Eighth Circuit Applies First Sec. Bank Limitation to § 482 Intangibles Allocation Despite the Commensurate with Income Standard Enacted in 1986 (10/2/25)

I recently wrote on the 3M case pending in the 8^th Circuit involving the issue of whether the commensurate with income standard in § 482 enacted in 1986 permits the IRS to use § 482 to allocate royalty income to 3M for intangibles it transferred to a Brazilian affiliate in excess of the amount of royalty income permitted by Brazilian law. The full text of the commensurate with income standard  enacted in 1986 is: “In the case of any transfer (or license) of intangible property (within the meaning of section 367(d)(4)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.” See Loper Bright’s Motivated Mistreatment of Statutory Ambiguity and Best Interpretations (Federal Tax Procedure Blog 8/28/25), here.

In 3M Company v. Commissioner, ___ F.4th ___ (8th Cir. 10/1/25), here, the Court held that the IRS could not use § 482's commensurate with income standard to tax a related party affiliate's (3M's)  income on the transfer of intangibles in excess of legal limits permitted by law applying to the party receiving and exploiting the intangibles transferred to it.

I think it might be helpful to illustrate the issue in a simple examples. I start with an example where no legal prohibition is involved: Suppose intangible property in an open market would have commanded a royalty of 10% in an unrelated party transaction (which I will call the fair market value (“FMV”) royalty). But, in a related party transaction, the U.S. party transferring intangibles to the foreign affiliate charged the foreign affiliate a royalty of 5%. The foreign affiliate earns extra income over what it would have earned if it paid the FMV 10% royalty. This example is a classic instance where the commensurate with income standard enacted in 1986 applies to permit the IRS to tax the U.S. affiliate on an additional 5% royalty.

The next example is the same, except the law where the foreign affiliate earns the extra income limits royalty payments to 5%. The foreign affiliate earns extra income by paying 5% rather than the 10% , FMV royalty. The 5% royalty rate is not commensurate with the income. The question in 3M is whether the IRS can apply the FMV commensurate with income royalty rate despite the local law prohibition?

In Commissioner v. First Sec. Bank of Utah, N.A., 405 U.S. 394 (1972), the Court held that pre-amendment § 482 did not permit an allocation where the recipient was not lawfully entitled to receive the income. In 3M, the taxpayer argued and the Eighth Circuit held that the commensurate with income standard did not apply because Brazilian law limited the royalty the 3M affiliate could pay 3M. The IRS argued that the 1986 commensurate with income amendment to § 482 permitted the allocation. I repeat the text of the commensurate with income standard: “ In the case of any transfer (or license) of intangible property (within the meaning of section 367(d)(4)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.” (Emphasis supplied.)

The text of the 1986 amendment does not facially say that it is overruling the holding in First Sec. Bank which interpreted other text in § 482. But the 1986 amendment does state an imperative that the “income with respect to the intangible shall be commensurate with the income attributable to the intangible.”  (Emphasis supplied.) The IRS interpreted the text to permit § 482 allocation without regard to such legal limits in what are called the blocked income regulation.

In the simple examples above, the income with respect to the intangible is 10% and the foreign affiliate paid only 5%. I would argue that, absent legislative history on the point, the straight-forward textualist reading of the commensurate with income text (“shall be commensurate”) would permit an allocation despite a legal limitation. In this regard, I see no legal infirmity to that reading, but will not go down that rabbit trail here.)

The Eighth Circuit in 3M decided otherwise. The Court relied upon First Sec. Bank’s definition of income not to include income that could not be received and limited the commensurate with income standard consistent with that definition of income. Readers should read the 3M opinion carefully to draw their own conclusions.

I suggest an alternative analysis the Eighth Circuit could have applied. The Court could have said that the commensurate with income text is ambiguous on the issue of whether it changed the holding in First Sec. Bank with respect to intangible transfers. In this regard, First Sec. Bank did not involve intangible transfers. Certainly, the text of the commensurate with income standard does not specifically state that it does not apply where there are legal limits on payment or receipt of the income attributable to the transferred intangibles. Nor does it specifically state that it can apply to income attributable to the intangibles that is limited by law from payment or receipt. At best, even if one does not accept the straight-forward textualist reading of the commensurate with income taxt, one must conclude that the commensurate with income text is ambiguous on that issue.

The Supreme Court’s nonsensical notion in Loper Bright that courts can always interpret out ambiguity does not help here. The Eighth Circuit’s claim that it is applying the best reading of the statute for which there is no best reading is equally nonsense. I suggest that the Eighth Circuit was merely guessing at an interpretation where there was, at best, no reason to think that the IRS’s interpretation was better or worse than 3M’s interpretation.

If that is right, the result should have been controlled by § 706(2)(A)’s command that an agency action (here an interpretation) not be held “unlawful and set aside” unless “not in accordance with law.” In the state of interpretive equipoise, the Court cannot affirmatively find that the agency interpretation is “not in accordance with law.” (That is how the Supreme Court interpreted the "not in accordance with law" standard of review in Dobson v. Commissioner, 320 U.S. 489 (1943).)