardly includes the
power to force a subsidiary to violate the law.” Commissioner v. First
Security Bank, 405 U.S. at 405. Because the complete power regulation
no longer exists—as a result of the 1994 promulgation—I disagree with
Judge Buch’s dissent’s reliance on First Security Bank.

       Judge Buch’s dissent also relies on a prior decision of this Court,
Procter & Gamble Co. v. Commissioner, 95 T.C. 323 (1990), aff’d, 961
F.2d 1255 (6th Cir. 1992), to bolster its argument that section 482 is
unambiguous. In Procter & Gamble the tax years in issue were 1978
and 1979, meaning that the 1954 version of section 482 governed that
dispute. We concluded in Procter & Gamble that the First Security Bank
analysis applied and held: “Where the controlling interest has not
utilized its power to shift income, a section 482 allocation is
inappropriate.” Procter & Gamble Co., 95 T.C. at 339. Once again,
Judge Buch’s dissent is relying upon a case that was grounded in the
complete power provision, which is no longer part of the regulations.

      None of the cases cited in Judge Buch’s dissent interpreted the
version of section 482 that controls this case. Those courts did not have
                                   277

the opportunity to consider whether the sentence added to section 482
addressing “commensurate with the income attributable to the
intangible” would affect their interpretation of section 482. In this case
the additional sentence is essential to our analysis because at issue is
the amount of income to be allocated upon the transfer or license of
intangible property.

       Here the Brazilian blocking statute would prevent petitioner from
receiving royalty income that is “commensurate with the income
attributable to the intangible.” By preventing the application of the
blocking statute, the challenged regulation accomplishes perfectly
Congress’ purpose in enacting the 1986 amendment. All considered, one
cannot argue that First Security Bank unambiguously defined section
482 since the Court there was not considering the current statute.

       Second, I agree with the opinion of the Court that Treasury
adhered to the APA’s procedural requirements in promulgating the
blocked income regulation. Legislative rules—those that “create[]
rights, assign[] duties, or impose[] obligations, the basic tenor of which
is not already outlined in the law itself”—are subject to APA notice-and-
comment rulemaking procedures. SIH Partners LLLP v. Commissioner,
150 T.C. 28, 40 (2018) (quoting Dia Navigation Co. v. Pomeroy, 34 F.3d
1255, 1264 (3d Cir. 1994)), aff’d, 923 F.3d 296 (3d Cir. 2019). To comply
with these procedures, the issuing agency must: “(1) publish a notice of
proposed rulemaking in the Federal Register; (2) provide ‘interested
persons an opportunity to participate * * * through submission of
written data, views, or arguments’; and (3) [a]fter consideration of the
relevant matter presented, * * * incorporate in the rules adopted a
concise general statement of their basis and purpose.” Oakbrook Land
Holdings, LLC v. Commissioner, 154 T.C. 180, 190 (2020) (citing
5 U.S.C. § 553(b) and (c)), aff’d, 28 F.4th 700 (6th Cir. 2022). The APA
provides that a reviewing court shall set aside an agency action that is
“arbitrary, capricious, an abuse of discretion, or otherwise not in
accordance with law.” 5 U.S.C. § 706(2)(a).

       The 1993 temporary regulations eliminated the complete power
regulation and included a place holder for rules relating to foreign legal
restrictions. See Temp. Treas. Reg. § 1.482-1T. The preamble to these
temporary regulations specifically addressed the 1986 amendment to
section 482 and the accompanying legislative history. T.D. 8470, 58 Fed.
Reg. 5264, (Jan. 21, 1993). The 1993 Notice of Proposed Rulemaking
(1993 Notice) included as proposed regulations Temporary Treasury
Regulation § 1.482-1T(f)(2), which addresses foreign legal restrictions,
                                  278

a.k.a. the blocked income regulation. See 58 Fed. Reg. 5312. The 1993
Notice does not specifically mention the 1986 amendment to section 482;
however, the background section includes the following: “The preamble
to the temporary regulations contains a full explanation of the reasons
underlying the issuance of the proposed regulation.” Id. at 5310. The
1993 Notice further states: “These provisions are proposed to take the
place of reserved section of the temporary regulations.” Id. It
additionally states: “Before adopting these regulations, consideration
will be given to any written comments that are timely submitted . . . .”
Id.

      In promulgating the 1994 regulations—which include the blocked
income regulation—Treasury issued proper notice, received comments
from various interested persons, and held a public hearing. Where
Treasury erred, Judge Toro’s dissent argues, was in failing to adequately
respond to the four comments relating to the blocked income regulation.
And because of that failure, according to Judge Toro’s dissent, the
regulation should be invalidated. I disagree.

       In their Stipulation of Facts, the parties agreed that the 1993
Notice stated the following: “Before adopting these regulations,
consideration will be given to any written comments that are timely
submitted . . . to the Commissioner of Internal Revenue.” The parties
stipulated further that the Commissioner received only four
comments—from the American Petroleum Institute, the Tax Executives
Institute, TRW, Inc., and the United States Council for International
Business—pertaining to the proposed blocked income regulation. The
comments generally contended that Treasury was attempting to
overturn Procter & Gamble and questioned whether the agency had the
authority to issue the proposed regulation. The comments failed to
address the elimination of the complete power regulation and the 1986
amendment to section 482 in the context of the blocked income
regulation.

       In July 1994 Treasury adopted final regulations which
specifically address the 1986 amendment to section 482 and include the
blocked income regulation. The preamble provides a history regarding
the regulations starting with proposed regulations in 1992. It also
specifically addresses the addition in the 1993 regulations of a section
dealing with foreign legal restrictions. The parties’ own stipulations
make it clear that Treasury reviewed the comments. I believe that the
preamble included in the 1994 regulation acknowledges that the
comments were considered. I would take it a step further and argue
                                  279

that the preamble is sufficient to respond to the four comments
regarding the proposed blocked income regulation.

       The opinion of the Court concludes that the comments are
insignificant. I do not think the determination of whether the comments
are significant affects our outcome under the second step of Chevron,
which requires us to consider whether the regulation “is based on a
permissible construction of the statute.” Chevron, 467 U.S. at 843. The
U.S. Court of Appeals for the D.C. Circuit in City of Waukesha v. EPA,
320 F.3d 228, 257 (D.C. Cir. 2003), stated that “the agency ‘need not
address every comment, but it must respond in a reasoned manner to
those that raise significant problems’” (quoting Reytblatt v. NRC, 105
F.3d 715, 722 (D.C. Cir. 1997)). City of Waukesha stated further that
“[t]he failure to respond to comments is significant only insofar as it
demonstrates that the agency’s decision was not based on a
consideration of the relevant factors.” Id. at 258 (quoting Tex. Mun.
Power Agency v. EPA, 89 F.3d 858, 876 (D.C. Cir. 1996)).

       The parties stipulated that Treasury considered all comments to
the 1994 regulations in their proposed form. Even assuming the
comments went to the relevant factors and raised significant problems—
they arguably did not—Treasury considered them and therefore the
regulations cannot be invalidated on the grounds that it failed to
specifically respond.

      The proposed regulations at issue make clear that the
regulations—including those on foreign legal restrictions—are
addressing the 1986 amendment to section 482. Treasury understood
that there was opposition to the new regulations. And I believe going
forward with the proposed blocked income regulation in the face of
opposing comments is indeed acknowledgment of them.

       On the basis of that analysis, I agree that Treasury adhered to
the APA’s procedural requirements. Thus it did not take an action that
was “arbitrary, capricious, an abuse of discretion, or otherwise not in
accordance with law.” See Motor Vehicle Mfrs. Ass’n of the U.S., Inc.
v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983) (finding that
the reviewing court considers only whether the agency “articulate[d] a
satisfactory explanation for its action”). Therefore, the second step of
Chevron is satisfied.

     Finally, I find aspects of Judge Toro’s dissent troubling.
Determining whether a comment is significant may result in an analysis
                                  280

that is more subjective than objective. That being so, I am concerned
that Judge Toro’s dissent would create a slippery slope whereby courts
would be constantly faced with determining whether comments are
significant and whether the agency responded appropriately to them.

      Judge Toro’s dissent maintains that Treasury should have
provided a more in-depth response. This viewpoint requires the Court
to consider whether the agency did enough. That clearly exceeds the
APA’s requirement that the reviewing court determine whether the
agency’s actions were “arbitrary, capricious, an abuse of discretion, or
otherwise not in accordance with law.” Judge Toro’s dissent would
therefore place a greater burden on both the agency and the court
system.

       The result of this heightened scrutiny would likely be the undoing
of years of regulatory promulgation. This would create uncertainty for
both taxpayers and Treasury, performing a disservice to the tax system
as a whole. For all of those reasons, I am wary of the approach taken in
Judge Toro’s dissent.

      GALE, PARIS, ASHFORD, and COPELAND, JJ., agree with this
concurring opinion.
                                   281

       COPELAND, J., concurring in the result: I agree with the
decision of the Court. In my view, the result of this case is dictated by
the plain text of section 482—specifically, the second sentence added by
amendment in 1986:

      In any case of two or more organizations, trades, or
      businesses . . . owned or controlled directly or indirectly by
      the same interests, the Secretary may distribute,
      apportion, or allocate gross income, deductions, credits, or
      allowances between or among such organizations, trades,
      or businesses, if he determines that such distribution,
      apportionment, or allocation is necessary in order to
      prevent evasion of taxes or clearly to reflect the income of
      any of such organizations, trades, or businesses. In the
      case of any transfer (or license) of intangible property . . .
      the income with respect to such transfer or license shall be
      commensurate with the income attributable to the
      intangible.

Tax Reform Act of 1986, Pub. L. No. 99-514, § 1231(e)(1), 100 Stat. 2085,
2562–63 (emphasis added).

       In Commissioner v. First Security Bank of Utah, N.A., 405 U.S.
394, 403 (1972), the Supreme Court held that for purposes of section 482
allocations, “income” may never include payments that the taxpayer
“did not receive and that he was prohibited from receiving.” This
holding was followed in our cases Procter & Gamble Co. v.
Commissioner, 95 T.C. 323 (1990), aff’d, 961 F.2d 1255 (6th Cir. 1992),
and Exxon Corp. v. Commissioner, T.C. Memo. 1993-616, aff’d sub nom.
Texaco, Inc. v. Commissioner, 98 F.3d 825 (5th Cir. 1996).

       In each of these cases—First Security Bank, Procter & Gamble,
and Exxon—the courts held that the IRS could not (for purposes of
properly allocating income under section 482) create deemed payments
between related companies if applicable law (whether domestic or
foreign) had forbidden such payments in fact. However, each of these
cases was decided with respect to tax years prior to 1986, the year
Congress amended section 482. And it appears that no cases on this
issue have been decided between Exxon and the case before us today.

      When we look to the legislative history of the 1986 amendment,
we find that Congress’ aim was to assist the IRS in the difficult task of
determining an arm’s-length value for the transfer and license of
                                    282

intangibles between related companies. See H.R. Rep. No. 99-841
(Vol. II), at II-637 (1986) (Conf. Rep.), 1986-3 C.B. (Vol. 4) 1, 637
(“Uncertainty exists regarding what transfers are appropriate to treat
as ‘arm’s-length’ comparables and regarding the significance of
profitability, including major changes in profitability of the intangible
after the transfer.”); H.R. Rep. No. 99-426, at 424 (1985), 1986-3 C.B.
(Vol. 2) 1, 424 (“The problems are particularly acute in the case of
transfers of high-profit potential intangibles. Taxpayers may transfer
such intangibles to foreign related corporations . . . at an early stage, for
a relatively low royalty, and take the position that it was not possible at
the time of the transfers to predict the subsequent success of the
product.”).

       To remedy the situation, Congress specified a new standard for
determining an arm’s-length value for intangibles: Whereas taxpayers
and the courts previously often looked to comparable transactions
between unrelated parties, or to industry norms, the commensurate-
with-income standard directs taxpayers, the courts, and the IRS to
consider also “the actual profit experience realized as a consequence of
the transfer. Thus, the committee intends to require that the payments
made for the intangible be adjusted over time to reflect changes in the
income attributable to the intangible.” H.R. Rep. No. 99-426, at 425‒26,
1986-3 C.B. (Vol. 2) at 425–26.

       Congress then invited the Treasury Department to modify its
regulations under section 482 to address the amended statute. See H.R.
Rep. No. 99-841 (Vol. II), at II-638, 1986-3 C.B. (Vol. 4) at 638. (“The
conferees are . . . aware that many important and difficult issues under
section 482 are left unresolved by this legislation. The conferees believe
that a comprehensive study of intercompany pricing rules by the
Internal Revenue Service should be conducted and that careful
consideration should be given to whether the existing regulations could
be modified in any respect.”). The Treasury Department accordingly
produced a “White Paper,” published as I.R.S. Notice 88-123, 1988-2
C.B. 458, and ultimately issued new regulations under section 482, in
part addressing the new commensurate-with-income standard. See T.D.
8552, 1994-2 C.B. 93. Congress’ invitation to the Treasury Department
further confirms that Congress intended to change the existing law
under section 482 as it related to the transfer and license of intangibles.

       The new regulations, which have remained in place for over 24
years, put logical concrete parameters on the concept of “commensurate
with income” as it relates to intangibles. They also provide certainty
                                   283

regarding the effects of foreign legal restrictions, which according to the
regulations will not upset otherwise necessary reallocations under
section 482 unless they are publicly promulgated—as was the case in
First Security Bank, Procter & Gamble, and Exxon but is not the case
here for 3M. The new regulations likewise require accountability, as the
legal restrictions must apply equally to controlled and uncontrolled
taxpayers, as was the situation confronted by the Supreme Court in
First Security Bank and our Court in Exxon. Specifically, the new
regulations provide that

      a foreign legal restriction will be taken into account only to
      the extent that it is shown that the restriction affected an
      uncontrolled taxpayer under comparable circumstances for
      a comparable period of time. In the absence of evidence
      indicating the effect of the foreign legal restriction on
      uncontrolled taxpayers, the restriction will be taken into
      account only to the extent provided in paragraphs (h)(2)
      (iii) and (iv) of this section (Deferred income method of
      accounting).

Treas. Reg. § 1.482-1(h)(2)(i) (1994).

       The legal restrictions at issue in First Security Bank and Exxon
applied equally to controlled and uncontrolled taxpayers.             The
restrictions at issue in Procter & Gamble applied only to controlled
taxpayers, so the new regulations might appear to have contradicted our
holding (and the U.S. Court of Appeals for the Sixth Circuit’s holding)
in that case. However, the courts in Procter & Gamble did not have the
opportunity to address the commensurate-with-income standard and
Congress’ mandate that the Treasury Department issue appropriate
regulations. The statute as it relates to intangibles specifically tasked
the Treasury Department with “careful consideration . . . [as] to whether
the existing regulations could be modified in any respect.” H.R. Rep. No.
99-841 (Vol. 2), at II-638, 1986-3 C.B. (Vol. 4) at 638.

       The first, preexisting, sentence of section 482 incorporated—
without modification—existing standards for determining taxable
income. This sentence authorized the IRS to reallocate gross income,
deductions, and credits among related parties if “necessary in order . . .
clearly to reflect the income of any of such organizations, trades, or
businesses.” (Emphasis added.) By contrast, the sentence added by the
1986 amendment specified a new standard for determining income in
the context of intangible transfers among related parties: “In the case of
                                  284

any transfer (or license) of intangible property . . . the income with
respect to such transfer or license shall be commensurate with the
income attributable to the intangible.” (Emphasis added.) However
taxable income from the transfer of intangibles was determined before
the amendment, now we must impose the commensurate-with-income
standard to determine the taxable portion of income of a taxpayer that
transfers an intangible to a taxpayer in the same controlled group. In
effect, the new sentence added to section 482 now more clearly defines
the “income” that must be “clearly reflect[ed]” under the first sentence.

      Indeed, Congress clearly intended “commensurate with income”
to mean something different from that which the then-existing caselaw
held. As the House Committee on Ways and Means explained:

             Certain judicial interpretations of section 482
      suggest that pricing arrangements between unrelated
      parties for items of the same apparent general category as
      those involved in the related party transfer may in some
      circumstances be considered a “safe harbor” for related
      party pricing arrangements, even though there are
      significant differences in the volume and risks involved, or
      in other factors. See, e.g., United States Steel Corporation
      v. Commissioner, 617 F.2d 942 (2d Cir. 1980). While the
      committee is concerned that such decisions may unduly
      emphasize the concept of comparables even in situations
      involving highly standardized commodities or services, it
      believes that such an approach is sufficiently troublesome
      where transfers of intangibles are concerned that a
      statutory modification to the intercompany pricing rules
      regarding transfers of intangibles is necessary.

H.R. Rep. No. 99-426, at 424, 1986-3 C.B. (Vol. 2) at 424 (emphasis
added).

       The committee report also supports an inference to what a plain
reading of the new statutory text indicates—namely, that the new
commensurate-with-income standard cannot be implemented
consistently with a strict adherence to the First Security Bank holding.
In particular:

      In requiring that payments be commensurate with the
      income stream [from the intangible], the bill does not
      intend to mandate the use of the “contract manufacturer”
                                        285

       or “cost-plus” methods of allocating income or any other
       particular method. As under present law, all the facts and
       circumstances are to be considered in determining what
       pricing methods are appropriate in cases involving
       intangible property, including the extent to which the
       transferee bears real risks with respect to its ability to
       make a profit from the intangible or, instead, sells products
       produced with the intangible largely to related parties
       (which may involve little sales risk or activity) and has a
       market essentially dependent on, or assured by, such
       related parties’ marketing efforts. However, the profit or
       income stream generated by or associated with intangible
       property is to be given primary weight.

Id. at 426, 1986-3 C.B. (Vol. 2) at 426 (emphasis added).

       In specifying “all the facts and circumstances” that are to be
weighed, the committee gives us an example—the relative risks borne
by the parties—which suggests that the relevant facts and
circumstances are those internal to generating income from the
intangible, rather than such external factors as legal restrictions on
payments to the transferor. Moreover, accommodating such restrictions
in cases like the present one would give “primary weight” to the
restriction, 1 rather than to the “income stream generated by . . . [the]
intangible property,” contrary to congressional intent.

        It is important to note that the tax years at issue in Procter &
Gamble were 1978 and 1979, and in Exxon 1979–81—all prior to the
1986 amendment of section 482 (which was effective for tax years
beginning after December 31, 1986). Therefore, there is no reason to
construe our decision in the present case as overturning either of our
precedents, as there we were dealing with a different version of the law
as it relates to income from intangibles.

       The Court views the IRS’s allocation to the 3M consolidated group
as “consistent with the 1986 statutory amendment” and “supported by
the language of the 1986 amendment.” Such allocation is in fact

       1 We also note that, if we were to agree with 3M in the present case, we would

be giving primary weight to a Brazilian legal restriction that was not publicly
promulgated, creating further uncertainty—arguably of the sort that Congress was
attempting to avert with the 1986 amendment.
                                 286

required by the amended statute, with or without the clarifications of
Treasury Regulation § 1.482-1(h)(2).

      KERRIGAN, GALE, and PARIS, JJ., agree with this opinion
concurring in the result.
                                   287

       BUCH, J., dissenting: “Blocked income” is income that a taxpayer
is prohibited by law from receiving. We have previously held that
blocked income cannot be taxed. L.E. Shunk Latex Prods., Inc. v.
Commissioner, 18 T.C. 940, 961 (1952). The U.S. Courts of Appeals for
the Fifth and Sixth Circuits have held that blocked income cannot be
taxed. Texaco, Inc. v. Commissioner, 98 F.3d 825 (5th Cir. 1996), aff’g
Exxon Corp. v. Commissioner, T.C. Memo. 1993-616; Procter & Gamble
Co. v. Commissioner, 961 F.2d 1255 (6th Cir. 1992), aff’g 95 T.C. 323
(1990). And the Supreme Court has held that blocked income cannot be
taxed. Commissioner v. First Sec. Bank of Utah, N.A., 405 U.S. 394
(1972). In response, the Department of the Treasury promulgated a
regulation under section 482 that results in the taxing of blocked
income. Treas. Reg. § 1.482-1(h)(2)(ii)(A) (promulgated by T.D. 8552,
1994-2 C.B. 93, 125–26). We are asked to decide whether this regulation
exceeds the Department of the Treasury’s power to tax.

