The Internal Revenue Service (IRS) won a high-profile $3.3 billion transfer-pricing case on Nov. 18, 2020, in the U.S. Tax Court. In The Coca-Cola Co. v. Commissioner, 155 T.C. No. 10 (2020), the Tax Court held that the IRS did not abuse its discretion by reallocating royalty income to Coca-Cola U.S. from foreign subsidiaries.
The case involves a 2015 IRS notice of deficiency contending that Coca-Cola’s foreign subsidiaries should have paid $9.4 billion in additional royalties during the 2007-2009 tax years for rights to Coca-Cola U.S.’s trademarks and product formulas.
The IRS saw Coca-Cola’s foreign subsidiaries (labeled “Supply Points”) as less complex entities (fewer functions performed, risks assumed and assets employed among other factors) who were provided access to Coca Cola’s proprietary formulas and developed brands from Coca-Cola U.S.’s headquarters without corresponding compensation consistent with the arm’s length standard. This represented a divergence from a previous closing agreement between Coca-Cola and the IRS that covered tax years 1987 to 1995.
The IRS treated the foreign Supply Points as less complex tested parties in a Comparable Profits Method (CPM) analysis – limiting their profitability and determining that the residual profit should return to Coca-Cola’s U.S. headquarters (and be taxed accordingly). Coca-Cola argued that the foreign Supply Points bore significant functions, risks and assets – especially in relation to marketing – which drove profitability. Coca-Cola developed methodologies consistent with their described complexity of the foreign operations and generally consistent with the decades old agreement, with residual profit flowing accordingly.
The Tax Court was unmoved and, on some points, a bit unnerved by Coca-Cola’s arguments, ultimately holding that the IRS’s position was appropriate. There is much to unpack with the Coca-Cola decision, and the case could certainly continue if appealed, however, multinational companies of all sizes should take note of the results and be prepared to produce transfer-pricing support accordingly – regardless of previous agreements.