The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
June 8 — Recent transfer pricing cases in the U.S. Tax Court reveal a troubling pattern on the part of the IRS, practitioners say, with the agency walking away from long-standing agreements on matters taxpayers thought had been settled.
Eaton Corp.'s advance pricing agreement, Coca-Cola Inc.'s closing agreement and Medtronic Plc's memorandum of understanding were all deals that the companies thought had locked in their transfer pricing. They were wrong. Each company has been embroiled in complex litigation in which the IRS has argued that the written agreements aren't binding.
Thomas Linguanti, a partner with Baker & McKenzie LLP in Chicago, said these cases gin up a sense of uncertainty, and not just for the taxpayers involved.
“At the end of the day we’re Monday morning quarterbacking,” Linguanti said. “There are a lot of things going on, very thoughtful professionals making decisions. But the ramifications are significant.”
Taxpayers are saying they feel “unmoored” by the realization that they can't depend on long-standing agreements with the IRS, Linguanti said, speaking June 8 at an international tax conference sponsored by Bloomberg BNA and Baker & McKenzie.
Linguanti represents Medtronic in its transfer pricing dispute with the IRS. A ruling in the case was issued June 9 (see related story).
The most striking example of the IRS walking away from an agreement is Coca-Cola's $9.4 billion transfer pricing dispute over the licensing of intangibles abroad. The IRS claims that Coca-Cola undercharged its foreign affiliates for the rights to its brand and other marketing intangibles, but the company says its approach is all set out in a closing agreement it worked out with the agency years earlier (24 Transfer Pricing Report 1083, 1/7/16).
Saul Mezei, a partner with Morgan, Lewis & Bockius LLP, said the fact that the agency rejected a long-standing closing agreement is particularly unsettling.
“The IRS did honor it for a really long time, through at least five successive audit cycles. And then the IRS decided suddenly that it wasn’t going to honor it anymore,” Mezei said.
Why the IRS made the decision to walk away from the closing agreement isn't clear. The agency has designated the case for litigation—bypassing the administrative appeals process—a move that suggests the IRS sees the dispute as an opportunity to reset current case law (24 Transfer Pricing Report 1382, 3/17/16).
But according to Mezei, the decision to take the case to court “has an ad hoc feel.”
“You'd like to think there is some grand scheme here, but with the agency reorganizing it seems every five minutes, it is hard to see that there is any coordination. It seems driven by individuals, by bad relationships, sometimes, and that's particularly troubling,” he said.
Drew Crousore, partner with Baker & McKenzie in Palo Alto, said the new environment of uncertainty creates a bad working relationship for practitioners and their clients, particularly when the IRS decides to rethink an agreement it signed off on earlier.
“For a tax professional or an adviser to have to go back a year or two later and say by the way, you know all that work we did three years ago and we reached that resolution? It’s for nothing. That’s not a career enhancing conversation.”
Holly McClellan, director of global transfer pricing with General Electric Co., jumped in: “Or even to have to explain up front that something could go wrong.”
After working to persuade a company to go ahead with an agreement with the IRS, she said, “you don’t want the next breath to be ‘you know, sometimes they walk away from this stuff.' But it would be irresponsible if you did not inform people that this is what could happen.”
And when it happens, Crousore said, “the dynamics of the relationship between the IRS and the taxpayer change drastically.”
The ill will created by such situations is ultimately counterproductive for the IRS, Crousore suggested, because taxpayers will be less inclined to work out administrative agreements. Instead, they will be more inclined to wait out the audit and head straight to court, where they know they can get a final judgment.
“The impact on non-docketed cases is a longer march to controversy or litigation than what you would have seen 10 years ago or five years ago,” he said.
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