The Tax Court Ruling Raising Coca-Cola’s Tax Bill to More Than $3 Billion and its Implications for Your Related Party Transactions

In a not so common outcome, on November 18, 2020 the US Tax Court upheld two Internal Revenue Service (“IRS”) adjustments that increased Coca-Cola Company’s (“Coca-Cola”) 2007-2009 taxable income by more than $9 billion and resulting in a tax bill of more than $3 billion. The IRS successfully challenged Coca-Cola’s transfer pricing methodology, specifically the intercompany arrangement between Coca-Cola and its foreign related party supply entities, which had the effect of undervaluing the intellectual property (“IP”) developed by Coca-Cola.

Judge Albert Lauber’s November 18, 2020 opinion summarizes the IRS’s interest in the case by asking why the foreign supply points were more profitable than Coca-Cola when it owns the intellectual property related to the product being sold.

In 1996 Coca-Cola and the IRS reached an agreement in an audit closing under which the supply points would be compensated for taxable years 1987–95 using a formulary approach, providing the supply points a 10 percent return on sales and allocating the remaining profits 50/50 between the supply points and Coca-Cola in the U.S. Coca-Cola applied the 10-50-50 method for all the years after the settlement period through 2006 and the I.R.S. accepted each and every year. After a five-year audit, the IRS issued a “notice of deficiency” in 2015 taking issue with the formulary approach.

Key Takeaways

I. The Coca-Cola case sets a precedent for transfer pricing audits of multinational groups with subsidiaries earning “excessive” profits. Notably, there is no rule for determining when profits become excessive.

II. An intercompany pricing policy accepted by the IRS in a prior year audit is no guarantee that the policy will be accepted in future audits. In short, the decision in this case signals to taxpayers that the IRS may challenge longstanding transfer pricing approaches and methods in the U.S. Tax Court and win.

III. This legal precedent may embolden the IRS to seek transfer pricing adjustments based on assessments of the relative profitability of group members.

Action Items for Multinational Taxpayers

The implications of the Coca-Cola transfer pricing case are particularly salient in times characterized by an economic downturn and decrease in the national tax base, including the present era as global economies continue to feel the impact of the Covid-19 pandemic. More than 30 percent of global trade is among related parties, which contributes to tax authorities’ interest in reviewing related party transactions.

I. An annual and short to medium-term review of the group level financials is highly recommended, particularly with respect to intercompany arrangements including licensing, loans, high volume sales, and strategic services.

II. We are recommending to taxpayers with crossborder related party transactions to evaluate their transfer pricing regimes and consult with transfer pricing professionals – both to (i) optimize their intercompany policies for the tax attributes available in various jurisdictions and (ii) help minimize the increasing level of audit risk related to transfer pricing.

III. We are recommending that taxpayers with crossborder related party transactions adopt and implement an intercompany agreement clearly indicating the functions performed, assets to be used, and risks to be assumed by each party. If the taxpayer already has an intercompany agreement, we recommend a review of the alignment of the functions performed by the parties, especially if the agreements are old and have not been recently updated. Aligning functions and legal agreements is a critical component to a strong transfer pricing regime.

Marcum’s Transfer Pricing team can assist in all matters related to transfer pricing consulting and compliance. If you have any questions about your transfer pricing strategy, contact your Marcum representative today.