      As a trial court, we may depart from our own precedent if we have
special justification for doing so. Sec. State Bank v. Commissioner, 111
T.C. 210, 213 (1998), aff’d, 214 F.3d 1254 (10th Cir. 2000). As a national
court whose cases can be appealed in any one of the geographic circuits,
we are not required to follow the precedent of circuits other than the one
in which the present case is appealable. Golsen v. Commissioner, 54 T.C.
742, 756–58 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971). But we are
required to follow the precedent of the Supreme Court. Parks v.
Commissioner, 145 T.C. 278, 341 (2015) (citing Rodriguez de Quijas v.
Shearson/Am. Express, Inc., 490 U.S. 477, 484 (1989)), aff’d sub nom.
Parks Found. v. Commissioner, 717 F. App’x 712 (9th Cir. 2017).
Because the opinion of the Court is contrary to established Supreme
Court precedent prohibiting the taxation of blocked income, I dissent.

I.    Background

       A predicate to imposing an income tax is to define what is income.
Section 61 does that in the broadest possible terms. It includes in the
definition of income: compensation for services, gross income from
businesses, gains, royalties, and many more items.

       Income is not limited to amounts actually received. Although
individuals are typically taxed on amounts they have received (i.e., on a
cash basis), businesses are often taxed on an accrual basis. A common
result is that businesses are often taxed on money they have the right
to receive in the future but have not yet received. See, e.g., Commissioner
v. Hansen, 360 U.S. 446, 466–67 (1959).
                                   288

       In an effort to minimize their tax liabilities, both individuals and
corporations have been known to manipulate their receipt of income.
One example might be a parent who is taxed at a higher rate attempting
to shift income to a child or a grandchild who is taxed at a lower rate.
See, e.g., Harrison v. Schaffner, 312 U.S. 579 (1941). Another example
might be a corporation diverting its income directly to its shareholders.
See, e.g., United States v. Joliet & C.R. Co., 315 U.S. 44, 45 (1942).

       Businesses that operate through multiple entities spread across
multiple countries can try to manipulate their receipt of income through
additional means. Different countries impose taxes at different rates,
and some countries don’t impose taxes on certain types of income. See,
e.g., Amazon.com, Inc. & Subs. v. Commissioner, 148 T.C. 108, 120–21
(2017) (discussing tax considerations in the selection of a potential
European headquarters location), aff’d, 934 F.3d 976 (9th Cir. 2019);
Bausch & Lomb, Inc. v. Commissioner, T.C. Memo. 1996-57, 71 T.C.M.
(CCH) 2031, 2035 (noting that Ireland “generally exempted from . . . tax
income earned through export sales of goods manufactured in Ireland”).
To take advantage of differing tax structures in different countries, a
corporation might attempt to shift income to a lower tax jurisdiction so
that it is taxed at a lower rate. See, e.g., Eaton Corp. & Subs. v.
Commissioner, 47 F.4th 434, 437 (6th Cir. 2022), aff’g in part, rev’g in
part T.C. Memo. 2017-147.

      A.     The Power to Allocate Income

       Long ago, Congress vested the Commissioner with the power to
allocate gross income between commonly controlled organizations. See
I.R.C. § 482. That power has remained largely unchanged since the
Internal Revenue Code of 1939, at which time section 45 of the 1939
Code provided:

              In any case of two or more organizations, trades, or
      businesses (whether or not incorporated, whether or not
      organized in the United States, and whether or not
      affiliated) owned or controlled directly or indirectly by the
      same interests, the Commissioner is authorized to
      distribute, apportion, or allocate gross income or
      deductions between or among such organizations, trades,
      or businesses, if he determines that such distribution,
      apportionment, or allocation is necessary in order to
      prevent evasion of taxes or clearly to reflect the income of
      any of such organizations, trades, or businesses.
                                  289

      Congress renumbered that provision as section 482 when
enacting the Internal Revenue Code of 1954. And it kept that same
numbering when it enacted the Internal Revenue Code of 1986. With
the enactment of both the 1954 Code and the 1986 Code, Congress made
minor changes to section 482. During the year at issue it provided:

      In any case of two or more organizations, trades, or
      businesses (whether or not incorporated, whether or not
      organized in the United States, and whether or not
      affiliated) owned or controlled directly or indirectly by the
      same interests, the Secretary may distribute, apportion, or
      allocate gross income, deductions, credits, or allowances
      between or among such organizations, trades, or
      businesses, if he determines that such distribution,
      apportionment, or allocation is necessary in order to
      prevent evasion of taxes or clearly to reflect the income of
      any of such organizations, trades, or businesses. In the case
      of any transfer (or license) of intangible property (within
      the meaning of section 936(h)(3)(B)), the income with
      respect to such transfer or license shall be commensurate
      with the income attributable to the intangible.

I.R.C. § 482. The only material change between the 1939 Code and the
Code as in effect during the year at issue is the addition of the second
sentence.

       The Commissioner has used section 482 in a variety of ways to
allocate items across controlled entities. For example, in Kenco
Restaurants, Inc. v. Commissioner, 206 F.3d 588 (6th Cir. 2000), aff’g
T.C. Memo. 1998-342, the Commissioner used section 482 to allocate
management fees and administrative expenses across a group of
commonly owned domestic companies to more clearly reflect the income
of the controlled entities. In Likins-Foster Honolulu Corp. v.
Commissioner, 840 F.2d 642, 647 (1988), aff’g T.C. Memo. 1985-572, the
Commissioner used section 482 to allocate interest income to a parent
company that had made an interest-free loan to its subsidiary, because
“[s]uch a scheme does not reflect true taxable income.” And in Bausch &
Lomb Inc. v. Commissioner, 933 F.2d 1084 (2d Cir. 1991), aff’g 92 T.C.
525 (1989), the Commissioner used section 482 to adjust royalty rates
paid by an Irish subsidiary for the use of its parent company’s
manufacturing technology and related intangibles to better reflect
arm’s-length consideration. As these varied examples illustrate, the
                                            290

Commissioner can use section 482 in myriad ways to allocate income
among commonly controlled entities.

        B.       The Blocked Income Problem

       Commonly controlled entities don’t necessarily have an
unfettered ability to allocate income amongst themselves. On occasion,
domestic or foreign laws may limit, or outright prohibit, the allocation
of income between commonly controlled entities. For example, a foreign
country might prohibit the payment of royalties from a subsidiary in
that country to a parent located elsewhere. See, e.g., Procter & Gamble,
discussed infra. Or a domestic law might prohibit a regulated entity
from receiving certain types of income. See, e.g., First Security Bank,
discussed infra. When a law prohibits an entity from receiving income,
that income is sometimes referred to as blocked income.

       Regulations in effect from 1934 through 1993 shed light on the
Commissioner’s interpretation of section 482 and its predecessor,
section 45. Throughout that time, the relevant portion of the regulation
remained unchanged in all material respects 1 and provided:

        The interests controlling a group of controlled taxpayers
        are assumed to have complete power to cause each
        controlled taxpayer so to conduct its affairs that its
        transactions and accounting records truly reflect the net
        income from the property and business of each of the
        controlled taxpayers. If, however, this has not been done,
        and the taxable net incomes are thereby understated, the
        statute contemplates that the Commissioner shall
        intervene, and, by making such distributions,
        apportionments, or allocations as he may deem necessary
        of gross income or deductions, or of any item or element
        affecting net income, between or among the controlled
        taxpayers constituting the group, shall determine the true
        net income of each controlled taxpayer.

         1 The opinion of the Court provides details regarding the various iterations

over time of the relevant portion of the 1934 regulation, quoted here. The opinion of
the Court characterizes those reiterations as “identical to,” see op. Ct. p. 83, “identical
to,” see op. Ct. p. 86, “substantively identical to,” see op. Ct. p. 87, “identical to . . .
except for a difference in prefixes,” see op. Ct. p. 89, “virtually identical to,” see op. Ct.
p. 114, “not substantively different from,” see op. Ct. p. 123‒24, and having “left in
place,” see op. Ct. p. 129, the preceding iterations. We will not repeat each iteration
here.
                                         291

Art. 45-1(b), Regulations 86, Regulations 86 Relating to the Income Tax
Under the Revenue Act of 1934, at 123 (Gov’t Prtg. Off. 1935). This
regulation acknowledges that, for the Commissioner to allocate income
to a taxpayer, that taxpayer must have “complete power” over that
income.

       C.      Taxing and Allocating Blocked Income

        Section 482 is silent as to blocked income, and the regulations in
effect from 1934 through 1993 did not explicitly purport to tax blocked
income. 2 But the Commissioner repeatedly attempted to use section 482
(and its predecessor, section 45) in an effort to tax blocked income.

       The first such case we have identified was L.E. Shunk Latex
Products, 18 T.C. 940, in which the Tax Court held that the
Commissioner could not allocate, and thereby tax, blocked income. In
L.E. Shunk Latex, three commonly controlled entities were involved in
the manufacture and sale of latex products. Two corporations, L.E.
Shunk Latex Products, Inc. (Shunk), and Killian Manufacturing Co.
(Killian), manufactured the products and sold them to a partnership,
Killashun Sales Division (Killashun), which resold them. Id. at 941. As
the U.S. involvement in World War II began, Killashun increased its
prices. Id. at 950. In 1942, after Killashun had increased its prices but
before Shunk or Killian had done so, the United States enacted wartime
price controls. Id. The result was that Shunk and Killian were selling
products to Killashun at pre-war prices while Killashun was reselling
those products at inflated wartime prices. The Commissioner sought to
allocate some of Killashun’s profits to Shunk and Killian. Id. at 952.

       The Tax Court opined that the Commissioner could not make
such an allocation. Had the Commissioner sought to allocate income
from the period before the price controls had taken effect, our Court
hypothesized that “we would be constrained to regard [the] action . . . as
warranted.” Id. at 957. But this Court used that counterfactual example
to highlight why the Commissioner could not allocate the income as he
chose. We noted “the uncontroverted effect of those [price control]

        2 During a portion of this time, the Treasury regulations included a provision

addressing blocked income. See, e.g., Treas. Reg. § 1.482-1(d)(6) (promulgated by T.D.
6952, 1968-1 C.B. 218, 222) (allowing treatment of blocked income as deferrable
income). Both this Court and the Sixth Circuit held that this regulation did not
authorize the taxing of blocked income, with the Sixth Circuit further stating that the
regulation applied only “where a temporary restriction under foreign law prevents
payments.” Procter & Gamble Co. v. Commissioner, 961 F.2d at 1260.
                                    292

regulations in prohibiting petitioners from receiving the very income
sought to be attributed to them.” Id. at 961. In allocating Killashun’s
income to Shunk and Killian, the Commissioner exceeded his authority
because “the Commissioner had no authority to attribute to petitioners
income which they could not have received.” Id. Nowhere in our opinion
did we rely on, or even mention, the “complete power” passage in the
regulations under (then) section 45.

       The only case we have identified in which the Commissioner was
permitted to allocate blocked income to a taxpayer is Local Finance
Corp. v. Commissioner, 407 F.2d 629 (7th Cir. 1969), aff’g 48 T.C. 773
(1967). In that case, the Commissioner successfully allocated
commissions from the sales of insurance policies to a finance company
notwithstanding a state law prohibiting that finance company from
receiving such commissions. Relying principally on federal supremacy
principles, the U.S. Court of Appeals for the Seventh Circuit held that
“the Commissioner is not precluded from making his allocation, since
the criteria of what constitutes income under section 61 and the
appropriateness of an allocation under section 482 are matters of federal
law.” Id. at 633. But subsequent developments demonstrate that this
case was an aberration.

      D.     The Supreme Court on Blocked Income

       In Commissioner v. First Security Bank of Utah, N.A., 405 U.S.
394, the Supreme Court considered facts remarkably similar to those
presented in Local Finance. First Security Bank involved a situation
where banks referred their customers for the purchase of insurance
policies. Those policies were underwritten by an independent insurer
and then reinsured with Security Life. Security Life and the banks were
commonly controlled by a holding company. Id. at 398. Although the
banks offered the insurance policies to their customers, they did not
receive commissions because they had been advised that they were
prohibited (blocked) by law from receiving income from their customers’
purchases of such insurance. Id. at 397. Because insurance companies
were taxed at a lower rate than banks, not paying commissions to the
banks lowered the overall tax liability of the commonly controlled
companies.

       In First Security Bank, the Supreme Court considered the
application of section 482 to the blocked income, and it explicitly rejected
the conclusion reached in Local Finance. The Court began its analysis
by looking to the definition of income, without regard to section 482:
                                   293

             We know of no decision of this Court wherein a
      person has been found to have taxable income that he did
      not receive and that he was prohibited from receiving. In
      cases dealing with the concept of income, it has been
      assumed that the person to whom the income was
      attributed could have received it. The underlying
      assumption always has been that in order to be taxed for
      income, a taxpayer must have complete dominion over it.

Id. at 403. Only after defining income did the Court look to the complete
power regulation as then in effect and only as reinforcement of its own
conclusion.

             One of the Commissioner’s regulations for the
      implementation of § 482 expressly recognizes the concept
      that income implies dominion or control of the
      taxpayer . . . . This regulation is consistent with the control
      concept heretofore approved by this Court, although in a
      different context.

Id. at 404. The Court did not rely on that regulation, but merely cited it
for the proposition that even the Commissioner recognized that blocked
income could not be taxed. Indeed, the Court was clear that it was
interpreting the statute, not the regulations, writing:

            Apart from the inequity of attributing to the Banks
      taxable income that they have not received and may not
      lawfully receive, neither the statute nor our prior decisions
      require such a result.

Id. at 405. Ultimately, the Court concluded that the “income received by
Security Life could not be attributable to the Banks.” Id. at 407
(emphasis added). For good measure, the Court noted that “Local
Finance Corp. was erroneously decided and that the earlier views of the
Tax Court [in L.E. Shunk Latex] were correct.” Id. at 406 n.22.

      The Supreme Court has explained on at least two occasions the
import of its holding in First Security Bank. In United States v. Basye,
410 U.S. 441 (1973), the Court explicitly described its holding in First
Security Bank as describing what the Commissioner is not permitted to
do. “We held there that the Commissioner could not properly allocate
income to one of a controlled group of corporations under 26 U. S. C.
§ 482 where that corporation could not have received that income as a
matter of law.” Id. at 453 n.13 (emphasis added). And in Commissioner
                                      294

v. Banks, 543 U.S. 426, 434 (2005), the Court cited First Security Bank
for the proposition that “attribution of income is resolved by asking
whether a taxpayer exercises complete dominion over the income in
question.”

       E.     Interpreting First Security Bank

       In the years since the Supreme Court decided First Security
Bank, cases involving many variations of blocked income have arisen.
Although First Security Bank involved a federal law that blocked
income, the later cases also dealt with state and foreign laws that
blocked income. Although First Security Bank involved a law that
prohibited the taxpayer from receiving income, subsequent cases also
dealt with laws that prohibited the controlled entity from making
payments to the taxpayer. And at least one of these cases involved a
situation in which a taxpayer could have taken steps to structure its
business in such a way that the blocking statute did not apply.
Notwithstanding these variations, in each case the deciding court found
that First Security Bank prohibited the Commissioner from allocating
and taxing blocked income.

              1.      Salyersville National Bank

       In Salyersville National Bank v. United States, 613 F.2d 650 (6th
Cir. 1980), the Sixth Circuit faced a set of facts very similar to those in
First Security Bank and Local Finance. Like those cases, Salyersville
National Bank involved a bank that was prohibited by state law from
receiving commissions from the sales of insurance. To facilitate the
purchase of insurance, the bank would refer its clients to the bank’s
president, who was licensed to sell insurance. Salyersville Nat’l Bank,
613 F.2d at 650–51. The bank president would sell the insurance and
receive the commissions. Id. The Commissioner attempted to use his
power under section 482 to allocate the commission income from the
bank president (a shareholder of the bank) to the bank under section
482. The court found that First Security Bank prohibited such an
allocation, describing the Supreme Court as having “held that income
could not be reallocated to a taxpayer who did not receive the income
and who could not lawfully have received it.” Id. at 655 (emphasis
added). 3

       3One additional observation about Salyersville National Bank is noteworthy.
The bank involved in that case could have received commissions if it took steps to
                                        295

               2.      Procter & Gamble

       In Procter & Gamble Co. v. Commissioner, 961 F.2d 1255, the
Sixth Circuit held that section 482 could not be used to allocate income
to a taxpayer when the controlled entity was prohibited by foreign law
from making payments to the taxpayer. Procter & Gamble organized a
Spanish entity to manufacture and sell products in Spain. Id. at 1256.
The Spanish entity relied on the intellectual property of other Procter &
Gamble affiliates. Id. at 1256–57. Various Spanish decrees limited the
ability of the Spanish entities to make royalty payments to their foreign
owners. Id. at 1257. These decrees varied depending on the extent of
foreign ownership; and although there was a procedure to seek a waiver,
Procter & Gamble did not avail itself of that procedure. Id. As a result,
Procter & Gamble’s Spanish entity was prohibited from making royalty
payments to other Procter & Gamble affiliates. Id. The Commissioner
attempted to use section 482 to allocate income from the Spanish entity
to another Procter & Gamble entity. Id. at 1257–58. Because the
Spanish entity was able to use Procter & Gamble’s intellectual property
without paying a royalty, the Commissioner based this allocation on a
hypothetical royalty that the Commissioner argued should have been
paid by the Spanish entity. Id.

       Both this Court and the Sixth Circuit rejected the Commissioner’s
arguments. In doing so, both this Court and the Sixth Circuit described
section 482, and not any regulations thereunder, as prohibiting the
Commissioner’s proposed allocation.

       The Tax Court determined that section 482 does not apply to
blocked income. Citing both First Security Bank and Salyersville
National Bank, we wrote: “As we understand these cases, section 482
simply does not apply where restrictions imposed by law, and not the
actions of the controlling interest, serve to distort income among the
controlled group.” Procter & Gamble, 95 T.C. at 336 (emphasis added).
We further explained that, when it is a law that blocks income, the
taxpayer is not using its control over its subsidiaries to manipulate or
shift income among them. Id. at 338. As he does in this case, the
Commissioner directed the Court in Procter & Gamble to his then-extant
regulations. But we expressly stated that, “[b]y virtue of our holding that

qualify as an insurance agent. The Commissioner argued that the bank had a duty to
do so. The court rejected this argument, because “the fact that taxpayer may have had
the power to enable it to receive the income legally does not require that it exercise
that power.” Salyersville Nat’l Bank, 613 F.2d at 655.
                                       296

section 482 does not apply, the regulations under section 482 likewise
do not apply.” Id. at 341.

       Dissatisfied, the Commissioner sought reconsideration. The
result, common when reconsideration is sought, was a more emphatic
statement of our interpretation of First Security Bank.

       Stated another way, in Commissioner v. First Security
       Bank of Utah, supra, the Supreme Court interpreted
       section 482 so that an allocation cannot be made when the
       taxpayer’s receipt of the allocated income is prohibited by
       law.

