In TC opinion of 18 November 2020 the US Tax Court agreed with the US tax authorities (IRS) that Coca-Cola’s US-based income should be increased by $9 billion in a dispute over royalties from its foreign-based licensees. The principal holding was that the Commissioner did not abuse his discretion in reallocating income to Coca-Cola using a “comparable profits method” (TNMM) that treated independent Coca-Cola bottlers as comparable parties. However, one question remained. Coca-Colas’s Brazilian subsidiary paid no actual royalties to Coca-Cola during 2007–2009. Rather, it compensated Coca-Cola for use of its intangibles by paying dividends of $886,823,232. The court held that the Brazilian subsidiary’s arm’s-length royalty obligation for 2007–2009 was actually about $1.768 billion, as determined by the IRS. But the court held that the dividends remitted in place of royalties should be deducted from that sum. This offset reduces the net transfer pricing adjustment to petitioner from the Brazilian supply point to about $882 million. Thus, the issue to be decided is whether this $882 million net transfer-pricing adjustment is barred by Brazilian law. During 2007–2009 Brazil capped the amounts of trademark royalties and technology transfer payments (collectively, royalties) that Brazilian companies could pay to foreign parent companies. Coca Cola contended that Brazilian law blocked the $882 million net transfer-pricing adjustment. IRS contended that the Brazilian legal restriction should be given no effect in determining the arm’s-length transfer price, relying on what is commonly called the “blocked income” regulation (Treas. Reg. § 1.482-1(h)(2)). According to tax authorities the “blocked income” regulation generally provides that foreign legal restrictions will be taken into account for transfer-pricing purposes only if four conditions are met, including the requirement that the restrictions must be “applicable to all similarly situated persons (both controlled and uncontrolled).” Judgement of the tax court The Tax Court sustained the transfer pricing adjustment in full. Excerpts “Allocation of Value Between Grandfathered Intangibles and Those Not Grandfathered Petitioner has shown that eight of TCCC’s trademarks were li-censed to the supply point before November 17, 1985. Those are the only intangibles in commercial use during 2007–2009 that were covered by the grandfather clause. We find that petitioner has failed to carry its burden of proving what portion of the Commissioner’s adjustment is at-tributable to income derived from this (relatively small) subset of the licensed intangibles. And the record does not contain data from which we could make a reliable estimate of that percentage.” “Because the supply point sold concentrate to preordained buyers, it had no occasion to use TCCC’s trademarks for economically significant marketing purposes. By contrast, the bottlers and service companies were much heavier users of TCCC’s trademarks. The bottlers placed those trademarks on every bottle and can they manufactured and on every delivery truck in their fleet. See id. at 264. And the service com-panies, which arranged consumer marketing, continuously exploited the trademarks in television, print, and social media advertising. See id. at 240, 263–64.” “We conclude that all non-trademark IP exploited by the Brazilian supply point was outside the scope of the grandfather clause. The blocked income regulation thus applies to that portion of the transfer-pricing adjustment attributable to exploitation of those intangible as-sets. We further find that this non-trademark IP represented the bulk of the value that the Brazilian supply point derived from use of TCCC’s intangibles generally. Petitioner has supplied no evidence that would enable us to determine, or even to guess, what percentage of the overall value was attributable to the residual intangible assets, i.e., the trademarks.” “In sum, petitioner has failed to satisfy its burden of proof in two major respects. It has offered no evidence that would enable us to determine what portion of the transfer-pricing adjustment is attributable to exploitation of the non-trademark IP, which we have found be the most valuable segment of the intangibles from the Brazilian supply point’s economic perspective. And petitioner has offered insufficient evidence to enable us to determine what portion of the transfer-pricing adjustment is attributable to exploitation of the 8 original core-product trademarks, as opposed to the 60 other core-product trademarks and the entire universe of non-core-product trademarks. Because petitioner has failed to establish what portion of the aggregate transfer-pricing adjustment might be attributable to exploitation of the eight grandfathered trademarks, we have no alternative but to sustain that adjustment in full.” ...

