By Richard Rubin
WASHINGTON -- Coca-Cola Co. placed too much of its profit in its foreign operations instead of its higher-taxed domestic parent company, a U.S. Tax Court judge ruled Wednesday.
The court adopted most of the U.S. government's main arguments, and the ruling marks a setback for the beverage giant's international tax strategy.
The Internal Revenue Service had been seeking more than $3.3 billion for the tax years 2007 through 2009. The cost to Coca-Cola could be more if the government applies the same successful rationale to subsequent tax years.
Wednesday's ruling doesn't set a final amount that Coca-Cola will owe from 2007 to 2009. The company and the government must make further calculations to determine that.
"We are disappointed with the outcome of the U.S. Tax Court opinion, which we are reviewing in detail to consider its impact and potential grounds for its appeal," the company said in a statement Thursday. "We intend to continue to vigorously defend our position."
The IRS typically doesn't speak publicly about litigation.
The dispute stemmed from Coca-Cola's subsidiaries in countries including Brazil, Ireland and Egypt. Those operations produce syrups and other ingredients for use in the company's beverages.
Especially before the 2017 U.S. tax law cut the corporate tax rate, U.S. companies had an incentive to pack profits into low-tax countries and defer U.S. taxes on those profits rather than attribute earnings to the U.S. parent, which faced an immediate 35% rate.
Companies within a single corporate structure are supposed to allocate profits between the parent and a foreign subsidiary based on what unrelated companies would do in an equivalent arm's length transaction. But there are plenty of gray areas, especially when companies profit from mobile, intangible assets like trademarks and patents. The IRS regularly engages in protracted legal fights with corporations over how those rules should apply in each situation.
In his ruling, Judge Albert Lauber noted that Coca-Cola's foreign subsidiaries had few trademarks or intellectual property and had little discretion over marketing, strategy and other decisions controlled by U.S. executives.
Yet, he noted, some of them had profits far higher than the company as a whole, thanks to their arrangements with the parent company. He rejected the arguments advanced by the company's experts as unpersuasive.
"Why are the supply points, engaged as they are in routine contract manufacturing, the most profitable food and beverage companies in the world?" he wrote. "And why does their profitability dwarf that of [Coca-Cola], which owns the intangibles upon which the Company's profitability depends?"
Coca-Cola had previously warned investors that the case could have a material adverse impact and has vowed to fight the IRS.
The company had argued that the IRS had blessed its profit split during an earlier dispute. But Judge Lauber rejected that argument, calling it "a formula to which the parties agreed in settling the dispute before them at that moment."
The judge sided with Coca-Cola on one point about how its tax deficiency should be calculated.
--Jennifer Maloney contributed to this article.
Write to Richard Rubin at email@example.com
(END) Dow Jones Newswires