Procter & Gamble Co. v. Commissioner, T.C. Memo. 1990-638, 60 T.C.M.
(CCH) 1463, 1466 (emphasis added).

       The Sixth Circuit agreed. It described the Supreme Court as
having “held in First Security that the Commissioner is authorized to
allocate income under section 482 only where a controlling interest has
complete power to shift income among its subsidiaries and has exercised
that power.” Procter & Gamble Co. v. Commissioner, 961 F.2d at 1259.
It cited the then-extant regulations, not as support for this proposition,
but as merely recognizing this limit on the Commissioner’s authority to
make an allocation. Id. at 1258.

               3.     Exxon/Texaco

       In Texaco, 4 the Tax Court and the Fifth Circuit were asked to
apply section 482 to income distortions caused by foreign price controls.
Saudi Arabia sold crude oil at a price that was below market rates, but
it required that the purchasers likewise resell it at below-market rates.
Texaco, Inc. v. Commissioner, 98 F.3d at 827. These price restrictions,
however, applied only to crude oil and not to products refined from that
oil. Id. Under this set of rules, Exxon and Texaco affiliates would
purchase Saudi crude oil and then sell it to their affiliates at below-
market rates. Those entities, in turn, would refine the oil and sell the
refined products at market rates. Because the refining affiliates
purchased crude at below-market rates but sold their refined products
at market rates, the profits of the refining affiliates were inflated. Id.

       4 For purposes of deciding the section 482 issue, cases involving Texaco and

Exxon were consolidated before the Tax Court.
                                  297

The Commissioner sought to use section 482 to allocate income from the
refining affiliates to the crude oil resellers.

       Both this Court and the Fifth Circuit rejected the Commissioner’s
arguments. In doing so, both this Court and the Fifth Circuit described
section 482, as interpreted by First Security Bank, as prohibiting the
Commissioner’s proposed allocation.

       In deciding whether the Commissioner could use section 482 to
allocate blocked income, the Tax Court looked to the cases that had
already addressed blocked income and found that the Commissioner had
no such authority. We described First Security Bank as standing for the
proposition that the Commissioner lacked the authority to reallocate
blocked income.

      The Supreme Court affirmed the Court of Appeals on the
      ground that, since the banks could not legally receive the
      commissions under Federal law, the Commissioner could
      not reallocate them to the banks.

Exxon Corp., 66 T.C.M. (CCH) at 1735. We understood that the Supreme
Court reached this conclusion without relying on the regulations under
section 482. We noted that the Supreme Court “observed that one of the
Commissioner’s regulations under section 482 also recognized the
concept that ‘income implies dominion or control’” and went on to quote
the regulation. Id. (emphasis added).

       We rightly observed in Exxon that the prohibition on allocating
blocked income relates to the very concept of income. We described our
holding in Procter & Gamble as being “premised upon the important
domestic tax concept, as espoused by the Supreme Court in First
Security, that a section 482 allocation cannot be made when receipt of
the income at issue is prohibited by law.” Id. at 1736. And quoting First
Security Bank, we explicitly characterized this as relating to the very
definition of income.

      [A] taxpayer who is legally prohibited from receiving
      income and who does not in fact receive such income,
      cannot be said to have “earned” the income under a
      section 61 analysis.

Id. at 1739.
                                         298

       The Fifth Circuit likewise agreed that First Security Bank stands
for the proposition that “§ 482 did not authorize the Commissioner to
allocate income to a party prohibited by law from receiving it.” Texaco,
Inc. v. Commissioner, 98 F.3d at 828. Like other courts before it, the
Fifth Circuit did not rely on the complete power regulation but instead
described it as merely explaining the purpose of section 482. Id. at 829.
And like the courts before it, the Fifth Circuit concluded that “where, as
here, the taxpayer lacks the power to control the allocation of the profits,
reallocation under § 482 is inappropriate.” Id. at 830.

                4.      Tower Loan

       The last case in our chronology adds a small but emphatic point
to this discussion. In Tower Loan of Mississippi, Inc. v. Commissioner,
T.C. Memo. 1996-152, 71 T.C.M. (CCH) 2581, we were again asked by
the Commissioner to allocate commissions on the sale of insurance to a
financial institution that was prohibited from receiving those
commissions. In denying the Commissioner’s proposed allocation, we
described First Security Bank in clear and concise terms.

               We understand the Supreme Court’s opinion to
        forbid allocation of income to a taxpayer when restrictions
        imposed by law prohibit the taxpayer from receiving such
        income.

Id. at 2583.

II.     The 1994 Blocked Income Regulation

      Faced with a string of losses spanning L.E. Shunk Latex in 1952
to the Sixth Circuit’s opinion in Procter & Gamble in 1992, the
Department of the Treasury promulgated regulations purporting to
authorize the allocation, and thus taxation, of blocked income. 5 The final
version of the blocked income portion of that regulation, which the
Commissioner would have us apply in this case, provides:

               (2) Effect of foreign legal restrictions—(i) In general.
        The district director will take into account the effect of a
        foreign legal restriction to the extent that such restriction

        5 Section 7805(a) authorizes the Secretary of the Treasury to “prescribe all

needful rules and regulations for the enforcement of this title, including all rules and
regulations as may be necessary by reason of any alteration of law in relation to
internal revenue.”
                            299

affects the results of transactions at arm’s length. Thus, a
foreign legal restriction will be taken into account only to
the extent that it is shown that the restriction affected an
uncontrolled taxpayer under comparable circumstances for
a comparable period of time. In the absence of evidence
indicating the effect of the foreign legal restriction on
uncontrolled taxpayers, the restriction will be taken into
account only to the extent provided in paragraphs (h)(2)(iii)
and (iv) of this section (Deferred income method of
accounting).

             (ii) Applicable legal restrictions. Foreign legal
      restrictions (whether temporary or permanent) will
      be taken into account for purposes of this paragraph
      (h)(2) only if, and so long as, the conditions set forth
      in paragraphs (h)(2)(ii)(A) through (D) of this
      section are met.

                   (A) The restrictions are publicly
             promulgated, generally applicable to all
             similarly situated persons (both controlled
             and uncontrolled), and not imposed as part of
             a commercial transaction between the
             taxpayer and the foreign sovereign;

                    (B) The taxpayer (or other member of
             the controlled group with respect to which the
             restrictions apply) has exhausted all remedies
             prescribed by foreign law or practice for
             obtaining a waiver of such restrictions (other
             than remedies that would have a negligible
             prospect of success if pursued);

                    (C)    The       restrictions   expressly
             prevented the payment or receipt, in any
             form, of part or all of the arm’s length amount
             that would otherwise be required under
             section 482 (for example, a restriction that
             applies only to the deductibility of an expense
             for tax purposes is not a restriction on
             payment or receipt for this purpose); and
                                          300

                               (D) The related parties subject to the
                        restriction did not engage in any arrangement
                        with controlled or uncontrolled parties that
                        had the effect of circumventing the
                        restriction, and have not otherwise violated
                        the restriction in any material respect.

Treas. Reg. § 1.482-1(h)(2)(i) and (ii).

       Some of the conditions set forth in paragraph (h)(2)(ii)(A) through
(D) were present in the cases discussed above. The Spanish decree at
issue in Procter & Gamble applied differently depending on the extent
of control and thus did not apply similarly to both controlled and
uncontrolled taxpayers. Also, Procter & Gamble did not exhaust all
remedies in seeking a waiver. Likewise, the bank in Salyersville
National Bank could have taken steps to qualify as an insurance agent
and thereby lift the restriction blocking its receipt of income.

        A.      The Test for Validity

        The path to analyze the validity of a regulation is well trod. We
begin with the statute and ask whether there is a gap to fill. “If the
intent of Congress is clear, that is the end of the matter; for the court,
as well as the agency, must give effect to the unambiguously expressed
intent of Congress.” Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc.
(Chevron), 467 U.S. 837, 842–43 (1984). 6 But if Congress has left a gap
to fill, then we look to see whether the regulation is a permissible
construction of the statute. Id. at 843. As a court, we give deference to
the agency; “the court does not simply impose its own construction on
the statute.” Id.

         6 Some have questioned the continuing viability of Chevron. See Nicholas R.

Bednar & Kristin E. Hickman, Chevron’s Inevitability, 85 Geo. Wash. L. Rev. 1392,
1408 (2017) (“Since 2000, several Supreme Court opinions have seemed to weaken
Chevron in both substance and scope.”); see also Perez v. Mortg. Bankers Ass’n, 575
U.S. 92, 109–11 (2015) (Scalia, J., concurring) (explaining that Chevron “developed an
elaborate law of deference to [agency] interpretations” “[h]eedless of the original design
of the [Administrative Procedure Act]” and suggesting that it may cause persistent
problems if not “uprooted”). We need not confront Chevron’s viability; it was well
settled long before Chevron was decided that a regulation that exceeds the power of its
governing statute is invalid. See, e.g., Manhattan Gen. Equip. Co. v. Commissioner,
297 U.S. 129, 134 (1936) (“A regulation which . . . operates to create a rule out of
harmony with the statute, is a mere nullity.”).
                                         301

       But what if the agency promulgates a regulation that is contrary
to existing caselaw? The Supreme Court answered this question in
National Cable & Telecommunications Ass’n v. Brand X Internet
Services, 545 U.S. 967 (2005). Relying on the framework set forth in
Chevron, the Court held that a “prior judicial construction of a statute
trumps an agency construction otherwise entitled to Chevron deference
only if the prior court decision holds that its construction follows from
the unambiguous terms of the statute and thus leaves no room for
agency discretion.” Brand X, 545 U.S. at 982. 7 Under Brand X and
predicated on Chevron, we look to prior cases interpreting a statute to
determine whether those cases held that the statute was unambiguous. 8

      A problem arises, however, when trying to apply this standard to
pre-Chevron cases. The problem was clearly described by Justice Scalia:

               In cases decided pre-Brand X, the Court had no
        inkling that it must utter the magic words “ambiguous” or
        “unambiguous” in order to (poof!) expand or abridge
        executive power, and (poof!) enable or disable
        administrative contradiction of the Supreme Court.
        Indeed, the Court was unaware of even the utility (much
        less the necessity) of making the ambiguous/nonambiguous
        determination in cases decided pre-Chevron, before that
        opinion made the so-called “Step 1” determination of
        ambiguity vel non a customary (though hardly mandatory)
        part of judicial-review analysis. For many of those earlier
        cases, therefore, it will be incredibly difficult to determine
        whether the decision purported to be giving meaning to an
        ambiguous, or rather an unambiguous, statute.

United States v. Home Concrete & Supply, LLC, 566 U.S. 478, 493–94
(2012) (Scalia, J., concurring) (footnote omitted).

      Home Concrete presented just such a problem. Section 6501(a)
generally provides the Commissioner with a three-year period within
        7 Justice Stevens, in concurrence, contrasted a prior judicial construction by a

court of appeals and one by the Supreme Court, noting that the latter “would
presumably remove any pre-existing ambiguity.” Brand X, 545 U.S. at 1003 (Stevens,
J., concurring).
         8 As with Chevron, some have questioned the continuing viability of Brand X.

See, e.g., Baldwin v. United States, 140 S. Ct. 690, 691, (2020) (Thomas, J., dissenting
from denial of certiorari) (“Brand X appears to be inconsistent with the Constitution,
the Administrative Procedure Act (APA), and traditional tools of statutory
interpretation.”). As with Chevron, we need not confront the viability of Brand X.
                                           302

which to assess tax. The Code extends that period to six years, however,
if the taxpayer omits gross income over a certain threshold. I.R.C.
§ 6501(e). In 2010, the Department of the Treasury promulgated a
regulation that defined an omission as including a situation in which a
taxpayer reported an overstated basis resulting in an understatement
of income. Treas. Reg. § 301.6501(e)-1. In deciding the validity of this
regulation, the Supreme Court looked to a pre-Chevron case to see
whether that case had left a gap for the agency to fill.

       The case on which Home Concrete relied expressly held that the
statute it was interpreting was ambiguous. In Colony, Inc. v.
Commissioner, 357 U.S. 28, 30 (1958), the taxpayer overstated its basis
in assets it sold, thereby understating its gross profit. Although it had
reported its gross receipts, the Commissioner sought to apply a special,
longer limitations period that applies when a taxpayer omits gross
income. Id. at 29–31. The taxpayer argued that, by virtue of having
reported its gross receipts, it did not “omit” income, even if income
(having been reduced by the overstated basis) was understated. Id.
at 33. Before embarking on a review of legislative history, the Supreme
Court in Colony expressly stated: “[I]t cannot be said that the language
is unambiguous.” Id. The Supreme Court ultimately held that when an
item is disclosed on the face of a return, as in the case of an overstated
basis, it is not omitted. Id. at 36

        Notwithstanding the express statement in Colony that the
operative text of the statute it was interpreting was ambiguous, the
Supreme Court in Home Concrete held that “Colony determines the
outcome in this case.” Home Concrete, 566 U.S. at 483. The Court
considered the Department of the Treasury’s new regulation redefining
an omission to include an overstatement of basis. Id. at 486. But the
Court held that “Colony has already interpreted the statute, and there
is no longer any different construction that is consistent with Colony and
available for adoption by the agency.” 9 Id. at 487.

        B.      Applying Brand X and Home Concrete

       The Supreme Court, in deciding First Security Bank, foreclosed
the allocation, and thus the taxation, of blocked income. Without using

        9 The opinion of the Court also cites Home Concrete, writing: “According to

Home Concrete, the opinion in Colony had held that Congress ‘had directly spoken to
the precise question at issue’ and therefore ‘left no gap for the agency to fill.’” See op.
Ct. p. 249. But that passage and others cited in the opinion of the Court are found in
Part IV-C of Home Concrete, which was not joined by a majority of the Court.
                                   303

the word “unambiguous,” the Court made clear that blocked income is
not, and cannot be, allocated to someone who did not and cannot receive
it. It said so directly: “[I]ncome received by Security Life could not be
attributable to the Banks.” Commissioner v. First Security Bank of Utah,
N.A., 405 U.S. at 407 (emphasis added). And it reiterated that holding
in a subsequent case: “[T]he Commissioner could not properly allocate
income to one of a controlled group of corporations under 26 U. S. C.
§ 482 where that corporation could not have received that income as a
matter of law.” Basye, 410 U.S. at 453 n.13.

        Every court to have considered First Security Bank in the context
of blocked income has understood it as describing a limit on the
Commissioner’s power to allocate income. The Sixth Circuit understood
it: “[T]he Commissioner is authorized to allocate income under section
482 only where a controlling interest has complete power to shift income
among its subsidiaries and has exercised that power.” Procter & Gamble
Co. v. Commissioner, 961 F.2d at 1259. The Fifth Circuit understood it:
“§ 482 did not authorize the Commissioner to allocate income to a party
prohibited by law from receiving it.” Texaco, Inc. v. Commissioner, 98
F.3d at 828. And until today, we understood it: “We understand the
Supreme Court’s opinion to forbid allocation of income to a taxpayer
when restrictions imposed by law prohibit the taxpayer from receiving
such income.” Tower Loan, 71 T.C.M. (CCH) at 2583. The opinion of the
Court runs counter to these repeated unambiguous statements
interpreting sections 61 and 482 as interpreted and applied by the
Supreme Court in First Security Bank.

       The opinion of the Court and the concurring opinions all observe
that a new sentence was added to section 482 in 1986. See op. Ct.
pp. 244–49; Kerrigan concurring op. pp. 277–78; Copeland op.
concurring in the result p. 281. During the year at issue, that sentence
provided: “In the case of any transfer (or license) of intangible property
(within the meaning of section 936(h)(3)(B)), the income with respect to
such transfer or license shall be commensurate with the income
attributable to the intangible.” Although the opinion of the Court notes
the passage of this amendment, it does not explain how this sentence
addresses blocked income.

      Nothing in this sentence addresses blocked income. It addresses
the transfer or license of intangible property, which may be wholly
unrelated to blocked income. Likewise, blocked income may be wholly
unrelated to the transfer or license of intangible property. Thus, for
example, the 1986 amendment does not address blocked income from
                                   304

price controls as occurred in Texaco, or the regulation of an industry as
occurred in First Security Bank.

       When amending a statute, Congress is presumptively aware of
existing judicial interpretations of that statute. Lamar, Archer & Cofrin,
LLP v. Appling, 138 S. Ct. 1752, 1762 (2018). And when it uses
materially the same wording, Congress indicates an intent to
incorporate existing judicial interpretations. Bragdon v. Abbott, 524
U.S. 624, 645 (1998). In First Security Bank, and as further explained in
Basye, the Supreme Court held that blocked income cannot be allocated
to someone who has not received it and is legally barred from receiving
it. As noted in Judge Pugh’s dissenting opinion, this goes to the very
definition of income under section 61. Nothing about the sentence added
to section 482 indicates that Congress intended to change the
longstanding precedent that blocked income cannot be allocated and
taxed.

      C.     Plain Meaning

       If the Supreme Court had not already answered the question
before us, a court would need to turn to the plain meaning of “income”
to determine whether a taxpayer could be taxed on income that it did
not receive and that it was prohibited from receiving. Because I would
find First Security Bank controlling, I need not answer that question.
But because the opinion of the Court does not find First Security Bank
controlling, it must wrestle with interpreting the operative statute.

       After purporting to identify the precise question at issue and
reciting the first sentence of section 482, the opinion of the Court
concludes in cursory fashion: “We do not see [in the first sentence of
section 482] an unambiguous expression of Congress’s intent on how to
account for legal restrictions that prevent the receipt of income.” See op.
Ct. p. 251. Chevron instructs that “[i]f a court, employing traditional
tools of statutory construction, ascertains that Congress had an
intention on the precise question at issue, that intention is the law and
must be given effect.” Chevron, 467 U.S. at 843 n.9. We cannot deem a
statute ambiguous until we exhaust these tools. See, e.g., Castañeda v.
Souza, 810 F.3d 15, 30 (1st Cir. 2015). Rather than open the toolbox, the
opinion of the Court summarily concludes that the statute is ambiguous
and defers to the Department of the Treasury. This is not sufficient. See
Pereira v. Sessions, 138 S. Ct. 2105, 2120–21 (2018) (Kennedy, J.,
concurring) (suggesting that such cursory analysis constitutes an
                                    305

abdication of the judiciary’s proper role in interpreting federal statutes
and noting that this type of reflexive deference is “troubling”).

       The appeal to legislative history offered by Judge Copeland in
concurring in the result is likewise unavailing. Judge Copeland argues
that a “Committee report also supports an inference to what a plain
reading of the new statutory language indicates—namely, that the new
commensurate-with-income standard cannot be implemented
consistently with a strict adherence to the First Security Bank holding.”
See Copeland op. concurring in the result pp. 284–85. The legislative
history cannot bear the weight of this inference. When a plain reading
of the statute is sufficient, we need not look to legislative history. Encino
Motorcars, LLC v. Navarro, 138 S. Ct. 1134, 1143 (2018) (“If the text is
clear, it needs no repetition in the legislative history . . . .”). And we do
not look to legislative history to find ambiguity where none exists. Food
Mktg. Inst. v. Argus Leader Media, 139 S. Ct. 2356, 2364 (2019) (“Even
[members of the Supreme Court] who sometimes consult legislative
history will never allow it to be used to ‘muddy’ the meaning of ‘clear
statutory language.’” (quoting Milner v. Dept. of Navy, 562 U.S. 562, 572
(2011))). Even if ambiguity existed, looking to legislative history is
fraught. Piper v. Chris-Craft Indus., 430 U.S. 1, 26 (1977) (“Reliance on
legislative history in divining the intent of Congress is, as has often been
observed, a step to be taken cautiously.”). But insofar as blocked income
is concerned, and as discussed in Judge Toro’s dissent, the legislative
history is silent. See Toro dissenting op. p. 338.

