United States: Is It The Real Thing? The IRS Makes $9+ Billion Of Transfer Pricing Adjustments Against The Coca-Cola Company

On September 17, 2015, the IRS issued a statutory notice of deficiency to the Coca-Cola Company, increasing its federal income taxes for 2007-2009 by $3.3 billion, based primarily on transfer pricing adjustments exceeding $9 billion. On December 14, 2015, Coca-Cola petitioned the U.S. Tax Court to overturn the adjustments.

This is a huge case. The $9 billion income adjustment relates only to three years and there's no reason to think the numbers will fall going forward. In this alert, we summarize some key aspects of Coca Cola's petition and suggest what to watch for as the case progresses.

The Petition

The principal dispute involves transfer pricing between Coca-Cola and seven related foreign licensees (the "Licensees"). The Licensees manufactured concentrate for sale to bottlers outside the United States. The IRS claims that royalties paid by the Licensees to Coca-Cola for use of trademarks and formula rights were less than arm's length. The IRS apparently made this determination based on a "comparable profits method" ("CPM") approach that tested the Licensees' return on operating assets against that of selected unrelated companies. In its Tax Court petition, Coca-Cola contends that:

  • The IRS accepted Coca-Cola’s non-CPM transfer pricing model for 20 years, first in a closing agreement covering 1987-1995, then through successive audits covering 1996-2006. The closing agreement went so far as to provide prospective penalty protection as long as the methodology was followed. The IRS gave no explanation for its departure from this approved methodology in the 2007-2009 audit.
  • The IRS improperly applied the CPM to the Licensees. The Licensees bore substantially all entrepreneurial risk and responsibility for their businesses. The Licensees were part of local business units and regional operating groups with important decision-making authority for their operations. They invested more than $45 billion in pre-royalty operating and marketing expenses and paid the parent more than $18 billion in royalties for 1987-2009. The petition seems to imply that allocating only "routine" returns to the Licensees, while assigning all non-routine profits to the parent (the legal owner of the intangibles), is inconsistent with an appropriate functional/risk analysis.
  • Moreover, the CPM analysis uses inappropriate comparables. The IRS used beverage bottlers as comparables rather than manufacturers like the Licensees.
  • In applying the CPM, the petition seems to imply that the IRS ignored the consequences of two rulings it had earlier issued with respect to Code section 367 transfers of intangibles to the Brazil and Ireland Licensees.
  • The IRS took inconsistent positions. In a separate adjustment covered by the petition, the IRS priced transactions between Coca-Cola US and its Canadian subsidiary (not one of the Licensees) by allocating a routine return to the legal owner of the intangible property (the Canadian subsidiary) and all residual profit to the entity allegedly bearing the entrepreneurial risk (the US parent).
  • The IRS improperly applied transfer pricing principles (the CPM) to reduce the income of a Mexican branch of a US group member, and thereby reduce creditable foreign taxes. Coca-Cola claims to have exhausted all effective and practical remedies (including seeking competent authority relief) with respect to the Mexican taxes so as to entitle it to the credit.
  • The IRS disregarded foreign legal restrictions (Brazilian currency and royalty limits) in making certain of the adjustments.
  • After adjustment by the IRS, the royalties exceeded 100% of the aggregate operating profits of the Licensees – implicitly suggesting the adjustments were unreasonable.
  • The royalties paid pursuant to the closing agreement methodology (as well as intercompany charges for headquarters expenses) were actually excessive, not the contrary.

Key Take-Aways

Although IRS resources are low and ebbing, the IRS Transfer Pricing Office is attempting to standardize the IRS approach to transfer pricing cases, both through the guidance and support of the Transfer Pricing Practice and through publication of International Practice Units. The IRS is also carefully selecting cases for litigation. What then does the IRS's approach in the Coca-Cola case portend for IRS behavior in other cases?

  • A willingness to ignore past agreements. The IRS is not always happy with the closing agreements it reaches ("buyer's remorse" . . .) and Coca-Cola may be a case in point. The pending Eaton case in the Tax Court also involves an IRS departure from past closing agreements (and APAs).
  • A willingness to ignore long-term risk allocations. In Coca-Cola, the IRS relied on a CPM for some (very) long-term licensees. Whatever the value of the intangibles licensed to the Licensees, ignoring the entrepreneurial risks that they undertook – as a CPM test may do – seems arbitrary. The IRS may, on the other hand, assert that the selected comparables faced similar risks and owned similar intangibles.
  • A willingness to ignore informal shared intangible development arrangements. The outcome of accepting risk is, in some contexts, the ownership of "soft" intangibles resulting from the associated expenditures. Although Coca-Cola US owned the trademarks and formula rights, the Licensees were responsible for developing local marketing strategies and relationships (expenses that the IRS often asserts give rise to intangibles). The IRS seemed to ignore any such intangibles as well as the intangibles transferred in Code section 367 transactions to the Brazilian and Irish Licensees. Again, the IRS may assert that its analysis is not flawed because the comparables faced similar risks and owned similar intangible assets.
  • Application of transfer pricing principles to determine foreign source income. While there are circumstances where transfer pricing principles may be applied to determine a US company's foreign source income (e.g., where US sourcing rules apply a facts and circumstances analysis or where the Authorized OECD Approach applies to determine the profits of a permanent establishment), the petition suggests that the IRS did so here based on Section 482 and that this was improper. The IRS took an expansive (some might say aggressive) approach in this regard in a 2013 Chief Counsel Advice Memorandum.
  • Continued (and unsurprising) defense of IRS regulations with respect to foreign legal restrictions (Treas. Reg. § 1.482-1(h)(2)). The case involves a reprise of the issues raised in the on-going 3M Tax Court litigation (Brazilian royalty limits), and adds Brazilian currency-remittance restrictions to the discussion.


We have heard so far from only one party. The IRS undoubtedly will offer robust defenses for its positions. However, if Coca Cola is correct that the IRS abandoned a long-accepted TPM in the absence of a material change of facts, the IRS may be hard-pressed to sustain the adjustments. Two of its substantive positions may be particularly problematic.

First, applying the CPM in these circumstances may be aggressive. Unless the comparables used in the analysis also accept entrepreneurial risk, have responsibility for managing a complex business model, and own some valuable intangibles, they likely are not truly comparable. And the functional differences between manufacturers and bottlers seem significant. Of course, it will be highly pertinent to learn what TPM was used in the IRS closing agreement for 1987-1995. Whether the IRS can defend the comparability of the companies it selected is thus the key issue in the case.

Second, the seemingly inconsistent position taken by the IRS with respect to the Canadian operation invites scrutiny. Given the huge adjustments relating to the seven Licensees, one has to wonder whether adding as a taxpayer target the much smaller adjustments relating to the Canadian subsidiary (some 2% of total adjustments) was a good strategy.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions