Landmark Transfer Pricing tax suit – Coca-Cola vs the U.S. IRS

The lawsuit is drawing loads of eyeballs since it could set a precedent for MNCs over their transfer pricing mechanism.

In a lawsuit, closely watched by tax experts, that marks a growing signs of tension between the U.S. Internal Revenue Service with multinationals over transfer pricing, soft drink giant Coca-Cola’s case against the IRS has all the hallmarks of a landmark suit.

Coca-Cola Co’s thought it had a deal with the IRS as to how much the company charged foreign affiliates for the rights to make and sell Coke products abroad, in September 2015, it received a bill of $3.3 billion from the IRS, which stunned it and it was caught completely off-guard.

Disputing the bill, Coca-Cola sued the IRS and since then case has been moving from court to court and has now landed in the U.S. Tax Court in Washington. A verdict is expected in mid-April.

The position the IRS has taken is that the royalties charged by Coca-Cola to several foreign affiliates from 2007 to 2009 were very low; this impacts its U.S. tax profile since it reduces the parent company’s U.S. income and resulted in underpayment of its U.S. income taxes by $3.3 billion.

The suit is gathering interests from tax experts since the verdict could set a precedent for MNCs who change the way they value their goods, services, patent rights, trademarks as they move among foreign units national boundaries.

In this context, transfer pricing is coming under close scrutiny by tax agencies worldwide because of the new global standards that are very strict, which raises the legal risks of investors and companies, alike.

Incidentally, last Friday the IRS reported that it had received 101 applications in 2017 for “advance pricing agreements” (APAs); this is similar to 2016’s level of 98 applications but well below 2015’s peak of 183.

Anecdotal evidence suggests the APA process, designed to prevent conflict, is under strain in many countries, with some tax lawyers citing Mexico, Italy and China as challenging.

“We’re really living in a different time and we can understand why tax authorities might be reluctant because there’s a lot more external scrutiny than there ever was,” said Amy Roberti, director of global tax and fiscal policy for Procter & Gamble Co.

Transfer Pricing – the beast is in the details

In 2016, under a Base Erosion and Profit Shifting framework set up by the Organization for Economic Cooperation and Development (OECD), 100 national tax agencies, including the IRS, agreed to use the “arm’s length” approach for arriving at the value of transfer pricing.

In the case of trademarks rights, for instance, this means that MNCs should charge royalties to their foreign units equal to their open market value. The problem is that, trademarks are typically unique, thus how does one approximate their “arm’s length” price?

To settle this discord, Coca-Cola said, in court filings, the IRS had approved the its method for setting its transfer prices for its affiliates in an agreement dated 1996. However the IRS has withdrawn the agreement and has instead submitted a bill for back taxes.

Although Coca-Cola did not have an APA with the IRS, it had an APA-like “audit closing agreement” that dates back to 1996 and which it claims was re-affirmed in later audits.

However, much has changed in transfer pricing over the years.

“It’s an interesting case,” said Steven Miller, a former IRS Acting Commissioner. “If I were a tax director, I would be thinking about how much I can rely on agreements like this. It does drive home how important it is not to just assume that an agreement can be relied on forever because apparently, maybe not”.

Miller, is now the national director of Alliantgroup, a tax consultancy firm.

Categories: Creativity, Economy & Finance, Entrepreneurship, HR & Organization, Regulations & Legal, Strategy

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