III.   Conclusion

       3M had a blocked income problem in that its Brazilian subsidiary
was compelled by foreign law to pay below-market royalty rates. The
Commissioner sought to apply section 482 to allocate blocked income to
3M. In First Security Bank, the Supreme Court held that section 482
cannot be used to allocate blocked income to someone who did not receive
it and could not receive it. Congress has not amended section 482 in any
way that would materially alter the Supreme Court’s holding in First
Security Bank. To the extent the Department of the Treasury
promulgated regulations that are inconsistent with limits on section
482, as described by the Supreme Court in First Security Bank, I would
hold those regulations to be invalid.

      URDA, JONES, TORO, and GREAVES, JJ., agree with this
dissent.
                                       306

       PUGH, J., dissenting: The opinion of the Court upholds Treasury
Regulation § 1.482-1(h)(2) (1994), addressing the effect of foreign legal
restrictions (“blocked income”), that itself is blocked by Supreme Court
and Tax Court precedent. For this simple reason I respectfully dissent.

      In Commissioner v. First Security Bank of Utah, N.A., 405 U.S.
394, 407 (1972), the Supreme Court construed “income” under section
482 when it held that “the premium income received by Security Life
could not be attributable to the Banks.” 1 That is how we viewed First
Security Bank in Procter & Gamble Co. v. Commissioner, 95 T.C. 323,
336 (1990) (holding that First Security Bank was controlling and
therefore “section 482 simply does not apply” to reallocate income that
a Spanish subsidiary could not pay under Spanish law), aff’d, 961 F.2d
1255 (6th Cir. 1992).

       The 1986 amendment to section 482 did not modify the meaning
of “income” in that section, so it could not open the door to the Treasury
Department to issue a regulation that contravenes First Security Bank
and Procter & Gamble. “It would be difficult, perhaps impossible, to give
the same [statutory] language here a different interpretation without
effectively overruling [a prior case interpreting identical operative
language], a course of action that basic principles of stare decisis wisely
counsel us not to take.” United States v. Home Concrete & Supply, LLC,
566 U.S. 478, 483 (2012) (citing John R. Sand & Gravel Co. v. United
States, 552 U.S. 130, 139 (2008)). “[S]tare decisis in respect to statutory
interpretation has ‘special force,’ for ‘Congress remains free to alter
what we have done.’” John R. Sand & Gravel Co., 552 U.S. at 139
(quoting Patterson v. McLean Credit Union, 491 U.S. 164, 172–73
(1989)).

       FOLEY, BUCH, URDA, and TORO, JJ., agree with this dissent.

        1 Rather than relying upon the “complete power” regulation, the Supreme

Court noted that the regulation “recognize[d]” and was “consistent with” the concept
that “in order to be taxed for income, a taxpayer must have complete dominion over
it.” Commissioner v. First Security Bank, 405 U.S. at 403–04.
                                   307

       TORO, J., dissenting: This case requires the Court to consider
whether the U.S. Department of the Treasury and the Internal Revenue
Service 1 complied with procedural requirements of the Administrative
Procedure Act (APA), 5 U.S.C. §§ 551–559, 701–706, in promulgating
Treasury Regulation § 1.482-1(h)(2) (2006). The answer to this question
is relevant because “deference [under Chevron, U.S.A., Inc. v. Natural
Resources Defense Council, Inc., 467 U.S. 837 (1984),] is not warranted
where the regulation is ‘procedurally defective’—that is, where the
agency errs by failing to follow the correct procedures in issuing the
regulation.” Encino Motorcars, LLC v. Navarro, 579 U.S. 211, 220
(2016) (first quoting United States v. Mead Corp., 533 U.S. 218, 227
(2001); and then citing Long Island Care at Home, Ltd. v. Coke, 551 U.S.
158, 174–76 (2007)).

       Three subsidiary questions inform this analysis. First, is
Treasury subject to the same APA procedural rules as other agencies?
Second, do those rules require Treasury to explain its reasoning and
respond to significant comments when adopting regulations? And,
third, did Treasury comply with these requirements in promulgating
Treasury Regulation § 1.482-1(h)(2)?

      The answers to these questions are plain and require a decision
for 3M.

       First, the Supreme Court made clear in Mayo Foundation for
Medical Education & Research v. United States, 562 U.S. 44, 55 (2011),
that it was “not inclined to carve out an approach to administrative
review good for tax law only.” Rather, the Court emphasized that it had
“expressly ‘[r]ecogniz[ed] the importance of maintaining a uniform
approach to judicial review of administrative action.’ ” Id. (quoting
Dickinson v. Zurko, 527 U.S. 150, 154 (1999)); see also 5 U.S.C.
§ 701(b)(1). Thus, Treasury is subject to the same APA procedural rules
as other agencies. See, e.g., Oakbrook Land Holdings, LLC v.
Commissioner, 28 F.4th 700 (6th Cir. 2022) (analyzing the procedural
validity of a Treasury regulation under the APA), aff’g 154 T.C. 180
(2020); Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021) (same),
rev’g and remanding T.C. Memo. 2020-89; see also Altera Corp. & Subs.
v. Commissioner, 145 T.C. 91, 119 (2015) (citing Mayo Foundation, 562
U.S. at 55), rev’d on other grounds, 926 F.3d 1061 (9th Cir. 2019).

       1 For convenience, I refer to the Treasury Department and the IRS as

“Treasury.”
                                     308

       Second, Supreme Court precedent, uniform court of appeals
authorities, and hornbook administrative law have long recognized that
an agency must both explain its reasoning and respond to significant
comments submitted in response to its proposed rulemaking. See, e.g.,
Encino Motorcars, LLC, 579 U.S. at 221 (“One of the basic procedural
requirements of administrative rulemaking is that an agency must give
adequate reasons for its decisions.”); Motor Vehicle Mfrs. Ass’n of U.S. v.
State Farm Mut. Auto. Ins. Co. (State Farm), 463 U.S. 29, 48 (1983) (“We
have frequently reiterated that an agency must cogently explain why it
has exercised its discretion in a given manner . . . .”); see also, e.g., Perez
v. Mortg. Bankers Ass’n, 575 U.S. 92, 96 (2015) (“An agency must
consider and respond to significant comments received during the period
for public comment.” (first citing Citizens to Pres. Overton Park, Inc. v.
Volpe, 401 U.S. 402, 416 (1971); and then citing Thompson v. Clark, 741
F.2d 401, 408 (D.C. Cir. 1984))); Kristin E. Hickman & Richard J.
Pierce, Jr., Administrative Law Treatise § 5.4 (6th ed. 2019) (“To have
any reasonable prospect of obtaining judicial affirmance of a major rule,
an agency must set forth the basis and purpose of the rule in a detailed
statement . . . in which the agency . . . explains its method of reasoning
from factual predicates to the expected effects of the rule, relates the
factual predicates and expected effects of the rule to each of the statutory
goals or purposes the agency is required to further or consider, responds
to all major criticisms contained in the comments on its proposed rule,
and explains why it has rejected at least some of the most plausible
alternatives to the rule it has adopted.”); James T. O’Reilly,
Administrative Rulemaking § 8:5 (2022) (“The APA creates a duty upon
the agency to give reasoned responses to all significant comments in a
rulemaking proceeding.”).

       Third, the record here leaves no doubt that Treasury failed to
comply with these requirements. In promulgating Treasury Regulation
§ 1.482-1(h)(2) (and the entire regulation package of which it was a
part), Treasury repeatedly expressed the view that it did not have to
follow the APA’s notice and comment procedures. See Intercompany
Transfer Pricing and Cost Sharing Regulations Under Section 482, 57
Fed. Reg. 3571, 3578 (proposed Jan. 30, 1992) (“It also has been
determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter
6) do not apply to these regulations, and, therefore, an initial Regulatory
Flexibility Analysis is not required.”); T.D. 8470, 58 Fed. Reg. 5263,
5271, 1993-1 C.B. 90, 98 (Jan. 21, 1993) (same); T.D. 8552, 59 Fed. Reg.
34,971, 34,988, 1994-2 C.B. 93, 112 (July 8, 1994) (same). Consistent
with this view, Treasury provided no explanation of why the existing
                                       309

rule on foreign legal restrictions (or, more colloquially, blocked income)
needed to be changed, failed to even mention that its new position was
contrary to judicial opinions on point, failed to explain how its new rule
was consistent with the text of the statute or related to the factors set
out in the statute, and neither acknowledged nor responded to
significant comments challenging Treasury’s authority to promulgate
the regulation and pointing out flaws in its proposed approach. These
failings resulted in an arbitrary and capricious action that cannot be
sustained. In view of this conclusion, Treasury Regulation § 1.482-1(h)(2)
can receive no deference. Encino Motorcars, LLC, 579 U.S. at 221.
Absent a regulation supporting the Commissioner’s determination, our
decision in Procter & Gamble Co. v. Commissioner, 95 T.C. 323 (1990),
aff’d, 961 F.2d 1255 (6th Cir. 1992), requires that we hold for 3M.
Because the opinion of the Court 2 reaches a contrary conclusion, I
respectfully dissent.

I.     The Opinion of the Court Analyzes the APA’s Procedural
       Requirements Incorrectly.

      The opinion of the Court, which spans 274 pages, spends little
time on the APA’s procedural requirements. Its analysis of 3M’s APA
procedural challenge to Treasury Regulation § 1.482-1(h)(2) takes a
mere eight pages. And in each step of that analysis, the opinion of the
Court draws the wrong conclusions.

       A.      Treasury Failed to Provide Adequate Reasons for Its Action.

       The opinion of the Court first considers 3M’s argument that
Treasury did not provide a satisfactory explanation for its action. The
opinion rejects the argument, concluding that “the regulation is not
invalid for want of explanation.” See op. Ct. p. 267. That conclusion
runs counter to more than four decades of administrative law.

       As the Supreme Court has explained,

              Section 4 of the APA, 5 U.S.C. § 553, prescribes a
       three-step procedure for so-called “notice-and-comment
       rulemaking.”[3] First, the agency must issue a “[g]eneral

       2 Following the Court’s tradition, I refer to the opinion by Judge Morrison,

which received 7 votes (out of 17) from active judges, as the opinion of the Court.
       Contrary to the position Treasury claimed in the rulemaking process, the
       3

Commissioner (correctly) does not dispute that the rulemaking here was subject to
                                         310

       notice of proposed rule making,” ordinarily by publication
       in the Federal Register. § 553(b). Second, if “notice [is]
       required,” the agency must “give interested persons an
       opportunity to participate in the rule making through
       submission of written data, views, or arguments.” § 553(c).
       An agency must consider and respond to significant
       comments received during the period for public comment.
       See Citizens to Preserve Overton Park, Inc. v. Volpe, 401
       U.S. 402, 416 (1971); Thompson v. Clark, 741 F.2d 401, 408
       (CADC 1984). Third, when the agency promulgates the
       final rule, it must include in the rule’s text “a concise
       general statement of [its] basis and purpose.” § 553(c).

Mortg. Bankers Ass’n, 575 U.S. at 96; see also id. at 109 (Scalia, J.,
concurring in the judgment) (“Before an agency makes a rule, it
normally must notify the public of the proposal, invite them to comment
on its shortcomings, consider and respond to their arguments, and
explain its final decision in a statement of the rule’s basis and purpose.
5 U.S.C. § 553(b)–(c); ante, at 96.”). Moreover, the APA grants authority
to a reviewing court to “hold unlawful and set aside agency action,
findings, and conclusions found to be . . . arbitrary, capricious, an abuse
of discretion, or otherwise not in accordance with law.” 5 U.S.C.
§ 706(2)(A).

       In exercising this authority, courts have interpreted the APA to
require agencies to engage in reasoned decisionmaking. Michigan v.
EPA, 576 U.S. 743, 750 (2015) (“Federal administrative agencies are
required to engage in ‘reasoned decisionmaking.’ ” (quoting Allentown
Mack Sales & Serv., Inc. v. NLRB, 522 U.S. 359, 374 (1998))). “One of
the basic procedural requirements of administrative rulemaking is that
an agency must give adequate reasons for its decisions.” Encino
Motorcars, LLC, 579 U.S. at 221. To comply with the APA, “[an] agency
must examine the relevant data and articulate a satisfactory
explanation for its action including a ‘rational connection between the
facts found and the choice made.’ ” State Farm, 463 U.S. at 43 (quoting
Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168 (1962)).
And when the rules reflect a change in the agency’s position, the agency
should provide a reasoned explanation for the change.             Encino

notice and comment under section 553(b) and (c) of the APA. See Green Valley Invs.,
LLC v. Commissioner, No. 17379-19, 159 T.C., slip op. at 7–8 (Nov. 9, 2022); see also,
e.g., Iowa League of Cities v. EPA, 711 F.3d 844, 873–75 (8th Cir. 2013) (distinguishing
between legislative rulemaking, which is subject to notice and comment, and
interpretative rulemaking, which is not).
                                        311

Motorcars, LLC, 579 U.S. at 221. The explanation need not always be
more detailed than that which would suffice in the absence of a change,
but it must “at least ‘display awareness that it is changing position’ and
‘show that there are good reasons for the new policy.’” Id. (quoting FCC
v. Fox Television Stations, Inc., 556 U.S. 502, 515 (2009)).

       Although the scope of judicial review under the APA is “narrow,”
“courts retain a role, and an important one, in ensuring that agencies
have engaged in reasoned decisionmaking.” Judulang v. Holder, 565
U.S. 42, 53 (2011). That role includes “examining the reasons for agency
decisions—or, as the case may be, the absence of such reasons.” Id.
(citing Fox Television Stations, Inc., 556 U.S. at 515 (noting “the
requirement that an agency provide reasoned explanation for its
action”)). 4

               1.      The Record Is Utterly Silent on Treasury’s Reasons
                       for Adopting Treasury Regulation § 1.482-1(h)(2).

       When it adopted Treasury Regulation § 1.482-1(h)(2), Treasury
offered no explanation for its choices with respect to the rule. Not a
single sentence. Treasury did not explain why a revision to the existing
rule was needed. Although it described how its new rule worked
(essentially repeating the text of the regulation in the preamble),
Treasury did not explain how the rule related to any particular statutory
text or how it took into account and advanced the factors reflected in the
statute. 5 It did not “display awareness that it [was] changing [its]
       4  The APA’s requirements on this point “are intended to assist judicial review
as well as to provide fair treatment for persons affected by a rule.” Home Box Office,
Inc. v. FCC, 567 F.2d 9, 35 (D.C. Cir. 1977).
       5 At the time Treasury Regulation § 1.482-1(h)(2) was proposed and finalized,
section 482 provided as follows:
       In any case of two or more organizations, trades, or businesses
       (whether or not incorporated, whether or not organized in the United
       States, and whether or not affiliated) owned or controlled directly or
       indirectly by the same interests, the Secretary may distribute,
       apportion, or allocate gross income, deductions, credits, or allowances
       between or among such organizations, trades, or businesses, if he
       determines that such distribution, apportionment, or allocation is
       necessary in order to prevent evasion of taxes or clearly to reflect the
       income of any of such organizations, trades, or businesses. In the case
       of any transfer (or license) of intangible property (within the meaning
       of section 936(h)(3)(B)), the income with respect to such transfer or
       license shall be commensurate with the income attributable to the
       intangible.
                                          312

position” or attempt to show the “good reasons” behind its new policy.
Encino Motorcars, LLC, 579 U.S. at 221. Under the relevant precedents,
these simple observations should suffice to find in 3M’s favor.

        The opinion of the Court, however, contends that at least one or
two of Treasury’s reasons for adopting the rule can be inferred from the
rule’s text and “principles of section 482.” See op. Ct. p. 266. Specifically,
the opinion points to the first two sentences of Treasury Regulation
§ 1.482-1(h)(2)(i), which read as follows:

        The district director will take into account the effect of a
        foreign legal restriction to the extent that such restriction
        affects the results of transactions at arm’s length. Thus, a
        foreign legal restriction will be taken into account only to
        the extent that it is shown that the restriction affected an
        uncontrolled taxpayer under comparable circumstances for
        a comparable period of time.

From these sentences, the opinion of the Court constructs a “reasonable
explanation” for Treasury’s action that is nowhere to be found in the
record itself. These sentences, the opinion argues, demonstrate that
“Treasury . . . satisfactorily explained that one of the reasons it
promulgated [the regulation] was to advance the goal of arm’s-length
comparisons,” see op. Ct. p. 266, and “the goal of tax parity,” id. at 267.

       But the two sentences on which the opinion of the Court relies do
no such thing. They simply tell us what the district director will do
under the new rule. Describing a rule is not the same as explaining its
rationale, cf. Gerber v. Norton, 294 F.3d 173, 183 (D.C. Cir. 2002), and
Treasury said nothing at all about its reasons for adopting Treasury
Regulation § 1.482-1(h)(2). Nor did it provide “a ‘rational connection
between the facts found and the choice made.’ ” State Farm, 463 U.S.
at 43 (quoting Burlington Truck Lines, 371 U.S. at 168). In the face of
Treasury’s utter silence, the opinion of the Court is constrained to
speculate and construct a rationale on the agency’s behalf.

As relevant here, therefore, one might surmise that the relevant statutory factors
included the presence of or absence of common control and an attempt to evade taxes
or a failure to clearly reflect income. In the case of an intangible transfer, the factors
would also have included whether income from the transfer was commensurate with
income attributable to the intangible.
                                    313

                2.     This Court Is Not Permitted to Make Up for
                       Treasury’s Omission.

        Judicial speculation of this kind is impermissible under
longstanding principles of administrative law. See, e.g., State Farm, 463
U.S. at 43 (“The reviewing court should not attempt itself to make up
for [the agency’s] deficiencies; we may not supply a reasoned basis for
the agency’s action that the agency itself has not given.” (citing SEC v.
Chenery Corp., 332 U.S. 194, 196 (1947))). The Supreme Court has
repeatedly emphasized that “[i]t is not the role of the courts to speculate
on reasons that might have supported an agency’s decision.” Encino
Motorcars, LLC, 579 U.S. at 224; see also State Farm, 463 U.S. at 50
(“[T]he courts may not accept . . . post hoc rationalizations for agency
action. It is well-established that an agency’s action must be upheld, if
at all, on the basis articulated by the agency itself.” (Citation omitted.)).
The opinion of the Court offers no explanation for ignoring these
principles. See Michigan, 576 U.S. at 758 (criticizing the dissent for
adopting a “line of reasoning [that] contradicts the foundational
principle of administrative law that a court may uphold agency action
only on the grounds that the agency invoked when it took the action”
(citing SEC v. Chenery Corp. (Chenery I), 318 U.S. 80, 87 (1943))).

       Indeed, the opinion of the Court’s efforts here constitute the type
of “laborious examination of the record” apparently designed to
“formulate in the first instance the significant issues faced by the agency
and articulate the rationale of their resolution” that courts have found
to be inappropriate. Home Box Office, 567 F.2d at 36 (quoting Auto.
Parts & Accessories Ass’n v. Boyd, 407 F.2d 330, 338 (D.C. Cir. 1968)).
They represent an implicit recognition that, with respect to Treasury
Regulation § 1.482-1(h)(2), the record here does not in fact “enable us to
see what major issues of policy were ventilated [during the rulemaking
process] and why the agency reacted to them as it did.” Id.; see also
Carlson v. Postal Regul. Comm’n, 938 F.3d 337, 344 (D.C. Cir. 2019)
(citing Del. Dep’t of Nat. Res. & Env’t Control v. EPA, 785 F.3d 1, 17
(D.C. Cir. 2015)). And Treasury’s “action must be measured by what [it]
did, not by what it might have done.” Michigan, 576 U.S. at 759 (quoting
Chenery I, 318 U.S. at 93–94).           Courts may overlook inartful
explanations when the agency’s path may be reasonably discerned, but
they may not clear a path for the agency where none exists.
                                         314

                 3.      Even if Accepted, the Reasons the Opinion of the
                         Court Supplies for Treasury’s Action Are
                         Insufficient.

