Implications of US Sixth Circuit Court’s reaffirmation that Whirlpool must pay taxes on US $45 million in income

By Jack Taylor, LLM Candidate, University of Minho

The U.S. Court of Appeals for the Sixth Circuit reaffirmed on March 2 the previous December 2021 decision in Whirlpool v. Commissioner of Internal Revenue, which held that Whirpool must pay taxes on USD 45 million in income. Whirlpool had filed a petition with the U.S. Tax Court and argued that the income of sales was not foreign base company sales income (FBCSI) under Section 954(d)(1).

The Sixth Circuit denied Whirlpool’s request to have the full appeals court go back to the case and reconsider the original court ruling. Consequently, the Luxembourg branch of Whirlpool must pay tax on the original USD 45 million of income earned in 2009. The Court found that the profits from the branch in Luxembourg needed to fall under the Internal Revenue Code Section 954(d)(2), applying the so-called branch rule.

Case facts

Whirlpool manufactures and sells appliances, such as refrigerators and washing machines, which are manufactured in Mexico, under Whirlpool-Mex. The company can benefit strategically from this model because of lower costs of production in Mexico and easy access to the U.S. market.

Whirlpool benefits from Mexico’s maquiladora programme, which essentially incentivizes foreign companies to invest in Mexico and stimulate employment and economic growth. Whirlpool set up two subsidiaries in Mexico and a subsidiary in Luxembourg to benefit from this programme.

The branch Whirlpool set up in Luxembourg, known as Whirlpool-Lux with one employee, effectively allowed the corporation to sell products in Mexico and benefit from lower tax rates in Luxembourg. At the same time, Whirlpool was able to sell products from Mexico (mainly to the U.S. market) at lower prices, shifting profits from the earned sales in Mexico to the main corporation in the United States.

Whirlpool-Lux, established in 2007, was established so that Whirlpool could enter into a manufacturing supply agreement where Whirlpool-Lux manufactured products and sold them at an arm’s length price to Whirlpool U.S. Tax authorities considered this arrangement as “driven largely by tax considerations.”

The relevant legislation for this case falls under Subpart F of the U.S. Internal Revenue Code, which taxes directly profits earned by subsidiaries of American companies, which are known as controlled foreign corporations (CFCs). These profits are known as CFCs foreign base company sales income (FBCSI).

The IRS found that USD 45 million worth of income which was derived from the branches in Mexico was FBCSI, meaning that Whirlpool should pay taxes. However, Whirlpool argued that the income was derived from manufacturing operations and not under the FBCSI.

Conclusion

Whirlpool Lux, according to the Mexican operations, had no permanent establishment (PE) status; however, it told the Luxembourg authorities that it did have a PE in Mexico, therefore benefitting from not paying income tax. The Luxembourg-Mexico income tax treaty allowed Luxembourgian companies to not pay income tax while having PE in Mexico.

This case is of great significance because it has implications for business models using the branch principle. The conclusion is that income of the CFC is attributable to branches. It talks about Subpart F income implemented by branch rule. Courts interpret the branch rule by policy.

Historically, the United States has typically not taxed income owned by foreign corporations, however, this case is an exception to that norm under IRC 954 (d), which targets FBCSI, which enables the IRS to levy taxation on sales income from manufacturing income through the sale of goods between foreign subsidiaries. Effectively, the manquiladora programme plays no role in Whirlpool’s tax responsibilities in the U.S. The Court held that the manquiladora programme helped Whirlpool generate manufacturing income.

• Jack Taylor is an LLM candidate at the University of Minho, Braga.