The parties recently completed briefing on an IRS motion for partial summary judgment in Western Digital Corporation v. Commissioner. The motion asks the US Tax Court to hold that a safe harbor in the Section 482 regulations is not relevant to whether intercompany receivable terms are “ordinary and necessary” under a provision in Subpart F. In our view, the motion is an unusual attempt to bar the taxpayer from making a well-founded legal argument in a case that is over a year away from trial.

The Subpart F issue hinges on foreign affiliates’ intercompany sales to a US affiliate. The US affiliate paid the foreign affiliate for finished goods within 90 of the invoice date. Under Section 956(c)(2)(C), intercompany receivables are treated as “United States property” if they are not “ordinary and necessary.” And the IRS determined that the receivables here were not “ordinary and necessary” because the 90-day period was a few weeks longer than appropriate. The IRS therefore concluded that all of the foreign affiliate’s intercompany receivables from the US affiliate were “United States property” under Section 956, leading to income adjustments totaling over $100 million.

Among its other arguments against these Subpart F adjustments, Western Digital points to Treas. Reg. § 1.482-2(a)(1)(iii)(B). That regulation provides that “[i]nterest is not required to be charged on an intercompany trade receivable until the first day of the third calendar month following the month in which the intercompany trade receivable arises.” Western Digital argues that this 90-day safe harbor in the Section 482 regulations helps show that its 90-day intercompany payment terms were “ordinary and necessary.”

The IRS disagrees and is requesting a determination that the safe harbor “does not apply to Section 956(c)(2)(C).” According to the IRS, the plain language of the statute is the “most basic cannon [sic] of statutory construction,” and Section 956 does not mention Section 482. Further, the IRS notes that Section 482 authorities constitute “a behemoth of incredibly complex and intertwined legal and economic principles” and “a mountain of tax law,” so permitting analogies to them would “clog the Court with … briefs filled with rubbish.” This is, perhaps, a strange point for the government to make in a case that primarily involves Section 482, as we discussed in a prior blog post.

Overall, the IRS’s motion strikes us as misguided. It is one thing to observe that the Section 482 regulations do not control the outcome of a Subpart F dispute. But it is another to try to bar the taxpayer from explaining an ambiguous phrase—“ordinary and necessary”—by analogizing to a provision in those regulations. More pointedly, the IRS’s motion effectively asks the Court to preemptively limit the types of legal arguments the Court itself can be informed of in deciding the Section 956 issue—a legal issue that will remain unresolved regardless of the outcome of the summary judgment motion. This makes the motion especially curious because one of the primary purposes of summary judgment is to simplify litigation by resolving issues before trial. Used appropriately, summary judgment can reduce the scope and complexity of evidence presented at trial, or perhaps eliminate the need for trial altogether. Here, even if the IRS were to prevail, the motion would not appear to resolve any issues or streamline the trial, which was recently pushed back to 2022.

The parties’ filings on the motion are below.

Respondent’s Motion for Partial Summary Judgment

Respondent’s Memorandum in Support

Petitioner’s Response

Respondent’s Reply

Petitioner’s Motion for Leave to File Sur-Reply

Petitioner’s Sur-Reply