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Abbott Laboratories Challenges Transfer Pricing, Other Adjustments

DEC. 22, 2023

Abott Laboratories et al. v. Commissioner

DATED DEC. 22, 2023
DOCUMENT ATTRIBUTES

Abott Laboratories et al. v. Commissioner

[Editor's Note:

View exhibits in the PDF version of the document.

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ABBOTT LABORATORIES AND US SUBSIDIARIES,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION

Abbott Laboratories (“Abbott US”) and US Subsidiaries (collectively, “Petitioner” or “Abbott”), hereby petitions for a redetermination of the deficiencies in federal income tax for the tax year ended December 31, 2019, as determined by the Commissioner of Internal Revenue (“Respondent”) in a notice of deficiency dated September 29, 2023 (the “Notice”).

As a basis for its request for redetermination, Petitioner alleges as follows:

1. Petitioner. Petitioner is a consolidated group of corporations whose common parent, Abbott US,1 is a corporation organized under the laws of the State of Illinois. Abbott US's principal office and place of business is 100 Abbott Park Road, Abbott Park, Illinois 60064. Petitioner electronically filed its timely 2019 Form 1120, “U.S. Corporate Income Tax Return,” with Respondent's Ogden, Utah office.

2. Notice of Deficiency. On September 29, 2023, Respondent, 230 South Dearborn Street, Stop 4031, Chicago, IL, 60604, issued the Notice to Petitioner. A copy of the Notice is attached hereto as Exhibit A.2

3. Amounts in Dispute.

3.a. In the Notice, Respondent determined a deficiency in federal income tax of $416,906,644 for Petitioner's 2019 tax year.

3.b. Petitioner does not dispute Respondent's adjustments to income and adjustments that affect income, taxes, and credits identified as No. 47 “Diagnostics Cost of Goods Sold — Section 482”, No. 46 “Diagnostics Royalty Income — Section 482”, No. 16 “Asset Basis Adjustment for No Section 338 Election — Foreign Source Income”, and No. 15 “Asset Basis Adjustment for No Section 338 Election — GILTI.” Petitioner disputes all other adjustments in the Notice.

3.c. In addition, Petitioner's taxable income should be decreased by $23,171,265 or by such other amounts as determined by the Court.

3.d. Petitioner also requests a refund of such amounts of tax that have been legally overpaid pursuant to I.R.C. § 6512(b).3

3.e. The Court's determinations in this case may require various correlative and computational adjustments under Rule 155 of the Tax Court Rules of Practice and Procedure.

4. Assignments of Error. Respondent's Notice is based upon the following errors:

4.a. Nutrition Royalty Income — Section 482 Adjustment.

4.a.1. Respondent erred in adjusting Petitioner's income by $475,875,122, erroneously increasing royalty payments from Petitioner's foreign manufacturing affiliates to Abbott US in exchange for intellectual property licenses related to nutritional products. The foreign manufacturing affiliates include Abbott Manufacturing Singapore Private Ltd. (“Abbott Singapore”), Abbott Laboratories Vascular Enterprises (“ALVE”),4 and Abbott Nederland C.V. (“Abbott Netherlands”) (together, the “OUS Manufacturers”).

4.a.1.1. Respondent erred in adjusting Petitioner's income because Respondent had previously entered into an Issue Resolution Agreement (“IRA”) with Petitioner, precluding Respondent from exercising his discretion under Section 482 to increase those royalty payments unless there were “substantial changes in [Petitioner's] Nutrition business segment” following the IRA. There were no substantial changes in Petitioner's Nutrition business segment following the IRA, and Respondent made no determination regarding any purported changes prior to exercising his discretion under Section 482.

4.a.1.2. Respondent erred in adjusting Petitioner's income because the OUS Manufacturers' royalty payments to Abbott US were arm's length.

4.a.1.3. Respondent's adjustments are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

4.b. Diabetes Royalty Income — Section 482 Adjustment.

4.b.1. Respondent erred in adjusting Petitioner's income by $422,901,932, erroneously increasing royalty payments from ALVE to Abbott US's subsidiary, Abbott Diabetes Care Inc. (“ADC US”), in exchange for intellectual property licenses for diabetes care products.

4.b.1.1. Respondent erred in adjusting Petitioner's income because ALVE's royalty payments to ADC US were arm's length.

4.b.1.2. Respondent's adjustments are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

4.c. Stock-Based Compensation Adjustment.

4.c.1. Respondent erred in adjusting Petitioner's income by $46,524,739, erroneously adding stock-based compensation to: (1) intercompany service fees that Abbott US and certain U.S. affiliates (together “Abbott US Affiliates”) charged to various foreign affiliates (“OUS Affiliates”) and (2) a shared cost pool under a qualified cost sharing arrangement (the “CSA”) between St. Jude Medical Puerto Rico LLC (“SJMPR”) and Pacesetter Inc. (“Pacesetter”).

4.c.2. Respondent erred in adjusting Petitioner's income under Treas. Reg. § 1.482-9 because the intercompany service fees charged by Abbott US Affiliates to OUS Affiliates were arm's length.

4.c.3. Respondent misapplied Treas. Reg. § 1.482-9, which only requires taxpayers to include stock-based compensation in cost bases for intercompany service charges in two limited circumstances: when the taxpayer (1) elects to apply the services cost method (“SCM”) for eligible services pursuant to Treas. Reg. § 1.482-9(b) and Rev. Proc. 2007-13, and (2) when the taxpayer applies the comparable profits method (“CPM”) using a return on total services cost (“ROTSC”) profit level indicator (“PLI”) pursuant to Treas. Reg. § 1.482-9(f)(2)(ii). The bulk of Respondent's adjustment (i.e., $42,709,782) is attributable to services transactions that do not fit into either of those two categories.

4.c.4. Respondent's adjustments related to intercompany services under Treas. Reg. § 1.482-9 are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

4.c.5. If Treas. Reg. § 1.482-9 is interpreted as requiring taxpayers to include stock-based compensation in all intercompany services' cost bases, it is invalid because it is inconsistent with Section 482's arm's length standard, and in promulgating it, the Treasury violated the Administrative Procedure Act, 5 U.S.C. § 551 et seq. (“APA”).

4.c.6. Respondent erred in adjusting Petitioner's income under Treas. Reg. § 1.482-7(d)(1) and (3) because the CSA shared cost pool between SJMPR and Pacesetter was arm's length.

4.c.7. Respondent's adjustments related to the CSA shared cost pool are precluded by Altera Corp. v. Commissioner, 145 T.C. 91 (2015),5 inconsistent with Section 482 and regulations promulgated thereunder, and are arbitrary, capricious, and unreasonable.

4.c.8. Treas. Reg. §§ 1.482-7(d)(1) and (3) are invalid because they are inconsistent with Section 482's arm's length standard and in promulgating them, Treasury violated the APA.

4.c.9. Alternatively, Respondent failed to appropriately exercise his discretion under Section 482 because, upon information and belief, adjustments related to the CSA shared cost pool are not appropriately reflected in the Notice.

4.d. Allocation of Amortization Expense to Tested Income Adjustments.

4.d.1. Respondent erred in increasing Petitioner's income in the amount of $528,318,336 by erroneously disallowing amortization deductions authorized under Section 197 when computing Petitioner's global intangible low-taxed income under Section 951A (“GILTI”), based on an application of Treas. Reg. § 1.951A-2(c)(5).

4.d.2. Treas. Reg. § 1.951A-2(c)(5) is invalid because it is contrary to the plain text of Section 951A.

4.d.3. Treas. Reg. § 1.951A-2(c)(5) is invalid because in promulgating it, Treasury violated the APA.

4.d.4. Treas. Reg. § 1.951A-2(c)(5) is invalid because it violates the general rule on retroactive rulemaking under 5 U.S.C. § 553(d).

4.d.5. Respondent also erred by raising in the alternative that certain transferred intangibles have no basis or that the basis is lower under Section 351 and the regulations thereunder or under substance over form, step transaction, business purpose, economic substance, sham transaction or other judicial doctrines.

4.e. Allocation and Apportionment of Stewardship and Supportive Expenses Adjustments.

4.e.1. Respondent erred in adjusting Petitioner's stewardship and supportive expenses' allocation and apportionment under Section 861 for purposes of computing Petitioner's Section 904(d) foreign tax credit limitation.

4.e.2. Respondent erroneously based his proposed stewardship expenses adjustments on Section 861 allocation and apportionment rules effective for tax years after 2019. As a result, Respondent impermissibly allocated stewardship expenses to Petitioner's non-dividend-related income inclusions, including under Sections 951 and 951A, and incorrectly apportioned the expenses to statutory and residual groupings based on the relative values of the entity or entities in each grouping.

4.e.3. Respondent also misapplied its erroneous stewardship expenses apportionment methodology, failing to appropriately account for the relative values of Petitioner's U.S. entities, which disproportionately directs stewardship expenses to foreign income statutory groupings.

4.e.4. Respondent mischaracterized expenses that are neither overhead, general and administrative, nor supervisory as supportive expenses.

4.e.5. Respondent then erroneously allocated or apportioned its reconstituted supportive expenses pool to statutory and residual categories based on Petitioner's U.S. versus outside the U.S. (“OUS”) sales to total global sales ratio (with an adjustment for export sales). Respondent then apportioned the foreign supportive expenses to Section 904(d) statutory groupings based on the relative percentages of gross income in those categories. The apportionment model does not “reflect[ ] to a reasonably close extent the factual relationship between the deduction[s] and the grouping of gross income.” Treas. Reg. § 1.861-8T(c)(1).

4.f. DASTM Adjustments.

4.f.1. Respondent erred in adjusting Petitioner's income inclusions under Section 965(a) by $6,633,656 and under Section 951A (GILTI) by $31,814,525. Respondent incorrectly determined that Treas. Reg. § 1.985-7, which requires U.S. shareholders to make certain adjustments to their gross income when their controlled foreign corporation (“CFC”) transitions from a local, hyperinflationary currency to the U.S. dollar under the dollar approximate separate transactions method (“DASTM”), does not apply to Section 965(a) and Section 951A.

4.f.1.1. Petitioner properly applied Treas. Reg. § 1.985-7, reducing its Subpart F income, for purposes of Section 965(a), by $6,633,656, and reducing its GILTI, for purposes of Section 951A, by $31,814,525.

4.g. Section 988 Adjustments.

4.g.1. Respondent erred in adjusting Petitioner's tested income under Section 951A by $13,316,536, erroneously computing Petitioner's Section 988 gain. Petitioner properly reported its Section 988 gain arising from its taxable foreign currency transactions.

4.h. Foreign Derived Deduction Eligible Income Adjustment.

4.h.1. Respondent erred in increasing Petitioner's deduction eligible income (“DEI”) by $15,014,808 and decreasing Petitioner's foreign derived deduction eligible income (“FDDEI”) by $24,521,671 for purposes of computing Petitioner's Section 250 foreign-derived intangible income (“FDII”) deduction.

4.h.2. For purposes of determining its FDII deduction, Petitioner properly allocated and apportioned deferred compensation expense (“DCE”) to Section 861 statutory and residual gross income groupings based on the groupings in existence when the DCE-related services were performed and generated income.

4.h.3. Respondent erroneously adjusted Petitioner's FDII deduction by erroneously allocating and apportioning Petitioner's DCE deductions to Section 861 statutory and residual gross income groupings that were not in existence when the DCE-related services were performed or generated income.

4.i. Meals and Entertainment Expenses Adjustment.

4.i.1. Respondent erred in disallowing Petitioner's Section 162 travel and meals expense deductions of $217,964,946, incorrectly determining that Petitioner cannot substantiate the deductions. Respondent further erred by failing to allow additional Section 162 travel and meals expense deductions of $171,116. Petitioner maintained sufficient records to substantiate deductions of $218,136,062, and is entitled to a credit or refund of any resulting overpayment of tax.

4.j. Carryover Adjustments.

4.j.1. Respondent erred in decreasing Petitioner's foreign tax credit carryover — general category, by $30,593,364, and increasing Petitioner's foreign tax credit carryover — branch category, by $1,196,103.

4.j.2. Respondent also erred in decreasing Petitioner's overall domestic loss carryover — general category, by $569,552,594, and overall domestic loss carryover — passive category, by $8,378,942.

4.j.3. Respondent based his adjustments on a purported “agree[ment]” with Petitioner “as part of the 2017/2018 exam.” Petitioner has not agreed to those adjustments and the relevant exam has not concluded.

4.k. Disallowed Claim — Section 482 Adjustment.

4.k.1. Respondent erred in disallowing Petitioner's informal claim, submitted November 22, 2022, that corrects Petitioner's inadvertent over-inclusion of taxable income. On its 2019 Form 1120, Petitioner mistakenly over-reported ADC US's income and under-reported ALVE's income arising from transactions between the controlled parties by $23,000,149. Respondent incorrectly determined that Petitioner's claim was a prohibited “affirmativ[e]” use of Section 482.

4.k.2. Petitioner's informal claim appropriately corrects its scrivener's error on its 2019 Form 1120. Petitioner did not affirmatively use Section 482 to “decrease taxable income based on allocations or other adjustments with respect to controlled transactions” under Treas. Reg. § 1.482-1(a)(3).

4.k.3. Alternatively, Petitioner's informal claim appropriately requests a setoff under Treas. Reg. § 1.482-1(g)(4).

4.l. Affirmative Claim — Meals and Entertainment Expenses Adjustment.

4.l.1. The allegations in paragraphs 4.i and 4.i.1, above, are incorporated herein by reference.

4.l.2. Petitioner is entitled to a refund resulting from additional Section 162 travel and meals expense deductions of $171,116.

4.m. Affirmative Claim — Section 965 Invalidity.

4.m.1. Petitioner's affirmative claim is contingent on a favorable, final resolution in Moore v. U.S., Dkt. 22-800, which is currently pending in the United States Supreme Court.

4.m.2. Section 965(a)'s one-time mandatory repatriation tax (“MRT”) violates the Sixteenth Amendment to the U.S. Constitution. Under Eisner v. Macomber, 252 U.S. 189 (1920) and its progeny, “income,” for Sixteenth Amendment purposes, requires realization.

