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.” ...

Maersk Oil and Gas A/S (later TotalEnergies EP Danmark A/S) continued to make operating losses, although the group’s combined oil and gas operations were highly profitable. Following an audit of Maersk Oil, the tax authorities considered that three items did not comply with the arm’s length principle. Maersk Oil incurred all the expenses for preliminary studies of where oil and gas could be found, but the results of these investigations and discoveries were handed over to the newly established subsidiaries free of charge. Licence agreements were signed with Qatar and Algeria for oil extraction. These agreements were entered into with the subsidiaries as contracting parties, but it was Maersk Oil that guaranteed that the subsidiaries could fulfil their obligations and committed to make the required technology and know-how available. Expert assistance (time writing) was provided to the subsidiaries, but these services were remunerated at cost with no profit to Maersk Oil. An assessment was issued where additional taxable income was determined on an aggregated basis as a share of profits from the activities – corresponding to a royalty of approximately 1,7 % of the turnover in the two subsidiaries. In 2018, the Tax Court upheld the decision and Maersk Oil and Gas A/S subsequently appealed to the High Court. In 2022, the High Court held that the subsidiaries in Algeria and Qatar owned the licences for oil extraction, both formally and in fact. In this regard, there was therefore no transaction. Furthermore the explorations studies in question were not completed until the 1990s and Maersk Oil and Gas A/S had not incurred any costs for the subsequent phases of the oil extraction. These studies therefore did not constitute controlled transactions. The Court therefore found no basis for an annual remuneration in the form of royalties or profit shares from the subsidiaries in Algeria and Qatar. On the other hand, the Regional Court found that Maersk Oil and Gas A/S’ so-called performance guarantees for the subsidiaries in Algeria and Qatar were controlled transactions and should therefore be priced at arm’s length. In addition, the Court found that technical and administrative assistance (so-called time writing) to the subsidiaries in Algeria and Qatar at cost was not in line with what could have been obtained if the transactions had been concluded between independent parties. These transactions should therefore also be priced at arm’s length. The High Court referred the cases back to the tax authorities for reconsideration. An appeal was then filed by the tax authorities with the Supreme Court. Judgement of the Supreme Court The Supreme Court decided in favour of the tax authorities and upheld the original assessment. The court stated that the preliminary exploration phases in connection with oil exploration and performance guarantees and the related know-how had an economic value for the subsidiaries, for which an independent party would require ongoing payment in the form of profit share, royalty or the like. They therefore constituted controlled transactions. Furthermore, the court stated that Maersk Oil and Gas A/S’ delivery of timewriting at cost price was outside the scope of what could have been achieved if the agreement had been entered into at arm’s length. Finally, the transactions were considered to be so closely related that they had to be assessed and priced on an aggregated basis and Maersk Oil and Gas A/S had not provided any basis for overturning the tax authorities’ assessment. Click here for English translation Click here for other translation ...

