Last week, after a U.S. Tax Court judge ruled against it in a transfer pricing case, Coca-Cola said it would pay $6 billion in taxes and accrued interest—and appeal the decision. But the stakes for both the company and the Internal Revenue Service (IRS) are even higher.
In its 10-Q quarterly report filed with the Securities & Exchange Commission on July 31, 2024, the company warned that if the IRS applies the same argument to other tax years and ultimately prevails, it would owe approximately $16 billion in back taxes and interest, counting interest through the end of last year.
In that same 10-Q, however, Coca-Cola hinted at what could be a big risk for the IRS, which has notched a string of wins in transfer pricing cases. The company said it was evaluating how recent Supreme Court decisions could affect the case. Most notably, it cited Loper Bright v. Raimondo, a June 28, 2024 Supreme Court case that overruled the four decade old doctrine (set out in Chevron U.S.A., Inc. v. NRDC) holding that courts should defer to regulators’ reasonable interpretations of ambiguous laws. In Loper Bright, the court decided that courts should “exercise independent judgment in determining the meaning of statutory provisions,’’ increasing the likelihood of success when parties challenge federal agencies.
That and other recent decisions clipping regulators’ wings, have led to speculation that some of the IRS’ existing regulations and guidance–including those governing transfer pricing–could be at risk. Facebook (now Meta), Medtronic, and Abbott Labs are among the companies currently in court battling the IRS over transfer pricing, which has in recent years become a lucrative and winning area for the government.
Transfer pricing is a tricky concept affecting multinational corporations and how they allocate costs and–ultimately–taxable profits. In a typical scenario, a parent company may set up several subsidiary companies all over the world and move goods, services, and assets from one to another—that’s completely okay. However, transactions between those companies are supposed to be at “arm’s length,” meaning that the goods, services, and assets are transferred for the same price as they would have been between unrelated parties. But often, that’s not what happens.
With a wink and a nudge, transactions are often structured to shift profits from high-tax countries to low-tax countries to cut their tax bills. The most popular target for transfer pricing abuse is intangible property, including licenses for manufacturing, distribution, sale, marketing, and promotion of products in overseas markets. Since intangible property doesn’t really have a physical home—unlike, say, real estate—it’s easy to transfer it to countries that offer certain benefits, including more favorable tax treatment. (That’s what’s in dispute in the Coca-Cola case.)
Transfer pricing cases are often referred to as section 482 cases. Section 482 of the Tax Code—which has existed since the 1920s—gives the IRS broad authority to make adjustments on returns and allocate the income, deductions, and credits of commonly owned or controlled organizations, entities, or businesses. According to the Treasury, these adjustments are made “to prevent evasion of taxes or to clearly reflect income.”
In 2012, the IRS stepped up its game, creating the Transfer Pricing Practice (TPP) group, a team of specialized transfer pricing professionals with a focus on audits. And, notably, the IRS also began designating cases for litigation—exactly what happened in the Coca-Cola case.
In 2016, the IRS announced that it had resolved a transfer pricing dispute with Glaxo SmithKline Holdings. At the time, it was the largest tax settlement in the IRS’s history. Under the terms of the agreement, GSK agreed to pay approximately $3.4 billion to resolve the transfer pricing matter for the tax years 1989 through 2005.
This was a big win for the IRS, for sure, but it also highlighted how complex and time and resource consuming these cases could be. For example, last year the Tax Court ruled in favor of the IRS in a transfer pricing case involving 3M and the 2006 tax year. The Tax Court agreed with the IRS’ tax adjustment to 3M’s royalty income to the tune of $23 million. The company has appealed the decision to the Eighth Circuit.
In the current Coca-Cola case, the IRS claims that from 2007 to 2009, the company underreported income from the foreign licensing of manufacturing, distribution, sale, marketing, and promotion of its products in overseas markets. The case has been in litigation for years. In 2015, the company announced that it could owe $3.3 billion in additional federal income taxes, noting in an SEC filing that the IRS had issued a Notice of Deficiency claiming an additional federal income tax liability of approximately $3.3 billion plus interest.
A Notice of Deficiency, sometimes called a “90-day letter,” informs a taxpayer that the IRS has assessed additional taxes. Typically, taxpayers have 90 days from the date of the notice to either agree to the changes or file a petition with the Tax Court. In October 2015, the IRS designated the matter for litigation–meaning it wasn’t going to negotiate with Coca-Cola. The company had a choice: accept the assessment and pay the tax in full or litigate. Coca-Cola chose the second option, filing a petition on December 14, 2015, disputing the tax.
Coca-Cola, for its part, contends it has been following the same transfer pricing methods that the IRS agreed it could use back in 1996 (to settle tax years back to 1987) and that the methods should still be valid. Moreover, it says the IRS audited and confirmed the company’s compliance with the agreed-upon methodology in five successive audit cycles for tax years 1996 through 2006. However, the IRS Notice issued in 2015 “retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years in favor of an entirely different methodology, without prior notice to the Company.”
The company claims that the new methodology reallocated over $9 billion of income from its foreign licensees to the U.S. parent company for tax years 2007 through 2009. (The IRS did not assert any penalties along with the tax, which the company says is consistent with the closing agreement.)
After years of procedural filings, the matter was finally heard in Tax Court in a two-month trial lasting from March to May of 2018. On November 18, 2020, the Tax Court ruled against Coca-Cola. Additional court maneuvers followed, and on November 8, 2023, the Tax Court issued a supplemental opinion again siding with the IRS. The most recent order filed on August 2, 2024, took note of those earlier opinions and confirmed that “there are deficiencies in income tax due from petitioner for the 2007, 2008, and 2009 taxable years in the amounts of $930,822,089; $865,202,130; and $932,972,594, respectively.”
In its July 31, 2024 10-Q, Coca-Cola warned that the IRS could apply the same logic to later years too–adding up to that $16 billion back tax and interest hit. The company, in a statement posted on its website said:
“Coca‑Cola strongly believes the IRS and the Tax Court misinterpreted and misapplied the applicable regulations involved in the case and will vigorously defend its position on appeal. The company has 90 days to file a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit. The company looks forward to the opportunity to begin the appellate process and, as part of that process, will pay the agreed-upon liability and interest to the IRS.”
The company maintained in its most recent 10-Q that it doesn’t believe the case will have a material impact on its finances, because it believes it is “more likely than not” that it will ultimately be successful on appeal. Like many large companies, it has a reserve for tax matters. In 2020, the company put aside $438 million for the case and recently raised that to $456 million.
Last year, Coca-Cola reported $46.1 billion in sales, landing it at #100 on the Forbes Global 2000.
Early Friday morning, shares of the company’s stock were valued at $69.38. They closed Monday at $68.10, suggesting investors are taking the Tax Court loss in stride.
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