On June 25, the 11th U.S. Circuit Court of Appeals considered Coca-Cola Company’s challenge to the IRS’ change to a long-standing transfer pricing formula, which resulted in a tax deficiency of roughly $2.7 billion for the beverage giant. The dispute centers on income from foreign subsidiaries that manufacture and sell concentrate for Coca-Cola products in overseas markets.
Background
In a 2020 opinion, the Tax Court sustained the IRS’ reallocation, for the 2007, 2008, and 2009 tax years, of about $9 billion in income from seven of Coca-Cola’s foreign manufacturing affiliates, known as “supply points,” to its U.S. parent company. (155 T.C. 145, 11/18/2020)
The IRS made the adjustment after it abandoned the transfer pricing method the parties had used for years — a formula known as the “10-50-50” method that was memorialized in a 1996 closing agreement for prior tax years. Instead, the IRS used the comparable profits method under IRC § 482, which determined the foreign subsidiaries’ profits by comparing them to independent Coca-Cola bottlers.
The Tax Court found this was not an abuse of the IRS’ discretion, and Coca-Cola appealed to the 11th Circuit.
Company argues method change was ‘arbitrary’ and applied inconsistently
In its opening appellate brief, Coca-Cola argued that the IRS’ decision to retroactively abandon the 10-50-50 method is a “classic bait and switch that is arbitrary and capricious under bedrock principles of administrative law.”
The company contends that the 1996 closing agreement, combined with a decade of subsequent audits where the IRS never disturbed the method, created “serious reliance interests.” Coca-Cola said it structured its global operations based on the IRS’ approval of the formula and that the agency cannot retroactively impose billions in tax liability by suddenly changing methods long after the tax years in question closed.
Gregory Garre, representing Coca-Cola, told the circuit court during oral arguments that the IRS had acknowledged that the 10-50-50 method produced arm’s-length results. The agency also has continued to apply the method to 11 of 18 supply points around the world, Garre added. In Coca-Cola’s view, the IRS’ disallowance of the methodology for seven supply points is “the height of inconsistent treatment.” Garre noted that Coca-Cola is not objecting to the motives, but rather to the inconsistency.
Garre acknowledged the IRS is not bound in perpetuity to any method, but contended the IRS had to give Coca-Cola notice before retroactively applying a new method that “wildly” increased tax liability. Garre said the IRS’ action was arbitrary both in the way it changed methods and in its choice of a new method.
Government defends use of the comparable profits method
The panel homed in on when and whether the IRS should have provided notice of its switch to a new method for some countries.
Arguing for the government, Jennifer Marie Rubin said there’s no basis for Coca-Cola’s argument over notice. The Tax Code doesn’t call for notice, Rubin stressed, noting that the requirements are set forth in the regulations. And all tax deficiencies are retroactive, Rubin said, adding “that’s how it works.”
In the government’s view, neither the 1996 closing agreement nor its acceptance of the 10-50-50 method in prior audits precluded it from making § 482 adjustments for the 2007–2009 tax years. “Each tax year stands on its own, and taxpayers have no vested rights in IRS acquiescence,” the government’s brief states.
The government notes that the closing agreement was used to settle Coca-Cola’s tax liability for the 1987–1995 tax years. “[T]he 1996 Closing Agreement was not a promise that Coca-Cola could use 10-50-50 during post-1995 years,” reads the government’s brief. While the agreement granted Coca-Cola protection from accuracy-related penalties if it continued to use the method, the government said this was “only ‘penalty’ relief, not relief from the § 482 adjustment itself.”
Garre, however, countered that it’s not just the agreement, but the IRS’ “subsequent conduct” that led to Coca-Cola’s reliance on the 10-50-50 method. He also highlighted the inconsistency of discontinuing application of the 10-50-50 method for only some supply points.
Rubin, however, noted there’s nothing in the record on whether the supply points for which the new methodology was applied were comparable to those for which the 10-50-50 method could still be applied. While Coca-Cola attributes the discrepancy to tax-treaty interference, Rubin dismissed this as a “conspiracy theory.”
Although the panel did not seem fully convinced by Rubin’s “conspiracy theory” characterization, multiple judges pushed Garre on the lack of evidence in the record on the distinctions between differently treated supply points.
Lessons from the dispute
Justen Ghwee, international tax director at Kaufman Rossin, called the dispute “a reminder that transfer-pricing positions are living obligations.”
“Coca-Cola’s exposure spans nearly two decades because the same disputed method carried forward year after year,” Ghwee noted. “That pattern is the central cautionary tale: a single un-revisited position can compound into multi-billion-dollar risk.”
“Comparables, functional profiles, and market conditions change,” Ghwee said. “A study prepared years ago may no longer support the current allocation,” he added, suggesting annual updates to documentation. And updates should account for both changes in facts and in “controlling law,” said Ghwee.
Ghwee also stressed that “closing agreements and Advance Pricing Agreements (APAs) have finite terms.” He explained that once those agreements lapse, the method “is no longer protected.”
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