4.m.3. Petitioner is entitled to a refund of its 2019 MRT installment payment under Section 965(h) and correlative and corresponding adjustments totaling $84,614,234.

4.n. Protective Claim — CRA Adjustments.

4.n.1. On December 18, 2023, the Canada Revenue Agency (“CRA”) issued to Abbott Laboratories Limited (Canada) (“Abbott Canada”), a reassessment of CAD 13,555,155 in Canadian taxes for Abbott Canada's 2019 tax year. The CRA's reassessment is based on its determination that Abbott Canada did not earn adequate returns on its sales of products that it purchased from affiliates (including Abbott).

4.n.2. On December 18, 2023, Petitioner submitted to Respondent a dual protective claim and treaty notification pursuant to Rev. Proc. 2015-40, §§ 11 and 12, and Articles IX and XXVI of the Convention between the United States of America and Canada with Respect to Taxes on Income and on Capital, signed at Washington on September 26, 1980, as amended by Protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007 (“U.S.-Canada Income Tax Treaty”), preserving its rights to seek a refund related to the CRA's reassessment and Competent Authority assistance through the U.S.-Canada Income Tax Treaty's mutual agreement procedures.

4.n.3. If the CRA's reassessment is upheld, in whole or in part, Petitioner may be entitled to correlative and corresponding adjustments.

4.o. Computational Adjustments. As a result of Respondent's errors set forth in paragraphs 4.a. through 4.n.3, which are incorporated herein by reference, various correlative, corresponding, or computational adjustments will be necessary, including but not limited to, adjustments to Petitioner's foreign tax credits, GILTI Section 250 Deduction, and dividends received deduction.

5. Supporting Facts. The facts upon which Petitioner bases the assignments of error are set forth below. Petitioner incorporates by reference all allegations in paragraph 4, above.

5.a. Nutrition Royalty Income — Section 482.

5.a.1. Petitioner's Business. Petitioner is a health care company involved in the discovery, research, development, manufacture, and marketing of healthcare products. In 2019, its product portfolio included nutrition, branded-generic pharmaceuticals, medical devices, and diagnostic products. Petitioner and its affiliates manufactured and distributed products worldwide.

5.a.2. Petitioner's Business Segments. In 2019, Petitioner had four reportable business segments: (1) Established Pharmaceutical Products, (2) Diagnostic Products, (3) Nutritional Products, and (4) Medical Devices.

5.a.3. Nutritional Products Industry Overview.

5.a.3.1, Regulatory Requirements. The nutritional products industry is highly regulated, subject to comprehensive domestic and foreign government oversight and controls. Regulatory agencies' rules and requirements, including those governing nutritional product content, can vary significantly by region and country.

5.a.3.1.a. Nutritional product manufacturing facilities had to be approved by multiple agencies and were regularly audited and inspected by government agencies from the country of location and from countries where manufactured products were sold.

5.a.3.1.b. Nutritional product manufacturers also had to abide by rules and restrictions from various religious communities, all of which had different requirements and expectations for manufacturing processes and ingredient components.

5.a.3.2. Product Quality. Product quality is critically important in nutritional product manufacturing. Quality issues can lead to product recalls as well as other significant operational, financial, and regulatory impacts.

5.a.3.3. Intellectual Property. Nutritional product manufacturers infrequently release new product innovations requiring intellectual property protection. The nutritional product industry does not have active ingredient patents like those traditionally found in the pharmaceutical industry. Instead, patents related to nutritional ingredients are claimed in relation to other ingredients within a nutritional supplement matrix.

5.a.3.4. Market Customization. Local consumer preferences and local marketing are key value drivers in the nutritional product industry. Nutritional product manufacturers customize products to cater to local consumer nutritional and taste preferences.

5.a.4. Abbott Nutrition Business Segment. In 2019, Petitioner's Nutritional Products business segment (“Abbott Nutrition”) sold a broad range of pediatric and adult nutritional products supporting healthy growth and development and balanced nutritional supplementation, including for children and adults with feeding difficulties. Abbott Nutrition's principal products were Similac®, Isomil®, Alimentum®, Gain®, Grow®, Eleva®, PediaSure®, EleCare®, Pedialyte®, Ensure®, Glucerna®, and Zone Perfect®, among others. The Similac, Pedisure, Glucerna, and Ensure product families generated most of Abbott Nutrition's revenue in 2019. Similac was first introduced to market in 1951, Ensure in 1973, Pediasure in 1988, and Glucerna in 1998.

5.a.4.1. Abbott Nutrition Local Market R&D and Customization. In general, Abbott Nutrition's new nutritional product releases leveraged its existing product portfolio or expanded existing product families and were often tailored to better meet consumer needs or a specific market's regulatory requirements. Abbott Nutrition had a research and development (“R&D”) center in the U.S., as well as multiple R&D and technical centers outside the U.S.

5.a.4.1.a. R&D Centers. Abbott US and Abbott Singapore were full-fledged regional R&D centers that independently supported product ideas from inception to commercialization.

5.a.4.1.b. Technical Centers. Abbott Netherlands and ALVE had technical centers that provided technical support for Abbott Nutrition's manufacturing operations in the Netherlands and Ireland, respectively. Abbott Netherlands and ALVE also developed and customized Abbott Nutrition products.

5.a.4.1.c. R&D Pilot Plants. Abbott US, Abbott Singapore, and Abbott Netherlands operated regional R&D pilot plants that conducted prototype trial manufacturing to evaluate new products and manufacturing processes prior to full scale production.

5.a.4.2. Abbott Nutrition Sales and Marketing. Abbott Nutrition had divisional, regional, and local marketing teams. In general, Abbott Nutrition did not create uniform global product messaging for its nutritional products. Instead, Abbott Nutrition's regional and local commercial affiliates conducted the majority of marketing activities for Abbott Nutrition products. Abbott Nutrition commercial affiliates marketed and sold directly to customers and to institutions, wholesalers, retailers, healthcare facilities, government agencies, and third-party distributors within their local country or region. In 2019, Abbott Nutrition's regional and local marketing expenditures significantly exceeded divisional expenditures for global (i.e., worldwide) marketing campaigns.

5.a.5. Abbott Nutrition Intercompany Agreements.

5.a.5.1. Nutrition Licenses. Abbott US owned nutritional product technology and trademark intellectual property that it licensed to the OUS Manufacturers in the following, substantially similar nonexclusive license agreements in effect in 2019 (collectively, the “Nutrition Licenses”).

5.a.5.1.a. Abbott Netherlands Nutrition License. Abbott US and Abbott Netherlands entered into a License Agreement effective as of December 16, 2005.

5.a.5.1.b. Abbott Singapore Nutrition License. Abbott US and Abbott Singapore entered into a License Agreement effective as of January 1, 2009.

5.a.5.1.c. ALVE Nutrition License. Abbott US and ALVE entered into a License Agreement effective as of August 1, 2013.

5.a.5.2. Nutrition Licenses' Terms.

5.a.5.2.a. IP License and Royalties. In each Nutrition License, Abbott US licensed technology and trademarks for the development, manufacture, marketing, and sale of Abbott Nutrition products in defined territories (“Nutrition IP”) in exchange for a 2 percent royalty on net intercompany sales.

5.a.5.2.b. Improvements. In each Nutrition License, the OUS Manufacturers were the sole owners of any improvements to Abbott Nutrition products arising through their own R&D.

5.a.5.2.c. Product Quality. In each Nutrition License, the OUS Manufacturers had a critical role in ensuring product quality and had to indemnify Abbott US from and against any claims related to the manufacture, development, marketing, or sale of any product.

5.a.5.3. Global Services Agreements. Under global services agreements (“GSAs”) between Abbott US and the OUS Manufacturers, effective January 1, 2014, Abbott US provided executive, management, marketing, financing, legal, human resources, public relations, corporate communications, business and finance integration, information technology, administrative, and other services (collectively the “Group Services”), in exchange for an annual service charge based on the cost of the Group Services plus a 5 percent markup.

5.a.5.4. Global Distribution Agreement. The OUS Manufacturers and commercial affiliates were parties to a Global Distribution Agreement, effective January 1, 2016, (“GDA”). Pursuant to the GDA, each OUS Manufacturer appointed each relevant commercial affiliate as a distributor and granted it a non-exclusive, non-transferable right to market, distribute, sell, maintain, and support Abbott Nutrition products in a relevant territory. Under the GDA, the OUS Manufacturers were responsible for setting the marketing and distribution strategy. The OUS Manufacturers guaranteed the commercial affiliates a limited risk distribution return, and bore all expenses related to the commercial affiliates' marketing and distribution activities. Under the GDA, the OUS Manufacturers owned all marketing materials, market data, regulatory and product authorizations.

5.a.5.5. Logistics. In addition, Abbott Logistics BV (“ALOG”), a Netherlands affiliate, provided logistics services to the OUS Manufacturers, earning a cost-plus 5 percent return. The OUS Manufacturers shipped finished products to ALOG, who in turn shipped products to the commercial affiliates for distribution to third-party customers.

5.a.6. OUS Manufacturers. In 2019, the OUS Manufacturers conducted large scale, quality manufacturing of Abbott Nutrition products, subject to strict regulatory requirements and diverse market customization demands, for multiple international markets. Each OUS Manufacturer produced multiple products, which were sold in multiple countries, necessitating management of a high number of stock keeping units (“SKUs”). The OUS Manufacturers also led manufacturing improvement initiatives to enhance efficiency and lower costs.

5.a.6.1. Manufacturing and R&D. Abbott Singapore, ALVE, and Abbott Netherlands manufactured various Abbott Nutrition products at manufacturing sites located in Singapore; Cootehill, Ireland; and Zwolle, Netherlands, respectively. The OUS Manufacturers also engaged in substantial R&D, product development, and product customization activities at their respective regional R&D or technical centers and manufacturing sites.

5.a.6.2. Quality Manufacturing. Each OUS Manufacturer had an on-site, dedicated quality assurance and quality control organization. The quality assurance teams were responsible for developing plant specific quality systems, overall quality compliance, and overseeing design and validation assurance, batch releases, audits, and corrective action preventative action (“CAPA”) activities. The quality control teams ensured product consistency and integrity.

5.a.6.3. Marketing. The OUS Manufacturers' regional R&D centers and local technical centers worked closely with commercial affiliates to, among other things, identify potential new products based on market research, validate product marketing claims, and generate ideas for new marketing campaigns.

5.a.6.4. Regulatory Teams. Each OUS Manufacturer had an on-site regulatory team that assisted with regulatory submissions and regulatory agency audit preparation and management.

5.a.6.5. OUS Manufacturers' Risks Assumed. The OUS Manufacturers bore numerous significant risks. For example, the OUS Manufacturers bore risks associated with, among other things: (1) their extensive R&D and product development activities, (2) maintaining and protecting their intellectual property, (3) producing, in extraordinary volumes, numerous product SKUs in a highly regulated environment using their own plant, equipment, and personnel, (4) product liability, (5) quality failures, (6) market dynamics, including those related to fluctuations in demand, costs, and nutritional product pricing, (7) various supply chain risks, (8) inventory, and (9) regulatory concerns.

5.a.7. Abbott US's Role. In general, Abbott US performed various headquarter functions, including legal, human resources, and public relations, and selected and qualified raw material suppliers and vendors. It also conducted general product development, researching new nutrients that could be incorporated into nutritional products, and performed limited marketing, regulatory, and maintenance assistance. Abbott US set broad global quality-related and food safety guidelines for the quality systems, but the OUS Manufacturers had broad discretion in developing and implementing plant specific quality systems and day-to-day operations.

5.a.8. Royalties. In 2019, the OUS Manufacturers paid total royalties to Abbott US in the following amounts:

OUS Manufacturer

Royalties to Abbott US

Abbott Netherlands

$8,798,923

Abbott Singapore

$13,196,390

ALVE

$12,361,525

5.a.9. IRA. In 2012, Respondent reviewed Petitioner's 2011 federal income tax return as part of Petitioner's participation in the Compliance Assurance Process (“CAP”). A key issue in that CAP review was whether royalty income that Abbott US earned from Abbott Singapore, in exchange for the use of trademarks and technology by Abbott Singapore related to Abbott Nutrition products, was arm's length under Section 482.

5.a.9.1. On August 23, 2012, Petitioner and Respondent entered into an IRA in which the parties agreed that a 2 percent royalty related to the intercompany sale of Abbott Nutrition products earned by Abbott US from Abbott Singapore was arm's length.

5.a.9.2. The IRA also indicated that the agreement would govern Abbott US's royalty rate for all “foreign Nutritional manufacturing entities” in future audit cycles, so long as there were no “substantial changes in the Nutrition business segment.”

5.a.9.3. Respondent's employee who executed the IRA on Respondent's behalf was authorized to do so. The same employee was also authorized to exercise Respondent's authority under Section 482.

5.a.9.4. Following the execution of the IRA in 2012, Abbott US continued to charge the OUS Manufacturers a 2 percent royalty for the use of its Nutrition IP.

5.a.9.5. There were no “substantial changes in the Nutrition business segment” between the year covered by the IRA (2011) and 2019.

5.a.10. Respondent's Abbreviated Audit. On March 5, 2019, Respondent accepted Petitioner's taxable year ended December 31, 2019 into the CAP program. Petitioner voluntarily withdrew from the CAP program on October 22, 2019.

5.a.10.1. Three years later, on October 27, 2022, Respondent and Abbott had an opening conference for Petitioner's taxable year ended December 31, 2019. Nine months later, on July 20, 2023, Respondent issued a Notice of Proposed Adjustment (“NOPA”) with the same income adjustments set forth in the Notice.

5.a.11. Respondent's Section 482 Adjustments. Based on information and belief, Respondent's Notice adjustment relied on an analysis prepared by an IRS internal economist (the “IRS Nutrition Analysis”) and appended to Respondent's NOPA. The IRS Nutrition Analysis purports to apply the CPM set forth in Treas. Reg. § 1.482-5 as the method that provides the most reliable measure of an arm's length result (the “best method”) for determining the OUS Manufacturers' royalties to Abbott US.