A Danish parent in the Maersk group’s oil and gas segment, Maersk Oil and Gas A/S (Mogas), had operating losses for FY 1986 to 2010, although the combined segment was highly profitable. The reoccurring losses was explained by the tax authorities as being a result of the group’s transfer pricing setup. “Mogas and its subsidiaries and branches are covered by the definition of persons in Article 2(1) of the Tax Act, which concerns group companies and permanent establishments abroad, it being irrelevant whether the subsidiaries and branches form part of local joint ventures. Mogas bears the costs of exploration and studies into the possibility of obtaining mining licences. The expenditure is incurred in the course of the company’s business of exploring for oil and gas deposits. The company is entitled to deduct the costs in accordance with Section 8B(2) of the Danish Income Tax Act. Mogas is responsible for negotiating licences and the terms thereof and for bearing the costs incurred in this connection. If a licence is obtained, subsequent expenditure is borne by a subsidiary or branch thereof, and this company or branch receives all revenue from extraction. Mogas shall ensure that the obligations under the licence right towards the State concerned (or a company established by the State for this purpose) and the contract with the independent joint venture participants are fulfilled by the local Mogas subsidiary or permanent establishment. Mogas has revenues from services provided to the subsidiaries, etc. These services are remunerated at cost. This business model means that Mogas will never make a profit from its operations. It must be assumed that the company would not enter into such a business model with independent parties. It should be noted that dividend income is not considered to be business income.” According to the tax authorities Mogas had provided know-how etc. to the subsidiaries in Algeria and Qatar and had also incurred expenses in years prior to the establishment of these subsidiaries. This constituted controlled transactions covered by the danish arm’s length provisions. Hence an estimated assessment was issued in which the additional income corresponded to a royalty rate of approximately 1,7 % of the turnover in the two subsidiaries. In 2018, the Tax Court upheld the decisions and Mogas subsequently appealed to the regional courts. Judgment of the Regional Court The Regional Court held that the subsidiaries in Algeria and Qatar owned the licences for oil extraction, both formally and in fact. In this regard, there was therefore no transaction. Furthermore the explorations studies in question were not completed until the 1990s and Mogas had not incurred any costs for the subsequent phases of the oil extraction. These studies therefore did not constitute controlled transactions. The Court therefore found no basis for an annual remuneration in the form of royalties or profit shares from the subsidiaries in Algeria and Qatar. On the other hand, the Regional Court found that Mogas’s so-called performance guarantees for the subsidiaries in Algeria and Qatar were controlled transactions and should therefore be priced at arm’s length. In addition, the Court found that technical and administrative assistance (so-called time writing) to the subsidiaries in Algeria and Qatar at cost was not in line with what could have been obtained if the transactions had been concluded between independent parties. These transactions should therefore also be priced at arm’s length. As a result, the Court referred the cases back to the tax authorities for reconsideration. Excerpts “It can be assumed that MOGAS’s profit before financial items and tax in the period 1986-2010 has essentially been negative, including in the income years in question 2006-2008, whereas MOGAS’s profit including financial items, including dividends, in the same period has been positive, and the Regional Court accepts that income from dividends cannot be regarded as business income in the sense that dividends received by MOGAS as owner do not constitute payment for transactions covered by section 2 of the Tax Act. However, the Regional Court considers that the fact that MOGAS’s profit before financial items and tax for the period 1986-2010 has been essentially negative cannot in itself justify allowing the tax authorities to make a discretionary assessment.” “As stated above, the performance guarantees provided by MOGAS and the technical and administrative assistance (timewriting) provided by MOGAS constitute controlled transactions covered by Article 2 of the Tax Code. The performance guarantees, which are provided free of charge to the benefit of the subsidiaries, are not mentioned in the transfer pricing documentation, and the Regional Court considers that this provides grounds for MOGAS’s income relating to the performance guarantees to be assessed on a discretionary basis pursuant to Section 3 B(8) of the Tax Control Act currently in force, cf. Section 5(3).” “Already because MOGAS neither participates in a joint venture nor acts as an operator in relation to oil extraction in Algeria and Qatar, the Court considers that MOGAS’ provision of technical and administrative assistance to the subsidiaries is not comparable to the stated industry practice or MOGAS’ provision of services to DUC, where MOGAS acts as an operator. Against this background, the Regional Court considers that the Ministry of Taxation has established that MOGAS’ provision of technical and administrative assistance (timewriting) to the subsidiaries at cost price is outside the scope of what could have been obtained if the agreement had been concluded between independent parties, cf. tax act Section 2 (1).” Only part of the decision have been published. Click here for English translation Click here for other translation ...

In a November 2020 opinion the US Tax Court agreed with the IRS that Coca-Cola’s US-based income should be increased by $9 billion in a dispute over royalties from its foreign-based licensees. Coca-Cola filed a Motion to Reconsider June 2, 2021 – 196 days after the Tax Court had served its opinion. Judgement of the tax court The Tax Court denied the motion to reconsider. There is a 30-day deadline to move for reconsideration and the court concluded that Coca-Cola was without a valid excuse for the late filing and that the motion would have failed on the merits in any event ...

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 ...