       Moreover, even if one were to (1) accept the opinion of the Court’s
position that at least some of Treasury’s reasons for adopting the rule
are self-evident, and (2) attribute the opinion’s explanation to Treasury,
that explanation still would not satisfy the APA’s procedural
requirements.

        When an agency changes an existing policy, the APA requires
that it “must at least ‘display awareness that it is changing position’ and
‘show that there are good reasons for the new policy.’ ” Encino
Motorcars, LLC, 579 U.S. at 221 (quoting Fox Television Stations, Inc.,
556 U.S. at 515). As the opinion of the Court recognizes, Treasury
Regulation § 1.482-1(h)(2) represented a departure from Treasury’s
previous approach to blocked income cases, which had been reflected in
Treasury Regulation § 1.482-1(d)(6) (1968) (1968 Regulation). 6 The
1968 Regulation was a taxpayer-favorable rule that allowed taxpayers
to use a deferred income method of accounting if the Commissioner
made a section 482 adjustment with respect to an item blocked by a
foreign legal restriction. Taxpayers generally could wait until after their
returns had been selected for audit to elect the deferred income method.
By contrast, Treasury Regulation § 1.482-1(h)(2) provides that the
Commissioner will respect a foreign legal restriction only if the
restriction meets specified criteria and “it is shown that the restriction
affected an uncontrolled taxpayer under comparable circumstances for
a comparable period of time.” Id. subdivs. (i) and (ii). A taxpayer may
still elect the deferred income method of accounting, but only if the
foreign legal restriction satisfies the specified criteria and the taxpayer
makes the election on a timely U.S. tax return or amended return filed
before the IRS first contacts the taxpayer regarding an examination of
that year. Id. subdivs. (iii) and (iv).

      These changes were significant, 7 and Treasury owed the public
and the courts an explanation for them. Neither Treasury’s silence nor

        6 In 1993, the 1968 Regulation was redesignated Treasury Regulation § 1.482-

1A(d)(6) and made applicable only for tax years beginning on or before April 21, 1993.
See T.D. 8470, 58 Fed. Reg. 5263, 5271, 1993-1 C.B. at 99 (Jan. 21, 1993).
       7 The Commissioner argues that Treasury Regulation § 1.482-1(h)(2) “simply
add[ed] clarity to Treasury’s longstanding position,” pointing to Treasury’s litigation
of blocked income cases and citing Macon County Samaritan Memorial Hospital v.
                                          315

the opinion of the Court’s proffered explanation “display[s] awareness”
of the changes or “show[s] that there are good reasons” for the new
approach. 8 Encino Motorcars, LLC, 579 U.S. at 221. And nothing in the
regulatory history explains whether or why the prior approach had
proved unsatisfactory. See, e.g., Fox Television Stations, Inc., 556 U.S.
at 535 (Kennedy, J., concurring in part and concurring in the
judgment); 9 Greater Bos. Television Corp. v. FCC, 444 F.2d 841, 852
(D.C. Cir. 1970) (“[A]n agency changing its course must supply a
reasoned analysis indicating that prior policies and standards are being
deliberately changed, not casually ignored, and if an agency glosses over
or swerves from prior precedents without discussion it may cross the

Shalala, 7 F.3d 762, 765–66 (8th Cir. 1993). But the fact pattern present in Macon
County is not comparable to the one present here. In that case, the controlling statute
had recently been amended to provide, for the first time, a definition of the very term
that the regulation interpreted. Id. at 764, 766. Accordingly, the reasons for amending
the regulation were to some extent self-evident: There had been a statutory reset. As
described in Part II below, the addition of the second sentence to section 482 is not
analogous because it did not manifestly bear on the blocked income issue.
Additionally, the U.S. Court of Appeals for the Eighth Circuit found that (1) the
regulatory change was not really a change because the agency had previously issued
informal guidance adopting the same position and (2) in any event, the agency had in
fact “provide[d] a reasoned analysis” in “repeated, detailed explanations of the initial
regulation and its subsequent amendments.” Id. at 766. Neither circumstance is
present here. Cf. Gatewood v. Outlaw, 560 F.3d 843, 847–48 (8th Cir. 2009) (upholding
final rule implementing agency policy on procedural grounds where (1) the agency had
“consistently sought to implement the same substantive policy” through various prior
interim rules, Program Statements, and positions in litigation regarding the validity
of those actions, and (2) the Supreme Court had discerned the reason for the policy and
concluded that the rule was substantively reasonable).
         8 Treasury had at least three chances to explain its reasoning: (1) in the

rulemaking redesignating the 1968 Regulations, see T.D. 8470, 58 Fed. Reg. 5263,
5271, 1993-1 C.B. at 96 (Jan. 21, 1993), (2) in the Notice of Proposed Rulemaking
proposing the new approach, see Intercompany Transfer Pricing Regulations Under
Section 482, 58 Fed. Reg. 5310, 5310–12, 1993-1 C.B. 825, 825–28 (proposed Jan. 21,
1993), and (3) when it finalized the rules after receiving comments that questioned the
approach, see T.D. 8552, 59 Fed. Reg. 34,971, 34,981, 1994-2 C.B. at 104 (July 8, 1994).
It availed itself of none of these opportunities.
        9 As Justice Kennedy observed in Fox Television Stations, he wrote separately

“to underscore certain background principles for the conclusion that an agency’s
decision to change course may be arbitrary and capricious if the agency sets a new
course that reverses an earlier determination but does not provide a reasoned
explanation for doing so” and to agree with the “dissenting opinion of Justice Breyer
[who wrote for four Justices] that the agency must explain why ‘it now reject[s] the
considerations that led it to adopt that initial policy.’ ” Fox Television Stations, Inc.,
556 U.S. at 535 (Kennedy, J., concurring in part and concurring in the judgment)
(quoting id. at 550 (Breyer, J., dissenting)).
                                        316

line from the tolerably terse to the intolerably mute.” (Footnote
omitted.)).

               4.      A Carefully Reasoned Explanation for Treasury’s
                       Actions Was Particularly Important in Light of the
                       Context of the Regulation and Adverse Judicial
                       Precedent.

        Providing reasons for Treasury’s proposed approach was
particularly important here, where several prior judicial decisions,
including a Supreme Court decision, had rejected the approach Treasury
adopted. According to the opinion of the Court, “[Treasury] was
. . . aware that the proposed regulation was inconsistent with the
caselaw.” See op. Ct. p. 268. Indeed, citing one of the commenters, the
opinion seems to imply that the regulation was a direct response to
Treasury’s losses in the courts. 10 See id. Of course (as already
discussed) the record itself says nothing about Treasury’s awareness.
But even if what the opinion of the Court assumes is true, then Treasury
should have explained why it disagreed with the considered views
expressed in the caselaw. Regardless of whether these cases precluded
Treasury’s actions as a matter of law, see Buch dissenting op. pp. 287–
305, the opinion of the Court does not and cannot dispute that at a
minimum the cases raised points that cast doubt on the wisdom of
Treasury’s proposed course. See, e.g., Commissioner v. First Sec. Bank
of Utah, N.A. (First Security), 405 U.S. 394, 405 (1972) (“We think that
fairness requires the tax to fall on the party that actually receives the
premiums rather than on the party that cannot.”); Procter & Gamble Co.
v. Commissioner, 961 F.2d at 1259 (“The purpose of section 482 is to
prevent artificial shifting of income between related taxpayers. Because
Spanish law prohibited royalty payments, P&G could not exercise the
control that section 482 contemplates, and allocation under section 482
is inappropriate.”); see also United States v. Basye, 410 U.S. 441, 453 n.13
(1973) (characterizing First Security as “involv[ing] a deflection of

        10 The regulatory timeline suggests that the opinion of the Court is likely

correct in this regard. As described further in Part II below, Treasury began
overhauling its transfer pricing regulations soon after Congress amended section 482
in 1986. It issued lengthy discussions of its proposed amendments in 1988, see I.R.S.
Notice 88-123, 1988-2 C.B. 458, and in 1992, see Intercompany Transfer Pricing and
Cost Sharing Regulations Under Section 482, 57 Fed. Reg. 3571. Neither set of
proposals included Treasury Regulation § 1.482-1(h)(2) or said anything else about
blocked income, however. The regulation was added to the broader package in 1993,
see T.D. 8470, 58 Fed. Reg. 5263, 5263–5271, 1993-1 C.B. at 90–123 (Jan. 21, 1993),
approximately nine months after the Commissioner lost his appeal on the blocked
income issue in Procter & Gamble Co. v. Commissioner, 961 F.2d 1255.
                                   317

income imposed by law, not an assignment arrived at by the consensual
agreement of two parties acting at arm’s length”). Thus, even assuming
Treasury had authority to act as it did, but see Buch dissenting op.
pp. 287‒305, it needed to explain its thinking before adopting a contrary
rule.

        To illustrate, the opinion of the Court argues that Treasury
adopted Treasury Regulation § 1.482-1(h)(2) to advance the goals of
arm’s-length comparisons and tax parity. If we assume for the sake of
argument that this is so, in the context of blocked income, these two
goals are in tension with principles that had been highlighted by the
Supreme Court, a court of appeals, and this Court. For example, the
courts had asked whether it is fair to interpret section 482 so as to
impose tax on an amount that a taxpayer is legally restricted from
receiving, see, e.g., First Security, 405 U.S. at 405, and whether, given
the focus of section 482 on controlled taxpayers, it is reasonable for the
Commissioner to reallocate income where the controlled taxpayers
themselves could not, see, e.g., Procter & Gamble Co. v. Commissioner,
961 F.2d at 1259. The cases answered no on both counts. And saying
that a rule advances the arm’s-length principle or tax parity does
nothing to explain how those goals should be weighed against the
statutory factors identified by the courts and the fairness concerns they
embody. In light of these considerations, which the opinion of the Court
argues Treasury was well aware of, and which multiple commenters
brought to its attention, see Part I.B.2 below, Treasury’s failure to “give
. . . reasons for its decisions,” see Encino Motorcars, LLC, 579 U.S.
at 221, cannot be overlooked.

             5.     Much More Robust Explanations by Other Agencies
                    Have Been Found Wanting.

      Records far more favorable to agencies than the one present here
have failed to pass muster with the Supreme Court. See, e.g., Encino
Motorcars, LLC, 579 U.S. 211; State Farm, 463 U.S. 29.

      Encino Motorcars, LLC, 579 U.S. 211, is particularly instructive.
A brief recitation of its facts is helpful for understanding the Court’s
holding, and I therefore summarize the Supreme Court’s description
here.

     In 1966, Congress passed a law exempting certain employees of
automobile dealerships from the requirements of the Fair Labor
Standard Act of 1938, 29 U.S.C. § 201–219. Encino Motorcars, LLC, 579
                                       318

U.S. at 215. The exemption applied to “any salesman, partsman, or
mechanic primarily engaged in selling or servicing automobiles.” Id.
(quoting Fair Labor Standards Amendments of 1966, Pub. L. No. 89-601,
§ 209, 80 Stat. 830, 836).

       In 1970, the Department of Labor (Department) issued a
regulation that interpreted the exemption as excluding “service
advisors,” dealership employees who market and sell automobile repairs
to customers. Id. at 214–16. The U.S. Court of Appeals for the Fifth
Circuit rejected the Department’s interpretation, and its holding in this
regard was followed by several district courts. See id. at 216 (first citing
Brennan v. Deel Motors, Inc., 475 F.2d 1095, 1096 (5th Cir. 1973); then
citing Yenney v. Cass Cnty. Motors, 81 CCH LC ¶ 33,506 (D. Neb. 1977);
then citing Brennan v. N. Bros. Ford, Inc., 76 CCH LC ¶ 33,247 (E.D.
Mich. 1975), aff’d sub nom. Dunlop v. N. Bros. Ford, Inc., 529 F.2d 524
(6th Cir. 1976) (unpublished table decision); and then citing Brennan v.
Imp. Volkswagen, Inc., 81 CCH LC ¶ 33,522 (D. Kan. 1975)). 11 In
parallel, Congress amended the statute. Id.

       In 1978, the Department issued an opinion letter adopting the
view of the courts that service advisors were exempt. Id. at 217. It
acknowledged that the new policy was a reversal of the Department’s
prior position. And in its Field Operations Handbook, the Department
stated that it would revise its 1970 regulation accordingly. Id. It finally
issued a notice of proposed rulemaking in 2008. See id. (citing 73 Fed.
Reg. 43,654 (July 28, 2008)).

       Three years later, however, the Department again reversed itself
and abandoned the proposed rule. Id. at 218 (citing 76 Fed. Reg. 18,832,
18,833 (Apr. 5, 2011)). Instead, it issued a final rule that followed the
original regulation, i.e., concluding that service advisors were not
exempt. Id. (citing 76 Fed. Reg. at 18,859). After reciting the history
and summarizing the comments it received on the issue, the
Department explained its decision by saying that “the statute does not
include such positions and the Department recognizes that there are
circumstances under which the requirements for the exemption would
not be met.” 76 Fed. Reg. at 18,838. It further stated that it “believes
that this interpretation is reasonable” and “sets forth the appropriate
approach,” and that the Department “disagrees with [a court of appeals]
that the regulation impermissibly narrows the statute.” Id.

       11 Years later, the U.S. Court of Appeals for the Fourth Circuit reached the

same conclusion. Walton v. Greenbrier Ford, 370 F.3d 446, 452–53 (4th Cir. 2004).
                                   319

       This explanation was not enough for the Supreme Court. In
particular, the Court focused on the change in a longstanding agency
position and the reliance interests that position had created. The Court
articulated the legal standards as follows:

      In explaining its changed position, an agency must also be
      cognizant that longstanding policies may have
      “engendered serious reliance interests that must be taken
      into account.” [Fox Television Stations, 556 U.S. at 515];
      see also Smiley v. Citibank (South Dakota), N.A., 517 U.S.
      735, 742 (1996). “In such cases it is not that further
      justification is demanded by the mere fact of policy change;
      but that a reasoned explanation is needed for disregarding
      facts and circumstances that underlay or were engendered
      by the prior policy.” Fox Television Stations, [556 U.S.] at
      515–516. It follows that an “[u]nexplained inconsistency”
      in agency policy is “a reason for holding an interpretation
      to be an arbitrary and capricious change from agency
      practice.” [Nat’l Cable & Telecomms. Ass’n v.] Brand X
      [Internet Servs., 545 U.S. 967,] 981 [(2005)].

Encino Motorcars, LLC, 579 U.S. at 221–22. Applying these principles
to the facts before it, the Court stated:

      [T]he unavoidable conclusion is that the 2011 regulation
      was issued without the reasoned explanation that was
      required in light of the Department’s change in position
      and the significant reliance interests involved.         In
      promulgating the 2011 regulation, the Department offered
      barely any explanation. A summary discussion may suffice
      in other circumstances, but here—in particular because of
      decades of industry reliance on the Department’s prior
      policy—the explanation fell short of the agency’s duty to
      explain why it deemed it necessary to overrule its previous
      position.

Id. at 222.

       The parallels to this case are easy to see. Here, too, we have a
change in agency position that is contrary to judicial decisions. Here,
too, we have longstanding industry reliance on those decisions and the
more moderate approach of the 1968 Regulation. And here we have
significantly less discussion (none in fact) of the reasons for the change
                                  320

than was present in Encino Motorcars. The opinion of the Court’s
conclusion is inconsistent with the holding of Encino Motorcars, where
the Supreme Court characterized the agency’s explanation as “[saying]
almost nothing,” id. at 223, and emphasized that “[i]t is not the role of
the courts to speculate on reasons that might have supported an
agency’s decision,” id. at 224.

      B.     Treasury Also Acted Arbitrarily and Capriciously by
             Failing to Address Significant Comments.

       The shortcomings identified above more than suffice to set aside
the challenged regulation. But that is not all. Treasury cannot complain
that it was never told of the problems with its proposed approach. That
is where the comments that Treasury failed to address come in.

              1. Administrative Law Requires an Agency to Respond
              to Significant Comments.

       As already discussed above, when promulgating regulations
subject to notice and comment, “the agency must ‘give interested persons
an opportunity to participate in the rule making through submission of
written data, views, or arguments.’ § 553(c). An agency must consider
and respond to significant comments received during the period for
public comment.” Mortg. Bankers Ass’n, 575 U.S. at 96.

      The reasons for the APA procedural requirements are easy to
understand, as courts have explained:

      [They] are intended to assist judicial review as well as to
      provide fair treatment for persons affected by a rule. To
      this end there must be an exchange of views, information,
      and criticism between interested persons and the agency.
      Consequently, the notice required by the APA, or
      information subsequently supplied to the public, must
      disclose in detail the thinking that has animated the form
      of a proposed rule and the data upon which that rule is
      based. Moreover, a dialogue is a two-way street: the
      opportunity to comment is meaningless unless the agency
      responds to significant points raised by the public. A
      response is also mandated by Overton Park, which requires
      a reviewing court to assure itself that all relevant factors
      have been considered by the agency.
                                          321

Home Box Office, 567 F.2d at 35–36 (footnote omitted) (citations
omitted); see also Azar v. Allina Health Servs., 139 S. Ct. 1804, 1816
(2019) (The purpose of notice and comment rulemaking is to “give[]
affected parties fair warning of potential changes in the law and an
opportunity to be heard on those changes” while “afford[ing] the agency
a chance to avoid errors and make a more informed decision.”); DHS v.
Regents of the Univ. of Cal., 140 S. Ct. 1891, 1929 n.13 (2020) (Thomas,
J., concurring in the judgment in part and dissenting in part) (“[T]he
notice and comment process at least attempts to provide a ‘surrogate
political process’ that takes some of the sting out of the inherently
undemocratic and unaccountable rulemaking process.” (quoting Michael
Asimow, Interim-Final Rules: Making Haste Slowly, 51 Admin. L. Rev.
703, 708 (1999))); Iowa League of Cities, 711 F.3d at 873 (“Notice and
comment procedures secure the values of government transparency and
public participation . . . .”); id. at 871 (“Notice and comment procedures
. . . were undoubtedly designed to protect the concrete interests of . . .
regulated entities by ensuring that they are treated with fairness and
transparency after due consideration and industry participation.”).

