Can’t Fix This One

You’d have to join me on the early senior hour line at the supermarket if you remember the late Jesse White, the original Ol’ Lonely, the Maytag Repairman long ago. He was lonely because, allegedly, Maytag appliances never needed repair.

Well, today Judge Albert G (“Scholar Al”) Lauber gives Maytag a problem Ol’ Lonely can’t fix in Whirlpool International Holdings S.a.r.l., f.k.a. Maytag Corporation & Consolidated Subsidiaries, 154 T. C. 9, filed 5/5/20.

It seems Maytag’s Luxembourg CFC, claiming to be a manufacturer of kitchen appliances, used a Mexican maquiladora (not a lady bullfighter, but an assembly plant, which gets favorable Mexican tax and trade treatment) to sell these appliances to Maytag’s Mexican and other customers. IRS spoiled the game by invoking Section 954(d), which would make Luxembourg’s earnings Foreign Base Company Sales Income (FBCSI) via Section 951(a), and thus taxable to Maytag onshore (DE Corp with principal place of business in MI). Wherefore Maytag hires seven (count ‘em, seven) lawyers, because IRS slugs Maytag on shore with a couple SNODs for two years at issue aggregating $500K.

The Luxembourg outfit had one (count ‘em, one) part-time employee, but that dude generated a ton of income from flogging these appliances. NOT!

There’s a question of fact whether the Mexican maquiladora actually transformed or manufactured the parts it bought, but for partial summary J Judge Scholar Al needn’t go there.

“Whether or not the Luxembourg CFC is regarded as having manufactured the products, its Mexican branch under section 954(d)(2) is treated as a subsidiary of the Luxembourg CFC, and the sales income the latter earned constitutes FBCSI taxable to petitioner as subpart F income. We will accordingly deny both of petitioners’ motions and grant respondent’s cross-motion to the extent it addresses the FBCSI issue.” 154 T. C. 9, at p. 5.

Prior to the first year at issue, Maytag ran the Mexican operations as CFC. Then Maytag set up the Luxembourg outfit, and transferred to it all plant, land, equipment, and employees via secondments and subcontracting. Mexico supposedly was only a bailee of all the stuff and people, to put it all together. Because Mexican law provided Luxembourg had no permanent establishment in Mexico, it was tax-exempt in Mexico, rather than paying the usual Mexican tax rate of 17%.

OK, what about Luxembourg? It has a 28% tax rate, no? Yes (or rather, si). But there’s the Mexico-Luxembourg tax treaty. Guess what the tax rate is for the owner of a Mexican maquiladora in Luxembourg. Try zero.

Sweet.

But Section 954(d)(2) is there to prevent dodging by flowing sales income through a low-or-no tax jurisdiction. The key is that the flowee doesn’t do much of anything except get checks and write checks.

“Petitioners’ operations in Mexico and Luxembourg, as restructured during 2007 and 2008, clearly fall within the scope of section 954(d)(2). The statute’s first precondition is met because Whirlpool Luxembourg carried on activities ‘through a branch or similar establishment outside * * * [its] country of incorporation.’ And the statute’s second precondition is met because this manner of operation had ‘substantially the same effect,’ for U.S. tax purposes, as if the Mexican branch were a wholly owned subsidiary of … Luxembourg.” 154 T. C. Memo. 9, at p. 39.

So Mexico is treated as a wholly-owned subsidiary of Luxembourg, Luxembourg is a CFC of Maytag, and Maytag owes the tax. Maytag’s claim that Luxembourg sold nothing is “facetious,” says Judge Scholar Al (154 T. C. 9, at p. 49). That’s not what Luxembourg told the Mexican taxing authorities. In order to get maquiladora exemption, Mexico could only assemble, not sell.

Maytag tries to duck by claiming manufacturing is not covered by Section 954(d) and the regs, and that’s a plausible argument. But Judge Scholar Al does a Chevron two-step. The statute is ambiguous (and a lawyer who can’t find an ambiguity in any document should find another way to make a living), and the regs are just fine.

Orders to follow.

Note that all this is pre-TCJA 2017. As the advertisement used to say, what goes on after that is up to you.