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The Tax Court’s decision Wednesday upheld the IRS’s method for reallocating profits between Coca-Cola and affiliates that made and sold ingredients for the company’s soft drinks. The ruling pertained to the beverage giant’s taxable income between 2007 and 2009.
Some differences between Coca-Cola’s business model and that of other multinationals in high-profile tax cases could insulate those other companies from being affected by the decision.
Still, one of the alternative allocation methods rejected by the court—the comparable uncontrolled transaction method—is the same one that’s been proposed by companies like Facebook and Medtronic. That method looks to comparable transactions between entities that aren’t part of the same multinational to figure out what a multinational’s tax bill should look like. In effect, the judge ruled there were no truly comparable transactions, according to Blaine Saito, a tax professor at the Northeastern University School of Law.
While courts have traditionally favored transactional methods, the ruling backing the IRS’s use of what’s known as the comparable profits method (CPM) shows that reading can prevail in other cases, Saito said, although he also emphasized that a court needs to “really find” there isn’t a comparable, uncontrolled transaction.
“That at least breathes some life back into CPM as a viable method, but the bar would be rather high,” Saito said.
Facebook is litigating a case that could cost the company up to $9 billion. The company is challenging just a $1.73 million tax bill for 2010 related to the value of intangible property—things like copyrights and trademarks—that it transferred to an Irish subsidiary. But the company said in its January 10-K filing that as much as $9 billion plus interest and penalties could be on the line because the IRS’s position could apply to its subsequent tax years.
In Medtronic, Inc. v. Commissioner, the U.S. Tax Court initially rejected the IRS’s determination that Medtronic owed about another $1.4 billion in taxes related to licensing and manufacturing deals between the medical-devices company and its subsidiary in Puerto Rico. Specifically, the court rejected the IRS’s use of the comparable profits method, instead using a comparable transactions method proposed by Medtronic, with some adjustments.
But after the IRS appealed, the U.S. Court of Appeals for the Eighth Circuit ordered the Tax Court to reconsider whether the agreement that the Tax Court used for the comparison was actually comparable. The case remains at the Tax Court for further proceedings.
The Coca-Cola ruling isn’t the first in which a court held for the IRS by finding that there weren’t comparable transactions to point to. In Altera v. Commissioner, the U.S. Court of Appeals for the Ninth Circuit found that the IRS didn’t need to analyze comparable transactions between unrelated parties when devising a regulation in situations where there weren’t actual comparable transactions.
“The major thread I see is that just because you cannot find comparable, uncontrolled transactions, doesn’t mean the IRS is stymied in figuring out what is the proper allocation of income where you’re dealing with U.S. and foreign entities,” said Gil Rothenberg, speaking of the Coca-Cola ruling. Rothenberg previously headed the Justice Department Tax Division’s Appellate Section and is now an adjunct law professor.
Unique Business Model
Judge Albert Lauber’s analysis in the Coca-Cola ruling emphasized that taxpayers bear the burden of proving that the IRS’s adjustment was arbitrary and capricious. That sends a message pertinent to other cases “that if the IRS doesn’t make an error in law and if it presents facts correctly, its adjustment is going to be upheld,” said Stephen Shay, a former Treasury official and current adjunct professor at Boston College Law School.
John Warner, a shareholder at Buchanan Ingersoll & Rooney PC in Washington, agreed that the burden of proof was highlighted. “Some of the language you certainly could interpret as putting a heavier thumb than usual on the scale in favor of the Commissioner,” he said.
The circumstances of the company and the case are unique, and not every company that uses the comparable uncontrolled transaction method for reallocating profits could be viewed the same way by the Tax Court. For example, Lauber noted that most Coca-Cola bottlers are independent of Coca-Cola, ranging from small, family-owned businesses to multinational companies.
These, he said, provided appropriate comparable parties for the IRS’s CPM analysis.
“Facebook has zero in common with Coca-Cola in terms of its business, its business model, etc.,” said Barbara Mantegani of Mantegani Tax PLLC.
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