       For these reasons, an agency fails to provide adequate reasons for
its decisions, see Encino Motorcars, LLC, 579 U.S. at 221, if it fails to
respond to “significant points” and consider “all relevant factors” raised
by public comments, see also, e.g., Home Box Office, 567 F.2d at 35–36
(establishing this principle); Carlson, 938 F.3d at 343–44 (applying the
principle). Our Court and other courts therefore require that an agency
respond to any “significant comments” received by the agency. See, e.g.,
Menorah Med. Ctr. v. Heckler, 768 F.2d 292, 295, 296–97 (8th Cir. 1985);
Lloyd Noland Hosp. & Clinic v. Heckler, 762 F.2d 1561, 1567 (11th Cir.
1985); Altera Corp. & Subs., 145 T.C. at 112. “[U]nless the [agency]
answers objections that on their face seem legitimate, its decision can
hardly be classified as reasoned.” PPL Wallingford Energy LLC v.
FERC, 419 F.3d 1194, 1198 (D.C. Cir. 2005) (quoting Can. Ass’n of
Petroleum Producers v. FERC, 254 F.3d 289, 299 (D.C. Cir. 2001)); see
also PSEG Energy Res. & Trade LLC v. FERC, 665 F.3d 203, 209 (D.C.
Cir. 2011) (same). Again, this is hornbook law, see, e.g., Hickman &
Pierce, supra, § 5.4, and courts of appeals have routinely affirmed the
requirement for more than four decades. 12

        12See, e.g., Home Box Office, 567 F.2d 9 (decided by the D.C. Circuit in 1977);
PPG Indus., Inc. v. Costle, 630 F.2d 462, 466 (6th Cir. 1980); St. James Hosp. v. Heckler,
760 F.2d 1460, 1470 (7th Cir. 1985); Menorah Med. Ctr., 768 F.2d at 295, 296–97
(decided by the Eighth Circuit in 1985); Brewer v. Madigan, 945 F.2d 449, 457 n.7 (1st
                                       322

        Significant comments generally are “those ‘comments which, if
true, . . . would require a change in [the] proposed rule.’ ” La. Fed. Land
Bank Ass’n, FLCA v. Farm Credit Admin., 336 F.3d 1075, 1080 (D.C.
Cir. 2003) (quoting Am. Mining Cong. v. EPA, 907 F.2d 1179, 1188 (D.C.
Cir. 1990)). Or, put another way, a significant comment “cast[s] doubt
on the reasonableness of the rule the agency adopts.” See Balt. Gas &
Elec. Co. v. United States, 817 F.2d 108, 116 (D.C. Cir. 1987). It is well
settled that “an agency must respond to comments ‘that can be thought
to challenge a fundamental premise’ underlying the proposed agency
decision.” Carlson, 938 F.3d at 344 (quoting MCI WorldCom, Inc. v.
FCC, 209 F.3d 760, 765 (D.C. Cir. 2000)). Such comments may include
“challenges to the lawfulness of the proposed rule” or “[c]hallenges to the
internal integrity or reasonableness of the regulatory structure.” See
Balt. Gas & Elec. Co., 817 F.2d at 116.

               2.     The Comments Here Were Significant and Required
                      a Response.

      3M argues that Treasury did not respond to significant comments
during the rulemaking process. The opinion of the Court rejects that
argument, concluding that (1) Treasury was not required to respond to
some of the comments 3M cites because Treasury was already aware of
the points raised by those comments, see op. Ct. pp. 268–69, and (2) the
Court need not decide whether Treasury was required to respond to the
remaining comments because those comments are irrelevant in the
context in this case, see op. Ct. pp. 269‒70. Once again the opinion’s
conclusions find no support in the APA or the caselaw.

       The comments at issue in this case, which the opinion of the Court
describes, see op. Ct. pp. 199–200, included, among other things,
concerns about Treasury’s authority to issue Treasury Regulation
§ 1.482-1(h)(2). Specifically, four commenters pointed out that the
proposed rule contradicted the Supreme Court’s decision in First
Security and the decisions of this Court and the U.S. Court of Appeals
for the Sixth Circuit in Procter & Gamble and called for changes to the
rule. The comments questioned whether, under that precedent,
Treasury had the authority to promulgate Treasury Regulation § 1.482-
1(h)(2) in the form that was ultimately adopted.

      These are quintessential “significant comments.” See, e.g., La.
Fed. Land Bank Ass’n, 336 F.3d at 1080; Balt. Gas & Elec. Co., 817 F.2d

Cir. 1991); Hussion v. Madigan, 950 F.2d 1546, 1554 (11th Cir. 1992); Huawei Techs.
USA, Inc. v. FCC, 2 F.4th 421, 449 (5th Cir. 2021).
                                   323

at 116. Treasury was required to respond to these comments because
they “challenge[d] a fundamental premise” of the proposed regulation,
Carlson, 938 F.3d at 344, and “cast doubt on the reasonableness of the
rule” that Treasury adopted, Balt. Gas & Elec. Co., 817 F.2d at 116. And
certainly, if true, the comments “would require a change in [the]
proposed rule.” La. Fed. Land Bank Ass’n., 336 F.3d at 1080 (quoting
Am. Mining Cong., 907 F.2d at 1188).

        Comments telling Treasury (in so many words) that “based on
Supreme Court and other judicial authorities, you are attempting to
regulate outside of your permissible sphere” squarely “ ‘challenge a
fundamental premise’ underlying the proposed agency decision.”
Carlson, 938 F.3d at 344 (quoting MCI WorldCom, 209 F.3d at 765).
They undercut Treasury’s assumption that section 482 permitted it to
act as it proposed to do. Confronted with that challenge, Treasury
needed to respond. Silence was not a viable option. Perhaps Treasury
thought it had good reasons to act (for example, because it believed an
amendment to section 482 had changed the legal landscape). But if it
did, it needed to state those reasons. It could not hold them in reserve
until its actions were challenged in court. See Grand Canyon Air Tour
Coal. v. FAA, 154 F.3d 455, 468 (D.C. Cir. 1998) (“An agency is required
to provide a meaningful opportunity for comments, which means that
the agency’s mind must be open to considering them.” (citing McLouth
Steel Prods. Corp. v. Thomas, 838 F.2d 1317, 1323 (D.C. Cir. 1988))); see
also id. (“An agency must also demonstrate the rationality of its
decision-making process by responding to those comments that are
relevant and significant.”).

       There is no dispute here that Treasury did not respond; in fact,
Treasury did not even acknowledge the comments. Cf. PSEG Energy
Res. & Trade LLC, 665 F.3d at 210 (“To characterize objections [which
Treasury did not even do here] . . . is not to answer them.”). Treasury’s
silence in this regard provides no basis on which to conclude that the
agency engaged in reasoned decisionmaking. Judulang, 565 U.S. at 53;
see also PPL Wallingford, 419 F.3d at 1198 (“An agency’s ‘failure to
respond meaningfully’ to objections raised by a party renders its decision
arbitrary and capricious.” (quoting Can. Ass’n, 254 F.3d at 299)); PSEG
Energy Res. & Trade LLC, 665 F.3d at 208 (same); cf. City of Brookings
Mun. Tel. Co. v. FCC, 822 F.2d 1153, 1168 (D.C. Cir. 1987) (“Lacking
                                          324

any indication of . . . a reasoned determination . . . we are forced to
conclude that the FCC acted irrationally . . . .”). 13

                3.      The Opinion of the Court’s Reliance on Thompson Is
                        Misplaced.

       In reaching its contrary conclusion that Treasury’s procedures
were adequate, the opinion of the Court cites Thompson, 741 F.2d at
409, for the proposition that “when a comment ‘brought to the attention
of the agency nothing which it had not already considered,’ the agency
need not respond.” The opinion reasons that, because Treasury was
already aware that Treasury Regulation § 1.482-1(h)(2) was
inconsistent with prior caselaw, it was not required to respond to
comments that raised the point. But this conclusion is wrong, for at
least three reasons.

       First, when promulgating the rule, Treasury never indicated its
awareness of the contrary caselaw. Of course, one might assume that
Treasury knew about the cases in light of their profile within the tax
community. But (as discussed in Part I.A.2 above) we are not permitted
to speculate. Rather, we evaluate agency decisionmaking based on what
the agency actually says at the time of its decision and not based on
assumptions or post hoc rationalizations. See Chenery I, 318 U.S. at 87

        13 Chief Judge Kerrigan’s concurring opinion contends that an agency’s
decision to “go[] forward with the proposed [challenged] regulation in the face of
opposing comments is indeed acknowledgement of them.” See concurring op. p. 279. I
am aware of no authority supporting the view. And as Part I demonstrates, plenty of
authority contradicts it.
         After all, “[t]he fundamental purpose of the response requirement is . . . to
show that the agency has indeed considered all significant points articulated by the
public.” Nat. Res. Def. Council, Inc. v. EPA, 859 F.2d 156, 188 (D.C. Cir. 1988); see
also, e.g., Mortg. Bankers Ass’n, 575 U.S. at 109 (Scalia, J., concurring in the judgment)
(“Before an agency makes a rule, it normally must notify the public of the proposal,
invite them to comment on its shortcomings, [and] consider and respond to their
arguments . . . .” (Emphasis added.)). And if “the agency’s mind must be open to
considering” the comments it receives, Grand Canyon Air Tour Coal., 154 F.3d at 468
(citing McLouth Steel Prods. Corp., 838 F.2d at 1323), the “agency must also
demonstrate the rationality of its decision-making process by responding to those
comments that are relevant and significant,” id. Forging ahead without any
explanation can hardly be viewed as rational decisionmaking.
         This makes sense. The opposite rule would permit agencies to say nothing at
all in response to comments and, when challenged, respond that moving forward with
the proposed rule was an implicit acknowledgement and rejection of the points the
comments had raised. The APA requires words (that is, an agency response to public
arguments) and, unlike elsewhere in life, actions cannot speak louder.
                                    325

(“The grounds upon which an administrative order must be judged are
those upon which the record discloses that its action was based.”); see
also State Farm, 463 U.S. at 50 (courts may not accept post hoc
rationalizations). And the parties agree that Treasury did not discuss
or even cite the adverse cases during the rulemaking process.

       Second, even if we assume that Treasury was aware of the cases
at the time of its rulemaking, “ ‘knowing’ is not . . . the same as actually
considering the problems raised by [commenters].” Gerber, 294 F.3d
at 183. The APA requires the latter. See 5 U.S.C. § 553(c) (providing
that an agency must “consider[ ] . . . the relevant matter presented” in
the notice and comment process). Indeed, the whole point of requiring
an agency to respond to significant comments is to ensure that the
agency complies with this aspect of the APA. See, e.g., Nat. Res. Def.
Council, Inc., 859 F.2d at 188. While Treasury may have considered
internally the implications of the contrary cases during the rulemaking
process, it did nothing to show commenters and our Court that it
engaged in such an analysis. It therefore cannot demonstrate that it
satisfied the requirements of the APA. And in the absence of any such
demonstration (e.g., a discussion of the caselaw or Treasury’s reasons
for adopting Treasury Regulation § 1.482-1(h)(2) despite that caselaw),
Treasury did not meet its APA obligations.

       Third, Thompson—the case on which the opinion of the Court
relies—and similar cases in fact refute the opinion of the Court’s
conclusion. In Thompson, 741 F.2d at 409, the D.C. Circuit found that
the agency had already explained its action and that its previous
explanations adequately addressed the comments it received. Other
cases reach similar conclusions where an agency has previously selected
and explained a course of action and continues to receive comments
objecting to its decision. See, e.g., Nat. Res. Def. Council, Inc., 859 F.2d
at 189 (“EPA, in effect, responded in advance; as a result, there was no
error in failing to respond to legal objections that were thereafter raised
during the comment period.”); cf. Gatewood, 560 F.3d at 848 (“When the
agency has articulated and acted on a consistent rationale throughout
the course of a lengthy informal rulemaking process, the final rule is not
arbitrary and capricious because the rationale was not fully reiterated
in the final agency action.”). Similarly, courts have not required
agencies to respond to comments that are fundamentally at odds with
policy determinations that have already been made by the executive
branch. See Sherley v. Sebelius, 689 F.3d 776, 784–85 (D.C. Cir. 2012)
(concluding that, in implementing an executive order expanding federal
support for embryonic stem cell research, the National Institute of
                                           326

Health was not required to respond to comments categorically rejecting
any such research). 14 This case does not present any of these
circumstances.

       To begin with, the comments at issue did not concern
discretionary, policy matters; rather, they addressed Treasury’s
authority for promulgating the rule. See Balt. Gas & Elec. Co., 817 F.2d
at 116 (noting that significant comments that require a response may
well include “challenges to the lawfulness of the proposed rule”).

       Moreover, unlike the agency in Thompson, during the course of
the rulemaking process, Treasury did not discuss Treasury Regulation
§ 1.482-1(h)(2) at all other than by summarizing its provisions. As
already noted, Treasury did not explain its reasons for adopting the rule,
why the existing rules needed changing, why blocked income rules
resulted in income not being clearly reflected, and so on. Nor did
Treasury discuss or even cite the contrary authorities flagged by the
commenters. Accordingly, cases like Thompson, 741 F.2d at 409, where
the agency has previously explained its decision, give Treasury no
quarter; rather they highlight the procedural failings in the rulemaking
process before us. See also Gatewood, 560 F.3d at 848; Balt. Gas & Elec.
Co., 817 F.2d at 116.

      For these reasons, the opinion of the Court errs when it cites
Thompson in support of its position. True—an agency need not respond
to comments it has already considered and addressed, as that case says.
But to rely on this rule an agency must show its work, 15 just as the
agency (and not the courts) must show that it has met all the APA’s
requirements. See Encino Motorcars, LLC, 579 U.S. at 224 (“It is not
         14 In that kind of case, the agency is not required to respond because “[t]he

failure to respond to comments is significant only insofar as it demonstrates that the
agency’s decision was not based on a consideration of the relevant factors.” Sherley,
689 F.3d at 784 (quoting Covad Commc’ns Co. v. FCC, 450 F.3d 528, 550 (D.C. Cir.
2006)).
         15   As the D.C. Circuit put it in Rodway v. USDA, 514 F.2d 809, 817 (D.C. Cir.
1975):
         The basis and purpose statement [required by the APA] is not intended
         to be an abstract explanation addressed to imaginary complaints.
         Rather, its purpose is, at least in part, to respond in a reasoned manner
         to the comments received, to explain how the agency resolved any
         significant problems raised by the comments, and to show how that
         resolution led the agency to the ultimate rule.
The court continued: “This purpose is patent on the face of the statute [i.e.,
section 553(c) of the APA].” Id. n.13.
                                         327

the role of the courts to speculate on reasons that might have supported
an agency’s decision.”); see also Physicians for Soc. Resp. v. Wheeler, 956
F.3d 634, 648 (D.C. Cir. 2020) (rejecting an agency’s claims that its
reasoning was apparent from its actions and “a backdrop of well-known
public disagreement”). The agency made the required showing in
Thompson, 741 F.2d at 409. But Treasury has failed to do so here. 16

       Natural Resources Defense Council, Inc., 859 F.2d 156, provides
another helpful example that refutes the opinion of the Court’s
conclusion. In that case, as here, existing caselaw raised questions
about the validity of a rule that the Environmental Protection Agency
(EPA) had proposed. Commenters flagged these questions at a public
hearing, then challenged final rules on the grounds that EPA had failed
to respond to comments. The D.C. Circuit described the EPA’s response
to this challenge as follows:

              EPA replies that there was no need to respond to
       Industry’s objections. The Notice of Proposed Rulemaking
       dealt fully, EPA contends, with the issues raised by the
       veto regulations, including the . . . legal objections. See 43
       Fed. Reg. 37,078, 37,087 (1978). The Federal Register
       notice discussed the Ford Motor Co. [v. EPA, 567 F.2d 661
       (6th Cir. 1977),] and State of Washington [v. EPA, 573 F.2d
       583 (9th Cir. 1978),] decisions, noting EPA’s view that the
       veto regulations, although perhaps in tension with dicta in

       16   When presented with facts closer to those now before us, courts have
consistently required more from the agency. See, e.g., Hewitt v. Commissioner, 21
F.4th at 1351 (holding that a comment on a proposed regulation “was significant and
required a response by Treasury to satisfy the APA’s procedural requirements”);
Carlson, 938 F.3d at 347 (holding that the Postal Regulatory Commission “fell short of
the APA’s requirement for reasoned decisionmaking” when it failed to address
significant public comments); Sierra Club v. EPA, 863 F.3d 834, 838 (D.C. Cir. 2017)
(noting that “if we conclude that the substantive comments raised meritorious issues
unanswered by EPA, then we must remand for further proceedings” and remanding
because “EPA failed to respond adequately to comments disputing [its] explanations”);
Menorah Med. Ctr., 768 F.2d at 295, 295–96 (stating that an agency’s failure to respond
to criticisms that “cast serious doubt on the premise grounding the [agency’s]
explanation” was arbitrary and capricious). Note that the Sixth Circuit’s approach in
Oakbrook Land Holdings, LLC v. Commissioner, 28 F.4th 700, was based on a finding
that the comments at issue did not address “the problem that Treasury sought to
solve—providing a method for I.R.C. § 170(h)(5)(A)’s perpetuity requirement to be met
upon judicial extinguishment.” Id. at 715. That kind of distinction is unavailable here,
where the comments were directed at Treasury’s authority to issue the very regulation
at issue and, therefore, were clearly addressed at “the problem Treasury sought to
solve.” Id.
                                        328

       those two cases, were consistent with the cases’ holdings.
       See [43 Fed. Reg.] at 37,087–88. The agency’s view, as set
       forth in the [Notice of Proposed Rulemaking], was that the
       veto regulations themselves constitute “guidelines” under
       the [APA] and therefore address the concern that federal
       supervision be pursuant to formally promulgated
       standards.

Nat. Res. Def. Council, Inc., 859 F.2d at 188. Not surprisingly, the D.C.
Circuit agreed that the EPA’s Notice of Proposed Rulemaking responded
adequately to the objections raised at the hearing:

              In the circumstances before us, EPA, in effect,
       responded in advance; as a result, there was no error in
       failing to respond to legal objections that were thereafter
       raised during the comment period. The agency had, for all
       practical purposes, already noted and addressed the
       objections. EPA’s legal position (which we have sustained)
       was clear to the public at all times, and the court is thus
       not faced on review with uncertainty as to whether the
       agency overlooked substantive objections. Accordingly,
       EPA did not run afoul of section 553(c) of the APA.

Id. at 189. 17

       Compare Treasury’s actions here to those of EPA. One looks in
vain in the record before us for a “discuss[ion]” of the relevant cases or
for an explanation by Treasury that its “regulation[ ], although perhaps
in tension with dicta [in the relevant cases was] consistent with [or even
distinguishable from] the cases’ holdings.” Id. at 188. All we have is
silence and post hoc rationalizations, with the resulting “uncertainty as
to whether the agency overlooked substantive objections.” Id. at 189.
Those are not the marks of nonarbitrary agency action. 18

        17 The D.C. Circuit decided Natural Resources Defense Council, Inc. in 1988,

before the Supreme Court issued its 2015 decision in Mortgage Bankers Ass’n, 575
U.S. 92. There the Supreme Court stated that “[a]n agency must consider and respond
to significant comments received during the period for public comment.” Id. at 96
(emphasis added). I need not resolve here whether, after Mortgage Bankers Ass’n, an
agency may rely on a response made “in advance.” Here, Treasury offered no response
at all—in advance or otherwise.
        18 For another example of an adequate explanation (even if “minimally” so) by

an agency in the face of adverse judicial precedent, see Peck v. Thomas, 697 F.3d 767,
773 (9th Cir. 2012).
                                         329

       To summarize, Thompson, the only case the opinion of the Court
cites in support of its “significant comments” holdings, in fact
contradicts the opinion’s conclusion. And the opinion’s repeated
assertion that “Treasury was aware” of the points made by comments,
see op. Ct. p. 269, has no legal significance. Accordingly, the opinion of
the Court errs in holding that Treasury was not required to respond to
the comments 3M identifies. The comments were significant, and
Treasury was required to respond. 19

               4.      The Elimination of the “Complete Power” Regulation
                       Does    Not    Excuse     Treasury’s    Procedural
                       Shortcomings.

      Chief Judge Kerrigan’s concurring opinion appears to suggest
that Treasury’s failure to comply with the APA’s procedural
requirements may be overlooked in part because of the elimination of
the “complete power” regulation. The concurring opinion faults the
commenters for “fail[ing] to address the elimination of the complete
power regulation . . . in the context of the blocked income regulation.”
See concurring op. p. 278. 20 But this gets the requirements of the APA
backwards.     As discussed in Part I.A above, it was Treasury’s
responsibility (not the commenters’) to explain adequately why it
departed from its existing position and how the elimination of the
“complete power” regulation was tied to its decision to adopt Treasury
Regulation § 1.482-1(h)(2). No one disputes that Treasury did not do so.

