Coca Cola, a U.S. corporation, was the legal owner of the intellectual property (IP) necessary to manufacture, distribute, and sell some of the best-known beverage brands in the world. This IP included trade- marks, product names, logos, patents, secret formulas, and proprietary manufacturing processes.
Coca Cola licensed foreign manufacturing affiliates, called “supply points,” to use this IP to produce concentrate that they sold to unrelated bottlers, who produced finished beverages for sale to distributors and retailers throughout the world. Coca Cola’s contracts with its supply points gave them limited rights to use the IP in performing their manufacturing and distribution functions but gave the supply points no ownership interest in that IP.
During 2007-2009 the supply points compensated Coca Cola for use of its IP under a formulary apportionment method to which Coca Cola and IRS had agreed in 1996 when settling Coca Cola’s tax liabilities for 1987-1995.
Under that method the supply points were permitted to satisfy their royalty obligations by paying actual royalties or by remitting dividends. During 2007-2009 the supply points remitted to Coca Cola dividends of about $1.8 billion in satisfaction of their royalty obligations. The 1996 agreement did not address the transfer pricing methodology to be used for years after 1995.
Upon examination of Coca Cola’s 2007-2009 returns IRS determined that Coca Cola’s methodology did not reflect arm’s-length norms because it over-compensated the supply points and undercompensated Coca Cola for the use of its IP.
IRS reallocated income between Coca Cola and the supply points employing a comparable profits method (CPM) that used Coca Cola’s unrelated bottlers as comparable parties.
These adjustments increased Coca Cola’s aggregate taxable income for 2007- 2009 by more than $9 billion.
The US Tax Court ruled on November 18 that Coca-Cola’s US-based income should be increased by about $9 billion in a dispute over the appropriate royalties owned by its foreign-based licensees for the years from 2007 to 2009.
The court reduced the IRS’s adjustment by $1.8 billion because the taxpayer made a valid and timely choice to use an offset treatment when it came to dividends paid by foreign manufacturing affiliates to satisfy royalty obligations.
4 comments on US vs Coca Cola, November 2020, US Tax Court, 155 T.C. No. 10
My discussion of this court decision includes an alternative interpretation involving the possible notion that licensees deserves a more modest portion of residual profits for bearing commercial risk:
Hi – can you please comment on who is responsible for running this site and providing the analysis, as well as TP guidelines? There is no information on either site. It would be great to understand, from the perspective of someone in the knowledge management field. Thank you.
It is very interesting and fact driven decision. The taxpayer has brought many factual aspects of its business in public domain to defend its position. I have two comments to make.
The arm’s length remuneration of service companies can be determined based on the margin on cost earned from third parties, the bottling companies. The tax administration of service companies can hold that TCCC or its affiliate did not remunerate for the service companies at arm’s length. Service companies should pay more tax .
Other issue is camouflaging receipt from bottling companies as price for concentrate by TCCC (through supply points) though it included royalty for use of intangibles by the bottling companies. The Coca-Cola group evaded tax in source countries by not paying tax on royalties. The IRS had argued that extra payment by bottling companies in comparison to payment by TCCC/Supply Points ( in case of service companies) is royalties. The tax administration of countries of location of bottling companies can direct Coca-Cola to pay royalties tax.
I have one more comment to make.
Coca-Cola group neither paid due and fair taxes in the countries of bottling companies (tax on royalty) nor in countries of service companies ( a mark of 5-7% on only some costs) and shifted most of profits of their operations (other than US) to low tax jurisdictions like Ireland and Singapore first and then where information is not available.