IRS Wins on Question of Aggregation in ‘Guidant' Case

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Feb. 29 — The IRS scored a major victory when the U.S. Tax Court ruled that the agency isn't obligated to determine the separate taxable income (STI) of each taxpayer in a consolidated group when the agency makes a transfer pricing adjustment (Guidant LLC v. Commissioner, T.C., No. 5989-11, 2/29/16).

The court ruled Feb. 29 on a motion for partial summary judgment filed by Guidant LLC in its $3.5 billion transfer pricing dispute. The company had maintained that the IRS abused its discretion when it failed to determine the STI for each controlled taxpayer in the group—even though the company admitted that it had refused to produce critical financial data the IRS requested.

The company also faulted the agency because it didn't make specific adjustments for each transaction involving an intangible, a purchase and sale of tangible property, or a provision of services.

In the unanimous division opinion, the court rejected both arguments. Whether the IRS abused its discretion in the case—either in making the adjustments or aggregating transactions—can't be decided as a matter of law, the court said, but both are questions of fact to be determined at trial.

John Warner, partner with Buchanan Ingersoll & Rooney PC, told Bloomberg BNA in an e-mail that the opinion wasn't surprising.

“The taxpayer has a fairly high bar to meet to throw out a Section 482 allocation based on the ‘arbitrary, capricious and unreasonable' standard,” he said. “The taxpayer's frustration with not having a member-by-member breakdown may be understandable because such a breakdown would permit the taxpayer to defend its pricing on a more granular basis, but if for some reason it was impractical for the IRS—whether or not due to the taxpayer's inability or unwillingness to do so—it is hard to say that the case should be thrown out on that basis.”

According to the opinion, nothing in tax code Section 482—which governs transfer pricing—and nothing in federal transfer pricing regulations requires the IRS to make separate company determinations before it makes an adjustment for the group as a whole, the court said.

Although the plain language of the regulations mandate that the IRS determine both consolidated taxable income and separate taxable income, they don't specifically require that STI be determined contemporaneously with a Section 482 adjustment.

Requiring the IRS to make STI adjustments contemporaneously with Section 482 adjustments in all cases “could completely eliminate the Commissioner's ability to make section 482 adjustments when a taxpayer consciously withholds or fails to maintain records,” the court said.

Further, the code and regulations both permit the IRS to aggregate related transactions when doing so provides “the best means of determining the true taxable income of a controlled taxpayer.”

Warner noted that the opinion didn't address the merits of the case.

“The question was whether the IRS was wrong as a matter of law—not whether its proposed adjustment was warranted upon an evaluation of all the facts and circumstances,” he said.

Consolidated Petitions

The Guidant litigation consolidates a half-dozen petitions challenging adjustments made to the income of medical device maker Guidant Corp. and its subsidiaries for tax years 2001-06. It also incorporates a petition filed by Boston Scientific Corp. challenging an adjustment for tax years 2006-07. Boston Scientific acquired Guidant in 2006.

The income adjustments total $3.5 billion and relate to the transfer of intangible property, sales of components and finished goods, and the provision of services among related parties. The transactions involved Guidant Corp. and its subsidiaries Cardiac Pacemakers Inc., CardioThoracic Systems Inc. and Guidant Sales Corp. For tax years 2001-06, the transactions also involved Advanced Cardiovascular Systems and for tax years 2001-03, Endovascular Technologies Inc. These companies collectively are referred to as Guidant U.S. in the IRS filings.

The Section 482 adjustments involved transactions between Guidant U.S. and Guidant's affiliates in Ireland and Puerto Rico and with its foreign distribution affiliates.

Guidant filed its motion for partial summary judgment in February 2015 and a hearing was held in June. During the hearing, Judge David Laro pressed the IRS attorney to explain why the agency didn't pressure Guidant to produce the financial data in the form that it wanted (105 DTR K-3, 6/2/15).

The IRS attorney cited the volume and complexity of the financial data as a factor, but stressed that the agency didn't think it legally necessary to insist on it. He also told the court that the IRS didn't consider making member-specific adjustments a required initial step. Rather, it has been IRS practice to arrive at member-specific adjustments after transfer pricing issues have been resolved.

At that point, the IRS attorney said, the parties sit down and make calculations, dealing with such questions as entity-specific setoffs, state and local taxes and other matters.

The court's Feb. 29 opinion echoed that understanding, noting that the IRS didn't believe it could make reliable member-specific adjustments based on the information available, particularly after considering the flow of products among Guidant's group entities, which involved multiple steps and multiple transfer pricing transactions.

“For many products, the flow involved a ‘round trip' from the United States to Ireland or to Puerto Rico and back,” the court said.

Records Dispute

Although the agency sought financial records to permit such an analysis, Guidant didn't maintain them in a form that would allow it to easily track income and expenses by place of manufacture, the court said.

Thus, Guidant couldn't tie income and expenses in its business unit financial statements to particular product lines or to products manufactured in the U.S., Ireland or Puerto Rico.

However, the company has argued that it had the necessary information and records, but that the IRS wouldn't undertake the expense of extracting the information at the time of the audit.

“Whether respondent's decision to delay the STI computations constitutes abuse of discretion under these circumstances is, thus, still in dispute and remains to be determined on the full record of the case as developed at trial,” the court said.

Likewise, the question of whether the IRS properly applied the regulations permitting the aggregation of interrelated transactions is a question of fact that must be resolved on the basis of the trial record.

To contact the reporter on this story: Dolores W. Gregory in Washington at
To contact the editor responsible for this story: Molly Moses at