       Treasury’s failure is all the more puzzling because the
elimination of the complete power regulation weakened Treasury’s
position in connection with Treasury Regulation § 1.482-1(h)(2), rather
than strengthening it as the concurring opinion appears to suggest. A

        19 Chief Judge Kerrigan’s concurring opinion suggests that the approach I have

followed here would “place a greater burden on both the agency and the court system.”
See concurring op. p. 280. Any such “burden” flows from the decisions Congress made
when enacting the APA and the interpretations given to that statute by the Supreme
Court and the courts of appeals. As a trial court, we are not authorized to relieve
Treasury from this burden, whether we deem it wise or not.
        20 The concurring opinion uses the phrase “the elimination of the complete

power” regulation as shorthand for Treasury’s decision in 1993 to redesignate former
Treasury Regulation § 1.482-1(b)(1) as Treasury Regulation § 1.482-1A(b)(1) and make
that regulation applicable only for tax years beginning on or before April 21, 1993. See
T.D. 8470, 58 Fed. Reg. 5263, 5271, 1993-1 C.B. at 99 (Jan. 21, 1993); see also op. Ct.
p. 68 n.38. For convenience, I will follow the concurring opinion’s convention,
recognizing that the regulation remains in effect for certain tax years.
                                  330

close reading of the text of the “complete power” regulation and First
Security confirms this.

      The “complete power” regulation provided:

      The interests controlling a group of controlled taxpayers
      are assumed to have complete power to cause each
      controlled taxpayer so to conduct its affairs that its
      transactions and accounting records truly reflect the
      taxable income from the property and business of each of
      the controlled taxpayers. If, however, this has not been
      done, and the taxable incomes are thereby understated, the
      district director shall intervene, and, by making such
      distributions, apportionments, or allocations as he may
      deem necessary of gross income, deductions, credits, or
      allowances, or of any item or element affecting taxable
      income, between or among the controlled taxpayers
      constituting the group, shall determine the true taxable
      income of each controlled taxpayer.

Treas. Reg. § 1.482-1A(b)(1) (2019) (emphasis added) (applicable for tax
years beginning on or before April 21, 1993). In other words, under this
regulation, in applying section 482, the Commissioner would assume—
that is, take as a given without having to prove it—that a group of
controlled taxpayers had full power to cause every member of the group
to reflect the correct income for tax purposes. Put yet another way, the
regulation permitted the Commissioner to assume that if the controlled
group wanted to get to the “right” tax answer, it could have done so. In
light of this assumption, if the Commissioner were to find that “this was
not done,” he could assume (again, take as a given without regard to the
facts) that this was the result of some action by the group and within
the group’s control.

        This assumption was beneficial to the Commissioner. Instead of
having to undertake a factual analysis to demonstrate that the group
had the power to control the tax affairs of a relevant member and that
it in fact had used that power for untoward purposes, the Commissioner
could simply “assume” that this was so and proceed with an adjustment.
In a way, the Commissioner could assume “guilt by association.”

       In its decision in First Security, the Supreme Court acknowledged
the existence of the “complete power” regulation. See First Security, 394
U.S. at 404. But the Supreme Court placed a limit on how far assumed
                                   331

“guilt by association” could be taken in light of the text of the statute
and existing interpretations of the term “income” as used in the Code.
In the Court’s view, an actual ability “to shift income among . . .
subsidiaries” must exist for section 482 to apply. Id. The Commissioner
was not allowed simply to “assume” this was so when applicable legal
rules defeated the assumption. Id. at 404–05. That is what the Court
meant when it said that “income implies dominion or control of the
taxpayer.” Id. at 404. And that is what the Court meant when it said
the “regulation is consistent with the control concept heretofore
approved by this Court, although in a different context.” Id. And that
is why the Court concludes “[t]he ‘complete power’ referred to in the
regulations hardly includes the power to force a subsidiary to violate the
law.” Id. at 405. In effect, the Supreme Court was saying it is fine for
the Commissioner to “assume” (and not to have to prove) that a common
group generally controls the income of its members, but that assumption
breaks down, and will not be respected by a court, when it results in the
fiction that the group has “the power to force a subsidiary to violate the
law.” Id.

       It is a mistake to read the “complete power” regulation as
somehow having limited the Commissioner’s authority. To the contrary,
the regulation made it easier for the Commissioner to win cases under
section 482. And the Supreme Court in First Security did not read the
“complete power” regulation as having imposed a limitation on the
Commissioner that the Commissioner could not disavow (resulting in
the Commissioner’s losing the case). Rather, First Security read the
“complete power” regulation as having given the Commissioner wide
latitude. Yet, even in the context of that wide latitude, the statute (and
particularly the definition of the word “income” as previously
interpreted by the Court) imposed limits. The “assumption” that
common groups could do what they wished with respect to their
members’ income did not hold when legal rules placed limits on that
power. In those circumstances, there was no “income” to allocate, and
the Commissioner could not make it otherwise by regulation, no matter
how favorable the “assumptions” asserted in his favor.

       With this background in mind, it is not clear to me why the
prospective elimination of the “complete power” regulation obviates the
need for Treasury to respond to the significant comments raised by the
commenters. Although the landscape had changed somewhat, the new
terrain was less favorable to Treasury, further weighing in favor of fully
addressing significant comments in compliance with the APA. The
                                          332

change simply does not insulate Treasury from APA requirements as
the Chief Judge’s concurrence suggests. 21

                5.      The Opinion of the Court Fails to Analyze Whether
                        Treasury Was Required to Respond to the Remaining
                        Comments.

       Although the errors described in the preceding sections are
sufficient to find for 3M, perplexingly, the opinion of the Court does not
even analyze the remaining comments on which 3M relies. Rather, the
opinion assumes that no response was required because the comments
(regarding the exhaustion of remedies rule, the no-circumvention
requirement, and electing the deferred income method) relate to
provisions of the regulation that do not control the outcome of this case.
For example, the opinion of the Court states that “any failure by
[Treasury] to appropriately respond to comments regarding the
exhaustion-of-remedies requirement is irrelevant” because “[i]n this

        21The concurring opinion also observes that “[t]he parties’ own stipulations
make it clear that Treasury reviewed the comments.” See concurring op. p. 278. The
concurring opinion “take[s] it a step further and argue[s] that [blanket statement in]
the preamble [that the comments were considered] is sufficient to respond to the four
comments regarding the proposed blocked income regulation.” See concurring op.
pp. 278‒79.
        To the extent the concurring opinion intends to suggest that 3M stipulated its
case away, that is not so. The stipulation of the parties to which the concurring opinion
refers states:
        As stated in T.D. 8552, “written comments responding to the notice of
        proposed rulemaking were received, and a public hearing was held on
        August 16, 1993,” and “after consideration of all the comments,” the
        proposed regulations under the 1993 Notice of Proposed Rulemaking,
        as revised by T.D. 8552, were adopted, and the temporary regulations
        under T.D. 8470 were removed.
That stipulation merely describes what the preamble states. It cannot fairly be read
as an admission by 3M that Treasury complied with the APA, a point that 3M
vigorously disputes. Nor does the Commissioner maintain that 3M should lose because
of the stipulation.
        More importantly, courts have repeatedly rejected agency claims that a
blanket statement that “all comments were considered” discharges an agency’s
obligations under the APA. See, e.g., PPG Indus., 630 F.2d at 466 (“[Courts] are not
required to ‘take the agency’s word that it considered all relevant matters.’” (quoting
Asarco, Inc. v. EPA, 616 F.2d 1153, 1160 (9th Cir. 1980))); see also Hewitt, 21 F.4th at
1351 (“[T]he fact that Treasury stated that it had considered ‘all comments,’ without
more discussion, does not change our analysis, as it does not ‘enable [us] to see
[NYLC’s] objections and why [Treasury] reacted to them as it did.’’ (quoting Lloyd
Noland, 762 F.2d at 1566)). The concurring opinion cites no authority to the contrary,
and I am aware of none.
                                       333

case . . . other requirements of [Treasury Regulation §] 1.482-1(h)(2)
(2006) are not met: i.e., the effect-on-uncontrolled-taxpayers
requirement, the public-promulgation requirement, and the general-
applicability requirement.” See op. Ct. p. 270. The reasoning seems to
be that, if 3M cannot satisfy at least one necessary element of the
regulation, then procedural defects with respect to any other element (or
indeed all other elements) of the regulation do not matter.

       But this analysis puts the cart before the horse. If Treasury
Regulation § 1.482-1(h)(2) is procedurally invalid, then 3M does not need
to satisfy any of its requirements. The opinion of the Court seems to
forget that a defect with respect to one aspect of a regulation can
invalidate the entire rule. See 33 Charles Alan Wright & Arthur R.
Miller, Federal Practice and Procedure § 8381 (2d ed. 2022) (“Sometimes
a court will determine that a portion of a complex agency action
(generally a rule) is legally defective but that the remainder of the action
is not. This situation raises the question of severance—i.e., whether the
court should vacate and remand the entire action or, instead, merely
vacate and remand the defective portion, leaving the rest in place.”).
And there is no showing in the opinion of the Court that the regulatory
requirements here would or could be severed. All of this is to say that
other comments on which 3M relies raised meaningful issues, and the
opinion of the Court has not engaged with them.

II.   The Commissioner’s            Additional   Arguments       Are    Similarly
      Unavailing.

      The Commissioner argues that Treasury satisfied its burden
because “the agency’s explanation need only be ‘clear enough that its
“path may reasonably be discerned.” ’ Encino Motorcars[, LLC, 579 U.S.
at 221] (citing Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419
U.S. 281, 286 (1974)).” 22 Resp’t’s Am. Answering Br. 23. Regarding
Treasury’s path here, the Commissioner says:

      22   As I have said before:
      In Bowman Transportation, the case that gave rise to the “path may
      reasonably be discerned” formulation, the Supreme Court observed
      that the Interstate Commerce Commission had in fact provided an
      explanation of how it had viewed the relevant evidence and proceeded
      to discuss that explanation. Bowman Transp., Inc. v. Ark.-Best Freight
      Sys., Inc., 419 U.S. 281, 290 (1974) (“The question before the
      Commission was whether service on the routes at issue would be
      enhanced by permitting new entry, and as to this the performance by
                                         334

       Section 1.482-1(h)(2) was part of a major effort by Treasury
       to overhaul the section 482 transfer pricing regulations
       following the 1986 amendment to section 482. Throughout
       the rulemaking process, Treasury issued extensive
       statements explaining the manner in which the revised
       rules (including section 1.482-1(h)(2)) operate and how
       they align with the statutory goals of section 482, as
       articulated by Congress.

Id. The Commissioner cites various administrative pronouncements
that were issued as part of the overhaul and elaborates on his reasoning
as follows:

       Section 1.482-1(h)(2) appears in revised section 1.482-1,
       along with bedrock transfer pricing principles such as tax
       parity, comparability, true taxable income, and the arm’s
       length standard. Treasury explained how the revisions to
       section 1.482-1 implement Congress’ objective to ensure a
       division of income between related parties that reflects the
       value of their respective economic contributions. . . . These
       extensive discussions not only explain the reasoning
       behind section 1.482-1(h)(2), but they are also incorporated
       in the plain text of the rule . . . .

Id. at 24. Thus, the Commissioner relies on the text of the regulation,
the regulation’s inclusion in a larger regulatory package, the reasons
provided for the package more generally, and the 1986 amendment to
section 482 to argue that the purpose of Treasury Regulation § 1.482-
1(h)(2) was both obvious and adequately explained.

      It is true that during the rulemaking process Treasury explained
the regulatory package more generally and responded to some
comments regarding other parts of the package. But a careful review of
the regulatory history shows that it undercuts, rather than supports,
the Commissioner’s position.

       prospective entrants on new routes was of limited relevance. The
       Commission noted with respect to transit times that different highway
       conditions might make experience there a poor indication of the times
       applicants could provide on the routes they sought to enter.”). The
       record here fails to provide even “that minimal level of analysis,”
       Encino Motorcars, LLC v. Navarro, 579 U.S. [at 221], required by
       Bowman Transportation.
Oakbrook Land Holdings, LLC, 154 T.C. at 225 n.18 (Toro, J., concurring in the result).
                                        335

       Treasury Regulation § 1.482-1(h)(2) was first proposed in 1993,
more than six years after Congress added the second sentence to
section 482. See Prop. Treas. Reg. § 1.482-1T(f)(2), 58 Fed. Reg. 5310,
5312 (Jan. 21, 1993). At the time, Treasury had already put forward
two detailed explanations of the 1986 amendment and Treasury’s plans
to overhaul the transfer pricing regulations: (1) Notice 88-123, 1988-2
C.B. 458 (generally known as the “white paper”), and (2) the 1992
proposed regulations, see Intercompany Transfer Pricing and Cost
Sharing Regulations Under Section 482, 57 Fed. Reg. 3571 (proposed
Jan. 30, 1992). Both were lengthy documents in which Treasury
explained how it intended to implement the statutory change and
otherwise amend the transfer pricing regulations. Neither publication
mentioned blocked income or any of the caselaw addressing the issue.

        When Treasury finally proposed the blocked income regulation in
1993, the regulatory preamble again said nothing about Treasury’s
reasons for issuing the proposal. See Intercompany Transfer Pricing
Regulations Under Section 482, 58 Fed. Reg. at 5310, 5310–12 (proposed
Jan. 21, 1993). Instead, the preamble referred to a package of temporary
regulations issued under section 482 on the same day, stating that “[t]he
preamble to the temporary regulations contains a full explanation of the
reasons underlying the issuance of the proposed regulations.” Id. at
5310. But when one turns to the preamble to the temporary regulations,
one again finds no mention of blocked income or related caselaw, see T.D.
8470, 58 Fed. Reg. 5263, 5263–5271, 1993-1 C.B. at 90–123 (Jan. 21,
1993), except that Temporary Treasury Regulation § 1.482-1T(f)(2),
titled “Effect of foreign legal restrictions,” was “[Reserved],” id. at 5281,
1993-1 C.B. at 111.

       The Commissioner is undeterred by this omission, pointing to
Treasury’s reasons for adopting the broader package as well as the text
of the proposed regulation as sufficient evidence of Treasury’s rationale.
But it cannot be that incorporating a rule into a broader package
eliminates the need to explain the reasons for the rule. 23 And
particularly given the context here, where multiple courts had rejected
Treasury’s proposed approach, general comments about transfer pricing
and the arm’s-length principle were insufficient to explain why Treasury
should (or could) include the blocked income rule in the broader package.
Thus, the materials Treasury cites do not allow us to “reasonably . . .

        23 Such an approach would invite agencies to consolidate their rulemakings to

avoid the requirements of the APA with respect to the individual components of a
package.
                                           336

discern[ ]” its rationale for going ahead with the rule despite the contrary
authorities. See Bowman Transp., Inc., 419 U.S. at 286.

      The Commissioner attempts to rely on Encino Motorcars, quoting
the Supreme Court’s statement that only a “minimal level of analysis”
is required to satisfy arbitrary and capricious review. See Encino
Motorcars, LLC, 579 U.S. at 221. But the Commissioner conveniently
ignores that, in this case, Treasury provided no analysis for why it
adopted Treasury Regulation § 1.482-1(h)(2). Additionally, in Encino
Motorcars the Court recognized that the level of explanation required
depends on context. Id. at 222 (“A summary discussion may suffice in
other circumstances, but here—in particular because of decades of
industry reliance on the Department’s prior policy—the explanation fell
short of the agency’s duty to explain why it deemed it necessary to
overrule its previous position.”). As already discussed, the circumstances
here are closely analogous to those in Encino Motorcars, which required
a more detailed explanation. And in that case, the Supreme Court found
the agency’s brief (but existing) explanation insufficient. See Part I.A.5
above. Here, I reach the same conclusion regarding Treasury’s
nonexistent explanation.

       Nor, as the Commissioner appears to contend, does the 1986
amendment to section 482 suffice to explain Treasury’s choices on
blocked income. The amendment added one sentence that said: “In the
case of any transfer (or license) of intangible property (within the
meaning of section 936(h)(3)(B)), the income with respect to such
transfer or license shall be commensurate with the income attributable
to the intangible.” Tax Reform Act of 1986, Pub. L. No. 99-514,
§ 1231(e)(1), 100 Stat. 2085, 2563. To state the obvious, nothing in this
sentence expressly mentions blocked income. For example, the sentence
does not specify whether legal restrictions should be taken into account
in deciding whether income is “commensurate.” Moreover, the sentence
seems perfectly consistent with what may be viewed as a central lesson
of the blocked income cases: that income for purposes of section 482 does
not include amounts that a taxpayer is legally prohibited from receiving.
See Buch dissenting op. pp. 287‒305. 24 And the sentence addresses

        24 As is evident from the text, the term “income” is front and center in the
second sentence of section 482. In promulgating Treasury Regulation § 1.482-1(h)(2),
Treasury offered no explanation why the usual canons of construction should not
inform the interpretation of that term in the second sentence. As the Supreme Court
has said, “[w]hen ‘all (or nearly all) of the’ relevant judicial decisions have given a term
or concept a consistent judicial gloss, we presume Congress intended the term or
                                         337

income from transfers of intangibles only, whereas blocked income can
be present in many types of transactions. 25          (Indeed, Treasury
Regulation § 1.482-1(h)(2) itself on its face applies to all transactions
and is not limited to those involving transfers of intangibles, as one
might expect it to be if it truly were an implementation of the 1986
amendment.) In short, if one wants to rely on the second sentence of
section 482 to support the rule reflected in Treasury Regulation § 1.482-
1(h)(2), one must show why that is so. Connecting the dots between the
second sentence of section 482 and Treasury Regulation § 1.482-1(h)(2)
requires explanation; it is neither obvious nor reasonably discernable.

      For those who consider legislative history relevant, Warger v.
Shauers, 574 U.S. 40, 48 (2014), the statute’s silence on these issues
should come as no surprise, for at least three reasons.

       First, the legislative history suggests that Congress was focused
on a problem other than blocked income—namely, the transfer of high-
profit potential intangibles offshore for compensation that did not reflect
their true value. See H.R. Rep. No. 99-841 (Vol. II), at II-637 (1986)
(Conf. Rep.) (hereinafter Conference Report), as reprinted in 1986-3 C.B.
(Vol. 4) 1, 637 (“Uncertainty exists regarding what transfers are
appropriate to treat as ‘arm’s-length’ comparables and regarding the
significance of profitability, including major changes in profitability of
the intangible after the transfer.”); H.R. Rep. No. 99-426, at 424 (1985)
(hereinafter House Report), as reprinted in 1986-3 C.B. (Vol. 2) 1, 424
(“The problems are particularly acute in the case of transfers of high-
profit potential intangibles. Taxpayers may transfer such intangibles to

concept to have that meaning when it incorporated it into a later-enacted statute.”
Bruesewitz v. Wyeth LLC, 562 U.S. 223, 243 (2011) (quoting Merck & Co. v. Reynolds,
559 U.S. 633, 659 (2010) (Scalia, J., concurring in part and concurring in the
judgment)). In such a case, “[t]he consistent gloss represents the public understanding
of the term.” Id.; see also, e.g., Hylton v. U.S. Attorney General, 992 F.3d 1154, 1158
(11th Cir. 2021) (declining to afford Chevron deference to a position of the Board of
Immigration Appeals because the application of canons of construction resolved any
ambiguity and relying in part on the prior-construction canon, which “establishes that
‘[i]f a statute uses words or phrases that have already received authoritative
construction by the jurisdiction’s court of last resort, . . . they are to be understood
according to that construction’” (quoting Antonin Scalia & Bryan A. Garner, Reading
Law: The Interpretation of Legal Texts § 54, at 322 (2012))); id. (“When Congress use[s]
the materially same language in [a more recent enactment], it presumptively [is]
aware of the longstanding judicial interpretation of the phrase and intend[s] for it to
retain its established meaning.” (quoting Lamar, Archer & Cofrin, LLP v. Appling, 138
S. Ct. 1752, 1762 (2018))).
        25 For a more detailed discussion of the second sentence, see Altera Corp. &

Subs., 145 T.C. at 96–98.
                                         338

foreign related corporations . . . at an early stage, for a relatively low
royalty, and take the position that it was not possible at the time of the
transfers to predict the subsequent success of the product.”). In other
words, Congress was focused on the undervaluation of high-profit-
potential intangibles by related parties. Consistent with this focus,
neither the discussion in the Conference Report nor that in the House
Report mentioned blocked income, even though both included detailed
explanations of the purpose and effect of adding the second sentence to
section 482. See, e.g., Conference Report, at II-637–38; House Report, at
420–27.

