Coca-Cola’s Ongoing Transfer Pricing Dispute with the IRS

Introduction

Coca-Cola has recently filed its appellant brief with the Eleventh Circuit in the ongoing transfer pricing dispute with the IRS. This case, initially ruled on in 2020, has been a significant issue for the company, involving over $9 billion in adjustments. The brief argues that the IRS’s actions were improper and that the company is entitled to prospective penalty protection under a 1996 closing agreement.

Background of the Dispute

The dispute began with a 1996 closing agreement that established a formula for calculating intercompany royalties. This "10-50-50" formula allocated 10% of sales and 50% of residual profits to Coca-Cola’s foreign subsidiaries, with the remaining 50% going to the U.S. parent company. While the formula was accepted by the IRS for over a decade, it was rejected for the 2007-2009 tax years, leading to significant deficiencies.

Key Arguments in the Appeal

Coca-Cola’s brief focuses on two main arguments: that the IRS’s change in approach after years of acceptance constitutes an estoppel-like violation of the closing agreement, and that the use of the comparable profits method (CPM) was unreliable. Additionally, the brief accuses the IRS of selectively targeting subsidiaries without treaty protections to avoid scrutiny from foreign tax authorities.

Challenges to the IRS’s Methodology

The IRS used the CPM with independent bottlers as comparables, calculating royalties based on the return on assets (ROA). Coca-Cola contends that this method fails to account for the significant investments made by its supply points in marketing, effectively denying them a fair return. The company argues that the supply points should be treated as investors in marketing intangibles rather than mere suppliers.

Rejection by the Tax Court

The Tax Court rejected Coca-Cola’s arguments, finding that the supply points’ marketing activities were controlled by the U.S. parent and did not represent genuine investments with associated risks. The court concluded that the bottlers were sufficiently comparable to the supply points for CPM purposes, as their functions, assets, and risks were similar despite some differences.

Conclusion

Coca-Cola’s appeal faces significant hurdles, as the Tax Court’s decision was based on detailed factual findings and a thorough application of regulatory standards. While the brief presents passionate arguments, it fails to identify clear errors in the court’s analysis, making it unlikely to overturn the decision. The outcome of this case could have important implications for transfer pricing disputes and the use of the CPM in similar situations.