Medical Device Manufacturer Challenges Transfer Pricing Adjustments

ZIMMER BIOMET HOLDINGS, INC. AND AFFILIATES FKA
ZIMMER HOLDINGS, INC. AND AFFILIATES,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION

Zimmer Biomet Holdings, Inc. and Affiliates FKA Zimmer Holdings, Inc. and Affiliates ("petitioner") hereby petitions for a redetermination of the deficiencies in income tax set forth by respondent in the Notice of Deficiency dated December 21, 2018, and a determination that petitioner is entitled to refunds. This Court has jurisdiction pursuant to 26 U.S.C. §§ 7442, 6213, and 6512.

In support, Petitioner alleges as follows:

1. Petitioner. Petitioner is a corporation organized under the laws of the State of Delaware (and includes affiliated companies) and its principal place of business is 345 East Main Street, Warsaw, Indiana 46580-0700. Petitioner's mailing address is P.O. Box 708, Warsaw, Indiana, 46581-0780. The returns for the periods here involved were filed electronically with the Internal Revenue Service.

2. The Notice of Deficiency. The Notice of Deficiency, dated December 21, 2018, was issued to petitioner by the Office of Appeals of the Internal Revenue Service in Chicago, Illinois. Pursuant to the amended Tax Court Rules of Practice and Procedure ("Rule") Rule 34(b)(8) a copy of the Notice of Deficiency and portions of attachments accompanying the notice is attached and labeled as Attachment A ("Notice of Deficiency") to this Petition. The Notice of Deficiency has been redacted pursuant to Rule 27.

3. Amounts in Dispute. The disputed deficiencies as determined by respondent are for income taxes for 2008 and 2009 as shown below:

Tax Year Ended	Tax Deficiency
December 31, 2008	$63,438,355
December 31, 2009	$66,731,655

In addition, petitioner made overpayments and seeks refunds of income taxes for 2008 and 2009 as shown below:

Tax Year Ended	Tax Refund Owed
December 31, 2008	$12,498,949
December 31, 2009	$5,768,157

Petitioner also seeks a refund of interest and any other additions to tax. The refund amounts above are subject to increase, for example, depending upon the development of additional facts, review of respondent's positions and collateral, secondary, or other related adjustments. Pursuant to agreement of the parties, petitioner reserves the right to timely file and prosecute claims for refund arising from or relating to additional or redetermined foreign taxes, including the collateral consequences thereof (such as IRC §78 gross-up) and/or to timely change its election to credit or deduct such taxes for any taxable year.

4. Assignment of Errors.

4.a. Respondent erred in his "Puerto Rico Transfer Pricing — Primary Position" ("Primary Position") by increasing taxable income with respect to the 2008 and 2009 tax years.

4.b. Respondent erred in his "Transfer Pricing — Alternative Position — IRC § 367(d)" by increasing taxable income with respect to the 2008 and 2009 tax years.

4.c. Respondent erred by denying petitioner's informal claims for refunds with respect to the tax treatment of state and local tax incentives for the 2008 and 2009 tax years om the amounts of $1,899,442.00 and $2,833,440.00, respectively.

4.d. Respondent erred by failing to determine an overpayment of taxes for the 2008 and 2009 tax years with respect to cost sharing payments.

4.e. As a result of respondent's errors set forth above, respondent computed erroneous collateral and secondary adjustments, including but not limited to correlative and conforming adjustments, with respect to petitioner's 2008 and 2009 tax years.

5. Supporting Facts.

5.a. Respondent's Erroneous "Puerto Rico Transfer Pricing — Primary Position."

5.a.1. Petitioner incorporates by reference allegations in the preceding paragraphs.

5.a.2. Petitioner is in the business of manufacturing and selling medical devices with a primary focus on joint replacement products. Products include hip, knee, and trauma, among other orthopedic devices.

5.a.3. The tax years at issue with respect to this proposed adjustment ended on December 31, 2008 and December 31, 2009. Unless specified otherwise, the allegations in this Petition relate to these tax years regardless of whether the statements are in the past or present tense.

5.a.4. Zimmer Manufacturing B.V. is a medical device manufacturer and is a corporation organized and existing under the laws of the Netherlands with a manufacturing branch in Puerto Rico.

5.a.5. Zimmer Manufacturing B.V. manufactures products that it sold to petitioner.

5.a.6. Zimmer Manufacturing B.V. has specialized manufacturing expertise regarding medical devices.

