Coca Cola collects royalties from foreign branches and subsidiaries for use of formulas, brand and other intellectual property.
Years ago an agreement was entered by Coca Cola and the IRS on these royalty payments to settle an audit of years 1987 to 1995. According to the agreement Coca-Cola licensees in other countries would pay the US parent company royalties using a 10-50-50 formula where 10% of the gross sales revenue is treated as a normal return to the licensee and the rest of the revenue is split evenly between the licensee and the US parent, with the part going to the US parent paid in the form of a royalty. The agreement expired in 1995, but Coca-Cola continued to use the model for transfer pricing in the following years.
Coca-Cola and the Mexican tax authorities had agreed on the same formula and Coca-Cola continued to use the pricing-formula in Mexico on the advice of Mexican counsel.
In 2015, the IRS made an adjustment related to 2007 – 2009 tax returns stating that Coca-Cola licensees should have paid a higher royalty to the US parent.
On that bases the IRS said that too much income had been declared in Coca Cola’s tax returns in Mexico because a higher royalty should have been deducted. The IRS therefore disallowed $43.5 to $50 million in foreign tax credits in each of the three years for taxes that the IRS said Coca-Cola overpaid in Mexico due to failure to deduct the right amount of royalty payments – voluntary tax payments cannot be claimed as a foreign tax credit in the United States.
The court sided with Coca-Cola on this question and concluded that the all practical remedies to reduce Mexican taxes had been exhausted and Coca Cola. Foreign tax credits were to be allowed.US vs Coca Cola 2017