By Richard Rubin and Theo Francis
When court rulings and tax regulations go against them, companies have an effective way to minimize or defer the bottom-line costs. They don't count them, and announce that they will beat the government in the future.
Coca-Cola Co., Whirlpool Corp. and Eaton Corp. have all lost to the Internal Revenue Service in the U.S. Tax Court over the past two years. But none of the companies subtracted the bulk of those costs from their publicly reported results.
Instead, they analyzed the law and declared they are confident those losses will eventually be overturned. Coca-Cola, in particular, is gearing up for a contentious constitutional fight against the government, with $12 billion on the line.
Others -- including Newell Brands Inc. and Maxim Integrated Products Inc. -- stand to lose millions under Treasury Department regulations issued in 2019, but say they remain confident the rules will eventually be thrown out and aren't recording the costs.
"For them to say the tax authority has got it all wrong, that's a pretty bold statement," said Jack Ciesielski, an accounting expert and owner of R.G. Associates Inc., an investment research firm. The more conservative approach is to recognize the cost, note the legal dispute and reverse the cost later if the company prevails, he said.
In securities filings, the companies generally argue they have strong cases and sometimes that federal authorities followed improper procedure in adopting regulations. They also say they and their accountants are careful to avoid market and legal repercussions if they ultimately lose.
"There's sufficient incentives there that exist that would prevent both the auditors and the corporation from being extremely aggressive," said Erin Emily Henry, an accounting professor at the University of Arkansas. "Nobody wants the egg on their face or a potential lawsuit."
The IRS, which doesn't comment on pending litigation, doesn't govern what companies tell their investors about those lawsuits. The Securities and Exchange Commission, which enforces corporate disclosure rules, declined to comment, as did the Financial Accounting Standards Board, which sets U.S. generally accepted accounting principles.
Determining whether the outcome of a tax dispute must be booked now, or can be postponed or ignored, is technical and subjective. If the company eventually loses beyond the point where it can appeal, it must absorb the costs.
Under U.S. accounting rules, companies must conclude that their eventual victory is "more likely than not." That requires executives, lawyers, accountants and auditors to assess the strength of their legal case after a court loss.
"One man's 'more likely than not' is another man's 'less than more likely than not,'" said Don Williamson, executive director of American University's Kogod Tax Center.
Among the largest examples is Coca-Cola, which lost its Tax Court case in November. The company has enlisted former federal judge J. Michael Luttig, a leading conservative lawyer, and just added Harvard professor and liberal scholar Laurence Tribe.
The tax court determined that Coca-Cola packed too much profit into low-taxed foreign subsidiaries and too little in its higher-taxed U.S. parent.
On its face, the case for tax years 2007 to 2009 concerned about $3.3 billion of taxes. But Coca-Cola has continued the same practices, so an IRS win would raise tax costs for subsequent years. Coca-Cola disclosed this month that the total tab could reach $12 billion, plus a 3.5-percentage-point tax-rate increase going forward.
That $12 billion exceeds Coca-Cola's 2020 profit. It's also more than all the cash, short-term investments and marketable securities the company reported holding Dec. 31.
In a nearly 1,600-word securities filing, Coca-Cola said it had consulted outside advisers and examined the court opinion, case law and its own intention to pursue every available appeal. The result: It recorded a $438 million reserve, 4% of the total potential cost.
"We intend to assert our claims on appeal and vigorously defend our position," Chief Executive James Quincey told analysts earlier this month. "Putting this all together, we believe we will ultimately prevail."
Coca-Cola argues the IRS acted unconstitutionally in 2015 by objecting to a formula the company and government had agreed to in 1996 to settle a tax dispute then. "The Constitution's Due Process Clause prohibits the IRS from baiting The Coca-Cola Company for two decades, abruptly switching its position on the appropriate tax calculation for no legitimate reason, and imposing taxes on the company retroactively," Mr. Tribe said in a statement issued by the company.
The agreement between the IRS and the company made clear that Coca-Cola wouldn't face penalties for continued use of the calculation, said Reuven Avi-Yonah, a University of Michigan law professor who has examined the case. But that doesn't mean the IRS is constitutionally bound by that agreement when calculating taxes. "That's nonsense," he said. "I don't know how [Coca-Cola] came up with that one."
However, he said, the company has some solid technical arguments and could prevail on some points on appeal. Moreover, companies often get their way, he said -- the IRS's victory over Coca-Cola is the agency's first significant win in this area of international tax law since 1979.
Whirlpool lost in Tax Court in May, when a judge determined that income from the Mexican branch of the appliance-maker's Luxembourg subsidiary should have been taxed in the U.S. The court ruling added about $50 million to Whirlpool's taxable income for 2009.
The company said it carefully reviewed its disclosures with outside advisers. Whirlpool and the government have been filing briefs in the Sixth U.S. Circuit Court of Appeals.
"The company believes that it will be successful upon appeal and has not recorded any impact of the U.S. Tax Court's decision in its consolidated financial statements," Whirlpool wrote in its securities filing, without estimating the potential cost.
Eaton, a power management company, lost part of its Tax Court case in 2019. It used similar language to Whirlpool in disclosing that it hadn't recorded or estimated any costs and declined to comment further.
Newell and Maxim are choosing to ignore an IRS regulation issued as a temporary rule in 2019. That rule tried to close a gap in the 2017 tax law that could have let companies earn low-taxed foreign income while avoiding a minimum tax imposed by the U.S. on foreign income.
Newell, which makes Krazy Glue and First Alert smoke detectors, said in a securities filing it believes the regulations weren't validly issued. If the company loses, it could pay $180 million to $220 million, plus interest and penalties, it said in its filing. That tax, if recognized last year, would have deepened Newell's net losses of $770 million.
Eventually, tax disputes are settled, either by the parties or by courts, and it becomes clear whether a company's "more likely than not" analysis was correct. That happened after some companies skipped booking a tax hit while a case involving an Intel Corp. subsidiary wound through federal courts.
The Ninth U.S. Circuit Court of Appeals ruled for the IRS in 2019, and after that, Facebook Inc., Twitter Inc. and Google parent Alphabet Inc. took charges for their tax costs.
But Xilinx Inc., looking at the same case, took the opposite accounting strategy, declaring the law unsettled. Xilinx recorded a $57 million cost in June 2020, only after the Supreme Court declined to hear Intel's appeal.
Write to Richard Rubin at email@example.com and Theo Francis at firstname.lastname@example.org
(END) Dow Jones Newswires