5.a.7. Zimmer Manufacturing B.V. had approximately 655 employees in 2008 and approximately 627 employees in 2009.

5.a.8. Zimmer Manufacturing B.V. had a quality assurance group consisting of approximately 79 employees in 2008 and 76 employees in 2009.

5.a.9. Zimmer Manufacturing B.V. determines its production scheduling, volumes, and target completion dates.

5.a.10. Zimmer Manufacturing B.V. controls the quality of its suppliers.

5.a.11. Zimmer Manufacturing B.V. owns its own manufacturing equipment.

5.a.12. Zimmer Manufacturing B.V. employees operate the production equipment.

5.a.13. Zimmer Manufacturing B.V. has structured training programs for its employees to comply with the Food and Drug Administration ("FDA") manufacturing and quality regulations.

5.a.14. Zimmer Manufacturing B.V. maintained excess manufacturing capacity for the benefit of petitioner.

5.a.15. Zimmer Manufacturing B.V. has manufacturing and process engineers.

5.a.16. Zimmer Manufacturing B.V. conducts extensive quality control activities.

5.a.17. Zimmer Manufacturing B.V. is liable for product liability complaints relating to its manufacture of products.

5.a.18. Zimmer Manufacturing B.V. has insurance coverage for product liability claims.

5.a.19. Zimmer Manufacturing B.V. pays insurance premiums costs relating to product liability risk.

5.a.20. Zimmer Manufacturing B.V. indemnified Zimmer, Inc. for any and all liabilities, losses, claims, and costs, including reasonable attorneys' fees, that resulted directly from products that as of the date of shipment by Zimmer Manufacturing B.V. contained defects in materials and workmanship.

5.a.21. Zimmer Manufacturing B.V. indemnified Zimmer, Inc. for any and all liabilities, losses, claims, and costs, including reasonable attorneys' fees, that resulted directly from products that as of the date of shipment by Zimmer Manufacturing B.V. were adulterated or misbranded within the applicable provisions of the Federal Food, Drug and Cosmetics Act ("FDC Act").

5.a.22. Zimmer Manufacturing B.V. indemnified Zimmer, Inc. for any and all liabilities, losses, claims, and costs, including reasonable attorneys' fees, that resulted directly from products that as of the date of shipment by Zimmer Manufacturing B.V. were prohibited from being introduced into interstate commerce by any provision of the FDC Act or Public Health Service Act.

5.a.23. Zimmer Manufacturing B.V. bore product liability risk.

5.a.24. Zimmer Manufacturing B.V. bore regulatory risk with respect to FDA compliance for manufacturing.

5.a.25. Zimmer Manufacturing B.V. bore quality control risk.

5.a.26. Zimmer Manufacturing B.V. bore manufacturing risk.

5.a.27. Zimmer Manufacturing B.V. bore market risk.

5.a.28. Zimmer Manufacturing B.V. bore risk associated with fluctuations in prices of raw materials.

5.a.29. Zimmer Manufacturing B.V. bore materials inventory risk.

5.a.30. Respondent's Primary Position is allegedly based upon principles of Internal Revenue Code ("section") section 482 and regulations promulgated thereunder.

5.a.31. Respondent's Primary Position asserts an increase in income in the amount of $193,356,793 for the 2008 tax year and asserts two different increases in income in the amounts of $198,298,404 and $198,238,404 for the 2009 tax year.

5.a.32. Respondent's Notice of Deficiency calculates transfer pricing adjustments based upon increases in income in the amount of $114,481,000 for the 2008 tax year and $104,714,000 for the 2009 tax year.

5.a.33. The increases to income used to calculate the Notice of Deficiency transfer pricing adjustments are not based on section 482 or regulations promulgated thereunder.

5.a.34. The increases to income used to calculate the Notice of Deficiency transfer pricing adjustments do not reflect the true taxable income of petitioner or Zimmer Manufacturing B.V.

5.a.35. The increases to income used to calculate the Notice of Deficiency transfer pricing adjustments do not meet the arm's-length standard of section 482 and the regulations promulgated thereunder.

5.a.36. The increases to income used to calculate the Notice of Deficiency transfer pricing adjustments are based upon the alleged application of sections other than section 482.

5.a.37. The increases in income used to calculate the Notice of Deficiency amounts for the transfer pricing adjustments are arbitrary and capricious.

5.a.38. Respondent's proposed transfer pricing adjustments in the Notice of Deficiency are arbitrary and capricious.

