Medical device manufacturer Medtronic on June 9 won its transfer pricing dispute with the IRS in Tax Court, beating back the IRS’s claim that the medical device manufacturer should have reported increased US royalty payments and 2005 and 2006 from a related Puerto Rico entity. The IRS adjustments would have increased Medtronic’s tax bill by $1.4 billion.
Medtronic was a US company during the tax years in dispute. It has since merged with Covidien PLC and relocated its headquarters to Ireland.
Central to the dispute was whether income related to intercompany licenses for intangible property required to manufacture medical devices and leads should be reallocated under section 482 to Medtronic US from its Puerto Rican subsidiary, Medtronic Puerto Rico Operations Co. (MPROC), for tax years 2005 and 2006.
The IRS reallocated the royalty payments using the comparable profits method and claimed that the only function MPROC performed was finished product manufacturing.
The Court disagreed, though, holding that Medtronic met its burden of proving that IRS’s section 482 allocations were arbitrary, capricious, or unreasonable.
The Court said the IRS’s transfer pricing analysis placed too little emphasis on MPROC’s role in insuring that the products were of good quality and thus provided too low of a return to the Puerto Rico subsidiary.
The Court also disagreed with aspects of Medtronic’s transfer pricing methodology, the comparable uncontrolled transaction method, though, noting, for example, that profit potential was not taken into consideration and making adjustments to Medtronic’s calculations. On that basis, the Court made its adjustments to Medtronic’s royalty rate.
The Court also rejected the IRS’s argument that there was a transfer of intangible property under section 367(d) when Medtronic’s Puerto Rican operations were established in 2002.
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