5.a.11.1. Respondent based his Section 482 adjustments on legal and factual errors.

5.a.11.2. Respondent disregarded his previous exercise of discretion under Section 482, finding that a 2 percent royalty related to the intercompany sale of Abbott Nutrition products earned by Abbott US was arm's length. Respondent ignored that he prospectively limited his exercise of discretion under Section 482 if there were no “substantial changes in the Nutrition business segment” — when in fact no such changes occurred.

5.a.11.3. Respondent erroneously selected the CPM as the best method and misapplied it, selecting purportedly comparable companies with materially different functional, asset, and risk profiles than those of the OUS Manufacturers.

5.a.11.4. The OUS Manufacturers' royalty payments to Abbott US were arm's length.

5.a.11.5. Respondent's adjustments are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

5b. Abbott Diabetes Care — Section 482 Adjustment. The allegations in paragraphs 5.a.1 through 5.a.2, above, are incorporated herein by reference.

5.b.1. ADC Organization. The Abbott Diabetes Care business (“ADC”), part of Abbott's Medical Devices business segment, had a worldwide organization consisting of: (1) groups outside of the U.S. involved in the ADC business; (2) groups in the U.S. in purely regional roles; and (3) groups in the U.S. that provided oversight to the global ADC business (the “ADC HQ”).

5.b.2. ADC Products. In 2019, ADC sold under its FreeStyle® brand blood glucose monitoring (“BGM”) systems and continuous glucose monitoring (“CGM”) systems for people with diabetes.

5.b.2.1. BGM. ADC's BGM system, the FreeStyle Strip system, allows customers to draw blood samples through routine finger pricks, deposit their blood samples onto a single use test strip, and insert the test strip into a meter that provides an instantaneous blood glucose reading.

5.b.2.2. CGM. ADC's CGM system, the FreeStyle Libre system, enables consumers to continuously measure glucose levels without routine finger pricks. Libre is a small device that measures glucose in the user's interstitial fluid through a tiny sensor inserted in the user's upper arm. Users receive glucose readings from their sensors with smart phones or readers.

5.b.2.2.a. ADC also offered the FreeStyle Libre Pro System, a professional CGM device that enabled doctors to detect trends and track their patients' glucose-level patterns.

5.b.3. ADC's BGM Business.

5.b.3.1. BGM Industry. The BGM industry is a mature, commodity-type business. The first blood glucose test strip was developed in 1960. By the 1980s, self-monitoring blood glucose with BGM strips became the standard of care. Most BGM consumers are diabetes patients whose BGM products are covered by their public (e.g., Medicare or Medicaid) or private health insurance plan. Winning exclusive or semi-exclusive contracts with government or private insurers drives BGM sales, and product pricing is a key negotiation factor for those contracts.

5.b.3.2. ADC's Historical BGM Business. Petitioner has manufactured and sold BGM strips for over 25 years. In 1996, Petitioner entered the BGM market, acquiring BGM product manufacturer, Medisense UK Holdings Ltd. In 2004, Petitioner acquired separate BGM product manufacturer Therasense, Inc. (“Therasense”). As part of its Therasense acquisition, Petitioner acquired rights to FreeStyle Strips, a BGM product. Therasense later became ADC US. When ADC began selling FreeStyle Strips, the market was led by a few global companies and the demand for BGM was growing due to the obesity epidemic and general rise in diabetes diagnoses.

5.b.3.2.a. Donegal Manufacturing. ADC first manufactured FreeStyle Strips in Alameda, California. In 2006, Abbott anticipated that the BGM market would maintain consistent growth and projected that demand for FreeStyle Strips would outrun Alameda manufacturing capacity. As a result, ADC expanded FreeStyle Strips manufacturing to ALVE's plant in Donegal, Ireland.

5.b.3.2.b. ALVE made approximately $30 million in capital investments to develop FreeStyle Strips manufacturing capacity in Donegal. In 2007, ALVE's Donegal plant began producing FreeStyle Strips.

5.b.3.2.c. Declining BGM Sales. In 2010, the BGM industry's growth slowed considerably, due in large part to BGM product commoditization caused by an influx of competitive products and increased pricing pressure. Accordingly, in that year, ADC consolidated its full FreeStyle Strips manufacturing to ALVE's Donegal plant. By 2012, ADC FreeStyle Strips sales began to decline, with that decline continuing through 2019.

5.b.3.3. Limited FreeStyle Strips Development. By 2019, ADC's BGM business had stagnated. It limited its FreeStyle Strips' R&D and technical activities to reactive or compliance activities related to regulatory or independent organizations' (e.g., the International Standards Organization) rare standard changes.

5.b.4. BGM Intercompany Agreements.

5.b.4.1. FreeStyle Strips License. In 2016, ADC US granted to ALVE a non-exclusive license to technology and trademarks to develop, manufacture, market, and sell FreeStyle Strips outside of the U.S., in exchange for a royalty equal to 50 percent of residual system profits (the “FreeStyle Strips License”).

5.b.4.2. GSA. Under a GSA between Abbott US and ALVE, effective January 1, 2014, Abbott US provided ALVE Group Services in exchange for an annual service charge based on the cost of the Group Services plus a 5 percent markup.

5.b.4.3. GDA. ALVE and its commercial affiliates were parties to the GDA, effective January 1, 2016. As discussed above at paragraph 5.a.5.4, pursuant to the GDA, ALVE appointed each relevant commercial affiliate as a distributor and granted a non-exclusive, non-transferable right to market, distribute, sell, maintain, and support FreeStyle Strips in a relevant territory. ALVE guaranteed the commercial affiliates a limited risk distribution return, and bore all expenses related to their marketing and distribution activities.

5.b.4.4. Logistics. In addition, Abbott Diagnostics GmbH, a German affiliate, provided logistics services to ALVE, earning a cost-plus 5 percent return.

5.b.5. FreeStyle Strips Manufacturing. By 2019, ALVE's FreeStyle Strips manufacturing process was well-established and fully optimized. Its batch manufacturing process was largely manual, with some automation, involving cutting and re-cutting and coating polyester sheets into strips.

5.b.5.1. Quality Assurance and Control. ADC HQ's quality group provided ALVE oversight for FreeStyle Strips quality-related activities and created broad divisional quality systems and procedures. Beginning in 2014, ADC HQ performed certain quality activities as a service to ALVE under the GSA.

5.b.5.1.a. Quality Teams. ALVE's quality teams used ADC HQ quality standards and developed their own plant-specific quality system. ALVE had a dedicated quality assurance and quality control organization on site at Donegal led by a quality director. ALVE was responsible for FreeStyle Strip validation, manufacturing, and product release and implemented various quality controls throughout its manufacturing process.

5.b.5.1.b. Technical Support. ALVE's technical team supported FreeStyle Strips manufacturing, identifying and remedying any technical issues that arose during the production process.

5.b.6. Sales and Marketing. FreeStyle Strips marketing activities were limited. An ADC HQ global strategic marketing team developed high level marketing plans and an ADC HQ global commercial team provided oversight for ADC commercial organizations worldwide. ADC's local market access teams were tasked with developing relationships and contracting with private insurers and government bodies.

5.b.7. Distribution. FreeStyle Strips were purchased by wholesalers and distributors for ultimate sale to end customers.

5.b.8. Risks Assumed. ALVE bore several, significant risks. For example, ALVE bore risks associated with, among other things: (1) managing and executing all FreeStyle Strip manufacturing activities, (2) unlimited product liability, (3) quality failures, (4) market dynamics, including those related to fluctuations in demand, costs, and product pricing, (5) various supply chain risks, and (6) regulatory concerns.

5.b.9. Royalties. In 2019, ALVE paid $29,071,031 in royalties to ADC US pursuant to the FreeStyle Strips License.

5.b.10. ADC's CGM Business.

5.b.10.1. CGM Industry. As the BGM industry was growing increasingly commoditized and sales growth declined, the market for Libre was emerging and growing rapidly.

5.b.10.2. ADC's Historical CGM Business. As part of its 2004 Therasense acquisition, Petitioner acquired the rights to FreeStyle Navigator (“Navigator”), a first generation CGM product. Like Libre, Navigator incorporated an on-body sensor and transmitter which measured the user's glucose levels and transmitted measurements to an off-body reader. Navigator, however, was not commercially successful. While the base “wired enzyme” technology in the sensor was effective at measuring glucose levels, the product itself was expensive and not user-friendly. Navigator's main drawback was that it required consumers to manually calibrate the system, meaning users would still have to finger prick to produce blood samples for calibration.

5.b.10.3. Libre Development. After Navigator's disappointing performance, ADC pursued a new strategy of producing a consumer-friendly, self-calibrating product that could be manufactured at a lower cost. In 2014, it introduced Libre, which did not require manual user calibration, was easy to use, and was sold at a consumer-friendly price point. The base wired enzyme technology used in the Navigator sensor remained the same in Libre.

5.b.10.4. The most significant change from Navigator to Libre was eliminating user calibration by having the Libre sensors calibrated by the manufacturer.

5.b.11. CGM Intercompany Agreements.

5.b.11.1. Libre License. In 2016, ADC US granted to ALVE an OUS non-exclusive license to its technology and trademarks to develop, manufacture, have manufactured, export, market, and sell Libre products (“Libre License”). Under the Libre License, ALVE paid a royalty equal to 8 percent of net sales.

5.b.11.2. Manufacturing and Supply Agreement. Pursuant to a Manufacturing and Supply Agreement, dated May 1, 2016, ALVE engaged a subsidiary of Abbott US located in the United Kingdom, Abbott Diabetes Care, Limited (“ADC UK”), to manufacture and supply Libre sensors under a cost plus 10 percent arrangement. ALVE granted ADC UK a non-exclusive, nontransferable, royalty-free license to use ALVE's intellectual property solely for the purpose of manufacturing and supplying the Libre sensors.

5.b.11.3. Services Agreement. ALVE also entered into a Services Agreement with ADC UK, dated May 1, 2016 (the “Services Agreement”). Under the Services Agreement, ADC UK agreed to provide advisory and consulting services to ALVE related to the OUS manufacture and development of Libre products. In exchange for those services, ALVE paid ADC UK a fee equal to cost plus 5 percent.

5.b.11.4. GSA. As discussed above at paragraph 5.a.5.3, Abbott US provided ALVE Group Services under the GSA in exchange for an annual service charge based on the cost of the Group Services plus a 5 percent markup.

5.b.11.5. GDA. As discussed above at paragraph 5.a.5.4, pursuant to the GDA, ALVE appointed each relevant commercial affiliate as a distributor and granted a non-exclusive, non-transferable right to market, distribute, sell, maintain, and support Libre in a relevant territory. ALVE guaranteed the commercial affiliates a limited risk distribution return, and bore all expenses related to their marketing and distribution activities.

5.b.11.5.a. Under the GDA, the commercial affiliates engaged in localized marketing and distribution activities in their respective markets. ALVE was responsible for setting the marketing and distribution strategy and funding the cost of any marketing materials used by the commercial affiliates. ALVE owned all marketing materials, market data, as well as all regulatory and product authorizations.

5.b.12. Third-Party Agreements. ALVE contracted with unrelated third-party manufacturers (“TPMs”), Sanmina Corporation (“Sanmina”) and West Pharmaceutical (“West”) under product supply agreements to manufacture non-sensor Libre system components — e.g., patches and patch delivery units or “PDUs” (i.e., the sensor packs and sensor applicators). ALVE paid for, and retained ownership of, all equipment, tooling, fixtures, and any associated software used solely by the third parties to manufacture Libre patches and PDUs.

5.b.12.1. A separate TPM, Flextronics, manufactured readers. ALVE bore all costs for readers sold in OUS markets.

5.b.13. ADC UK Manufacturing.

5.b.13.1. Manufacturing Process Development. ADC UK developed and refined the sophisticated manufacturing processes and know-how that made high volume, low cost sensor factory calibration possible.

5.b.13.1.a. Low-Volume Manufacturing. By 2012, ADC US had formed the initial design for the Libre sensor, but its manufacturing process was not fully developed. ADC UK engineering, operations, and quality employees, with ADC US's R&D support, developed low-volume manufacturing equipment, manufacturing processes, know-how, and controls. The low-volume manufacturing process was semi-automated, but included several manual steps, and limited output. Initial launch capacity in 2014 was only one million units.

5.b.13.1.b. High-Volume Manufacturing. In 2013 and 2014, ADC UK developed fully automated, high-volume Libre manufacturing processes and know-how, placing the first high-volume equipment online in 2015. By the end of 2017, ADC UK increased overall sensor manufacturing capacity to 40 million units.

5.b.13.1.c. ADC US bore only R&D costs for Libre development. ADC UK bore all the other costs associated with the development of the Libre sensor manufacturing process (including all costs associated with the ADC UK team members), as well as the substantial capital expenditures incurred to launch Libre sensor manufacturing.

5.b.13.1.d. High-volume Libre sensor manufacturing was extremely technical and entirely automated, involving, among other things, circuit printing, chemistry application, enzyme dispensing, and laser singulation. Careful manufacturing process execution, necessary for manufacturing process calibration, was essential to the product's commercial success.

5.b.13.1.e. ADC UK Quality Assurance and Control. ADC UK's quality team played a vital role during the development and build-up of both the low volume and the high-volume manufacturing lines, determining validation standards for new equipment and raw materials and establishing quality standards and procedures for every step of the newly developed manufacturing process. The ADC UK quality team also created all quality requirements, quality attributes, and process points for the equipment setup.

5.b.13.1.f. ADC UK's quality team managed all quality procedures and processes throughout every stage of the manufacturing process, monitoring all quality data for each individual sensor. It also had its own CAPA team under the plant's quality director who was responsible for addressing any quality problems arising in the manufacturing process.

5.b.13.2. ADC UK Process Improvements. In 2016, after ADC UK established its high-volume manufacturing process, it also launched a continuous improvement project called Project Orion. The project involved a dedicated cross-functional team tasked with improving yields and increasing manufacturing efficiency. Upon Project Orion's completion, ADC UK's yields increased significantly, with increased manufacturing and final process yields, machine speed improvements, and decreased machine stoppages.

