The revenue service spent a large part of last year battling to defend its positions in court cases with major companies like Coca-Cola and Medtronic. But it looks like 2019 will offer no respite for the IRS in its pursuit of taxpayers.

IRS Commissioner Charles Rettig, a former tax litigator, addressed the 31^st Annual Institute on Current Issues in International Taxation in Washington DC.

“A win for me is when the community tightens it up a little bit, [providing] better economic reports, etcetera,” the commissioner said. “That’s the game we are playing going forward – future compliance.”

Rettig said that the IRS was “on its heels” in the 1980s when taxpayers took more aggressive strategies to limit their tax bills. This was the height of tax shelter schemes. “That is not going to happen on my watch,” he said.

“If we bring five transfer pricing cases and the courts tend to rule against us in five cases, I am not a commissioner that thinks we lost, I am going to wonder why we did not do 10,” Rettig told the audience.

As the Starr International case demonstrated, transfer pricing remains one of the most dispute-riven areas of tax law. In December 2018, the US Court of Appeals for the Washington DC Circuit reversed the federal district court’s dismissal of Starr International’s claim to a refund.

The court based the decision on the benefits available to American companies under the US-Switzerland tax treaty. The court battle had implications for US taxpayers trying to apply the principle purpose test (PPT) in such cases.

“Companies need more guidance on the PPT,” said Larissa Neumann, partner at Fenwick & West. “Subjectivity creates uncertainty.”

“If companies are not certain a treaty will apply, it makes it difficult for them to invest and expand,” she added.

Companies are under more audit scrutiny than ever before. Heightened transparency and pressure for revenue collection has meant tax authorities are requesting more and more information from multinationals to defend their transfer pricing practices.

The past year saw its fair share of disagreements between companies and tax authorities, and headlines accusing multinationals of tax dodging have become a familiar sight.

However, not all TP disputes are equally important. Some cases can set precedents for the future, which will help or hinder taxpayers.

Cases to watch

Coca-Cola

The Coca-Cola Company is waiting for a final decision in its multibillion-dollar dispute with the IRS. The case will decide whether Coke’s prior agreement with the revenue service is still relevant, even though the arrangement dates back more than 20 years.

Coca-Cola thought it had a cast-iron agreement with the IRS on how much the company charged foreign affiliates for the right to produce and distribute its signature product. This goes back to the 1996 agreement with the IRS, which settled a dispute over the company’s tax bill on its bottling operations in Puerto Rico.

The settlement reduced the company’s tax burden by $320 million. It also set in place the 10-50-10 method for attributing profits to foreign affiliates. Yet the IRS came back to the company in September 2015 with a hefty bill for back taxes from 2007 to 2009.

The US Tax Court ruled in the company's favour against the tax authority in June 2016. It looked like the case was finally wrapped up after more than a decade of proceedings. Just when it seemed to be all done, the IRS launched an appeal to challenge the verdict.

At the time James Fuller, partner at Fenwick & West, described the appeal as “surprising”.

“In a case like this, which is highly factual like most transfer pricing cases, the government's decision to appeal is a surprise," Fuller said. “This is because the rule in an appeal is that you have to prove that the lower court – in this case, the US Tax Court – made a clear error of fact, and that's pretty hard to do. That's a very heavy standard to achieve.”

The company decided to fight the claim and sued the US tax authority. The IRS fought back and later increased the claim by $385 million in October 2017, only for the Tax Court to rule on the side of the company and reduce the claim by $138 million.

If the IRS loses the Coca-Cola case, the tax authority could launch an appeal or accept defeat. This dispute could stretch on and on.

The court proceedings closed on May 11 2018, but several months on the court has yet to issue a final ruling.

Medtronic

The IRS has another chance to win its decade-long tussle with Medtronic. The Eighth Circuit Court referred the case back to the US Tax Court for a deeper analysis in August 2018.

“The Eighth Circuit determined that it needed additional analysis from the Tax Court before it could rule on the merits of the appeal,” the company said. “We still believe our initially filed tax returns were correct and will continue to defend our position.”

Chief Judge Roger Wollman poked numerous holes in the Tax Court’s 2016 judgment (Medtronic, Inc. v. Commissioner) and ordered the court to justify how it decided that the Pacesetter-Medtronic agreement’s use of the comparable uncontrolled transactions (CUT) transfer pricing method complied with Section 1.482 of the Treasury Regulations.

“The tax court reached these conclusions without making a specific finding as to what amount of risk and product liability expense was properly attributable to Medtronic Puerto Rico,” Judge Wollman opined.

Much like in the case of Coca-Cola, Medtronic has a Puerto Rican subsidiary through which it allocates income from the sale of medical devices. The IRS claimed that the US parent company was undervaluing the royalty rates the subsidiary had paid for the intangibles used in making the products.

The case could cost Medtronic dearly if the US Tax Court reverses its decision to slash the medical company’s tax liability. The dispute is a part of a rising trend of TP cases worldwide, where the tax authorities take companies to task over their intergroup arrangements.

If the IRS had won two years ago, the tax authorities could have extended its claim to the company’s tax returns since 2007, amounting to billions of dollars. However, the case may have implications for other US businesses.

The Medtronic case is no small matter for Puerto Rico or the US companies based on the island territory. Around 50% of Puerto Rico’s GDP growth comes from multinationals basing their manufacturing operations on the island.

The IRS has its chance and the next round of proceedings may decide whether the revenue service can claim a hefty amount of back taxes. Once again, Medtronic has to defend its record.

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