5.a.39. Respondent's application of the comparable profits method violates section 482 and the regulations promulgated thereunder, including Treas. Reg. § 1.482-5(a).

5.a.40. Respondent's proposed transfer pricing adjustments in the Notice of Deficiency violate the requirements of section 482 and the regulations promulgated thereunder.

5.a.41. Respondent's proposed transfer pricing adjustments in the Notice of Deficiency violate his administrative practices.

5.a.42. Respondent's proposed transfer pricing adjustments in the Notice of Deficiency fail to reflect properly the functions of Zimmer Manufacturing B.V.

5.a.43. Respondent's proposed transfer pricing adjustments in the Notice of Deficiency fail to reflect properly the assets of Zimmer Manufacturing B.V.

5.a.44. Respondent's proposed transfer pricing adjustments in the Notice of Deficiency fail to reflect properly the risks assumed by Zimmer Manufacturing B.V.

5.a.45. Petitioner's corporate income tax returns reported the true taxable income with respect to intercompany transactions with Zimmer Manufacturing B.V.

5.a.46. Petitioner's intercompany transactions with Zimmer Manufacturing B.V. properly accounted for the functions, assets, and risks of Zimmer Manufacturing B.V.

5.a.47. Petitioner's 'transfer pricing treatment of intercompany transactions with Zimmer Manufacturing B.V. complied with the requirements of section 482 and regulations promulgated thereunder.

5.a.48. Respondent improperly ignored contractual terms in petitioner's written agreements.

5.a.49. Respondent improperly ignored petitioner's agreements.

5.a.50. Respondent improperly ignored petitioner's corporate structure.

5.a.51. Petitioner Zimmer, Inc. licensed product-related rights in a written agreement that met the arm's-length standard.

5.a.52. Petitioner Zimmer Caribe, Inc. licensed intangibles to Zimmer Manufacturing B.V. in a written agreement that met the arm's-length standard.

5.a.53. Zimmer Manufacturing B.V. agreed to sell products to Zimmer, Inc. as reflected in a written agreement that met the arm's length standard.

5.a.54. Zimmer Manufacturing B.V. agreed to pay Zimmer, Inc. for services provided to Zimmer Manufacturing B.V. in a written contemporaneous agreement that met the arm's-length standard of section 482 and regulations promulgated thereunder.

5.a.55. Petitioner's income is not increased under section 482 and regulations promulgated thereunder.

5.b. Respondent's Erroneous "Transfer Pricing — Alternative Position."

5.b.1. Petitioner incorporates by reference allegations in the preceding paragraphs.

5.b.2. Petitioner's income is not increased under section 367(d).

5.b.3. Section 367(d) does not apply.

5.b.4. Respondent's "Transfer Pricing — Alternative Position" is not based upon the transfer of specified intangible property.

5.b.5. Respondent's "Transfer Pricing — Alternative Position" is not based upon the transfer of specified intangible property within the meaning of section 936(h)(3)(B).

5.b.6. Respondent's "Transfer Pricing — Alternative Position" is not based upon any specified transfer.

5.b.7. Respondent's proposed adjustment is not based upon respondent's identification of any specified intangible property within the meaning of section 936(h)(3)(B).

5.b.8. Respondent's proposed adjustment is based upon the valuation of property to which section 367(d) does not apply.

5.b.9. Section 367(d) does not apply to any transfers of property from petitioner to Zimmer Manufacturing B.V.

5.b.10. Section 367(d) does not apply to transfers of intangible property within the meaning of section 936(h)(3)(B) from petitioner to Zimmer Manufacturing B.V.

5.b.11. To the extent respondent's section 367 regulations require imposition of tax on any transfer of property to Zimmer Manufacturing B.V., those portions of such regulations are not valid.

5.b.12. Respondent did not comply with the Administrative Procedure Act (the "APA"), 5 U.S.C. §§ 551-559, 701-706, when he promulgated the section 367 regulations.

5.c. Respondent's Erroneous Disallowance of Claims for Refunds for State and Local Tax Incentives.

5.c.1. Petitioner incorporates by reference the allegations in the preceding paragraphs.

5.c.2. Petitioner timely filed a refund claim claiming a reduction of income in the amount of $1,899,442 for state and local tax incentives with respect to the 2008 tax year.

5.c.3. Petitioner timely filed a refund claim claiming a reduction of income in the amount of $2,833,440 for state and local tax incentives with respect to the 2009 tax year.

