Apple’s appeal against a European Commission ruling involving $14.5 billion in “illegal” Irish State Aid promises to tie up the EU General Court in Luxembourg for at least five years, and likely another five before it reaches the European Court of Justice. The size of the tax penalty is staggering, but how does it compare to other multi-billion dollar US disputes?
Microsoft
Microsoft is the focus of an IRS audit of its transfer pricing, one of the largest audits in IRS history. Revenue authorities have suggested that Microsoft may have understated its income by $30 billion over several years.
Microsoft’s transfer pricing methodology for its cost-sharing arrangements is in dispute, which could lead to a multi-billion dollar income adjustment. The case became headline news when Microsoft challenged the IRS’s use of law firm Quinn Emanuel Urquhart & Sullivan – the same law firm that advises Microsoft’s competitor Google.
The IRS filed a summons enforcement action against Microsoft seeking information including documents and interviews. Microsoft challenged the requests and argued that the use of Quinn was an improper delegation of a government function and raised taxpayer confidentiality and privacy concerns. IRS officials have since indicated that the tax authority will not use outside law firms in other audits.
(Source: Fenwick & West, US)
Coca-Cola
The US Internal Revenue Service (IRS) proposed a $9.4 billion income adjustment ($3.3 billion tax deficiency) related to intercompany royalties charged by Coca-Cola Co. to seven foreign affiliates.
The royalty adjustment related to trademark and product formula licenses granted to the foreign affiliates. The affiliates used the licensed rights to produce beverage concentrates which were then sold to third-party bottlers who produced and sold the finished beverage products to distributors and retailers. Although the IRS’s asserted adjustments are significant, the potential long-term continuing impact on Coca-Cola is likely to be much larger if the continuing intercompany royalty rates are adjusted.
The tax authority’s case is similar to the IRS position in Medtronic (see below). In both cases, the taxpayer and IRS appear to have reached a formal agreement regarding the intercompany royalties, which had been applied for years. The IRS’s proposed royalty adjustment appeared to be a significant departure from the methodology that was previously agreed
The taxpayer’s petition accuses the IRS of adopting an inconsistent position in a separate adjustment. In a situation where Coca-Cola’s Canadian subsidiary owned the IP, the IRS allocated only a routine return to the legal owner of
The case is in the early stages, with the taxpayer having filed its petition in the Tax Court in December 2015 and the IRS having filed its answer in February 2016, it will be a while before a decision is expected.
(Source: ITR & Fenwick and West, US)
In what might prove to be one of the biggest US transfer pricing cases of 2016, Facebook has been ordered into court to explain to a California judge why the company should not have to comply with IRS demands for information about an intellectual property transfer to Ireland. The dispute could cost Facebook as much as $5 billion.
Facebook lawyers have until late October to file their
"The information gathered suggested to the IRS examination team that the EY approach to evaluating Facebook’s transferred intangibles on a stand-alone basis was problematic,” according to the IRS lawsuit. "The IRS examination team’s preliminary positions suggested that the EY valuations of the transferred intangible were understated by billions of dollars.”
Facebook does not agree with the position of the IRS and is planning to file a petition in the US Tax Court challenging the Notice. In a Securities and Exchange Commission filing on July 28, the technology company said that a Statutory Notice of Deficiency issued by the IRS on July 27 stated that the authority would also
American tax authorities are looking at whether Facebook US and Facebook Ireland agreed in 2010 to transfer rights associated with the worldwide business, excluding Canada and the US. The transfer purportedly involved the user base and online platform which lets Facebook members communicate, allows Facebook store information, and lets advertisers reach users. The agreements also purported to
(Source: TP Week)
Amazon
The Tax Court in 2016 could issue an opinion on Amazon.com Inc. v. Commissioner, which involves a cost-sharing agreement with allocated amounts of more than $2 billion for the two years in issue.
The closed-door trial took place in November of 2014. Essentially, the Amazon
The IRS valued the pre-existing technology and marketing intangibles buy-in at more than 20 times the amount paid by Amazon's Luxembourg subsidiary to Amazon. A study performed for the IRS by Horst Frisch found that the intangibles contributed had a value of $3.6 billion using a discounted cash flow with an 18% discount rate and a perpetual life.
The judge stated that he rejected an assumption of a 5% increase in the intangible development costs a year. He said that a higher projected IDC, perhaps as high as projected revenues, is the right number. The larger the IDC that is required the smaller the initial buy-in value should be, which is good for Amazon.
(Source: ITR & Fenwick & West, US)
Medtronic
The US Tax Court in Medtronic, Inc. v. Commissioner held that the IRS’s transfer pricing adjustments amounting to almost $1.4 billion for the 2005 and 2006 tax years were arbitrary, capricious, or unreasonable.
The case revolved around whether income related to intercompany licenses for intangible property needed to make medical devices and leads should be reallocated under § 482 from Medtronic US to MPROC, its subsidiary in Puerto Rico.
The taxpayer and the IRS had reached an agreement on the royalty rates in a previous audit cycle, resulting in a memorandum of understanding (MoU) regarding the royalties. But the IRS departed from the MoU after examining Medtronic’s 2005 and 2006 tax returns. Authorities asserted a large royalty adjustment. Medtronic then asserted a refund based on its pre-MoU pricing.
Medtronic applied the comparable uncontrolled transaction (CUT) method to determine the arm’s length royalty rate on intercompany sales. But the IRS asserted that the comparable profits method (CPM) was better able to determine the arm’s length royalty rates on intercompany sales. Essentially, the IRS argued that
The Tax Court rejected the IRS’s use of the CPM method. The court found that the commensurate-with-income standard under § 482 does not replace the arm’s length standard. It followed that the IRS’s use of CPM was not required under the commensurate-with-income standard.
(Source: TP Week, ITR and Fenwick & West, US)
Other disputes to keep an eye on in 2016:
Cost-sharing arrangements in Altera - The IRS has filed its appeal of the Tax Court’s decision in Altera Corporation v. Commissioner in the Ninth Circuit. Altera is a follow-on to Xilinx v. Commissioner.
