Coca-Cola Fights $9.4 Billion Transfer Pricing Adjustment

Dec. 14 — The Coca-Cola Co. filed a petition in U.S. Tax Court challenging a proposed $9.4 billion income adjustment related to the company’s transfer pricing for tax years 2007-09 (Coca-Cola Co. v. Commissioner, T.C., petition filed, 12/14/15).

If the adjustment is sustained, the company could face a tax bill of as much as $3.3 billion, not including interest.
According to the Dec. 14 petition, the Internal Revenue Service claims Coca-Cola undercharged seven foreign affiliates for intellectual property—including trademarks and formulas—used in the production and sale of Coca-Cola concentrates abroad.

Coca-Cola also is challenging proposed reductions in foreign tax credits for taxes paid or accrued to its licensee in Mexico, as well as other income allocations and correlative adjustments related to an affiliate in Canada.

‘Without Merit.’

Petro Kacur, media relations director for Coca-Cola, told Bloomberg BNA that the company thinks the proposed income tax assessments are “without merit.”

“We have followed the same methodology for determining our U.S. taxable income from certain foreign company operations for nearly 30 years,” Kacur said in a Dec. 14 e-mail. “The IRS formally agreed to this methodology for the Company’s 1987-1995 tax years and subsequently approved the methodology during five successive audits through tax year 2006. We disagree with the IRS’ effort to depart from this long-standing practice in order to increase substantially the amount of U.S. tax.”

The case apparently involves an issue that the IRS is eager to see adjudicated. In a filing with the Securities and Exchange Commission earlier this year, Coca-Cola said the agency had designated the case for litigation, thus precluding the company from pursuing administrative settlement through the IRS Office of Appeals or through the agency’s Advance Pricing and Mutual Agreement program.

Pricing Method in Dispute

The foreign licensees are located in Ireland, Swaziland, Brazil, Mexico, Chile, Costa Rica and Egypt. They produce concentrates for sale to bottlers of Coca-Cola beverages in their respective markets, funding all or most of the expenses they incurred for operations, marketing, research and development, and quality assurance, according to the petition.

A central issue in the dispute is whether the IRS properly relied on the comparable profits method (CPM) to allocate routine returns to the foreign licensees. Coca-Cola maintains that a 1996 closing agreement, which established a different method of allocating income between the licensees and the U.S. parent, should continue to apply.

Coca-Cola and the IRS executed the closing agreement following an audit of the company’s 1987-89 tax years. The agreement, which is retroactive to 1987, provided that no penalties would be assessed so long as Coca-Cola followed the prescribed method.

According to the petition, that method reflects an understanding that the foreign licensees assumed entrepreneurial risks and responsibilities. The petition noted that, under the terms of the closing agreement, the licensees collectively invested $45 billion in pre-royalty operating expenses and marketing and incentive programs between 1987 and 2009. The licensees paid the U.S. parent $18 billion in royalties during that same period—of which $6 billion was paid in the 2007-09 tax years.

No Explanation

Why the IRS departed from the method established in the closing agreement wasn’t explained, the company said. However, the adjustments appear to be based on a report by an outside economist whose CPM analysis turned on the wrong assumptions, according to the petition.

The analysis used return on operating assets as a profit level indicator, the petition said, but rather than compare the returns of the licensees to those of comparable manufacturers, the IRS economist compared them to the returns of beverage bottlers, who are customers of the manufacturers and use the concentrate to produce the final product.
The petitioner is requesting trial in Washington.

Coca-Cola is represented by co-counsel John B. Magee of Morgan, Lewis & Bockius LLP in Washington, and Kevin L. Kenworthy of Miller & Chevalier Chartered in Washington.