Three international tax cases practitioners must watch in 2025

• Economic substance doctrine case could expand IRS discretion
• Foreign stock ownership, blocked income rules under review

Federal courts next year are set to decide several cases that could shape how international tax planners will account for uncertainty and enforcement risks in 2025 and beyond.

The Treasury Department is trying to capture more international income by arguing for a broadly applicable economic substance doctrine, taking an expansive view of controlled foreign corporation status, and taxing income allocations a taxpayer says don’t comply with foreign laws.

Here are three cases tax practitioners should watch next year:

Liberty Global Inc. v. United States

The IRS could have more discretion to crack down on tax-advantaged restructuring transactions if the US Court of Appeals for the Tenth Circuit sides with the agency in its $110 million dispute with Liberty Global Inc.

The telecommunications company asked the Tenth Circuit to examine a lower court’s use of the economic substance doctrine to disregard transactions vital to its refund claim. The doctrine, found in IRC Section 7701, only allows businesses to take advantage of a transaction’s tax benefits if it has some other nontax motive and causes a change in economic position.

Liberty Global argued the Colorado federal judge wrongly invoked the doctrine to undermine its claimed Section 245A deduction for certain foreign dividends. The government says the doctrine generally applies throughout the tax code, except where Congress enacted exceptions.

“If the government were to succeed with that argument, then we’d encounter the economic substance doctrine throughout all corporate tax planning,” said Mario Verdolini, head of Davis Polk & Wardwell LLP’s tax controversy practice. “You’d need to make sure you’re very solid on your defense, on every step of a transaction.”

Liberty Global argues the doctrine can’t unwind its transaction choices, which the code permitted. But the lower court ruled that several transactions in the company’s overall strategy, code-named “Project Soy,” were designed to avoid paying taxes on capital gains and global intangible low-taxed income by leveraging a loophole in the 2017 Republican tax law.

Affirming that ruling could give the IRS the “flexibility to pick and choose” what to target on economic substance grounds when examining complex transactions, said Bill Curran, a Davis Polk partner.

“I think that would create an uncomfortable amount of discretion for the IRS,” Curran said.

Altria Group Inc. v. United States

Altria Group Inc.‘s $105 million refund suit in a Virginia federal district court potentially will clarify whether due process concerns limit the circumstances where a US taxpayer must impute income for foreign stock ownership.

The cigarette maker argues that its 10.2% equity interest in Anheuser-Busch InBev didn’t provide the necessary level of control for the US to require that Altria include ABI foreign subsidiary earnings when imputing taxable income. The government says the 2017 tax overhaul made includable income from those subsidiaries subject to taxes under subpart F.

“Under normal principles, and common sense, you would never think that a 10% holder of a company would have to impute income from the activities of that foreign corporation, and that was the rule up through tax reform,” Curran said. But now, “we’re in a situation where you have all these people who don’t even know they have the income and so are not reporting it.”

The repeal of IRC Section 958(b)(4), which prevented downward attribution of foreign-owned stock to a US taxpayer, caused many companies to become controlled foreign corporations that weren’t previously treated as such, said Lauren Azebu, a Steptoe LLP partner advising on US tax consequences of crossborder investments.

The government said the US Supreme Court’s decision in Moore v. United States undermines Altria’s request for summary judgment, and its due process arguments “cannot reincarnate what Congress expressly repealed.”

But if Altria prevails, minority US shareholders of CFCs that aren’t majority-US owned may see reduced tax liability, Azebu said.

3M Co. v. Commissioner

3M Co. is urging the US Court of Appeals for the Eighth Circuit to reverse a finding that the IRS can reallocate income from foreign subsidiaries for tax purposes, a case with potentially constitutional implications.

3M appealed a 2023 US Tax Court decision that the company’s $23.65 million royalty income tied to a Brazilian subsidiary was properly reallocated to the US parent, resulting in a $4.85 million tax liability.

October’s oral arguments set up a potential for a wider precedent because other companies are facing similar issues, said Michelle Abroms Levin, a managing partner at Dentons Sirote. Coca-Cola Co. and Airbnb Inc. are each litigating transfer pricing cases where the IRS is alleging billions in unpaid taxes for similar transactions.

3M said the IRS used its authority under a Treasury regulation issued under IRC Section 482 to reallocate the Brazilian company’s royalty income to 3M for tax purposes. But 3M said it can’t comply with both US and Brazil’s laws because Brazil’s tax code limits royalty payments, and so the Brazilian subsidiary wouldn’t have been allowed to pay 3M that income had they been separate companies.

“The IRS certainly doesn’t want the decision to apply beyond this case, but it’ll be an element they decide on how the regulation applies, and how it will be specific to 3M or big enough that fits elsewhere,” Levin said.

A representative for the IRS said the agency doesn’t comment on pending litigation.

3M’s case could have wider constitutional implications beyond multinational companies’ dealings, said Justen Ghwee, director of International Tax at Kaufman Rossin CPA + Advisors. The company’s briefs question whether the IRS’ interpretation of Section 482 is even allowed under the 16th Amendment, which involves Congress’ income taxation powers.

“The argument goes far beyond transfer pricing and could go all the way to the Sixteenth Amendment,” he said.

Read the full article at Bloomberg Law.