5.b.14. ADC UK Workforce. ADC UK added to its workforce a team of highly educated specialists to operate the new sophisticated sensor manufacturing equipment at its plant located in Witney, UK. Its Witney plant grew from approximately 500 people in 2014 to around 734 people in 2019, with the increase attributable almost entirely to the Libre sensor manufacturing.

5.b.15. Libre Manufacturing Expansion. In 2018, ADC expanded Libre manufacturing to ALVE's Donegal plant to meet Libre's market demand. ALVE's operations, engineering, and quality groups, with the assistance of ADC UK, implemented the Libre sensor manufacturing launch at the Donegal plant. ALVE also sent its teams of technicians, operators, and engineers to ADC UK's Witney plant for extensive training on Libre's unique manufacturing equipment and processes.

5.b.15.1. While the Donegal sensor manufacturing process shared some similarities with Witney, ALVE made various enhancements.

5.b.15.2. By the fourth quarter of 2019, ALVE's Donegal plant was commercially producing Libre sensors.

5.b.16. New Libre Sales and Marketing Model. Unlike for legacy BGM products, ADC did not primarily rely on contracting with public and private health insurance providers as the primary avenue to reach CGM end user consumers and, because of Libre's consumer focus, ADC could not rely on an existing hospital distribution model. Accordingly, ADC had to create a new multifaceted marketing and distribution model that reached direct-to-consumer channels and leveraged market access relationships with health insurers.

5.b.16.1. As a result, ALVE's Libre commercial affiliates dramatically increased their sales forces and invested heavily in sales force education. The commercial affiliates also developed direct to consumer advertising through television, digital (i.e., developing and maintaining online digital stores), and social media.

5.b.16.2. In addition, the Libre commercial affiliates developed customized upstream and downstream marketing plans based on local conditions in various jurisdictions.

5.b.17. TPM Set Up. ADC US's R&D team and ADC UK and ALVE's engineering teams developed Libre patch and PDU manufacturing processes at the TPMs. This involved designing new, customized equipment and processes to achieve the quality manufacturing at the lowest possible cost. ALVE's quality team was also involved in qualifying all high-volume lines at the Irish TPMs.

5.b.17.1. ADC UK's and ALVE's TPM groups were involved in day-to-day TPM management, with several engineers working on site at the TPMs. Additionally, ALVE had a dedicated quality team managing and overseeing the quality function at Irish TPMs.

5.b.17.2. In 2018, as a result of its success in launching the Irish TPMs, ALVE assisted in further TPM expansion in the U.S.

5.b.18. Risks Assumed. ALVE and ADC UK bore numerous, significant risks. For example, ALVE and ADC UK bore risks associated with, among other things: (1) incurring large non-recoverable capital expenditures and project expenses to develop the new sensor manufacturing processes in the UK, both prior to and at Libre's launch in 2014, and to implement and expand the patch and PDU TPM manufacturing at the TPMs, (2) maintaining and protecting their trade secrets developed with respect to the Libre sensor manufacturing process, as well as TPM manufacturing processes, (3) executing the highly technical and precise Libre manufacturing processes using their own plant, equipment, and personnel, (4) R&D, (5) unlimited product liability, (6) quality failures, (7) market dynamics, including those related to fluctuations in demand, costs, and product pricing, (8) various supply chain risks, (9) inventory, and (10) regulatory concerns.

5.b.19. ADC US's Role. In general, ADC US conducted product-related R&D, global sourcing functions, and provided high-level quality, regulatory, and marketing guidance and oversight.

5.b.20. Royalties. In 2019, ALVE paid $111,243,725 in royalties to ADC US pursuant to the Libre License.

5.b.21. Respondent's Abbreviated Audit. The allegations in paragraphs 5.a.10 and 5.a.10.1, above, are incorporated herein by reference.

5.b.22. Respondent's Section 482 Adjustments. Based on information and belief, Respondent's Notice adjustment relied on an analysis prepared by an IRS internal economist (the “IRS ADC Analysis”) and appended to Respondent's NOPA. The IRS ADC Analysis purports to apply an aggregated CPM as the best method for determining ALVE's collective royalties, for both Libre and FreeStyle Strips, to ADC US.

5.b.22.1. Respondent based his Section 482 adjustments on legal and factual errors.

5.b.22.2. Respondent erroneously selected as best method and applied an aggregate CPM, collapsing without basis Petitioner's separate, unrelated Libre and FreeStyle Strips business lines. Respondent's one-sided CPM disregarded ALVE's, ADC UK's, and other related participants' nonroutine contributions to the Libre supply chain

5.b.22.3. Respondent's CPM benchmarked ALVE's returns based on profits earned by companies with entirely different functional, asset, and risk bearing profiles.

5.b.22.4. Respondent then unreasonably allocated to ADC US all residual Libre and FreeStyle Strips profit. Respondent's resulting Section 482 adjustments led to non-economic results, grossly overcompensating ADC US for its contributions to the Libre and FreeStyle Strips supply chains.

5.b.22.5. ALVE's royalty payments to ADC US were arm's length.

5.b.22.6. Respondent's adjustments are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

5.c. Stock-Based Compensation — Section 482 Adjustment.

5.c.1. Intercompany Services. In 2019, Abbott US Affiliates provided the following services to the OUS Affiliates.

5.c.1.1. Group Services. Abbott US provided Group Services to OUS Affiliates under the GSAs, earning annual service fees equalling its costs plus a 5 percent markup. Petitioner determined the arm's length mark-up by applying the CPM/Transactional Net Margin Method (“TNMM”), with Abbott US as the tested party and the net cost plus ratio (i.e., Operating Profit / (Operating Expenses plus Cost of Sales)) as the PLI. Stock-based compensation costs were not included in the cost base when determining the Group Services charge.

5.c.1.2. SJM Services. St. Jude Medical Business Services, Inc. (“SJM BSI”) provided human resources, information technology, marketing, legal, clinical, global communications, finance, security, sales support, and other services (the “SJM Services”) to OUS Affiliates pursuant to a Management Services Agreement, effective January 1, 2014. All SJM Services, with the exception of marketing services, were determined to be eligible for the SCM. Petitioner elected to apply the SCM for 84 percent of its SJM Services charges. SJM BSI charged out the remaining 16 percent of its SJM Services charges, consisting of marketing support services, at a cost plus a 5 percent markup. Petitioner determined the arm's length mark-up applying the CPM, with SJM BSI as the tested party and an operating profit to total cost ratio as the PLI. Stock-based compensation costs were not included in the cost base for any SJM Services charges.

5.c.1.3. ACS Contract R&D Services. Abbott Cardiovascular Systems, Inc. (“ACS”) provided R&D services (“ACS Contract R&D Services”) to ALVE pursuant to a Research and Development Agreement, effective January 1, 2010. ACS earned an annual service fee based on its costs plus a 5 percent markup. Petitioner determined the arm's length mark-up under the CPM, with ACS as the tested party and a markup on total costs as the PLI. Stock-based compensation costs were not included in the cost base for the ACS Contract R&D Services charge.

5.c.1.4. SJM Contract R&D Services. Certain Abbott US Affiliates (“SJM US Affiliates”) provided R&D Services (“SJM Contract R&D Services”) to certain Abbott OUS affiliates (“SJM OUS Affiliates”) pursuant to various R&D service agreements (“R&D Service Agreements”). SJM US Affiliates earned an annual service fee based on their costs plus a 5 percent markup. Stock-based compensation costs were not included in the cost base for any services charges.

5.c.2. CSA. SJMPR and Pacesetter entered into a cost sharing agreement on January 1, 2008 (the “2008 CSA”). The parties subsequently entered into an Amended and Restated Agreement for Sharing Research and Development Costs, effective January 5, 2009 (“2009 Grandfathered CSA”) to comply with transition rules under Treas. Reg. § 1.482-7(m), enabling the parties to continue to operate under the 2008 CSA's substantive provisions.

5.c.2.1. The 2009 Grandfathered CSA provided that “[t]he [p]arties acknowledge and agree that the costs of stock-based compensation granted in tax years beginning after August 26, 2003, are being included in IDCs . . . solely in order to comply with the Stock-Based Compensation Regulations” and that the parties “reserve[d] the right to challenge the validity of Temp. Treas. Reg. § 1.482-7T(d)(3) and/or its predecessor Treas. Reg. § 1.482-7A(d)(2).”

5.c.2.2. In 2019, the parties did not include stock-based compensation in the CSA shared cost pool.

5.c.3. Respondent's Controlled Services Adjustments are Inconsistent with the Services Regulations. Treas. Reg. § 1.482-9 requires taxpayers to include stock-based compensation in the cost base for intercompany service fees only when the taxpayer: (1) elects to apply the SCM for eligible services or (2) when the taxpayer applies the CPM using a ROTSC PLI. Petitioner elected to apply the SCM for 84 percent ($3,814,957) of its SJM Services charges. Therefore, the bulk of Respondent's adjustments (i.e., $42,709,782) is attributable to services transactions that do not fit into either of those two categories.

5.c.4. Respondent's Controlled Services Adjustments are Inconsistent with the Arm's Length Standard. Section 482 regulations make clear that the standard to be applied “in every case” is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer (i.e., the “arm's length standard”). Unrelated parties do not bear the cost of the other's stock-based compensation in service transactions. Respondent's adjustments, therefore, erroneously extend stock-based compensation inclusions to all intercompany services while avoiding the Section 482 regulation's mandate to apply the arm's length standard “in every case.” Respondent's adjustments, therefore, are a per se abuse of discretion.

5.c.5. Respondent's adjustments are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

5.c.6. Respondent's Services Regulations and Controlled Services Adjustments are Invalid under the APA. To the extent that Treas. Reg. § 1.482-9 is interpreted as requiring stock-based compensation in the cost base for all intercompany service fees, those regulations are invalid under the APA because they would have been promulgated in excess of statutory jurisdiction or authority, fail to reflect reasoned decision-making, and would be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. See 5 U.S.C. § 706(2).

5.c.6.1, On September 10, 2003, Treasury published a Notice of Proposed Rulemaking, REG-146893-02, to propose regulations addressing the transfer pricing of intercompany services between related parties (the “Proposed Services Regulations (2003)”). See 68 Fed. Reg. 53448. The Proposed Services Regulations (2003) had no provisions requiring stock-based compensation to be included in the cost base for intercompany service charges.

5.c.6.2. The Notice of Proposed Rulemaking stated, without explanation, that “[S]ection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”

5.c.6.3. Treasury received public comments to the Proposed Services Regulations (2003). Even though the Proposed Services Regulations (2003) did not address stock-based compensation, some commentators unilaterally urged Treasury to exclude stock-based compensation from the cost base for intercompany service charges to be consistent with comparable cost-plus government contracts, other uncontrolled services transactions, and the arm's length standard.

5.c.6.4. Effective for tax years beginning after December 31, 2006, Treasury promulgated Temp. Treas. Reg. § 1.482-9T(j) (the “Temporary Services Regulations (2006)”), which included stock-based compensation in the definition of “total services cost” for certain controlled services transactions.

5.c.6.5. Prior to promulgating the Temporary Services Regulations (2006), Treasury did not provide prior notice or an opportunity for public comment specifically on whether stock-based compensation should be treated as a cost of services.

5.c.6.6. Treasury acknowledged in the preamble to the Temporary Services Regulations (2006), Treas. Dec. 9278 (August 4, 2006), that the Proposed Services Regulations (2003), REG-146893-02, had no provisions requiring stock-based compensation to be included in the cost base used to compute total services costs. The preamble to the Temporary Services Regulations (2006) did not provide any further explanation, evidence or facts to support treating stock-based compensation as a total services cost. When it promulgated the Temporary Services Regulations (2006), Treasury did not provide or rely upon any arm's length transactions between unrelated parties, the results of any search of publicly available agreements, any survey of companies that entered into service transactions, any statement from any professional who negotiated service agreements between unrelated parties, any contract involving the U.S. government and a third party in which stock-based compensation costs were shared or reimbursed, or any published or unpublished article or any report or memorandum from an expert in the field of economics that supported treating stock-based compensation as a total services cost.

5.c.6.7. The preamble to the Temporary Services Regulations (2006) stated without explanation that “[S]ection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”

5.c.6.8. Treasury received public comments to the Temporary Services Regulations (2006). Multiple commentators highlighted Treasury's new inclusion of stock-based compensation in the total services cost definition and indicated that such costs should not be included because arm's length parties do not agree to bear those costs in service transactions. Multiple commentators also referenced Xilinx v. Commissioner, 125 T.C. 37 (2005), where this Court held that there was no evidence that unrelated parties share stock-based compensation costs.

5.c.6.9. Effective for tax years beginning after July 31, 2009, Treasury promulgated final Treas. Reg. § 1.482-9 (the “Final Services Regulations (2009)”). Treasury made no change to the treatment of stock-based compensation as a total services cost from the Temporary Services Regulations (2006) to the Final Services Regulations (2009).

5.c.6.10. Treasury acknowledged in the preamble to the Final Services Regulations (2009), Treas. Dec. 9456 (August 4, 2009), that commentators objected to the Temporary Services Regulations (2006)'s inclusion of stock-based compensation as a “total services cost.” However, it declined to provide any further guidance regarding stock-based compensation in the context of controlled services transactions. The preamble to the Final Services Regulations (2009) did not provide any further explanation, evidence, or facts to support treating stock-based compensation as a total services cost. When it promulgated the Final Services Regulations (2009), Treasury did not provide or rely upon any arm's length transactions between unrelated parties, the results of any search of publicly available agreements, any survey of companies that entered into service transactions, any statement from any professional who negotiated service agreements between unrelated parties, any contract involving the U.S. government and a third party in which stock-based compensation costs were shared or reimbursed, or any published or unpublished article or any report or memorandum from an expert in the field of economics that supported treating stock-based compensation as a total services cost.