“3M Parent” is the parent company of the 3M Group and owns the Group’s trademarks. Other intellectual property, including patents and unpatented technology, is owned by “3M Sub-parent”, a second-tier wholly owned US subsidiary of 3M Parent. “3M Brazil” has used trademarks owned by 3M US in its business operations. 3M Brazil’s use of these trademarks was governed by three trademark licences entered into by 3M Parent and 3M Brazil in 1998. Each licence covered a separate set of trademarks. Under the terms of the licences, 3M Brazil paid 3M Parent a royalty equal to 1% of its sales of the trademarked products. Some products sold by 3M Brazil were covered by trademarks covered by more than one of the three trademark licences. For such products, 3M Brazil and 3M Parent calculated the trademark royalties using a stacking principle whereby, for example, if a particular product used trademarks covered by all three trademark licences, the royalties would be 3% of the sales of that product. By calculating royalties using this stacking principle, 3M Brazil paid trademark royalties to 3M Parent in 2006. 3M Brazil also used patents and unpatented technology owned by 3M Sub-parent in its operations. 3M Brazil paid no patent royalties and made no technology transfer payments to 3M Sub-parent. There was no patent licence or technology transfer agreement between 3M Sub-parent and 3M Brazil. On its 2006 consolidated federal income tax return, 3M Parent reported as income the trademark royalties paid by 3M Brazil to 3M Parent in 2006. In the notice of deficiency, the IRS determined that the income of the 3M Parent consolidated group under I.R.C. sec. 482 to reflect 3M Brazil’s use of intellectual property owned by 3M Parent and 3M Sub-parent. The increase in income determined in the notice of deficiency represents an arm’s length compensation for the intellectual property used by 3M Brazil. 3M Parent’s position was that the I.R.C. sec. 482 allocation should be the maximum amount 3M Brazil could have paid for the intellectual property in question under Brazilian law, less related expenses. 3M Parent also contended that the entire regulation was invalid because income could not be allocated to a taxpayer that did not receive income and could not legally receive the income. The IRS’s position was that the I.R.C. sec. 482 adjustment does not take into account the effect of the Brazilian statutory restrictions unless certain conditions are met, and that the Brazilian statutory restrictions did not meet those conditions. The blocked income rules in section 1.482-1(h)(2) require, among other things, that the foreign law restriction apply equally to controlled and uncontrolled parties, be publicly announced, and prevent the payment or receipt of an arm’s length amount in any form. Tax Court opinion The US Tax Court agreed with the IRS that 3M’s US income should be increased by royalties from 3M Brazil’s use of its trademarks and other intellectual property – without regard to the legal restrictions on related party royalty payments in Brazil ...

Bluestar Silicones France (BSF), now Elkem Silicones France SAS (ESF), produces silicones and various products that it sells to other companies belonging to the Bluestar Silicones International group. The company was audited for the financial years 2007 – 2008 and an assessment was issued. According to the tax authorities, the selling prices of the silicone products had been below the arm’s length price and the company had refrained from invoicing of management exepences and cost of secondment of employees . In the course of the proceedings agreement had been reached on the pricing of products. Hence, in dispute before the court was the issue of lacking invoicing of management exepences and cost of secondment of employees for the benefit of the Chinese and Brazilian subsidiaries of the Group. According to the company there had been no hidden transfer of profits; its method of constructing the group’s prices has not changed and compliance with the arm’s length principle has been demonstrated by a study by the firm Taj using the transactional net margin method and the criticisms of its prices are unfounded. The results must be analyzed in the context of heavy investments made by the Bluestar Silicones International sub-group, 80% of which it financed, and which are at the root of the heavy losses recorded in the sub-group’s first fiscal years for the years 2007 to 2009. Furthermore, the business tax adjustments was considered unjustified by the company since, the transfer prices charged did not constitute transfers of profits; Decision of the Court No charge of management fees from Brazil and Hong Kong: “Under these conditions, the administration was justified in considering that BSF’s renunciation to invoice management fees to the Chinese and Brazilian companies of the Bluestar Silicones International group constituted an abnormal act of management. It was thus entitled to correct the company’s profit and also to correct the company’s added value for the determination of its business tax.” No charge of cost of provision of employees in China: “While BSF claims that it derived a direct benefit from the provision of these three expatriates through the development of sales by the Chinese subsidiary, it does not establish this, even though it has been shown that the project manager and the two technicians worked at the Jiangxi site, which was acquiring the technology needed to manufacture products similar to those previously purchased by the Chinese subsidiary from BSF and therefore potentially competing with it. The impossibility of charging such fees due to Chinese legislation has also not been demonstrated, nor has any compensation resulting from insufficient transfer pricing. Under these conditions, the applicant company does not demonstrate that the advantage granted to the Chinese company had sufficient consideration in the interest of its operations and, consequently, was justified by normal management of its own interests.” Additional withholding tax and business tax However, the Court did find that the company was “entitled to argue that the Montreuil Administrative Court wrongly refused to discharge it from the additional withholding tax contributions charged to it for the financial year ended in 2007 and the additional business tax contributions for the year 2007 resulting from the correction made by the tax authorities of its transfer prices practiced with the company BSI Hong Kong.” Click here for English Translation Click here for other translation ...