       Second, the second sentence of section 482 makes perfect sense as
a response to the intangible valuation issue and little sense as a
response to blocked income concerns. As already discussed, the second
sentence says nothing about cases in which a taxpayer is legally
prohibited from receiving income. 26 Rather, it focuses specifically on
transfers of intangibles and provides that an intangible should be priced
according to the income it generates. Moreover, First Security, the most
famous blocked income case at the time, did not even involve a transfer
of intangibles, so its outcome was unaffected by the second sentence
regardless of how one reads it. It is unclear why Congress would have
enacted a partial fix rather than a complete one if it wished to reverse
the blocked income cases.

       Finally, when a committee of Congress prepares a detailed
explanation of a legislative proposal, one might expect it to mention that
the proposal reverses a decision of the Supreme Court if that in fact is
one of the proposal’s objectives. As noted above, neither the Conference
Report nor the House Report mentions First Security or any other
blocked income case. See Conference Report, at II-637–38; House
Report, at 420–27. The House Report does, however, address a separate
line of cases that the proposal was intended to reverse, cases that were
relevant to—as one might expect—the undervaluation of high-profit-
potential intangibles. See House Report, at 424 (citing U.S. Steel Corp.
v. Commissioner, 617 F.2d 942 (2d Cir. 1980)). All of which leaves the

        26 The legislative history’s general endorsement of allocating income based on

a taxpayer’s economic activity, see, e.g., Conference Report, at II-637–38, does not
establish that Congress intended for legal restrictions that bind the taxpayer to be
ignored. Treasury can apply economic principles while respecting legal rules that are
binding on the taxpayer, and nothing in the legislative history suggests that it should
do otherwise.
                                         339

reader of the legislative history with a feeling of “expressio unius est
exclusio alterius.”

       To summarize, nothing in the second sentence or its history
directs Treasury to act with respect to blocked income as it did. 27
Accordingly, Treasury cannot rely on the second sentence or the
legislative history accompanying its enactment to argue that Treasury’s
path in adopting Treasury Regulation § 1.482-1(h)(2) “may reasonably
be discerned.” See Encino Motorcars, LLC, 579 U.S. at 221 (quoting
Bowman Transp., Inc., 419 U.S. at 286). 28

       Judge Copeland’s opinion concurring in the result contends that
“the new commensurate-with-income standard cannot be implemented
consistently with a strict adherence to the First Security Bank holding.”
See Copeland concurring in the result op. p. 284. The concurring opinion
appears to rely on legislative history in support of this conclusion. But,
regardless of the merits (or demerits) of relying on legislative history
either generally or in this case, see Buch dissenting op. p. 305, as I have
explained above, the legislative history is simply silent on the issue of
blocked income.

       The passage quoted by Judge Copeland proves this point. It begins
by stating that, “[i]n requiring that payments be commensurate with the
income stream [from the intangible], the bill does not intend to mandate
the use of the ‘contract manufacturer’ or ‘cost-plus’ methods of allocating
income or any other particular method.” House Report, at 426. Thus, the
passage’s focus is on the choice of method, an issue entirely separate from
blocked income. The second sentence of the passage confirms this focus,
stating that “[a]s under present law, all the facts and circumstances are to
be considered in determining what pricing methods are appropriate in cases
involving intangible property.” Id. (emphasis added). The sentence then
provides examples of factors, such as the degree of risk borne by parties,

       27 Indeed, given the text and history of the second sentence, it makes sense

that Treasury did not immediately think to include the blocked income rule in its
update to the regulations.
         28 The Commissioner also argues that “the data-based factors under State

Farm do not apply” if “an agency rule does not require fact-finding or empirical
analysis.” Resp’t’s Am. Answering Br. 18. But the Supreme Court relied in part on
the State Farm standard in Encino Motorcars, LLC, 579 U.S. at 221, a case which, like
this one, involved statutory interpretation in the face of contrary caselaw. See id. at
216–18. And in any event, my conclusions here do not depend on any “data-based
factors.”
                                         340

that typically are considered in selecting a transfer pricing method. Again,
selecting a method has nothing to do with blocked income.

       Moreover, even if one were to read the legislative history Judge
Copeland cites as having something to say about blocked income, a rule
that categorically excludes certain foreign restrictions from consideration,
as Treasury Regulation § 1.482-1(h)(2) does, can hardly be reconciled with
the passage’s statement that “all facts and circumstances are to be
considered.” And even more importantly for my purposes, none of the
“weighing” of relevant factors that Judge Copeland undertakes, see
Copeland concurring in the result op. p. 285, appears anywhere in the
administrative rulemaking record that Treasury developed. We may not
affirm the Commissioner’s decision here for reasons Treasury did not offer
or based on a “weighing” of factors Treasury did not undertake. 29

III.   Treasury’s Historical Position on the Nature of Its Regulations
       Provides a Better Explanation for Its Actions Here Than the
       Justifications Offered by Either the Opinion of the Court or the
       Commissioner.

      As Justice Holmes wrote in another tax case, “a page of history is
worth a volume of logic.” N.Y. Tr. Co. v. Eisner, 256 U.S. 345, 349 (1921).
That observation is particularly apt here. History appears to offer a
better explanation for Treasury’s actions with respect to Treasury
Regulation § 1.482-1(h)(2) than either the opinion of the Court or the
Commissioner.     As noted above, when adopting the challenged
regulation (and the entire package of which that regulation was a part),
Treasury “determined” that “that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) . . . do[es] not apply to these
regulations.”

       “When an agency engaged in a particular rulemaking exercise
believes the APA does not require it to provide notice and receive
comments at all, it is not difficult to see why that agency might think

         29 To the extent Judge Copeland argues that the Commissioner should prevail

based on the second sentence of section 482, regardless of Treasury Regulation § 1.482-
1(h)(2), I further note that neither the Commissioner nor Judge Copeland’s opinion (or
the opinion of the Court for that matter) actually undertakes to show what “the profit
or income stream generated by or associated with intangible property is.” See
Copeland concurring in the result op. p. 285 (quoting House Report, at 426). We simply
do not know how much more income 3M Brazil made as a result of using the relevant
intangibles than it would have made without them. This seems to me a critical
omission for anyone who wishes to rely on the commensurate-with-income principle to
decide this case.
                                   341

that a rather brief explanation, offered as it were out of its own
generosity, should be good enough.” Oakbrook Land Holdings, LLC, 154
T.C. at 222 (Toro, J., concurring in the result). Here Treasury
“determined” that notice and comment were not required by the APA.
Thus, although it in fact provided both notice and an opportunity to
comment, it appears not to have thought itself bound to satisfy the
standards set out in Home Box Office and its progeny and affirmed in
State Farm, Encino Motorcars, and other recent Supreme Court
decisions. Viewed in that light, I can at least understand Treasury’s
actions, even if, in carrying out my reviewing responsibility under the
APA, I cannot approve of them.

         Treasury’s position appears to have been based on its historical
view that the regulations were interpretative and therefore not subject
to notice and comment under the APA. See Kristin E. Hickman,
Coloring Outside the Lines: Examining Treasury’s (Lack of) Compliance
with Administrative Procedure Act Rulemaking Requirements, 82 Notre
Dame L. Rev. 1727, 1729 (2007) (“Treasury acknowledges that APA
section 553 governs its various regulatory efforts. Treasury also
contends, however, that most Treasury regulations are interpretive in
character and thus exempt from the public notice and comment
requirements by the APA’s own terms.” (Footnote omitted.)). Indeed,
provisions of the Internal Revenue Manual (IRM) dating back to at least
1994 reflect the IRS’s by-then-longstanding view that nearly all
Treasury regulations were interpretative (rather than legislative) rules
that did not require notice and comment. One such provision stated:
“Most regulations set forth interpretations to resolve ambiguities or fill
gaps in the tax statutes. . . . In rare instances, regulations contain
guidance that is technically legislative, rather than interpretative.”
IRM (30)(15)20 § 212 (Aug. 1, 1994). And the IRM continued on to state:
“[The APA’s] requirements do not apply if the rules are interpretative
. . . . If you think that there are unusual circumstances so that your
regulations would not be interpretative, consult with your Assistant or
Associate Chief Counsel to determine whether the [APA] applies to your
regulations project.” Id. § 531.1. But as we have recently made clear,
and as the Commissioner does not dispute, a regulation like the one here
is legislative, not interpretative. See Green Valley, No. 17379-19, 159
T.C., slip op. at 8–15.

      Put simply, Treasury erroneously assumed the regulations were
interpretative. That assumption colored its view of its responsibilities
under the APA, which in turn contributed to its failure to meet the APA
procedural requirements. While all of this may be understandable (and
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regrettable) and one cannot fault the drafters of these particular
regulations for following what they thought were long-established
Treasury positions, it does not justify this Court’s jumping into the
breach to rescue Treasury from its own mistake. 30

IV.    Additional Considerations

         A. Compliance with the APA’s Procedural Requirements
         Serves Important Values.

      It bears emphasizing that requiring agencies to comply with the
APA’s procedural requirements is not a pointless exercise. Although
some might argue what Treasury was trying to do when adopting
Treasury Regulation § 1.482-1(h)(2)—essentially overturn judicial
precedent it did not like—was “obvious” to the tax world and that
Treasury’s failure to explain its reasoning and address comments on the
record is harmless, the argument would be misplaced.

       As the Supreme Court recently explained, “[p]rocedural
requirements can often seem [an idle and useless formality].” Regents
of the Univ. of Cal., 140 S. Ct. at 1909 (citations omitted). But they
“serve[ ] important values of administrative law.” Id.

     Requiring Treasury to explain its reasoning and respond to
comments here

       promotes “agency accountability,” Bowen v. American
       Hospital Assn., 476 U.S. 610, 643 (1986), by ensuring that
       parties and the public can respond fully and in a timely
       manner to an agency’s exercise of authority. Considering
       only contemporaneous explanations for agency action also
       instills confidence that the reasons given are not simply
       “convenient litigating position[s].”        Christopher v.
       SmithKline Beecham Corp., 567 U.S. 142, 155 (2012)
       (internal quotation marks omitted). Permitting agencies to
       invoke belated justifications, on the other hand, can upset
       “the orderly functioning of the process of review,”

        30 Chief Judge Kerrigan’s concurring opinion expresses concern that my

“dissent would create a slippery slope whereby courts would be constantly faced with
determining whether comments are significant and if the agency responded
appropriately to them.” See concurring op. p. 280. But the APA already requires
precisely this type of review, and decades of administrative law jurisprudence from the
Supreme Court and the courts of appeals demonstrate that we must not shy away from
our duty. See Part I above.
                                         343

       [Chenery I], 318 U.S. [at] 94 . . . , forcing both litigants and
       courts to chase a moving target.

Id. The facts of this case demonstrate the wisdom of the Supreme
Court’s observations, and “[e]ach of the[ ] values [identified by the
Supreme Court is] markedly undermined,” id., when the opinion of the
Court gives Treasury a pass on explaining its reasoning and responding
to comments here. 31

       That an agency’s attempt to overturn judicial precedent might be
viewed as “obvious” makes it more important (not less) for the agency to
explain its reasoning contemporaneously. The rule of law would be
undermined if courts were to permit agencies to attempt to overrule
judicial decisions without so much as an acknowledgment that they are
doing so. I am not aware of any other agency that has made as bold a
claim as that made here. Nor of any other court’s countenancing such a
claim. Treasury’s silence in these circumstances was arbitrary and
capricious under the APA.

       B.      Review of Tax Regulations May Raise Special Concerns.

      Before concluding, I wish to return briefly to the first subsidiary
question I asked at the beginning of this dissent: Is Treasury subject to
the same procedural APA rules as other agencies? In Mayo Foundation
the Supreme Court said “yes.” The analysis above is based on that
premise.

       In reaching its conclusion in Mayo Foundation, however, the
Court noted that “Mayo has not advanced any justification” supporting
a different outcome, and the Court’s conclusion there appears to have
been premised on the “the absence of such justification.” Mayo
Foundation, 562 U.S. at 55.

         31 The outcome here would be no different under Justice Kavanaugh’s partial

dissent in Regents of the University of California, 140 S. Ct. at 1934. In Justice
Kavanaugh’s view, under the relevant Supreme Court precedents, “the post hoc
justification doctrine merely requires that courts assess agency action based on the
official explanations of the agency decisionmakers, and not based on after-the-fact
explanations advanced by agency lawyers during litigation (or by judges).” Id. Even
under that view, however, the Commissioner could not prevail as we do not have before
us any additional “official explanations of the agency decisionmakers.” Id. Rather, all
we have are an utterly silent record and “explanations advanced by agency lawyers
during litigation” or arguments offered “by judges.” Id. (emphasis omitted).
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      As a lower court, we are bound to follow the Supreme Court’s
Mayo Foundation decision. But it is appropriate to note that applying
the APA’s procedural requirements to Treasury regulations creates
some wrinkles that may not be present when courts review rulemaking
by other agencies.

       For example, in general, courts can review promptly rulemaking
proceedings that other agencies undertake. See Wright & Miller, supra,
§ 8303 (describing “special statutory review proceedings [that] funnel
judicial review of agency action directly to courts of appeals” (often the
D.C. Circuit) subject to strict time limits, such as 60 or 90 days). By
contrast, Treasury regulations might not be subject to judicial review for
decades. The Anti-Injunction Act generally precludes an aggrieved
taxpayer’s immediate challenge of a newly adopted regulation. 32 I.R.C.
§ 7421(a); CIC Servs., LLC v. IRS, 141 S. Ct. 1582, 1593 (2021) (“[T]he
Anti-Injunction Act bars pre-enforcement review, prohibiting a taxpayer
from bringing . . . a ‘preemptive[ ]’ suit to foreclose tax liability. . . . And
it does so always—whatever the taxpayer’s subjective reason for
contesting the tax at issue. If the dispute is about a tax rule—as it is in
the run-of-the-mine suits the Government raises—the sole recourse is to
pay the tax and seek a refund.”); Nat’l Fed’n of Indep. Bus. v. Sebelius
(NFIB), 567 U.S. 519, 543 (2012) (“Because of the Anti-Injunction Act,
taxes can ordinarily be challenged only after they are paid, by suing for
a refund.”). As then-Judge Kavanaugh has explained:

       Among other things, the [Anti-Injunction] Act generally
       bars pre-enforcement challenges to certain tax statutes
       and regulations. The Act requires plaintiffs to instead
       raise such challenges in refund suits after the tax has been
       paid, or in deficiency proceedings. The Act thus creates a
       narrow exception to the general administrative law
       principle that pre-enforcement review of agency
       regulations is available in federal court. See Abbott
       Laboratories v. Gardner, 387 U.S. 136, 152–53 (1967). The
       Act thereby “protects the Government’s ability to collect a
       consistent stream of revenue.”

        32 The Anti-Injunction Act forbids any “suit for the purpose of restraining the

assessment or collection of any tax.” I.R.C. § 7421(a). The Declaratory Judgment Act’s
tax exception, 28 U.S.C. § 2201(a), which “is at least as broad as the Anti-Injunction
Act,” Bob Jones Univ. v. Simon, 416 U.S. 725, 733 n.7 (1974), reinforces that
prohibition.
                                       345

Fla. Bankers Ass’n v. U.S. Dep’t of the Treas., 799 F.3d 1065, 1066–67
(D.C. Cir. 2015) (Kavanaugh, J.) (quoting NFIB, 567 U.S. at 543). Thus,
an aggrieved taxpayer must wait until the Commissioner applies the
regulation at issue to that taxpayer and either determines a deficiency
with respect to the taxpayer or denies a request for a refund (or fails to
act on such a request) by the taxpayer. Only then would the taxpayer
have the opportunity to seek judicial review to address any procedural
shortcomings in the adoption of the relevant regulation. And, as this
case demonstrates, by then many years may have passed since the
challenged regulation was first adopted.

       In addition, when another agency fails to comply with the APA’s
procedural requirements, the reviewing court usually can order a
remand permitting the agency promptly to address any procedural
shortfall. By contrast, our authority in a case like this one is limited to
redetermining the deficiency. We can set aside the regulation in
reaching our decision, but ordering a remand for further rulemaking is
not open to us. Any further rulemaking would be left to Treasury’s
discretion.

      Thus, judicial review of Treasury regulations differs in some key
respects from judicial review of other regulations. And, when combined,
these differences create some challenges.

      For example, we must review in 2023 a regulation Treasury
promulgated in 1993. And in undertaking our review, we must apply
the APA using the Mayo Foundation lens, which the Supreme Court
provided in 2011, as well as other APA-related decisions (such as Encino
Motorcars) issued long after 1993. It is possible that, if Treasury had
been aware of these subsequent pronouncements, it might have
recognized that the regulation at issue was legislative (not
interpretative) and prepared a different record that addressed the
procedural deficiencies identified above. 33 But we must review the
record that Treasury actually developed back in 1993, not one that it
might have developed with the benefit of decisions issued in 2011 and

        33 Treasury of course knows how to provide meaningful responses to comments.

See, e.g., T.D. 9846, 2019-9 I.R.B. 583, 84 Fed. Reg. 1838 (Feb. 5, 2019) (Treasury
Decision concerning regulations under section 965 spanned 78 pages of the Federal
Register, including a preamble of more than 36 pages, of which more than 30 pages
responded to comments); T.D. 9790, 2016-45 I.R.B. 540, 81 Fed. Reg. 72,858 (Oct. 21,
2016) (Treasury Decision concerning regulations under section 385 spanned 127 pages
of the Federal Register, including a preamble of more than 90 pages, of which more
than 80 pages responded to comments).
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beyond. The unfortunate predicament Treasury faces flows (1) from its
own assumptions about the nature of the regulations at issue and
(2) from Congress’s decision to make Treasury subject to the APA and
at the same time, under the Anti-Injunction Act, defer most APA
challenges to Treasury regulations until an issue arises in the context of
an actual dispute between a taxpayer and the Commissioner. This may
seem unfair and may subject to an APA challenge regulations long on
the books, but if the current state of the law is unsatisfactory from
Treasury’s perspective, relief must come from Congress (or perhaps the
Supreme Court), not us. Constrained as I am to evaluate Treasury’s
regulations using the same standards as those used for other agency
rulemaking, I must conclude that Treasury’s action here did not meet
those standards.

V.    Conclusion

       For the reasons noted above, Treasury “fail[ed] to follow the
correct procedures in issuing” Treasury Regulation § 1.482-1(h)(2).
Encino Motorcars, LLC, 579 U.S. at 220. Therefore, that regulation
cannot receive Chevron deference. Id. at 221. In the absence of a valid
regulation, Procter & Gamble Co., 95 T.C. 323, requires us to hold for
3M. Because the opinion of the Court concludes otherwise, I respectfully
dissent.

      BUCH, URDA, JONES, GREAVES, and WEILER, JJ., agree
with this dissent.