On 15 February 2018 the IRS filed a pre-trial memorandum against The Coca Cola Company on the grounds that the transfer pricing methods used by Coca Cola were not in compliance with the arm’s length standard under section 482. The case relates to the years 2007 to 2009. The IRS is proposing to adjust the taxable profits of Coca Cola upwards by around USD 9.4 billion, resulting in additional tax payable of around USD 3.3 billion. The case begins on 5 March 2018 and is to continue for around six weeks.

The IRS is arguing that Coca Cola did not charge arm’s length royalties to foreign licensees for the use of intellectual property used in the production, marketing and sale of concentrates in foreign markets.  The IRS asserts that the use of the Comparable Uncontrolled Transaction (CUT) method to test the controlled transaction did not comply with section 482 and did not correspond to income that was attributable to the intangible itself.

The IRS is claiming that the Comparable Profits Method (CPM) is the best method to use for determining the profits to which foreign licensees are entitled. Under the CPM the profits of the foreign licensees would be compared to profits earned by potentially comparable companies in the same industry.

Coca Cola on the other hand is arguing that the argument by the IRS that the CPM is the best method is subjective and cannot be supported. The functional and risk profile of the foreign licensees is not similar to that of potentially comparable companies under the CPM. The foreign licensees selected by the IRS as comparable companies are resident in countries that do not have tax treaties with the US, whereas Coca Cola has selected as comparables licensees resident in treaty partner countries.

Similar arguments in favour of a profit based method rather than the CUT have been put forward by the IRS in other recent cases such as Amazon.com and Medtronic Inc. In those cases the Tax Court has ruled in favour of the taxpayers and rejected the methods put forward by the IRS.

Coca Cola also refers to a Royalty Closing Agreement (RCA) of 1996 with the IRS which established that the foreign licensees of Coca Cola were to retain 10% of gross sales, with a residual operating profit to be split equally between Coca Cola and the licensees. This RCA will be used by Coca Cola to support its position. The RCA was intended to cover the years 1989 to 1995 but was also intended to give Coca Cola penalty protection for future intercompany pricing issues. The IRS did not want this RCA to be used in the current case but the Tax Court ruled on 23 February 2018 that it could be used.