Supplemental Briefs Ordered in Coca-Cola Transfer Pricing Case

THE COCA-COLA COMPANY AND SUBSIDIARIES,
Petitioner
v.
COMMISSIONER OF INTERNAL
REVENUE,
Respondent

United States Tax Court

ORDER

On November 18, 2020, the Court issued its Opinion deciding all but one of the issues presented by this case. See Coca-Cola Co. & Subs. v. Commissioner, 155 T.C. 145 (2020). The issue not decided is whether the transfer-pricing adjustment to petitioner from its Brazilian supply point should be reduced because Brazilian law prevented that entity from paying, for the use of petitioner's intangibles, royalties in the arm's-length amounts determined in our Opinion.

During 2007–2009 Brazilian law restricted the amount of trademark royalty and technology transfer payments that a Brazilian entity could pay to a foreign parent. The parties have stipulated that those maximum amounts were roughly $16 million for 2007, $19 million for 2008, and $21 million for 2009. Relying on what is commonly called the “blocked income” regulation, the Internal Revenue Service (IRS or respondent) contends that this Brazilian legal restriction should be given no effect in determining the arm's-length transfer price. See Treas. Reg. §1.482-1(h)(2)(1994).1 The regulation generally provides that foreign legal restrictions will be taken into account only if four conditions are met, and respondent contends that some or all of those conditions have not been met. See id. subdiv. (ii). Petitioner contends that this regulation does not apply here or that, if it does apply, the necessary conditions were met. Alternatively, it contends that the “blocked income” regulation is invalid under the Administrative Procedure Act (APA) and/or Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).

At the time we issued our Opinion, challenges to the validity of the “blocked income” regulation had been taken under advisement by another Division of this Court. See 3M Co. & Subs. v. Commissioner, T.C. Dkt. No. 5816-13 (filed Mar. 11, 2013). We accordingly reserved ruling on the parties' arguments “until an opinion in the 3M case has been issued.” 155 T.C. at 185. On February 9, 2023, a Court-reviewed opinion was issued in the 3M case, rejecting by a 9-8 vote the taxpayer's Chevron and APA arguments and upholding the validity of the “blocked income” regulation. See 160 T.C. No. 3 (2023). We will ask the parties to file supplemental briefs in light of that opinion.

The first question is how the remaining issue in this case should be decided, given the Court‘s holding that the “blocked income” regulation is valid. This case and the 3M case both involve the Brazilian affiliate of a US parent. In each case the Brazilian affiliate used intangible assets of the US parent without paying arm's-length compensation therefor. But the tax years at issue in the two cases are different: 2006 for 3M and 2007–2009 for Coca-Cola.

Petitioner contends that, because of the timing of certain trademark registrations in Brazil, the “blocked income” regulation may be inapplicable in the case of certain intangibles. In our Opinion we addressed the ownership of certain Brazilian intangibles in connection with petitioner's arguments under the so-called “developer assister” rules. See 155 T.C. at 175–184. It is not entirely clear to the Court how our holding on that point intersects with petitioner's arguments regarding application of the “blocked income” regulation.

Secondly, we invite the parties' views as to how the remaining issue in this case should be decided if one were to assume arguendo that the “blocked income” regulation is invalid. In that event, the question would be decided under the text of I.R.C. §482, as amended in 1986, and under the case law that antedated promulgation of this regulation.

The premise of petitioner's argument is that Brazil's blocking law prevented the Brazilian supply point from paying arm's-length compensation to petitioner for the use of petitioner's intangibles. During the tax years at issue, however, the Brazilian supply point, to the extent prevented by Brazilian law from paying actual royalties, paid dividends to petitioner in the amounts necessary to satisfy what petitioner believed to be the Brazilian supply point's arm's-length royalty obligation. During 2007–2009, the Brazilian supply point appears to have remitted to petitioner about $887 million in dividends for that purpose. And we have held that these dividends, plus another $915 million of dividends paid by other supply points, are to be treated as royalties and credited against the transfer-pricing adjustments determined in our Opinion. See 155 T.C. at 218–29. This poses the question of whether Brazilian law actually “blocked” the payment of arm's-length compensation for the use of petitioner's intangibles.

The U.S. Court of Appeals for the Sixth Circuit addressed a similar question in a case decided before the Treasury Department promulgated the “blocked income” regulation. See Proctor & Gamble Co. v. Commissioner, 961 F.2d 1255 (6th Cir. 1992), aff'g 95 T.C. 323 (1990). The Commissioner had made a transfer-pricing adjustment to Proctor & Gamble (P&G) from its Spanish subsidiary (España) to reflect the arm's-length price for use of petitioner's intangibles. In response to petitioner's argument that a Spanish blocking statute prevented payment of royalties in that amount, the IRS countered that España could have paid a dividend in the required amount and that “the Commissioner would have treated such a dividend as a royalty for United States tax purposes.” 961 F.2d at 1259. The Court rejected that argument, reasoning as follows (ibid.):

Assuming that España had profits from which it could pay a dividend under Spanish law, we find that [P&G] had no such obligation. A taxpayer need not arrange its affairs so as to maximize taxes as long as a transaction has a legitimate business purpose. Salyersville Nat'l Bank v. United States, 613 F.2d 650, 653 (6th Cir. 1980). We firmly disagree with the Commissioner's suggestion that [P&G] should purposely evade Spanish law by making royalty payments under the guise of calling the payments something else. Furthermore, the record reflects that España did not have distributable earnings from which to pay dividends. [P&G‘s] federal income tax returns indicate that España had accumulated deficits during the years at issue and would be unable to distribute dividends.

We invite the parties' views as to how this reasoning would apply to the facts of the instant case, and also as to whether the U.S. Court of Appeals for the Eleventh Circuit, to which appeal of this case apparently lies, would be likely to adopt the same or different reasoning.

In consideration of the foregoing, it is

ORDERED that the parties shall file, on or before March 27, 2023, simultaneous supplemental briefs addressing the matters discussed above. It is further

ORDERED that the parties shall file, on or before April 18, 2023, supplemental reply briefs addressing the arguments advanced in the opposing party's supplemental brief.

(Signed) Albert G. Lauber
Judge

Unless otherwise indicated, all statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure.