Tax Notes legal reporter Ryan Finley discusses the latest updates in recent transfer pricing cases, including Coca-Cola and Medtronic, and reviews the upcoming Amgen case.
This transcript has been edited for length and clarity.
David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: transfer pricing on trial.
Over the years, we've covered a number of U.S. court cases focused on transfer pricing issues. For much of the history of U.S. transfer pricing litigation, there's been a nearly uninterrupted streak of taxpayer wins.
But that situation has changed. Today we're going to check in on a case that we've covered a few months ago, hear about a recent trial in the U.S. Tax Court, and take an early look at a dispute that's just getting started.
Here to go over all of this is Tax Notes legal reporter Ryan Finley. Ryan, welcome back to the podcast.
Ryan Finley: Thanks for having me.
David D. Stewart: Now, I mentioned at the top that the government has had a track record of losing transfer pricing cases, but that that seems to be turning around. Could you tell us about that?
Ryan Finley: Sure. The IRS's track record, particularly in some of the highest-profile cases involving the largest dollar sums, has been relatively poor going back for decades. Looking at the last couple of years, the IRS lost the Altera case before the Tax Court in 2015. It lost the Medtronic case before the Tax Court in 2016. It lost the Amazon case before the Tax Court in 2017.
The Amazon opinion by the Tax Court was eventually upheld by the Ninth Circuit, but the IRS succeeded in getting Medtronic vacated and remanded in 2018. It also succeeded in getting Altera reversed in 2019.
In the last couple of years, it has been looking a lot more favorable for the IRS. The Coca-Cola opinion is probably the biggest indication of that new trend.
David D. Stewart: Let's start with Coca-Cola. You were on in late 2020 to talk about this case. Could you start off with an overview of the issue and what the Tax Court decided?
Ryan Finley: Sure. In Coca-Cola there were a number of issues. One of the issues was whether a profit allocation formula approved in a closing agreement that covered 1987 through 1995, and was subsequently accepted for a decade thereafter, was binding on the IRS for the 2007 through 2009 tax years.
The IRS for those tax years, after having accepted this profit allocation formula for nearly two decades, decided that the method was unreasonable and required the application of a different method. In this case, a comparable profits method or CPM.
There's a dispute in addition to the binding nature of the closing agreement about whether the CPM under the U.S. section 482 regulations was the best method or whether the sort of routine return on assets that it left The Coca-Cola Co.'s foreign subsidiaries with was insufficient in relation to the intangibles and risks held by these affiliates.
David D. Stewart: What's happened more recently?
Ryan Finley: The biggest recent development is a motion for reconsideration that was filed by Coca-Cola in June. Since the Tax Court opinion came out in 2020, which basically upheld nearly $10 billion in transfer pricing adjustments, Coca-Cola has given every indication that it planned to appeal.
But it can't appeal Coca-Cola until a Tax Court opinion in another case, 3M, is released. That case deals with the blocked income issue. The Coca-Cola opinion was released, but stayed that issue.
In the meantime, the company filed a motion for reconsideration with the Tax Court. It previews a lot of the arguments that Coca-Cola would be likely to bring on an appeal. The arguments generally focus more on administrative law and alleged constitutional violations by the IRS.
Basically, the argument is that the company's agreement with the IRS on a profit allocation formula and then the IRS's subsequent acceptance of that formula for over 10 years — in combination with this penalty protection provision that the closing agreement extended for Coca-Cola, if it continued applying the same method — gave Coca-Cola what it called reasonable reliance interests in the IRS's continued acceptance of that formula.
The motion also criticizes the Tax Court's acceptance of the IRS's preferred method, the CPM. According to the motion, the supply points were risks by virtue of the marketing costs that were allocated to them, and they also held rights and intangibles under their licenses with Coca-Cola. These risks and intangibles entitled these foreign affiliates or supply points to a higher return under the section 42 regulations.
David D. Stewart: How much money are we talking about being at risk in this case?
Ryan Finley: Well, the original deficiencies associated with the roughly $10 billion transfer pricing adjustments added up to about $3.3 billion. That doesn't directly translate into what the deficiency would be now because the Tax Court accepted Coca-Cola's secondary argument about whether repatriated dividends could be credited against the transfer pricing adjustments.
We don't know exactly what the amount of the deficiencies will be, but somewhat less than the original $3.3 billion.
David D. Stewart: Have you heard from practitioners about how they view this motion for reconsideration?
Ryan Finley: The practitioners I've spoken to have been largely skeptical of these arguments, particularly the arguments regarding alleged constitutional violations, which is somewhat striking. Usually private practitioners are a little more critical of decisions that go in favor of the IRS.
