Skip to main content

Three Transfer Pricing Cases and What We’ve Learned from Them 

5th October 2021

In today’s globalized society, multinational enterprises (MNEs) know transfer pricing scrutiny comes with the territory. And sometimes the hawkish oversight of tax authorities will land a multinational in court. This can mean, at best, an exercise in sidestepping administrative and reputational repercussions. Or, at worst, a hefty tax bill. Coca-Cola, Glencore, and Altera, of course, know the realities of transfer pricing legal battles all too well, as they’ve faced various challenges in the pursuit of transfer pricing justice. What can you learn from their unfortunate experiences? Here we highlight a few facts from each case that we think are especially educational for MNEs. Did we cover every detail of each dispute? No—we thought it better to skip the legal minutiae and cut straight to the important part: What each ordeal means for you.  

Coca-Cola vs IRS 

Crux of the Case: Transfer pricing and intangibles. 

Long Story Short: During tax years 2007-2009, the beverage giant licensed intellectual property to operating plants in Ireland, Brazil, and Mexico, among other jurisdictions. The operating plants manufactured soft drink concentrate then sold and distributed the concentrate to bottlers. 

How was Coca-Cola compensated? Coca-Cola adhered to a 1996 closing agreement with the IRS and used the 10-50-50 method as stipulated to determine royalty prices. The 10-50-50 method allocated the operating plants 10% of gross sales, with the remainder split equally between the operating plants and Coca-Cola. A move which increased taxable income everywhere but the United States. No surprise, that didn’t go over so well with the IRS.   

The problem? The agreement applied to tax years 1987 through 1995, which was long past. The IRS used the comparable profits method to determine a different royalty amount, which they argued more accurately reflected how the owner of valuable intellectual property would be compensated. After a five-year legal battle, in November 2020, the U.S. Tax Court ruled in favor of the IRS and ordered Coca-Cola to pay $3.4 billion in additional taxes. But it wasn’t all bad news for the soft drink multinational. The court acknowledged the company’s dividend offset treatment to honor royalty requirements, which reduced the bill by $1.8 billion. 

The Takeaway:  

  • Like many tax authorities, the IRS isn’t messing around when it comes to transfer pricing involving intangible assets. Make sure you’re reviewing the DEMPE functions—development, enhancement, maintenance, protection, and exploitation—on your intellectual property, as part of a robust functional analysis, so you know (and can defend) where value is genuinely coming from.  
  • Routinely review legal agreements to make sure they illustrate the facts and circumstances of the business and—you wouldn’t think we’d need to say this—make sure they’re up to date.   
  • Be smart: Look at your analysis and ask yourself if it makes sense. In the case of Coca-Cola, entities performing routine functions were more profitable than the IP-owning parent. You don’t need the IRS to see that something’s out of whack.  

Glencore vs Australian Taxation Office  

Crux of the Case: Comparability.  

Long Story Short: Granted, this case was a win for the taxpayer, but it’s still hard to dismiss the lessons we learned from Glencore. Australia-based Cobar Management Pty. Ltd. (CMPL) sold copper concentrate to its Swiss parent, Glencore International AG (GIAG). Historically, pricing was “market-related,” but in 2007, the taxpayers entered into a new price-sharing agreement, which would result in reduced tax revenue for the ATO. CMPL priced the copper concentrate based on an official London Metal Exchange price, averaged over an optional quotational, period and deducted treatment costs and refining costs (TCRC) at a fixed 23% of the copper price. Still with us? The purchaser had the option to elect pricing averaged over three possible timeframes. The arrangement required both parties to assume risk.  

The ATO argued that Glencore’s new intercompany agreement, and therefore pricing, wasn’t at arm’s length. The taxpayer disagreed and they ended up in court. While Glencore admitted that none of the third-party contracts were fully comparable, it did provide adequate evidence of similar price-sharing mechanisms in third-party contracts. After two years of litigation, the Australian Federal Court ruled in favor of Glencore, citing that when you take risk into account, the intercompany transaction was priced at arm’s length. In May 2021, the High Court of Australia denied the ATO’s request for appeal.    

The Takeaway: 

  • Reliable comparables and robust benchmarking analyses are key in supporting any intercompany transactions.  
  • Intercompany agreements should be reviewed and updated to ensure they are in line with third-party arrangements.   
  • A strong functional analysis is the foundation of your documentation—had Glencore not shown that both parties assumed risk, this case could have gone in another direction—one that includes a tax bill of an additional $A92.6 million for the taxpayer.  

Altera vs. IRS 

Crux of the Case: Should stock-based compensation be included in cost-sharing agreements? 

Long Story Short: May 1997 kicked off cost-sharing agreements between Altera Corporation and its Cayman Island subsidiary, Altera International, Inc. The agreements included stock-based compensation (SBC) for U.S. employees conducting R&D in the Cayman Islands and were solidified through an advance pricing agreement (APA) between the IRS and Altera for tax years 1997-2003.    

It’s in 2003 that things start to get murky. The United States amended the cost-sharing regulations, Treas. Reg. § 1.482-7, to require taxpayers to include SBC in the cost pool under all cost-sharing agreements. Altera and its subsidiary revised the cost sharing agreement in 2003 to align with the new regulations. However, in 2005, following the Tax Court’s opinion in Xilinx Inc. vs. IRS, Altera and its subsidiary revised the cost sharing agreement again to omit the SBC costs for tax years 2004-2007.  This move prompted the IRS to take Altera to court over $80 million in perceived missing taxable income.  

In July 2015, the U.S. Tax Court ruled against the IRS, claiming it didn’t provide a compelling argument that the SBC rule aligned with the arm’s length standard. In July 2018, the Ninth Circuit overturned the U.S. Tax Court ruling in a two-to-one decision, putting the SBC rule back on the map. And, just when you thought this case couldn’t get any juicer: The IRS and Altera went to the Ninth Circuit Court of Appeals in 2019, where the Ninth Circuit ruled that the 2003 regulation was valid, and Altera was “inconsistent with the traditional arm’s length standard.”    

The Takeaway: 

  • Include stock-based compensation costs in cost-sharing agreements.  
  • Given this ruling, along with the newish OECD guidance on financial transactions, MNEs need to be ready for increased scrutiny on all cost-sharing agreements.  
  • Taxpayers are responsible for meeting regulations even through changing legislation. So, keep up on them.  

For more deep dives into transfer pricing court cases, regulations, and trends, subscribe to The Fiona Show: Transfer Pricing on Apple or Spotify.