The U.S. Tax Court in the case of Whirlpool Financial Corp. v. Commissioner, Nos. 1899/1900 upheld the Internal Revenue Service’s (IRS) decision of considering the sales income derived by Whirlpool Luxembourg from the manufacturing operations in Mexico as Foreign Base Company Sales Income (FBCSI) to the parent company in the U.S. under section 951(a).

This article provides a summary of the case law. 

Taxation can be a burden on every company, calling on the need to find creative, but legal, ways to reduce tax burden. The recent case of Whirlpool vs IRS Case provides great insight into a strategy that misfired but is still incorporated by many companies in their business model to reduce taxable income.

Company Background

Whirlpool Financial Corporation (Whirlpool US or Taxpayer) is a U.S. based corporation that manufactures and distributes various household appliances, including refrigerators and washing machines. Whirlpool US has many subsidiaries, one of which is Whirlpool Mex, created under Mexican Law. Within Whirlpool Mex are two additional subsidiaries: Commercial Arcos, engaged in performing administrative functions, and Industrias Arcos, engaged in manufacturing refrigerators and washing machines.

Corporate Restructuring

Prior to 2007, Industrias Arcos sold finished goods to Whirlpool Mex, which in turn sold the same to Whirlpool US and paid the corresponding 28% tax on the income from the sale. However, in an attempt to reduce a portion of the tax burden, Whirlpool US restructured Whirlpool Mex in 2007. As a result, Whirlpool Overseas Manufacturing (LUX), was formed and incorporated under Luxembourg Laws. A second corporation was also created under Mexican Law; Whirlpool Internacional (WIN). According to US law, WIN was a disregarded entity for tax purposes.

LUX only retained one administrative employee while WIN was merely a holding company. Industrias Arcos sold parts and tools required to manufacture the appliances; and leased land and building for two factories in Mexico to WIN. It also sold machinery, equipment, and title to works-in-progress to LUX. Thereafter, an agreement was entered between WIN and LUX, whereby WIN agreed to provide contract manufacturing services to LUX using subcontracted employees and seconded executives of Industrias Arcos and Commercial Arcos; and raw materials, machinery, and equipment provided by LUX. The finished goods manufactured were then sold to LUX, which in turn are sold to Whirlpool US and Whirlpool Mex. WIN was being compensated by LUX at an arm’s length for the contract manufacturing services it provides.

Case Facts

The restructuring did not change the workforce, tools, machinery, equipment, or materials used to make the appliances that were being sold by Whirlpool US. In 2009, WIN qualified as a Maquiladora entity and was able to take advantage of a tax rate reduction from 28% down to 17% for services performed by LUX. Under Mexican law, LUX did not have a permanent establishment, creating a tax-exempt status for sales to Whirlpool US. At the same time, LUX applied for tax-exempt status from Luxembourgian tax officials on the premise that the permanent establishment was in Mexico. Not only did Whirlpool US avoid double-taxation, but they also neglected to pay any taxes on roughly $45 million of sales.

The IRS Point of View

The Taxpayer’s willful avoidance of taxation on income derived from Mexican operations was picked up on by the IRS. The IRS argued that WIN was not a disregarded entity of Whirlpool US, but instead part of LUX and not a separate entity. Finally, the IRS determined that the income from sale of finished goods by LUX, which was not taxed in either Mexico or Luxembourg, constituted a Foreign Base Company Sales Income (FBSCI) under IRC section 954(d)(2), the “branch rule”, that must be included in the taxpayer’s income under subpart F.

Tax Court Ruling

The first issue the Tax Court needed to decide on was if Whirlpool LUX purchased and sold personal property to a related entity. There was no doubt that LUX’s income derived from selling manufactured goods to a related party is not FBCSI. Under the manufacturing exception, materials purchased, substantially transformed, and sold to a related party were exempt and not FBSCI under IRC Section 954(d)(1); however, under IRC Section 954(d)(2), the income did qualify as FBSCI.

IRC Section 954(d)(2) details that two preconditions must be met for the Controlled Foreign Corporation (CFC) income to be taxable to the parent. First, the CFC must be carrying on activities outside of the country the business is incorporated in. Second, the branch must have arrangements that are similar to the ones that would be in place if the company was a wholly owned subsidiary. There was no doubt by the Tax Court that the first precondition was met, as WIN elected to be disregarded entity, and it would be treated as a branch of Whirlpool Luxembourg for US tax purposes. With regards to the second pre-condition, the Tax Court determined that WIN’s manufacturing activities had substantially the same effect, i.e., deferral of tax on its income from sale of goods to related persons, as if it were a wholly owned subsidiary of Whirlpool Luxembourg. With both preconditions met, the Tax Court ruled that the income generated by LUX should have been reported on Whirlpool US’s tax returns as FBCSI.

Sixth Circuit Court Ruling

Whirlpool US appealed this decision, sending the case into the Sixth Circuit Court. Like the Tax Court, the Majority found both preconditions of IRC Section 954(d)(2) to be true, ultimately affirming the decision. However, when the case moved along, Whirlpool US did receive a dissenting Judge’s opinion. The judge stated that the Manufacturing Exception found in IRC Section 954(d)(1) needs to be looked at in conjunction with FBSCI in IRC Section 954(d)(2). The Manufacturing Exception focuses on the object being altered rather than the entity transforming. Turning metal sheets into working appliances is a substantial transformation, resulting in an applicable Manufacturing Exception. As a result, the Judge overturned the prior decisions, arguing that LUX’s income was not FBSCI.


The Whirlpool vs IRS case highlights one tax planning strategy that many large corporations implement to reduce their tax burden. However, tax optimization by setting up a Controlled Foreign Corporation needs meticulously planning and a thorough understanding of the local and international tax laws. Reach out to our team today to see what tax planning strategies might be right for your business.