On 18 August 2022, the U.S. Tax Court issued an opinion on the transfer pricing case of Medtronic, Inc. v. Commissioner, T.C.  Memo 2022-85.

Facts of the case

Medtronic US is the parent company of a global medical device company that manufactures and sells implantable medical devices. Medtronic US has entered into licensing agreements (the MPROC Agreements) with its Puerto Rican subsidiary (MPROC) to manufacture medical devices (devices and leads).

In the taxpayer’s 2002 income tax return, the Comparable Uncontrolled Transactions Transfer Pricing Method (CUT) was used to determine the royalty rate paid for its intercompany licenses. An audit by the IRS found that the taxpayer was shifting too much profit to Puerto Rico to avoid taxation in the United States. The IRS used the residual profit split method and conclude that 90% of the earnings were attributable to the US operations and 10% to the Puerto Rico operations.

Background

In June 2016, in response to the taxpayer’s appeal, the court rejected both the taxpayer’s and the IRS’s positions and “performed its own valuation analysis” to determine that the CUT methodology was used to determine the arm’s length royalty rate for intercompany agreements – but with some adjustments. The tax court found that the arm’s length royalty rate for device licenses was 44% and the rate for lead licenses was 22%.

On 16 August 2018, the US Federal Appeals Court reversed the Tax Court’s initial opinion and concluded that the Tax Court had not produced sufficient findings of fact to to enable the appeals court to rule on the Tax Court’s determination of best transfer pricing methodology. As a result, the Eighth Circuit remanded the case to the Tax Court for those determinations.

Decision of the case

On 18 August 2022, the US Tax Court issued its 2nd opinion in Medtronic, Inc. and Consolidated Subsidiaries v. Commissioner (Medtronic III). In this opinion, the Tax Court rejected the principal transfer pricing analysis of both the Internal Revenue Service (IRS) and Medtronic Inc. (Medtronic US), and instead applied an unspecified methodology proposed by Medtronic in the alternative to determine the royalty rate for licensing agreements between Medtronic US and its Puerto Rican subsidiary (MPROC). Using this method, the Tax Court increased the wholesale royalty rate for devices and leads to 48.8% for 2005 and 2006.