5.c.6.11. The preamble to the Final Services Regulations (2009) stated, without explanation, that “[S]ection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”

5.c.6.I2. In advance of promulgating both the Temporary Services Regulations (2006) and the Final Services Regulations (2009), Treasury provided no underlying rationale for including stock-based compensation in total services costs and did not provide any evidence of actual transactions between unrelated parties in which one party paid or reimbursed the costs of stock-based compensation of the other party.

5.c.6.13. In advance of promulgating both the Temporary Services Regulations (2006) and the Final Services Regulations (2009), Treasury received public comments that there was no evidence of any arm's length transaction, including agreements for the provision of services, under which unrelated parties agreed to reimburse stock-based compensation in the cost of services performed.

5.c.7 Respondent's CSA Adjustments are Inconsistent with the Arm's Length Standard. Under Section 482, the arm's length standard must be applied “in every case.” Unrelated parties do not bear the cost of the other's stock-based compensation in CSAs. Respondent's adjustments, therefore, erroneously extend stock-based compensation to CSAs while avoiding the Section 482 regulation's mandate to apply the arm's length standard “in every case.” Respondent's adjustments, therefore, are a per se abuse of discretion.

5.c.8. Respondent's adjustments are inconsistent with Section 482 and regulations promulgated thereunder and are arbitrary, capricious, and unreasonable.

5.c.9. Respondent's CSA Regulations and CSA Adjustments are Invalid Under the APA. Treas. Reg. §§ 1.482-7(d)(1) and (d)(3)'s requirement that CSA participants share stock-based compensation costs is invalid under the APA because it has been promulgated in excess of statutory jurisdiction or authority, fails to reflect reasoned decision-making, and is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. See 5 U.S.C. § 706(2).

5.c.9.1. On July 29, 2002, Treasury published a Notice of Proposed Rulemaking, REG-106359-02, proposing regulations that would expressly require parties to a cost sharing arrangement to share amounts attributable to stock-based compensation. See 67 Fed. Reg. 48997.

5.c.9.2. The Notice of Proposed Rulemaking stated, without explanation, that “[S]ection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”

5.c.9.3. At the time Treasury published the Notice of Proposed Rulemaking, it: (1) had not identified, was not aware of, and did not have in its possession any written contract between unrelated parties in a cost sharing arrangement that required one party to pay or reimburse the other party for amounts attributable to stock-based compensation, (2) had not identified, was not aware of, and did not have in their possession any written cost sharing agreement, services agreement, or other contract between unrelated parties that required one party to pay or reimburse the other party for amounts attributable to stock-based compensation, (3) did not have any evidence of any actual transaction between unrelated parties in a cost sharing arrangement in which one party paid or reimbursed the other party for amounts attributable to stock-based compensation, and (4) did not have any evidence of any actual transaction between unrelated parties in which one party paid or reimbursed the other party for amounts attributable to stock-based compensation.

5.c.9.4. Treasury received public comments to the proposed regulations. Multiple commentators informed Treasury that there was no evidence of transactions between unrelated parties, including any cost sharing arrangement or other contract, that required stock-based compensation to be shared. Commentators also informed Treasury that unrelated parties would not, for economic reasons, agree to share or reimburse amounts attributable to stock-based compensation in arm's length transactions. Commentators separately indicated that the U.S. government, itself, also did not share amounts attributable to stock-based compensation in contracts with unrelated parties.

5.c.9.5. On August 26, 2003, Treasury published final regulations applicable to cost sharing arrangements, which included Treas. Reg. § 1.482-7(d)(2),6 requiring parties to a CSA to share amounts attributable to stock-based compensation (“SBC Rule”).

5.c.9.6. In promulgating Treas. Reg. § 1.482-7A(d)(2), Treasury did not provide or rely upon any arm's length transactions between unrelated parties, the results of any search of publicly available agreements, any survey of companies that entered into cost sharing transactions, any statement from any professional who negotiated cost sharing agreements between unrelated parties, any contract involving the U.S. government and a third party in which stock-based compensation costs were shared or reimbursed, or any published or unpublished article or any report or memorandum from an expert in the field of economics supporting that the SBC Rule achieved an arm's length result.

5.c.9.7. At the time Treasury published Treas. Reg. § 1.482-7A(d)(2), it: (1) had not identified, was not aware of, and did not have in its possession any written contract between unrelated parties that required one party to pay or reimburse the other party for amounts attributable to stock-based compensation, (2) had not identified, was not aware of, and did not have in its

5.c.9.8. In a reviewed opinion issued on July 27, 2015, Altera Corp. v. Commissioner, 145 T.C. 91, this Court unanimously held that the SBC Rule under Treas. Reg. § 1.482-7A(d)(2) is invalid because, inter alia, the regulations at issue were legislative regulations for purposes of the APA, the SBC Rule lacked a basis in fact, Treasury failed to rationally connect the choice it made with the facts it found, Treasury failed to respond to significant comments, and Treasury's explanation ran counter to the evidence before the agency regarding the behavior of parties at arm's length. Therefore, this Court held that the SBC rule is invalid under the APA because it fail to reflect reasoned decision-making, and was arbitrary and capricious.

5.c.9.9. On June 7, 2019, the United States Court of Appeals for the Ninth Circuit reversed this Court. See Altera Corp. v. Commissioner, 926 F.3d 1061. This Court's opinion, however, remains precedential in this case. Petitioner is not a Ninth Circuit taxpayer and appeal in this matter does not lie in that circuit. See Section 7482(b); Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971).

5.c.9.10. On August 29, 2005, Treasury published proposed regulations relating to the treatment of cost sharing arrangements in a Notice of Proposed Rulemaking, REG-144615-02 (the “Proposed CSA Regulations (2005)”). See 70 Fed. Reg. 51116. The Proposed CSA Regulations (2005) materially restate the SBC Rule, requiring parties to a cost sharing agreement to share amounts attributable to stock-based compensation. The Notice of Proposed Rulemaking did not provide any further explanation, evidence, or facts to support the SBC Rule. Treasury did not provide or rely upon any arm's length transaction between unrelated parties, the results of any search of publicly available agreements, any survey of companies that entered into cost sharing transactions, any statement from any professional who negotiated cost sharing transactions between unrelated parties, any contract involving the U.S. government and a third party in which costs were shared or reimbursed, or any published or unpublished article, or any report or memorandum from an expert in the field of economics that supported that the SBC Rule achieved an arm's length result.

5.c.9.11. Effective January 5, 2009, Treasury promulgated Temp. Treas. Reg. §§ 1.482-7T(d)(1) and (3) (the “Temporary CSA Regulations (2009)”). The Temporary CSA Regulations (2009) materially restate the SBC Rule, requiring parties to a cost sharing agreement to share amounts attributable to stock-based compensation. The preamble to the Temporary CSA Regulations (2009), Treas. Dec. 9441 (January 5, 2009), did not provide any further explanation, evidence, or facts to support the SBC Rule. When it promulgated the Temporary CSA Regulations (2009), Treasury did not provide or rely upon any arm's length transaction between unrelated parties, the results of any search of publicly available agreements, any survey of companies that entered into cost sharing transactions, any statement from any professional who negotiated cost sharing transactions between unrelated parties, any contract involving the U.S. government and a third party in which costs were shared or reimbursed, any published or unpublished article, or any report or memorandum from an expert in the field of economics that supported that the SBC Rule achieved an arm's length result.

5.c.9.11.a. The preamble to the Temporary CSA Regulations (2009) stated, without explanation, that “[S]ection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”

5.c.9.12. Effective December 16, 2011, Treasury promulgated Treas. Reg. §§ 1.482-7(d)(1) and (3) (the “Final CSA Regulations (2011)”). The Final CSA Regulations (2011) materially restate the SBC Rule requiring parties to a cost sharing agreement to share amounts attributable to stock-based compensation. The preamble to the Final CSA Regulations (2011), Treas. Dec. 9568 (December 22, 2011), did not provide any further explanation, evidence or facts to support the SBC Rule. When it promulgated the Final CSA Regulations (2011), Treasury did not provide or rely upon any arm's length transaction between unrelated parties, the results of any search of publicly available agreements, any survey of companies that entered into cost sharing transactions, any statement from any professional who negotiated cost sharing transactions between unrelated parties, any contract involving the U.S. government and a third party in which costs were shared or reimbursed, any published or unpublished article, or any report or memorandum from an expert in the field of economics that supported that the SBC Rule achieved an arm's length result.

5.c.9.12.a. The preamble to the Final CSA Regulations (2011) states without explanation that “[S]ection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”

5.c.9.13. Alternatively, Respondent Failed to Appropriately Exercise His Discretion Under Section 482. Respondent failed to appropriately exercise his discretion under Section 482 because, upon information and belief, Respondent's CSA shared cost pool adjustments are not appropriately reflected in the Notice.

5.d. Allocation of Amortization Expense to Tested Income Adjustments.

5.d.1. At issue is whether an amortization deduction under Section 197 is allowed when computing GILTI or whether the deduction is disallowed under Treas. Reg. § 1.951A-2(c)(5), as asserted by Respondent. Alternatively, Respondent asserted that certain transferred intangibles have no basis or that the basis is lower under Section 351 and the regulations thereunder or under substance over form, step transaction, business purpose, economic substance, sham transaction or other judicial doctrines.

5.d.2. Petitioner's Vascular Business Prior to its St. Jude Acquisition. At the time Abbott US acquired St. Jude Medical, Inc. (“SJM”) in 2017, Abbott US owned a vascular products business that included a broad line of coronary, endovascular, vessel closure, and structural heart devices for the treatment of vascular disease (the “Abbott Vascular Business”).

5.d.2.1. The manufacturing activities for the Abbott Vascular Business outside the U.S. were conducted through Abbott US's indirectly owned CFCs and disregarded entities operating in Ireland, Costa Rica and Puerto Rico.

5.d.2.2. The manufacturing operations for the Abbott Vascular Business in Ireland were conducted by ALVE, an Irish CFC that was a tax resident of Bermuda with a tax year ending November 30, and AIB, its disregarded Bermuda entity that was a tax resident in Ireland.

5.d.2.3. The manufacturing operations for the Abbott Vascular Business in Costa Rica were conducted by Abbott Vascular Limitada (“Abbott CR”), a Costa Rican entity owned by ALVE and disregarded for U.S. federal income tax purposes.

5.d.2.4. The manufacturing operations for the Abbott Vascular Business in Puerto Rico were conducted by the Puerto Rican branch of Abbott Diagnostics International Limited (“ADIL”), a Bermuda CFC with a November 30 tax year-end.

5.d.3. Abbott US's Acquisition of St. Jude. When Abbott US acquired SJM in 2017, SJM was one of the world's largest medical device manufacturers and offered a broad line of cardiovascular medical devices (the “SJM Vascular Business”) complementary to the Abbott Vascular Business.

5.d.3.1. SJM Vascular Business products were manufactured in the U.S., Brazil, Costa Rica, Malaysia, and Puerto Rico.

5.d.3.2. The manufacturing operations for the SJM Vascular Business in Costa Rica were conducted by St. Jude Medical Costa Rica Limitada (“SJMCR”), a Costa Rican entity, disregarded for U.S. federal income tax purposes and owned by the U.S. branch of St. Jude Medical International Holding Sarl (“SJMIH”), a Luxembourg entity, disregarded for U.S. federal income tax purposes and owned by St. Jude Medical Luxembourg Holding TC Sarl, a Luxembourg CFC indirectly owned by SJM.

5.d.3.3. The manufacturing operations for the SJM Vascular Business in Puerto Rico were conducted by SJMPR, a Puerto Rican entity, owned by the U.S. branch of SJMIH and disregarded for U.S. federal income tax purposes.

5.d.3.4. As a result of its acquisition of SJM, Abbott US also indirectly owned St. Jude Medical Luxembourg Holding TC Sarl.

5.d.4. Restructuring of Abbott US's Acquisition Debt. In 2016 and 2017, Abbott US incurred significant debt to acquire SJM and Alere Inc. In 2018, Abbott US determined that it could lower its interest expense by borrowing on the European market to pay down Abbott US's U.S. public debt.

5.d.4.1. ALVE used its wholly-owned subsidiary, Abbott Ireland Financing DAC, an Irish entity that was disregarded for U.S. federal purposes, to borrow EUR 3.42 billion through the issuance of bonds that were traded on the Swiss exchange and then loan the borrowed Euros to ALVE on September 27, 2018.

5.d.4.2. ALVE, on September 27, 2018, loaned $4,027,602,803.91 (the “AHL Note”) to Abbott Holdings Limited (“AHL”), a Bahamian CFC indirectly owned by Abbott US. AHL in turn loaned the proceeds to Abbott US, which used the proceeds to pay down its debt.

5.d.5. Integration of Abbott's and St. Jude's Vascular Businesses. Abbott's management decided to integrate Abbott's and St. Jude's Vascular Businesses in Costa Rica and Puerto Rico in 2018.

5.d.5.1. On November 2, 2018, Abbott Overseas Cyprus Limited (“Abbott Cyprus”), a Cyprus entity disregarded for U.S. federal income tax purposes from Abbott Holding (Gibraltar) Limited, a Gibraltar CFC indirectly owned by Abbott US, contributed ADIL to its newly formed subsidiary, Abbott International Enterprises Ltd. (“New ADIL”), a Bermuda CFC. On November 4, 2018, an election was made to treat ADIL as a disregarded entity for U.S. federal income tax purposes. The combined steps were a tax-free reorganization under Section 368(a)(1)(F). New ADIL, like ADIL, had a November 30 year end, and used USD as its functional currency.

5.d.5.2. On November 6, 2018, New ADIL was contributed in successive contributions to Abbott Products Unlimited (“Abbott Products”), an Irish entity disregarded for U.S. federal income tax purposes from AHL.

5.d.5.3. On November 6, 2018, Abbott Products contributed ALVE, and SJMIH contributed SJMPR and SJMCR, to New ADIL, with each contributor receiving common stock of New ADIL in a tax-free transaction under Section 351(a).