5.c.4. Respondent denied petitioner's claims for refund for state and local tax incentives for the 2008 and 2009 tax years.

5.c.5. Petitioner timely filed this suit seeking refunds and the amounts of refunds are not limited by the dates of payments.

5.c.6. Petitioner is entitled to a refund reflecting a reduction in income in the amount of $1,899,442 for state and local tax incentives with respect to the 2008 tax year. Since the amount of the refund is contingent upon further calculations pursuant to this case, petitioner protectively claims the amount of the refund is $1,899,442 since respondent disallowed this amount in the Notice of Deficiency.

5.c.7. Petitioner is entitled to a refund reflecting a reduction in income in the amount of $2,833,440 for state and local tax incentives with respect to the 2009 tax year. Since the amount of the refund is contingent upon further calculations pursuant to this case, petitioner protectively claims the amount of the refund is $2,833,440 since respondent disallowed this amount in the Notice of Deficiency.

5.d. Petitioner made an overpayment of taxes and is entitled to a refund with respect to cost sharing payments during 2008 and 2009.

5.d.1. Petitioner incorporates by reference the allegations in the preceding paragraphs.

5.d.2. The parties agreed to an extension of time for the period of assessment with respect to the 2008 and 2009 tax years.

5.d.3. All payments of tax subject to overpayments of tax regarding cost sharing payments were made within the periods allowed under section 6511(c).

5.d.4. Petitioner timely filed this suit seeking refunds and the amounts of refunds are not limited by the dates of payments.

5.d.5. Respondent erroneously made adjustments with respect to Zimmer Trabecular Metal Technology, Inc. R&D in the amounts of $1,967,000 and $3,969,000 for 2008 and 2009 respectively.

5.d.6. Respondent erroneously made adjustments with respect to Abbott Spine, Inc. R&D in the amounts of $2,846,000 and $6,034,000 for 2008 and 2009 respectively.

5.d.7. Respondent erroneously made an adjustment with respect to Abbott Spine in process R&D in the amount of $26,500,000 for 2008.

5.d.8. Respondent erroneously made adjustments with respect to the issue respondent entitled "Acquired IP from Healthcare Professionals" in the amounts of $109,400,000 and $35,800,000 for 2008 and 2009 respectively.

5.d.9. Respondent overstated the total amount of R&D costs subject to cost sharing.

5.d.10. Respondent overstated the amount of costs to be shared under the cost sharing arrangement.

5.d.11. Respondent erroneously increased petitioner's U.S. taxable income due to an incorrect computation of shares of reasonably anticipated benefits ("RAB share") and due to applications of incorrect RAB shares.

5.d.12. Each of respondent's determinations referenced in paragraph 5.d herein are arbitrary and capricious.

5.d.13. Petitioner made an overpayment of taxes of at least $11,837,645 and $4,776,453 with respect to the cost sharing payments for the 2008 and 2009 tax years respectively.

5.d.14. Petitioner is entitled to a refund of taxes for the 2008 and 2009 tax years.

5.d.15. To the extent that the Court determines a deficiency, the amount of the overpayment should be applied to reduce the deficiency through a setoff or otherwise.

5.e. Respondent's Erroneous Collateral and Secondary Adjustments Will Require Further Calculations.

5.e.1. In calculating the Notice of Deficiency, respondent made adjustments to numerous items.

5.e.2. Many of respondent's adjustments would be affected should this Court sustain all or any portion of petitioner's claims herein.

5.e.3. Petitioner is entitled to any favorable collateral or secondary adjustments flowing from any decision entered in this case.

5.e.4. Petitioner hereby claims and reserves the right to make any collateral or secondary adjustments in accord with the decision of the Court.

5.e.5. Correlative or secondary adjustments could include but are not limited to correlative or other adjustments of credits, deductions, and the basis of property.

WHEREFORE petitioner prays that this Court hear this case and determine:

1. That respondent erred as alleged in each assignment of error described in paragraph 4 above;

2. That there is no deficiency in income tax with respect to petitioner's 2008 and 2009 tax years;

3. That petitioner is entitled to refunds for the 2008 and 2009 tax years along with interest and any other additions to tax;

4. That judgment should be entered in favor of Petitioner; and

5. That petitioner is entitled to such further relief as this Court deems just and appropriate.

Respectfully submitted this 20th day of March 2019.

William F. Colgin, Jr.
Tax Court Bar No.: CW0636
wfcolgin@hollandhart.com

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