Are Facebook, Coke Next for Transfer Pricing Tax?

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Are Facebook, Coke Next for Transfer Pricing Tax?

Following the legal challenges faced by Medtronic PLC (MDT) in evading a $1.4 billion tax in the United States, Facebook Inc. (FB) and The Coca-Cola Co. (KO) may be the next companies to face the Internal Revenue Service (IRS) over the use of foreign payments to reduce their taxes.

Over the years, top multinational corporations (MNCs) have clashed with the IRS over transfer pricing—a practice employed by MNCs to decrease their tax liability by assigning a lower value to intangible assets such as intellectual property (IP).Companies gain from relocating their intangible assets to low-tax countries such as the Cayman Islands, Puerto Rico, or Ireland.

Accounting for Intellectual Property

While accounting for economic activity with quantifiable aspects such as sales and personnel is simple, accounting for intellectual property becomes more difficult. For example, if a person does a Google search from his home computer in Finland, the search results may be displayed by Google servers in the United Kingdom, despite the fact that the whole search operation is owned by the Google corporation, which is situated in the United States. However, the majority of the value in the “global” activity is in the intellectual property that enables the search. There is uncertainty regarding where and how much to account for this IP value, making it a point of dispute between MNCs and the IRS.

For the tax years 2005 and 2006, Medtronic, a Dublin, Ireland-based firm with operational headquarters in Minneapolis, moved $2.2 billion in intercompany licenses to a Puerto Rican manufacturing subsidiary. According to Bloomberg, the IRS believes the company’s activities are a “typical instance” of a US multinational moving money from its highly successful US operations and intangibles to an offshore subsidiary in a tax haven by charging an artificially low rate for the intangibles. According to the commission, Medtronic underestimated the royalty rates paid to it by its Puerto Rican subsidiary for intellectual property utilized in the manufacture of medical devices in Puerto Rico. On August 16, a federal appeals court remanded the Medtronic lawsuit to the United States Tax Court for reconsideration. While Medtronic has already paid the IRS $1.1 billion to cover potential taxes, the firm may potentially owe more if the court rules otherwise during the review.

  Induced Taxes Definition

Other MNCs Could Face Similar Fate

Tax expert Robert Willens describes the current result as “an unmitigated catastrophe for Medtronic,” adding that it is a “serious blow” to other corporations that employ transfer pricing and might make it more difficult, if not impossible, to adopt procedures that price transactions to cut taxes.

When Facebook claimed it moved $6.5 billion in intangible assets to Ireland in 2010, the IRS objected to a similar transfer pricing estimate. If the IRS wins the lawsuit, Facebook might be forced to pay up to $5 billion in taxes (without penalties or interest) starting next August.

Coca-Cola is involved in a similar dispute with the IRS over $3.3 billion in taxes. The dispute concerns a royalty arrangement through which the corporation transferred intellectual property value to its overseas companies in Africa, Europe, and South America between 2007 and 2009. (See also: How to Profit from Your Intellectual Property.)

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