5.d.5.4. On November 6, 2018, New ADIL acquired Abbott Mature Products International Limited (“AMPI”), an Irish entity owned indirectly by Abbott US and disregarded for U.S. federal income tax purposes, with USD as its functional currency.

5.d.5.5. On November 6, 2018, New ADIL contributed the shares of ALVE, SJMCR, SJMPR, and ADIL to AMPI in a disregarded transaction for U.S. federal income tax purposes.

5.d.5.6. On November 29, 2018, AMPI contributed SJMCR, SJMPR, and ADIL to ALVE in exchange for: (1) USD intercompany receivables owed to ALVE by several CFCs indirectly owned by Abbott US (“the Receivables”), (2) the AHL Note, (3) $2 billion of notes issued by ALVE, comprised of two notes from ALVE in the amount of $500 million each and ten notes from ALVE in the amount of $100 million each, and (4) 30,354 ordinary shares of ALVE (jointly, the “ALVE Contribution”), in a tax-free Section 351 transaction, except for the gain recognized by New ADIL (as owner of AMPI) under Section 351(b).

5.d.5.7. New ADIL's interest in SJMCR, SJMPR, and ADIL was valued at $12,004,493,000. The Receivables, AHL Note and the notes issued by ALVE in the Section 351(b) exchange were in the aggregate amount of $8,824,691,445.

5.d.6. Petitioner's Form 1120. Petitioner reported the ALVE Contribution as follows:

5.d.6.1. The ALVE Contribution was treated as a transfer by New ADIL of the assets of SJMCR, SJMPR, and ADIL since each of AMPI, SJMCR, SJMPR, and ADIL was a disregarded entity owned by New ADIL.

5.d.6.2. Under Section 351(b), New ADIL recognized gain on the ALVE Contribution in the amount of $8,158,226,802 (“Recognized Gain”) of which $81,578,089 was attributable to inventory assets (“Inventory”) and $8,076,648,713 was attributable to intangible assets and goodwill (the “Intangibles”).

5.d.6.3. The Recognized Gain was not required to be taken into account by Abbott under Section 882 as effectively connected income or Section 951(a)(1)(A) as Subpart F income.

5.d.6.4. The Recognized Gain was not required to be taken into account by Abbott under Section 951A because Section 951A is effective for tax years of CFCs beginning after December 31, 2017, and the Recognized Gain arose in New ADIL's tax year that began on December 1, 2017.

5.d.6.5. Under Section 362(a), ALVE's basis in the Inventory was equal to the basis New ADIL had in the Inventory immediately prior to the ALVE Contribution ($98,131,911) increased by the Recognized Gain attributable to Inventory ($81,578,089), and ALVE's basis in the Intangibles was equal to the basis New ADIL had in the Intangibles immediately prior to the ALVE Contribution ($0) increased by the Recognized Gain attributable to the Intangibles ($8,076,648,713). Of the $8,076,648,713 basis in the Intangibles, $7,924,775,034 was subject to amortization under Section 197 (the “Amortizable Intangibles”).

5.d.6.6. For ALVE's tax year ending November 30, 2019, ALVE claimed $528,318,336 of deductions under Section 197 with respect to Amortizable Intangibles and allocated those deductions to gross tested income under the principles of Section 954(b)(5), as required by Section 951A(c)(2)(A)(ii).

5.d.6.7. Petitioner filed a Form 8275-R, “Regulation Disclosure Statement,” with its 2019 return, disclosing that Petitioner was taking a position contrary to Treas. Reg. § 1.951A-2(c)(5) and provided the relevant facts and legal authority supporting its position that Treas. Reg. § 1.951A-2(c)(5) is invalid.

5.d.7. The Statutory Framework: Section 951A. Section 951A contains rules applicable to tax imposed on GILTI and was enacted as part of the 2017 Tax Cuts and Jobs Act (“TCJA”), Pub. L. No. 115-97, 131 Stat. 2054 (Dec. 22, 2017), to be effective for tax years of foreign corporations beginning after December 31, 2017, and to tax years of U.S. shareholders in which such tax years of foreign corporations end.

5.d.7.1. Section 951A(b)(1) defines GILTI as the excess of the “net CFC tested income” for the year over the “net deemed tangible income return” for the year.

5.d.7.2. Section 951A(c)(1) defines “net CFC tested income” as the U.S. shareholder's aggregate pro rata shares of tested income from the shareholder's CFCs over the U.S. shareholder's aggregate pro rata shares of tested loss from the shareholder's CFCs.

5.d.7.3. Section 951A(c)(2)(A) defines “tested income” to mean gross income (with certain exclusions) over “the deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5) (or to which such deductions would be allocable if there were such gross income).”

5.d.7.4. Section 951A(b)(2) defines “net deemed tangible income return” as 10 percent of the U.S. shareholder's aggregate pro rata shares of “qualified business asset investment” (“QBAI”), with certain adjustments, of the shareholder's CFCs.

5.d.7.5. Sections 951A(d)(1) and (2) define QBAI to include only “tangible property” used in a trade or business of the corporation to produce tested income and “of a type with respect to which a deduction is allowed under section 167.”

5.d.7.6. Section 951A(d)(4), which is part of subsection (d) titled “Qualified Business Asset Investment,” directs the Secretary of the Treasury to issue regulations or other guidance “to prevent the avoidance of the purposes of this subsection. . . .”

5.d.7.7. Based on the plain meaning of Sections 951A(c)(2)(A) and 951A(d)(1), (2) and (4), ALVE is entitled to amortize the Amortizable Intangibles under Section 197 and use the amortization deductions to reduce gross tested income in computing tested income or loss. Specifically, these deductions are “properly allocable” to gross tested income under “rules similar to the rules of [S]ection 954(b)(5),” and Section 951A(d)(4)'s anti-abuse regulatory authority is limited to transactions affecting a CFC's QBAI.

5.d.8. The Rulemaking Process and the Final Regulations for Treas. Reg. § 1.951A-2(c)(5). On September 13, 2018, Treasury issued proposed regulations under Section 951A, which were published in the Federal Register on October 10, 2018 (the “Proposed Section 951A Regulations”). See 83 Fed. Reg. 51072.

5.d.8.1. Using the anti-abuse regulatory authority in Section 951A(d)(4) as justification, the Proposed Section 951A Regulations disallowed, for purposes of determining tested income or loss, a Section 197 deduction attributable to “disqualified basis” in amortizable property resulting from a “disqualified transfer” of such property. Prop. Treas. Reg. §§ 1.951A-2(c)(5)(i), — 3(h)(2)(ii)(C), (D). The term “disqualified basis” referred to an increase in adjusted basis in property arising from a disqualified transfer, and the term “disqualified transfer” referred to a transfer of property during the period beginning on January 1, 2018 and ending on the close of the CFC's tax year that began before January 1, 2018.

5.d.8.2. The IRS and Treasury received comment letters questioning Treasury's and the IRS's authority for issuing Prop. Treas. Reg. § 1.951A-2(c)(5)(i) on grounds that Section 951A(d)(4)'s regulatory authority was limited to combating abuses involving depreciable tangible property in the calculation of a CFC's QBAI, and Section 197 deductions attributable to intangible property are permitted under Section 951A(c)(2)(A)(ii) for which there is no anti-abuse provision.

5.d.8.3. Treasury issued final regulations under Section 951A, which were published in the Federal Register on June 21, 2019 (the “Final Section 951A Regulations”). See T.D. 9866, 84 Fed. Reg. 29288 (June 21, 2019).

5.d.8.4. In response to comment letters questioning the authority for Prop. Treas. Reg. § 1.951A-2(c)(5), Treasury modified this provision in the Final Section 951A Regulations so that a Section 197 deduction attributable to disqualified basis is not ostensibly disallowed under the anti-abuse regulatory authority in Section 951A(d)(4). Rather, this provision in the Final Section 951A Regulations disallows a Section 197 deduction attributable to disqualified basis for purposes of determining tested income or loss by requiring that this deduction be “allocated and apportioned solely to residual CFC gross income.” Treas. Reg. § 1.951A-2(c)(5)(i).

5.d.8.5. Treas. Reg. § 1.951A-2(c)(5)(iii)(B) defines “residual CFC gross income” as “gross income other than gross tested income, gross income taken into account in determining Subpart F income, or gross income that is effectively connected, or treated as effectively connected, with the conduct of a trade or business in the United States (as described in § 1.882-4(a)(1)).”

5.d.8.6. The phrase “properly allocable to such gross income under rules similar to the rules of section 954(b)(5)” in Section 951A(c)(2)(A)(ii) requires that the rules of Section 954(b)(5) be applied when determining the extent to which a CFC's Section 197 deductions are taken into account in calculating tested income or loss.

5.d.8.7. The phrase “properly allocable” in Section 954(d)(5) has been interpreted for many years in regulations, case law, and administrative guidance to mean that there is a “factual relationship” between the deduction and the item of income.

5.d.8.8. If a similar “factual relationship” test were applied to the Section 197 deductions at issue in this case, those deductions would be allowed under Section 951A(c)(2)(A)(ii) because they are directly attributable to gross tested income.

5.d.8.9. Treasury and the IRS took the position that they are “not constrain[ed] . . . from taking into account other considerations in determining whether it is 'proper' for a certain item of expense to be allocated to, and therefore reduce, a particular item of gross income . . . and . . . are not required to issue rules that mechanically allocate an item of expense to gross income to which such expense factually relates if taxable income would be distorted by reason of such allocation.” T.D. 9866, 84 Fed. Reg. 29299.

5.d.8.10. If the Final Section 951A Regulations are valid, the increased basis that ALVE received in the Amortizable Intangibles pursuant to Sections 362(a) and 351(b) as a result of the ALVE Contribution is treated as disqualified basis, and any amortization of such basis under Section 197 would not reduce ALVE's gross tested income for purposes of Section 951A.

5.d.9. The Final Section 951A Regulations are Invalid. The Final Section 951A Regulations are invalid because they are contrary to the controlling statute.

5.d.9.1. The Final Section 951A Regulations are invalid under the APA because they have been promulgated in excess of statutory jurisdiction or authority, fail to reflect reasoned decision-making, and are arbitrary, capricious, an abuse of discretion, procedurally defective, or otherwise not in accordance with the law.

5.d.9.2. The Final Section 951A Regulations are invalid because they incorporated significant changes from the Proposed Regulations and were issued without an opportunity for pre-promulgation notice and comment, as required by the APA and Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29 (1983).

5.d.9.3. The Final Section 951A Regulations are invalid because they violate the general rule on retroactive rulemaking under the APA. Treas. Reg. § 1.951A-7 provides that the Final Section 951A Regulations apply to tax years of foreign corporations beginning after December 31, 2017 and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end. The Final Section 951A Regulations were published in June 2019.

5.d.9.4. IRS and Treasury provided no good cause for the retroactive effective date.

5.d.9.5. Because the Final Section 951A Regulations are invalid, Respondent erred by applying the Final Regulations to the ALVE Contribution.

5.d.10. Respondent also erred by raising in the alternative that certain transferred intangibles have no basis or that the basis is lower under Section 351 and the regulations thereunder or under substance over form, step transaction, business purpose, economic substance, sham transaction or other judicial doctrines. Respondent provided no explanation other than the foregoing boilerplate language.

5.d.11. For the foregoing reasons, when computing GILTI, Petitioner is entitled to take into account ALVE's Section 197 amortization deduction of $528,318,336, and Respondent erred in disallowing the deduction.

5.e. Allocation and Apportionment of Stewardship and Supportive Expenses Adjustments.

5.e.1. General — Section 861 Allocation and Apportionment. Sections 861 through 863, and regulations promulgated thereunder, establish a two-step process to allocate and apportion deductions to determine net income for certain Code sections, including Section 904(d) (foreign tax credit limitation).

5.e.1.1. First, taxpayers allocate deductions to “classes of gross income” (i.e., the gross income items (or item subdivisions) enumerated in Section 61) to which the deductions are “definitely related.” A deduction is definitely related to a class of gross income if it is “incurred as a result of, or incident to, an activity or in connection with property from which such class of gross income is derived.” Treas. Reg. § 1.861-8(b)(2).

5.e.1.2. Second, taxpayers apportion those deductions among “statutory” and “residual” groupings of gross income for the specific operative sections. Deductions allocated to classes of gross income consisting entirely of a single statutory grouping or the residual grouping, remain in those discrete groupings (i.e., they are not apportioned). See Temp. Treas. Reg. § 1.861-8T(c)(1). Deductions definitively related to a class of gross income included in one statutory grouping and the residual grouping must be apportioned between the statutory grouping and the residual grouping. Id.

5.e.1.3. The allocations and apportionments must be made on the basis of the factual relationship of deductions to gross income. Treas. Reg. § 1.861-8(a)(2); see also Temp. Treas. Reg. § 1.861-8T(c)(1).

5.e.2. Stewardship Expenses. Stewardship expenses, “which result from 'overseeing' functions undertaken for a corporation's own benefit as an investor in a related corporation, [are] considered definitely related and allocable to dividends received, or to be received, from the related corporation.” Treas. Reg. § 1.861-8(e)(4)(ii).

5.e.2.1. On December 17, 2019, Treasury issued proposed regulations (the “Proposed Stewardship Regulations”), seeking to alter post-TCJA stewardship expense apportionment rules. It concluded that stewardship expenses “are, at least in part, intended to protect the shareholder's capital investment and thus are factually related to the income that arises from the investment” and, therefore, allocable not to only to dividends, but also “inclusions under [S]ections 951 and 951A, [S]ection 78 dividends, and all amounts included under the passive foreign investment company provisions.” 84 FR 69124 (Dec. 17, 2019).

5.e.2.2. On November 12, 2020, Treasury issued final regulations (the “Final Stewardship Regulations”), substantially mirroring — but, also expanding — the Proposed Stewardship Regulations. The Final Stewardship Regulations clarify that all changes to expense allocation and apportionment rules would be effective for tax years beginning after December 31, 2019. See Treas. Dec. 9922 (Nov. 12, 2020).

