19 November 2020TrademarksMuireann Bolger

Coca-Cola liable for billion-dollar tax bill in IP row

Coca-Cola has lost its bid to avoid paying a substantial portion of a $3.4 billion tax bill levied by the US Inland Revenue Service, at the US Tax Court on Wednesday, November 18.

The case centred on a dispute around transfer pricing—how the company valued its IP with its affiliate companies operating in Brazil, Chile, Costa Rica, Egypt, Ireland, Mexico, and Swaziland.

According to the ruling, Coca-Cola enabled these companies to manufacture and sell “concentrate”, the ingredient used in its world-famous beverages, and licensed them to use its IP, “including trademarks, brand names, logos, patents, secret formulas, and proprietary manufacturing processes”.

During 2007-2009, the companies paid Coca-Cola dividends of about $1.8 billion to meet their royalty obligations, according to the stipulations outlined by a 1996 agreement.

But after examining Coca-Cola’s returns for this period, the IRS determined that the companies paid insufficient compensation for the rights to use Coca-Cola’s IP because this agreement did not apply a “transfer pricing” methodology.

The IRS found that Coca-Cola’s affiliates, which “functioned essentially as contract manufacturers”, retained most of the profits generated by sales of “concentrate” to “foreign bottlers”. Consequently, the agency concluded that a reallocation of income was necessary to reflect more clearly the income of Coca-Cola and its affiliates.

Subsequently, the agency used a new method to reallocate profits, particularly from the Irish and Brazilian affiliates, increasing Coca-Cola’s taxable income for 2007-2009 by more than $9 billion. The Irish and Brazilian companies accounted for roughly 85% of the disputed income adjustments.

Coca-Cola opposed this decision, holding that the reallocations were “arbitrary and capricious”, and contended that the IRS acted arbitrarily by abandoning a method that had been used in five prior audit cycles spanning a decade.

The company further argued that the IRS erred in viewing the status of independent Coca-Cola bottlers as comparable to its affiliate companies in foreign countries because the latter own “immensely valuable” intangible assets “that do not appear on their balance sheets or in any written contract”.

The bottlers are “marketinglight” businesses that operate at a different level of the market, said Coca-Cola.

It argued that its affiliate companies owned local rights to its valuable brands and should  enjoy “supranormal returns” as “master franchisees” or “long-term licensees”.

The court reasoned that in order to show that the commissioner has reached an unreasonable result in cases “involving unique and extremely valuable intangible property”, the taxpayer typically needs to show that the commissioner applied an “unreasonable methodology”.

However, the court found that Coca-Cola had failed to do this and concluded that the commissioner did not abuse his discretion by using his chosen method to reallocate income between Coca-Cola and its affiliates. It ruled that the “analysis was appropriate given the nature of the assets owned and the activities performed by the controlled taxpayers”.

But the court also found that Coca-Cola made a valid, timely choice to use an “offset treatment” regarding dividends paid by foreign manufacturers, and ruled that the IRS’s reallocations must be reduced by $1.8 billion.

The court confirmed it will determine the amount of the final tax bill at a later date.

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