Tax disputes to watch in 2023
Multinational companies like Amazon and Medtronic are locked in court battles over their tax and transfer pricing (TP) arrangements. Here, ITR reviews the biggest tax disputes for tax professionals to look out for in 2023.
Courts may have issued key decisions in several landmark cases last year, but there are still many long-running tax disputes open.
Technology company Amazon is looking to defend its 2021 court victory from an appeal by the European Commission. Social media company Facebook awaits a court decision in its case with the Internal Revenue Service (IRS).
Meanwhile, pharmaceutical group Amgen and medical technology company Medtronic are also hoping to win their court battles with the IRS. These cases could set precedents for entire industries and not just individual businesses.
Tax directors are expecting an increase in disputes due to the competition among countries for tax revenue. Businesses can expect more audits, more scrutiny and potentially more disputes in 2023. Much like last year, the only certainty is uncertainty for taxpayers.
US e-commerce company Amazon could be about to get hit with a €250 million ($270 million) in its case with the European Commission. This may not sound like a fortune for such a large global company, but the implications of the case are far-reaching.
Amazon won its case at the European General Court in May 2021, but it now has to defend its Luxembourg tax arrangements in the Court of Justice of the EU. The Commission decided not to accept defeat and launched an appeal at the Court of Justice.
Much like in the Apple state aid case (see below), the Commission argues that the General Court should have based its decision on Amazon’s profits recorded in Luxembourg rather than its US profits.
The US company structured its European operations through Amazon EU Sàrl, a Luxembourg-based operating subsidiary, to shift profits to Amazon Europe Holding Technologies. The latter holding company was a limited partnership with no employees, offices or business activities.
Amazon EU Sàrl held the intellectual property (IP) rights under a November 2003 cost-sharing agreement with Amazon US. This arrangement allowed the holding company to grant an exclusive license to Amazon EU and receive royalty payments in return.
Although Amazon argues that this agreement was in line with the arm’s-length principle, the European Commission maintains that the royalties were inflated to reduce the company’s taxable profits and gain an unfair competitive advantage.
The company overhauled its Luxembourg arrangement in 2014 to prevent such a clash with the Commission. But it was far from an unusual arrangement. Many companies had similar deals in Luxembourg and this case will set a strong precedent whatever the outcome.
US pharmaceutical manufacturing company Amgen is in a court battle with the IRS over $10.7 billion in back taxes for profits routed through Puerto Rico. This may sound like a familiar story, but this case is really a combination of two different tax disputes.
The case goes back to IRS claims that Amgen under-reported its US taxable income by nearly $24 billion from 2010 to 2015. The company did so, according to the IRS, by allocating profit, including important assets, to its Puerto Rican manufacturing subsidiary.
Originally, Amgen was facing an IRS claim of $3.6 billion in back taxes plus interest from 2010 to 2012. However, the IRS later raised the stakes in April 2022 with $5.1 billion in back taxes plus $2 billion in penalties from 2013 to 2015.
In August 2022, Amgen successfully consolidated two separate tax disputes with the Internal Revenue Service. As a result, the pharmaceutical company is facing a full tax bill of $10.7 billion should it lose the case.
Nevertheless, Amgen is determined to win this case. The US Tax Court has not issued a ruling on the case and the company has told investors this could take several years to resolve.
The Amgen case comes at a time when the pharmaceutical industry is facing intense scrutiny on tax matters from the US Senate. A defeat for Amgen could be a defeat for an entire industry, but a victory for the taxpayer could create more legal certainty for the sector.
The European Commission is seeking to overturn the General Court decision in the Apple state aid case at the Court of Justice of the EU. So the case continues despite the historic victory the US technology company won against the European Commission in July 2020.
In July 2020, the General Court annulled the Commission's controversial 2016 decision on the grounds that it had failed to show that Apple had gained an unfair competitive advantage from its tax arrangements in Ireland.
Apple operated in Europe through a double Irish structure, whereby most of its European sales were routed through its head office. This is how the company reported profits of €16 billion in 2011 and paid tax on just €50 million in Ireland, according to US Senate hearings.
The European Competition Commission argued that Apple’s effective tax rate in Ireland fell to an all-time low of 0.005% in 2014. However, the US company maintains that this rate is misleading because it includes Apple’s global revenue, and the company’s global effective tax rate was 24.6%.
In any case, the double Irish structure was perfectly above board in Ireland. The point of contention was whether or not the Irish tax rulings granted to Apple in 1991 and 2007 breached EU state aid law.
Both the Irish authorities and Apple have vehemently denied any wrongdoing from the start of the EU state aid investigation to today. Apple and Ireland may have won the case at the European General Court, but the Commission is hoping to win this case in the final round.
Social media company Facebook is waiting for a court decision in its dispute with the IRS regarding its past use of an Irish tax structure. The IRS took Facebook to the US Tax Court in February 2020 over the valuation of its intangible assets.
Facebook faces the possibility of a multibillion-dollar tax bill. The IRS alleged the social media company had overvalued its intellectual property (IP) and owed the revenue service more than $9 billion in taxes.
In 2010, Facebook moved its IP to Ireland and the social media company valued the assets at $6.5 billion. However, this was before Facebook went public in 2012. The IRS argues that the true value was $21 billion and that the company owes more than $9 billion in taxes. Facebook stands by its 2010 valuation.
A lot has changed since 2010. Not only is Facebook a global brand, the company has overhauled its Irish structure and adopted a local seller model in 2017 and, three years later, dismantled its IP structures. The company synonymous with social media is also supporting the OECD’s work on the digital economy.
Researchers gave testimony on Facebook’s early business tactics and valuation in May 2022. Tax lawyers are expecting more news on the case in 2023, but whether it will be good news for the taxpayer is far from guaranteed.
US medical device company Medtronic is still fighting its case against the IRS over a $1.4 billion tax bill. The proceedings span more than a decade, as the case goes back to 2005 and 2006 – when the IRS claimed Medtronic was due to pay $1.4 billion in taxes to Puerto Rico.
The case revolves around whether or not Medtronic was paying its due tax on income not allocated to its Puerto Rican operations. The IRS claims that the company undervalued royalty rates between its Puerto Rican subsidiary and the US company for intangibles used in manufacturing.
A crucial issue of contention in the case has been whether Medtronic used the most appropriate transfer pricing method. Medtronic applied the comparable uncontrolled transaction (CUT) method to determine the arm’s-length rate on the inter-company sales, whereas the IRS favoured the comparable profits method (CPM).
The IRS claimed that the subsidiary played a minimal role in the company’s functions and contributed little to Medtronic US. In short, the US revenue service argued that the company used this arrangement to reduce its tax burden rather than for commercial reasons.
In 2016, the US Tax Court ruled that the medical device company owed just $14 million in taxes. This was a huge drop in the tax bill. However, it wasn’t over yet. The Eighth Circuit Court of Appeals sent the case back to the Tax Court for a new ruling.
The Tax Court ruled in August 2022 that the company used an “unspecified method” to determine its liabilities, but it rejected both the CUT and the CPM as the right way to determine Medtronic’s royalty rates. In the end, the final tax bill may be higher than $14 million and lower than $1.4 billion.