5.e.3. Supportive Expenses. Supportive expenses, “such as overhead, general and administrative, and supervisory expenses[ ] may relate to other deductions which can more readily be allocated to gross income.” Treas. Reg. § 1.861-8(b)(3). It is “equally acceptable to attribute supportive deductions on some reasonable basis directly to activities or property which generate, have generated or could reasonably be expected to generate gross income. This would ordinarily be accomplished by allocating the supportive expenses to all gross income or to another broad class of gross income and apportioning the expenses” pursuant to general apportionment methodologies. Id.

5.e.4. Petitioner's Stewardship and Supportive Expenses Allocation and Apportionment. Petitioner allocated and apportioned its stewardship and supportive expenses in several steps.

5.e.4.1. First, it identified stewardship expenses under Treas. Reg. § 1.861-8(e)(4)(ii) from a larger pool of Abbott US's selling, general, and administrative expenses (“SG&A”).

5.e.4.2. Second, it apportioned those expenses to general U.S. and foreign income groupings based on a U.S. to foreign sales ratio.

5.e.4.3. Third, it directly allocated all stewardship expenses to a Section 245A subgroup based on Treas. Reg. § 1.861-8(e)(4)(ii)'s directive that stewardship expenses are “considered definitely related and allocable to dividends received, or to be received, from the related corporation.”

5.e.4.4. Fourth, it identified supportive expenses from corporate administrative, treasury-related, financial reporting, legal, and other costs in its SG&A pool and apportioned those expenses to all items of gross income under Treas. Reg. § 1.861-8(b)(3).

5.e.5. Respondent's Erroneous Adjustments.

5.e.5.1. Stewardship Expenses.

5.e.5.1.a. Respondent applied either the Proposed Stewardship Regulations or the Final Stewardship Regulations. Neither, however, supplies the operative standard for 2019. The Proposed Stewardship Regulations are non-binding, and the Final Stewardship Regulations do not apply by their terms. See Treas. Reg. § 1.861-8(h)(2).

5.0.5.1.b. To the extent that Respondent applied the Final Stewardship Regulations, Respondent also incorrectly applied those regulations. Those regulations require stewardship expenses to be “apportioned between the statutory and residual groupings based on the relative values of the entity or entities in each grouping that are owned by the investor taxpayer.” Treas. Reg. § 1.861-8(e)(4)(2)(C). Respondent's apportionment, however, undervalued Abbott's US entities, resulting in an over-apportionment to foreign income statutory groupings.

5.e.5.1.c. Petitioner applied Treasury Regulations applicable for 2019, appropriately allocating all stewardship expenses to a Section 245A subgroup based on Treas. Reg. § 1.861-8(e)(4)(ii)'s directive that stewardship expenses are “considered definitely related and allocable to dividends received, or to be received, from the related corporation.”

5.e.5.2. Supportive Expenses.

5.e.5.2.a. Respondent erroneously added to Petitioner's supportive expense pool expenses that are not “supportive in nature” (i.e., not properly characterized as overhead, general and administrative, and supervisory expenses), including various divisional and “other manufacturing” costs.

5.e.5.2.b. Respondent then incorrectly “allocate[d]” supportive expenses to U.S. and foreign income as the first step in its allocation and apportionment methodology. U.S. and foreign income are not “classes of gross income” (i.e., gross income items (or item subdivisions) enumerated in Section 61) upon which expenses are allocated under Section 861.

5.e.5.2.c. Alternatively, Respondent's primary allocation is, in substance, the first tier in a two-tiered apportionment methodology that is contrary to applicable Treasury Regulations, distortive, and reflects no rational relationship between the supportive expenses and the income derived from those expenses. Respondent's primary U.S.-OUS sales-based apportionment methodology, used to arbitrarily attribute supportive expenses to foreign statutory groupings and the U.S. residual grouping, is at odds with its secondary gross income-based apportionment methodology, used to apportion the supportive expenses among foreign statutory groupings.

5.e.5.2.d. Petitioner appropriately allocated supportive expenses to all items of gross income and then appropriately apportioned supportive expenses to all items of gross income attributable to statutory groupings. See Treas. Reg. § 1.861-8(b)(3); Temp. Treas. Reg. § 1.861-8T(c)(1). This method aligns with Treasury's default approach for apportioning supportive expenses, using gross income as the proper expense apportionment matrix, and reflects that Petitioner's various supportive expenses contributed to its gross income generated from worldwide operations.

5.f. DASTM Adjustments.

5.f.1. Petitioner's Argentinian Business. In 2019, Petitioner conducted business in Argentina primarily through four CFCs: (1) Abbott Laboratories Argentina, S.A., (2) Atlas Farmaceutica S.A., (3) Laboratorio Internacional Argentino S.A., and (4) St. Jude Medical Argentina S.A. (collectively, the “Argentine CFCs”).

5.f.2. Hyperinflationary Currency. In 2019, Argentina's local currency, the Argentine peso, became “hyperinflationary” as defined in Treas. Reg. § 1.985-1(b)(2)(ii)(D).

5.f.2.1. As a result, Petitioner was required to change its Argentine CFCs' functional currency from the Argentine peso to the U.S. dollar and apply DASTM under Treas. Reg. § 1.985-3, making any necessary adjustments under Treas. Reg. § 1.985-7.

5.f.3. DASTM Adjustments. Petitioner made two required adjustments under Treas. Reg. § 1.985-7 for its Argentine CFCs: (1) an adjustment impacting Petitioner's Section 965(a) inclusion (the “Section 965 Adjustment”), and (2) an adjustment impacting Petitioner's Section 951A GILTI inclusion (the “GILTI Adjustment,” and, together with the Section 965 Adjustment, the “DASTM Adjustments”).

5.f.3.1. Section 965 Adjustment. Under Treas. Reg. § 1.985-7, Petitioner reduced its Subpart F income, for purposes of Section 965(a), by $6,633,656 — i.e., one-fourth of the total Section 965 Adjustment of $26,534,624, to be taken rateably into income over a four year period under Treas. Reg. § 1.985-7(c)(1).

5.f.3.2. GILTI Adjustment. Under Treas. Reg. § 1.985-7, Petitioner reduced its GILTI, for purposes of Section 951A by $31,814,525 — i.e., one-fourth of the total GILTI Adjustment of $127,258,101, to be taken rateably into income over a four year period under Treas. Reg. § 1.985-7(c)(1).

5.f.4. Respondent's Erroneous Adjustments. Respondent incorrectly reversed the DASTM Adjustments. First, Respondent erroneously determined that Petitioner's Section 965(a) inclusion was not Subpart F income, notwithstanding that Section 965 cross-references Subpart F and provides that taxpayers' “subpart F income shall be increased” by the relevant inclusion. Second, Respondent erroneously determined that the GILTI Adjustment was not an adjustment specified in Treas. Reg. § 1.985-7(c), which ignored both Section 951A(f)(1)(B)'s express terms and case law permitting taxpayers to interpret outdated regulations based on the current statutory framework.

5.g. Section 988 Adjustment.

5.g.1. ALVE's Payables and Hedges. During 2019, ALVE, a CFC whose functional currency under Section 985 was the EUR, had two U.S. dollar-denominated intercompany loan payables (the “Payables”). ALVE hedged its Payables' foreign currency exposure with forward contracts to purchase U.S. dollars (the “Hedges”).

5.g.2. Section 988 Transactions. Under Section 988, taxpayers are required to recognize foreign currency exchange gain or loss for certain transactions involving nonfunctional currency, including acquiring or becoming the obligor under a debt instrument denominated in a nonfunctional currency (“Nonfunctional Currency Debt Instruments”) or entering into or acquiring any forward contract, futures contract, option, or similar financial instrument determined by reference to a nonfunctional currency (“Nonfunctional Currency Financial Instruments”).

5.g.2.1. Payables. ALVE was a Euro-functional entity and, therefore, the Payables, as U.S. dollar-denominated debt instruments, were Nonfunctional Currency Debt Instruments in ALVE's hands. Accordingly, ALVE was required to calculate its foreign currency exchange gain or loss for the Payables' interest and principal payments under Section 988 and the regulations promulgated thereunder.

5.g.2.2. Hedges. Because ALVE was a Euro functional taxpayer, the Hedges, as forward contracts to purchase U.S. dollars, were Nonfunctional Currency Financial Instruments in ALVE's hands. Accordingly, ALVE was required to calculate its foreign currency exchange gain or loss for payments on the Hedges under Section 988 and the regulations promulgated thereunder.

5.g.3. Foreign Currency Mark-to-Market Accounting Method. Instead of applying the general realization and recognition rules applicable to Section 988 transactions, ALVE elected to apply the foreign currency mark-to-market accounting method under Prop. Treas. Reg. § 1.988-7 for all of its Section 988 transactions, including the Payables and Hedges.

5.g.4. Subpart F. A U.S. shareholder's Subpart F income includes foreign base company income, which, in turn, includes foreign personal holding company income (“FPHCI”). Sections 952(a), 954(a)(1). FPHCI generally includes the entire excess of Section 988 foreign currency gains over foreign currency losses. In the case of foreign currency gain or loss arising from (1) interest-bearing liabilities, and (2) “bona fide hedging transactions” entered into by the CFC that manage exchange rate risk for interest-bearing liabilities, however, some or even all of such gain or loss may be excluded from FPHCI and, therefore, Subpart F. A special rule treats such gain or loss as Subpart F income and non-Subpart F income in the same manner that interest expense associated with the liability would be allocated and apportioned between Subpart F income and non-Subpart F income under Treas. Reg. §§ 1.861-9T and 1.861-12T (the “Special Rule”). Treas. Reg. § 1.954-2(g)(2)(iii); Prop. Treas. Reg. § 1.954-2(g)(2)(iii).

5.g.4.1. The Payables were interest-bearing liabilities and, therefore, subject to Treas. Reg. § 1.954-2(g)(2)(iii).

5.g.4.2. The Hedges were “bona fide hedging transactions” of interest-bearing liabilities (i.e., the Payables) and, therefore, subject to Prop. Treas. Reg. § 1.954-2(g)(2)(iii).

5.g.5. GILTI. Under Section 951A, “tested income” for purposes of computing a U.S. shareholder's GILTI includes the CFC's gross income (determined without regard to Subpart F income and certain other income) minus attributable expenses. Section 951A(c)(2)(A)(i). Accordingly, the net Section 988 gains that are excluded from Subpart F under the Special Rule would be included in tested income.

5.g.6. Form 1120.

5.g.6.1. On its 2019 Form 1120, Petitioner incorrectly reported its Section 988 gains from the Hedges as EUR 49,627,549. The correct Section 988 gain is EUR 61,528,485 (a difference of EUR 11,900,936).

5.g.6.2. Petitioner correctly reported its total net Section 988 gain (EUR 26,296,044).

5.g.7. Subpart F Adjustment. Abbott's FPHCI percentage is 0.35411 percent. Under Prop. Treas. Reg. § 1.954-2(g)(2)(iii), the difference in Section 988 gain of EUR 11,900,936 results in additional Subpart F income of EUR 42,142 (EUR 11,900,936 multiplied by 0.35411 percent).

5.g.8. No Tested Income Adjustment. The remaining EUR 11,858,794 (i.e., EUR 11,900,936 minus EUR 42,142) is not automatically included as tested income. Only the net Section 988 gain generates tested income subject to GILTI. Petitioner correctly reported its net Section 988 gain of EUR 26,296,044. The increase to Subpart F income is offset by a commensurate decrease in GILTI tested income. Because Petitioner reported on its Form 1120 EUR 42,142 as tested income subject to GILTI, it correspondingly overstated its tested income by the same amount.

5.g.9. Respondent's Erroneous Adjustments. Respondent misconstrued Petitioner's corrected position, erroneously concluding that Petitioner's additional Section 988 gain should increase Petitioner's tested income by EUR 11,858,794 ($13,316,536). As noted above, only the net Section 988 gain (EUR 42,142) generates tested income subject to GILTI. And because Petitioner reported on its Form 1120 EUR 42,142 as tested income subject to GILTI, it correspondingly overstated its tested income by the same amount.

5.h. Foreign Derived Deduction Eligible Income Adjustment.

5.h.1. FDII. Section 250 provides a 37.5 percent deduction against a domestic corporation's FDII for tax years beginning after December 31, 2017, and before January 1, 2026. A domestic corporation's FDII equals an amount which bears the same ratio to its “deemed intangible income” (“DII”) as its FDDEI bears to its DEI.

5.h.1.1. DEI. A domestic corporation's DEI is its gross income with certain exclusions (i.e., its “gross DEI”), reduced by deductions “properly allocable” to that gross income. Section 250(b)(3). Gross DEI is comprised of “gross FDDEI” and “gross RDEI” (originally referred to as “gross non-FDDEI”).

5.h.1.2. Gross FDDEI. A domestic corporation's gross FDDEI equals its DEI derived in connection with: (1) property sold by the taxpayer to any person who is not a U.S. person that the taxpayer establishes is for a foreign use, and (2) services provided by the taxpayer which the taxpayer establishes are provided to any person, or with respect to property, not located within the U.S. Section 250(b)(4); Treas. Reg. § 1.250(b)-1(c)(16); Prop. Treas. Reg. § 1.250(b)-1(c)(15).

5.h.1.3. Gross RDEI. A domestic corporation's gross RDEI is the corporation's gross DEI that is not gross FDDEI. Treas. Reg.§ 1.250(b)-1(c)(14).

5.h.1.4. FDDEI. A domestic corporation's FDDEI is its gross FDDEI over the deductions “properly allocable” to that gross FDDEI. Treas. Reg. § 1.250(b)-1(c)(12).

5.h.1.5. DII. A domestic corporation's DII equals its DEI less a deemed 10 percent return on its tangible assets. Section 250(b)(2).

5.h.2. Expense Allocation and Apportionment Mechanics. For tax years beginning before 2021, taxpayers could choose to apply final regulations under Section 250 issued in 2020, which directed taxpayers to allocate and apportion deductions for purposes of computing DEI in a manner consistent with Treas. Reg. §§ 1.861-8 through 1.861-14T and 1.861-17 (the “Section 861 regulations”) or rely on Prop. Treas. Reg. § 1.250(b)-1(d)(2) (which incorporated the same rules for allocating and apportioning deductions under the Section 861 regulations). Under Section 861, allocations and apportionments must be “made on the basis of the factual relationship of deductions to gross income.” Treas. Reg. § 1.861-8(a)(2).

