Coca-Cola Chairman Punts on IRS Interrogations in Parties’ Trial

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Sony Kassam

Coca-Cola Co.'s current chairman punted on a series of IRS questions intended to emphasize the role the company’s bottlers played in its beverage distribution system.

Muhtar Kent repeatedly highlighted the contributions the company’s supply points—its business units—make to the success of Coca-Cola’s beverage sales, during cross-examination March 6 at a trial that centers on a $3.3 billion tax bill.

Kent kept circling back to a “pull-push” theme, saying the business units “pull” customers to the product, while the bottlers “push” the product out to customers.

Kent also likened the business units to software companies that don’t tend to be asset-heavy. “They depend on the capacity of the people,” he said during direct examination from Sanford Stark, a partner at Morgan, Lewis & Bockius LLP.

By contrast, the bottlers are similar to hardware companies because they’re more capital-heavy. The bottlers’ business is skewed toward distribution and balance sheets, Kent said.

Role of Supply Points

The IRS shifted $9.4 billion of income to Coca-Cola from six foreign licensees, or supply points, for 2007-09 because it asserted the company didn’t charge them enough money for intellectual property used in the production, marketing, and sale of Coca-Cola concentrates. That income adjustment led the agency to surprise Coca-Cola with a $3.3 billion bill in September 2015.

The underlying issue involves determining whether the supply points had a greater role than the bottling companies that were supplied Coca-Cola concentrate, or whether those supply points had equivalent functions to the bottling companies.

The company argues that the supply points act entrepreneurially, taking investment risks and developing marketing and sales strategies for their local markets, so the profits should be allocated to them.

The IRS contends Coca-Cola’s supply points should be treated like its bottlers, which are independent companies that have contracts with Coca-Cola to purchase concentrate and manufacture product.

Bottlers’ Role Within Coca-Cola Co

During cross-examination, Jill A. Frisch, special trial attorney at the IRS’s Large Business and International Division, asked Kent if bottlers are obligated to spend money to develop markets. Kent said the method by which the business units interact with the bottler isn’t spelled out in detail in the bottler agreement.

Asked if the details are worked out in a business plan, Kent said the business units present their strategies and consumer insights to the bottler management, and then the planning process happens jointly.

The business units also have the ability to shut down a bottling plant if that plant isn’t complying with certain standards, Kent said. Are there “any foreign particles in the package? Does the label look good?” are some questions that factor into data collection.

U.S. Tax Court Judge Albert G. Lauber questioned Kent on a point he made during the first day of the trial. Kent had said that two different retailers on the same city block will sometimes sell different brands to two kinds of customers based on shopper socioeconomics.

“What kind of person would bring that granular knowledge?” Lauber said. “Would it be the bottler?”

The knowledge comes from the research and insights group, Kent replied, which is part of the business unit. All of that information is then fed to sales personnel from the bottlers, he said.

Frisch revisited the topic later, asking if both consumer and trade marketing is needed for Coca-Cola to be successful.

Kent said the two are needed for Coca-Cola’s beverage sales to be successful. Again, it’s a symbiotic relationship, he said.

Power of Brands

Frisch asked a series of questions related to the “scale” of Coca-Cola and if that led to greater financial success. Kent said it didn’t.

She kept pushing.

Lauber eventually interjected, saying the scaling was to impress investors and that Frisch had pushed the scaling question enough.

Frisch persisted, asking if she could try once more.

“Do you agree that the ability to scale leads to increased brand power, which increases alignment, which leads to greater financial success?” she asked Kent.

“No, increased scale doesn’t lead to brand power,” he said. “Increased insights and brand knowledge applied to marketing leads to power of brands.”

Different Answers?

Frisch then displayed portions of Kent’s deposition testimony on a screen. In his deposition, Kent said the ability to scale led to increased profitability, which led to increased brand power and happiness with bottlers, thereby resulting in financial success.

However, Kent said his comments were made in reference to the increased scale of the company’s water brand, Glaceau Smartwater.

“It doesn’t start with increased scale, it starts with the brand, Glaceau,” Kent said.

If the question was whether “brand power leads to more satisfaction and profitability, I would’ve answered yes,” he told Frisch. “The way you asked the question in generic terms without any brand attached, then I would say ‘no.’”

Another Attempt

Frisch then asked Kent if he had participated in business planning with the business units and bottlers during his time as chief operating officer. When Kent said he didn’t, Frisch displayed additional portions of Kent’s deposition.

Kent again said that the context behind those deposition answers was different than the context of the questions asked in court.

Frisch then realized that during the deposition Kent had been asked about a separate position within the Coca-Cola system that fell under a senior field operating position.

“That was a field role, madam,” Kent said, “and not a corporate role.”

The six-week trial is expected to run in a pair of three-week sessions, concluding April 20.

Morgan, Lewis & Bockius LLP and Miller & Chevalier Chartered represent Coca-Cola.

The case is Coca-Cola Co. v. Commissioner, T.C., No. 31183-15, cross-examination 3/6/18 .

To contact the reporter on this story: Sony Kassam in Washington at skassam1@bloombergtax.com

To contact the editor responsible for this story: Kevin A. Bell at kbell@bloombergtax.com

Copyright © 2018 Tax Management Inc. All Rights Reserved.

Request Transfer Pricing Report