In light of the general reception, which has generally been more or less approving of the Tax Court's decision, Coca-Cola's prospects of success are unclear.
David D. Stewart: Let's turn to the more recent trial that you covered: Medtronic. Could you first give us an idea of what is the main issue in that case?
Ryan Finley: The main issue is the proper selection of method. As in Coca-Cola, it's also a dispute about whether the comparable profits method, the IRS's chosen method, is the best method. Or, in this case, whether the comparable uncontrolled transaction method or CUT method was a more reliable method.
This is actually the second trial on the case, which was remanded by the Eighth Circuit. After the Tax Court basically handed Medtronic an almost complete win in a 2016 decision, that decision was vacated on appeal in 2018. According to the Eighth Circuit, the Tax Court had failed to support its opinion with the factual findings required by the regulations.
The focus of the second trial was on the selection of transfer pricing method and determination of any necessary adjustments to the results of applying that method. As it argued in the first trial, Medtronic said that the CUT method was the best method, which it applied on the basis of a 1992 litigation settlement agreement with Siemens Pacesetter Inc.
The Pacesetter agreement was a cross-license of both parties' cardiological device patent portfolios. It settled a number of disputes between the companies, including patent infringement claims.
But Medtronic argues that the differences between the Pacesetter agreement and a 2001 license of cardiological and neurological device patents, along with a range of other intangibles relating to those patents and its manufacturing subsidiary, can be reliably accounted for through adjusting the royalty originally charged in that Pacesetter agreement. The Tax Court had originally accepted this approach in 2016.
The IRS, on the other hand, says that the differences between these two licenses, in terms of the circumstances of the transaction and the scope of license intangibles, are just too great to be resolved through adjustments. The allocation of profit that results from applying this method between Medtronic U.S. and Puerto Rico was unreasonable. As a result, according to the IRS, these differences required using a different transfer pricing method or the CPM.
David D. Stewart: What sort of things did you hear at the trial?
Ryan Finley: Well, the parties for the most part sort of repeated in many ways the arguments that they've made since the beginning. But Judge Kathleen Kerrigan, the judge who oversaw the first trial and this one as well, she said that she would approach the issue of adjustments differently than she did in her 2016 opinion. At the same time, she indicated that she's still leaning in favor of using the Pacesetter agreement, and then adjusting the royalty to account for differences between it and Medtronic's controlled license.
Kerrigan acknowledged flaws in both parties' approaches, but in her remarks at the conclusion of the trial, she suggested that the IRS's CPM-based approach was the more flawed of the two. She said the adjustments that she's envisioning may turn the method into an unspecified method instead of a version of the CUT method. But at the same time, this unspecified method would still use the Pacesetter agreement as the original reference point.
It's an interesting position in light of the Eighth Circuit's seeming skepticism of whether the Pacesetter agreement could be used as a comparable, even though the Eighth Circuit's opinion focuses on the failure to make factual findings that were necessary under the regulation's comparability standards. It generally strikes a skeptical tone about whether the agreement should be considered comparable. One of the judges issued a concurring opinion that very strongly suggests that that this agreement could not be considered comparable.
It's not clear whether the Eighth Circuit would share Kerrigan's views on the case if an eventual appeal takes place.
David D. Stewart: I understand that there is also a new transfer pricing case that the transfer pricing community will be tracking closely. Can you tell us about that?
Ryan Finley: Sure. In early August, U.S. biotech company Amgen Inc. told its investors that it filed a Tax Court petition contesting $3.6 billion in deficiencies. These deficiencies related to transfer pricing adjustments for the 2010 through 2012 tax years.
It's interesting that the announcement suggests some strong parallels with Medtronic. Like Medtronic, the case involves the allocation of profit to a Puerto Rican manufacturing subsidiary and whether the returns initially allocated by the company and then argued by the IRS are reasonable in light of the transfer pricing regulations.
It's also interesting just in light of the amounts involved. That $3.6 billion figure represents only deficiencies, not interest and penalties. On top of that, the company announced that there are similar adjustments for 2013 through 2015 that are currently in the IRS appeals process.
More adjustments may be forthcoming based on similar grounds for 2016 through 2018. Amgen hasn't provided any dollar amounts for those adjustments, but judging from the deficiencies for 2010 through 2012, they're likely to involve significant amounts.
David D. Stewart: Alright, we'll have to watch this space. Ryan, thank you for being here.
Ryan Finley: Thank you.