5.h.3. Petitioner's Deferred Compensation. Prior to 2018, Petitioner granted to its employees restricted and non-qualified stock options and certain pension rights for services performed and income generated during the pre-2018 periods.

5.h.4. DCE. In 2019, Petitioner incurred $986,603,455 of DCE. In computing its DEI, Petitioner did not allocate to DEI $472,481,163 of DCE related to restricted stock options, non-qualified stock options, or pension rights granted prior to 2018 (collectively, “Pre-2018 DCE”).

5.h.5. No Factual Nexus to Gross Income in 2019. Petitioner's Pre-2018 DCE has no factual relationship to gross income in 2019. The Pre-2018 DCE factually relates to, and should be allocated and apportioned based on, Pre-2018 DCE-related activities generating gross income in pre-2018 years. Because Section 250 did not exist prior to 2018, income from those activities earned in pre-2018 years cannot be characterized as gross FDDEI or gross RDEI.

5.h.6. Return Position. Consistent with the Section 861 regulations, and in the absence of any other relevant guidance, Petitioner properly apportioned the Pre-2018 DCE deductions to non-DEI (i.e., the residual grouping of income excluded from gross DEI). See Gottesman v. Commissioner, 77 T.C. 1149, 1157 (1981) (Court could not “fault [taxpayer] for not knowing what the law was in this area when the Commissioner, charged by Congress to announce the law . . . never decided what it was himself.”).

5.h.7. Respondent's Erroneous Adjustments. Respondent allocated and apportioned Petitioner's total DCE to FDDEI and RDEI, erroneously severing the factual nexus between those deductions and the gross income they generated. Petitioner's return position appropriately maintained this factual relationship.

5.i. Meals and Entertainment Expenses Adjustment.

5.i.1. Section 162. Under Section 162, taxpayers may deduct expenses related to travel, transportation, and meals that are ordinary and necessary, reasonable in amount, and paid or incurred in pursuit of a trade or business.

5.i.2. Substantiation. Under Section 274(d), taxpayers must substantiate certain travel and meals expenses with “adequate records or by sufficient evidence corroborating the taxpayer's own statement,” for the following items: (1) the amount of the expense, (2) the time and place of the travel, (3) the business purpose of the expense, and (4) the business relationship to the taxpayer of the person receiving the benefit.

5.i.3. Petitioner's Meals, Entertainment, and Travel Expenses. In 2019, Petitioner incurred $260,430,575 in travel, meals, and entertainment (“TM&E”) expenses. On its 2019 Form 1120, Abbott reduced its TM&E expenses amount by $42,465,629 for expenses related to non-deductible meals and entertainment, claiming a net deduction of $217,964,946.

5.i.4. Petitioner's TM&E Expenses Substantiation. Pursuant to Petitioner's Travel, Entertainment and Other Employee Business Expenses Policy, Petitioner's employees prepared expense reports with receipts for reimbursed TM&E expenses. Those reports and receipts include all relevant information required under Section 274(d).

5.i.5. For 2019, Petitioner has properly substantiated $218,136,062 in expenses related to travel and meals, which exceeds Petitioner's claimed Section 162 deduction for travel and meal expenses by $171,116. Accordingly, Petitioner is entitled to additional Section 162 deductions of $171,116, and to corresponding credits or a refund for any resulting overpayment of income tax.

5.i.6. Respondent's Erroneous Adjustments. Respondent incorrectly determined, without reviewing Petitioner's supportive reports and receipts, that Petitioner could not substantiate its TM&E expenses.

5.j. Carryover Adjustments.

5.j.1. 2017 and 2018 Tax Years Exam. On May 9, 2017 and May 15, 2018, Respondent began a CAP examination of Petitioner's taxable years ended December 31, 2017 (“2017”) and December 31, 2018 (“2018”), respectively.

5.j.2. Forms 870. On January 9, 2023, Petitioner executed Forms 870, “Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment,” consenting to the immediate assessment and collection of tax for 2017 and 2018. The Forms 870 acknowledged that Petitioner will be unable to “contest th[o]se years in the United States Tax Court, unless additional deficiencies are determined for th[o]se years.”

5.j.3. 2017 and 2018 Tax Years Examination Status. As of the date of this Petition, Respondent continues to audit Petitioner's 2017 and 2018 tax years.

5.j.4. Premature Adjustments. Respondent's carryover adjustments are premature and Petitioner has never “agreed to” the adjustments “as part of the 2017/2018 exam.” Accordingly, Respondent's adjustments are erroneous.

5.k. Computational Matters. Respondent erred in all other correlative and computational adjustments that affect income, taxes, and credits included in the Notice. Those adjustments are erroneous for the same reasons articulated in paragraph 5, above.

5.l. Disallowed Claim — Section 482 Adjustment.

5.l.1. Petitioner's True-Up Adjustments. Petitioner reports Section 482 true-up adjustments — reconciling its financial books and records prepared under generally accepted accounting principles (“GAAP books”) with its Form 1120 return positions — through Schedule M-1 adjustments.

5.l.2. GAAP Books True-Up. Before filing its 2019 Form 1120, Petitioner recorded a true-up adjustment in its GAAP books related to 2019 controlled transactions between ADC US and ALVE. The adjustment resulted in $23,445,535 in additional income for ADC US and a commensurate increase in expenses for ALVE.

5.l.3. Petitioner's 2019 Form 1120. As a result, Petitioner should have reported a 2019 Schedule M-1 adjustment increasing ADC US's taxable income by $23,445,535 and reducing ALVE's income by the same amount. Instead, Petitioner mistakenly reported a $46,445,684 increase in ADC US's taxable income and a commensurate reduction in ALVE's income.

5.l.4. Petitioner's Informal Claim. On November 22, 2022, Petitioner appropriately filed an informal claim correcting its scrivener's error, decreasing ADC US's taxable income and increasing ALVE's income by $23,000,149, respectively.

5.l.5. Notice Disallowance. Respondent disallowed Petitioner's informal claim, incorrectly concluding that the claim was an impermissible affirmative use of Section 482. Petitioner was not affirmatively using Section 482; it was correcting a scrivener's error.

5.l.6. Alternative Setoff. Alternatively, Petitioner's informal claim appropriately requests a setoff under Treas. Reg. § 1.482-1(g)(4).

5.m. Affirmative Claim — Meals and Entertainment Expenses Adjustment.

5.m.1. The allegations in paragraphs 5.i though 5.i.6, above, are incorporated herein by reference.

5.m.2. Petitioner is entitled to a refund resulting from additional Section 162 travel and meals expense deductions of $171,116.

5.n. Affirmative Claim — Section 965 Invalidity.

5.n.1. Contingent Claim. Petitioner's affirmative claim is contingent on favorable, final resolution of Moore v. U.S., Dkt. 22-800, which is currently pending in the United States Supreme Court.

5.n.2. The MRT. The TCJA included the MRT under Section 965(a) to offset other tax benefits granted to U.S. corporations. The MRT modified Subpart F by classifying CFC earnings after 1986 as income taxable in the CFC's last year beginning before January 1, 2018. Section 965(a), (d). Under the Subpart F revision, U.S. persons owning at least 10 percent of a CFC are taxed on the CFC's profits after 1986 at either 15.5 percent for earnings held in cash or 8 percent otherwise. Section 965(c). The MRT imposes this tax regardless of whether the CFC distributed earnings.

5.n.3. Sixteenth Amendment. The Sixteenth Amendment to the U.S. Constitution provides: “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

5.n.4. Supreme Court Precedent. Beginning with Eisner v. Macomber, 252 U.S. 189 (1920), the Supreme Court has uniformly held “income,” for Sixteenth Amendment purposes, requires realization by the taxpayer.

5.n.5. The MRT Abandons Settled Law. The MRT abandons the Sixteenth Amendment's realization requirement and disregards Macomber. The MRT is, therefore, constitutionally invalid.

5.n.6. Petitioner's Section 965(a) Payment.

5.n.6.1. Petitioner made an MRT payment for 2017 in the amount of $25,123,328.

5.n.6.2. Petitioner elected on its 2018 Form 1120 to pay its MRT for that tax year in installments under Section 965(h). For 2018 and 2019, Petitioner paid 8 percent ($89,517,455 in each tax year) in annual installments.

5.n.7. Affirmative Claim. Petitioner is entitled to a refund of its 2019 MRT installment and correlative and corresponding adjustments totaling $84,614,234.

5.o. Protective Claim — CRA Adjustments.

5.o.1. On December 18, 2023, the CRA issued to Abbott Canada a reassessment of CAD 13,555,155 in Canadian taxes for Abbott Canada's 2019 tax year. The CRA's reassessment is based on its determination that Abbott Canada did not earn adequate returns on its sales of products that it purchased from related parties (including Abbott).

5.o.2. On December 18, 2023, Abbott submitted to Respondent a dual protective claim and treaty notification pursuant to Rev. Proc. 2015-40, §§ 11 and 12, and Articles IX and XXVI of the U.S.-Canada Income Tax Treaty, preserving its rights to seek a refund related to the CRA's reassessment and Competent Authority assistance through the U.S.-Canada Income Tax Treaty's mutual agreement procedures.

5.o.3. If the CRA's reassessment is upheld, in whole or in part, Petitioner may be entitled to correlative and corresponding adjustments.

WHEREFORE, Petitioner requests that this Court hear this case and determine that: (1) the deficiencies asserted by Respondent for Petitioner's 2019 tax year are erroneous, (2) there are no deficiencies in Petitioner's income tax for 2019, and (3) Petitioner is entitled to a refund for 2019 in amounts set forth in its claims. Petitioner further requests that this Court grant such other and further relief as this Court deems just and proper.

Dated: December 22, 2023

Respectfully submitted,

ROBERT H. ALBARAL
Counsel for Petitioner
Tax Court Bar No. AR0375
Baker & McKenzie LLP
1900 N. Pearl St., Suite 1500
Dallas, TX 75201
Telephone: (214) 978-3044
Robert.Albaral@bakermckenzie.com

GARY B. WILCOX
Counsel for Petitioner
Tax Court Bar No. WG0363
Mayer Brown LLP
1999 K Street, N.W.
Washington, DC 20006
Telephone: (202) 263-3399
GWilcox@mayerbrown.com

DANIEL A. ROSEN
Counsel for Petitioner
Tax Court Bar No. RD0473
Baker & McKenzie LLP
452 Fifth Avenue
New York, NY 10018
Telephone: (212) 626-4272
Daniel.Rosen@bakermckenzie.com

THOMAS L. KITTLE-KAMP
Counsel for Petitioner
Tax Court Bar No. KT0200
Mayer Brown LLP
71 S. Wacker Drive
Chicago, IL 60606
Telephone: (312) 701-7028
TKittleKamp@mayerbrown.com

BRENDAN SPONHEIMER
Counsel for Petitioner
Tax Court Bar No. SB0492
Baker & McKenzie LLP
452 Fifth Avenue
New York, NY 10018
Telephone: (212) 626-4435
Brendan.Sponheimer@bakermckenzie.com

JENNY A. AUSTIN
Counsel for Petitioner
Tax Court Bar No. AJ0616
Mayer Brown LLP
71 S. Wacker Drive
Chicago, IL 60606
Telephone: (312) 701-7140
JAustin@mayerbrown.com

CARLTON TARPLEY
Counsel for Petitioner
Tax Court Bar No. TC23712
Baker & McKenzie LLP
452 Fifth Avenue
New York, NY 10018
Telephone: (212) 626-4498
Carlton.Tarpley@bakermckenzie.com

MORGAN M. DEPAGTER
Counsel for Petitioner
T.C. Bar No. DM23691
Mayer Brown LLP
71 S. Wacker Drive
Chicago, IL 60606
Telephone: (312) 701-7941
MDePagter@mayerbrown.com

FOOTNOTES

1Abbott US wholly owns Abbott International, LLC (“AILLC”), a U.S. limited liability company that is disregarded for U.S. federal income tax purposes. We refer to Abbott US and AILLC collectively as Abbott US. The text will note whether an entity is disregarded for U.S. federal income tax purposes. Unless an entity is identified as a disregarded entity, it is a regarded entity for U.S. federal income tax purposes.

2Respondent's Notice includes The United States Court of Appeals for the Ninth Circuit's reversal of Altera, 926 F.3d 1061 (9th Cir. 2019), does not control here. See paragraph 5.c.9.9, below. taxed income under Section 951A (“GILTI”), based on an application of Treas. Reg. § 1.951A-2(c)(5).s, in the upper-right hand corner of its Form 4549-A and -B, Report of Income Tax Examination Changes, a pagination range purporting to encompass 84 pages. However, the Form 4549-A and -B is only seven pages and the entire Notice is only 35 pages.

3All references to “Section” or “Code” refer to the Internal Revenue Code of 1986, as amended, or the regulations thereunder issued by the U.S. Department of the Treasury (“Treasury”), as appropriate.

4Unless stated otherwise, all references to ALVE include Abbott Ireland (“AIB”), an entity disregarded from ALVE for U.S. federal income tax purposes, which performed manufacturing and related activities.

5The United States Court of Appeals for the Ninth Circuit's reversal of Altera, 926 F.3d 1061 (9th Cir. 2019), does not control here. See paragraph 5.c.9.9, below. taxed income under Section 951A (“GILTI”), based on an application of Treas. Reg. § 1.951A-2(c)(5).

6These regulations were later redesignated as Treas. Reg. § 1.482-7A(d)(2). possession any written contract between unrelated parties in a cost sharing arrangement that provided that one party was to pay or reimburse the other party for amounts attributable to stock-based compensation, and (3) did not have any evidence of any actual transaction between unrelated parties in a cost sharing arrangement in which one party paid or reimbursed the other party for amounts attributable to stock-based compensation.

END FOOTNOTES

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