## Facts

- Brown Group, Inc., a U.S. footwear company, imported shoes from Brazil and other countries for resale in the United States.
- In 1985, Brown Group consolidated its Brazilian buying by using a single purchasing agent.
- Brown Cayman, Ltd. (BCL), a Cayman Islands corporation wholly owned by a U.S. subsidiary, was a controlled foreign corporation (CFC) for Subpart F purposes.
- BCL became the majority partner in Brinco, a Brazilian partnership formed to act as Brown Group’s Brazilian purchasing agent.
- Brinco purchased Brazilian-manufactured shoes for Brown Group and received commissions from Brown Group for its services.
- For the tax year ending November 1, 1986, Brinco’s only income was commissions from Brown Group; BCL received a distributive share of that partnership income.
- Brown Group deducted the commissions paid to Brinco on its U.S. return.
- The Commissioner asserted that BCL’s distributive share should be treated as foreign base company sales income (Subpart F income) and currently included in Brown Group’s income under §§ 951–964, relying on the pre-1987 version of § 954(d)(3).

## Issues

1. Whether, under the pre-1987 version of 26 U.S.C. § 954(d)(3), a CFC’s distributive share of a foreign partnership’s commission income can be treated as Subpart F foreign base company sales income and currently taxed to the U.S. shareholder.

## Decision

- The Eighth Circuit vacated the Tax Court’s decision and remanded.
- The court held that, under pre-1987 § 954(d)(3), BCL’s distributive share of Brinco’s commission income could not be treated as Subpart F income.
- The court rejected the Commissioner’s attempt to “look through” the partnership to recharacterize the commissions as if earned directly by BCL as foreign base company sales income.
- The court relied on the statutory text and structure, concluding that the partnership income was not Subpart F income under the pre-1987 definition of “related person,” and could not be transformed into Subpart F income by attribution to the CFC partner.
- The court treated the 1986 amendments (effective for later years) addressing partnership arrangements as confirming that the pre-amendment statute did not reach this structure.

## Legal Principles

- Subpart F inclusion depends on whether the relevant income fits a statutory Subpart F category under the version of the Code applicable to the taxable year.
- Under pre-1987 § 954(d)(3), the foreign base company sales income “related person” framework focused on corporate relationships; it did not supply an explicit rule treating foreign partnership commission income as Subpart F income through a CFC partner.
- The IRS may not expand Subpart F by administrative interpretation where the statutory text does not cover the arrangement.
- Later statutory amendments that expressly extend Subpart F to partnership structures are not applied retroactively absent congressional authorization.

## Conclusion

The Eighth Circuit held that, for the pre-1987 tax year, a CFC partner’s distributive share of a foreign partnership’s commission income could not be recharacterized as Subpart F foreign base company sales income under § 954(d)(3), vacating the Tax Court’s deficiency determination and remanding.


Brown Grp., Inc. v. Commissioner, 77 F.3d 217 (8th Cir. 1996)