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Coca-Cola Granted Summary Judgement on Foreign Tax Credits Issue

On Dec. 14, 2015, Coca-Cola filed a petition in the U.S. Tax Court fighting a proposed $9.4 billion transfer pricing adjustment by the IRS. Among the many items being challenged by the Service are royalty payments made to Coca-Cola from a licensee in Mexico resulting in foreign tax credits (FTC). Now, two years to the day of Coca-Cola’s filing of their original petition, the Tax Court has granted Coca-Cola’s motion for Summary Judgement on the FTC issue. Although the overall case will continue, the Court ruled that Coca-Cola is entitled to the FTCs generated by the royalty payments made by the Mexico Licensee.


In 2015, the IRS challenged Coca-Cola’s method of calculating its U.S. taxable income from several of its foreign affiliates for the 2007 through 2009 tax years. In addition to asserting that Coca-Cola undercharged seven foreign affiliates for intellectual property, the IRS also challenged income allocations from a Canadian affiliate and asserted that the FTCs generated by payments made to Coca-Cola from a Mexico Licensee were overstated. Coca-Cola responded by filing a petition in the Tax Court. Coca-Cola Co. et al. v. Commissioner, No. 31183-15, 149 T.C. No. 21.

In their petition Coca-Cola asserted that their pricing method was valid, including the fact that in 1995, the Service and Coca-Cola entered into a closing agreement stating that it was proper for Coca-Cola’s affiliates to use an agreed methodology (“the 10-50-50 method”). This method states that Coca-Cola’s foreign affiliate would receive 10% of their gross sales and then split the remaining profit 50-50 with Coca-Cola. This agreement on pricing methodology also provided Coca-Cola with penalty protections. Although the agreement expired Dec. 31, 1995, the Service continued to use it as guidance when conducting exams of Coca-Cola from 1996 through 2006. It was not until Coca-Cola’s 2007 through 2009 tax years were examined that the Service took a position that 10-50-50 methodology was incorrect. If the IRS adjustment is upheld, the result would be Coca-Cola owing the IRS $3.3 billion of tax plus the accrued interest on that amount.

FTC Issue

On June 20, 2017, Coca-Cola filed a motion for partial Summary Judgement on the Mexico FTC issue. On Aug. 28, 2017, the Service filed a Motion for Summary Judgement requesting that the Tax Court find the Closing Agreement not relevant to the FTC issue in this case. The Tax Court determined that the Closing Agreement was relevant and dismissed the Service’s motion. The Tax Court granted Coca-Cola’s motion on Dec. 14, 2017.

In 1950, Coca-Cola opened a licensee in Mexico. This licensee was owned by a subsidiary of Coca-Cola and as such was included in Coca-Cola’s affiliated group and made deductible royalty payments to Coca-Cola. However, Mexico did not require an arms-length standard for these transactions prior to 1998.

On Jan. 1, 2001, Coca-Cola entered into an agreement with the Mexican taxing authority, the Servicio de Administracion Tributaria (SAT), stating that the 10-50-50 method was appropriate for the royalty payments made during the 2000 tax year. Later, Coca-Cola entered into a second agreement with SAT to the same effect, good until 2004. Following 2004, the Mexico Licensee continued to make royalty payments to Coca-Cola using the 10-50-50 method on the advice of a Mexican tax attorney. The taxpayer’s position was explained that because the IRS and SAT had both blessed the 10-50-50 method up until that point and since no material changes had occurred in the arrangement between Coca-Cola and the Mexico Licensee, the methodology would continue to be valid.

In their 2015 Notice of Disallowance, the IRS determined that this was no longer the case. Through this assertion, the Service determined that the Mexico Licensee was understating royalty payments to Coca-Cola. These underpayments in turn led to fewer deductions against the Mexican income tax. Therefore, because the Mexico Licensee was paying more in Mexican taxes than was necessary, the taxes were not compulsory and Coca-Cola’s FTCs were inflated.

When determining if a tax is compulsory, the Court must look at two things under Treas. Reg. 1.901-2. First, the taxpayer’s position must be a “reasonable interpretation and application” of the foreign tax law, so as to reduce the taxpayer’s foreign tax liability. Second, the taxpayer must exhaust all avenues to lower their foreign tax liability, “including invocation of competent authority procedures available under applicable tax treaties.”

The Court first reviewed Coca-Cola’s application of the 10-50-50 methodology. When determining if an interpretation and application of a foreign tax law is reasonable, taxpayers may rely on a safe harbor provision in the regulations. Treas. Reg. 1.901-2 states that “a taxpayer may generally rely on advice obtained in good faith from competent foreign tax advisors to whom the taxpayer has disclosed the relevant facts.” Based on this provision, and the above stated facts regarding the IRS closing agreement, the SAT agreements, and the fact that Coca-Cola had relied on the advice of a competent tax attorney, the Court determined that the 10-50-50 methodology met the first prong of the compulsory test.

The Court next looked to determine if Coca-Cola had exhausted all of their possible remedies to lower their foreign tax. In their initial letter notifying Coca-Cola that they were looking into these royalty payments, the IRS notified the Taxpayer that they could seek relief through a competent authority proceeding under the US-Mexico tax treaty. In 2013, Coca-Cola requested this proceeding, however the IRS refused to initiate it because they were planning to litigate the transfer pricing issue. Therefore, Coca-Cola argued that because the transfer pricing issues had not yet been litigated and because the government refused to initiate a remedy under the US-Mexico tax treaty, that they had exhausted all of their possible remedies.

The IRS argued that Coca-Cola could wait until the transfer pricing adjustments were finalized and then attempt to challenge their Mexican tax liability. The Court rejected this argument, stating that although this was technically correct, it was not what “Congress envisioned when it enacted the code.”

The IRS also argued that Coca-Cola could file a refund claim in Mexico. The Court again disagreed with the Service. The Court determined that the likelihood of SAT agreeing to the refund was poor given their prior agreements with the Taxpayer. Writing for the Court, Judge Lauber stated “A taxpayer ‘is not required to take futile additional administrative steps’ in order to satisfy the exhaustion-of-remedies requirement.” Ultimately, the Court determined that there were no remedies available to Coca-Cola.

Having met both prongs of the compulsory test, the Court determined that Coca-Cola met its burden for proving it deserved a partial motion for summary judgement on the FTC issue.

Although the taxpayer won a hard earned victory in this case, foreign tax credit and transfer pricing issues can be very complex. Taxpayers engaged in intercompany or international transactions should be cognizant of the many requirements surrounding these transactions. We will continue to follow the conclusion of this case as it raises important issues regarding the arm’s-length standard, reliance on Advance Pricing Agreements and foreign tax credits. Should you have any questions regarding transfer pricing, foreign tax credits, or other complex tax issues please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at [email protected].


Contact our team today with any tax controversy concern you’re facing. We fight every day to protect the interests of the taxpayer, and we look forward to putting you in the best tax situation possible.


Contact our team today with any tax controversy concern you’re facing. We fight every day to protect the interests of the taxpayer, and we look forward to putting you in the best tax situation possible.


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© 2021 alliantNational.- All Rights Reserved.


Washington D.C.
Willard Office Building, Suite 300 1455 Pennsylvania Ave.
Washington, D.C. 20004

© 2021 alliantNational. - All Rights Reserved.

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