main navigation
my pace

Philip G. Cohen | PACE UNIVERSITY

News & Events

Sort/Filter

Filter Newsfeed

News Item

"Law360" featured Lubin's Associate Professor Philip Cohen in "4 International Tax Cases To Watch In The 2nd Half Of 2019"

07/15/2019

"Law360" featured Lubin's Associate Professor Philip Cohen in "4 International Tax Cases To Watch In The 2nd Half Of 2019"

A handful of high-stakes transfer pricing cases will continue to play out this year, including Coca-Cola's fight against a $3.3 billion tax bill and a dispute over what, exactly, Amazon included among the intangibles it licensed to a European subsidiary.

At their cores, all the cases concern whether the Internal Revenue Serviceabused its discretion in reallocating income to U.S. companies from their foreign affiliates. Each dispute, however, grapples with this question in a different way.

In Coca-Cola's case, the beverage maker has claimed the IRS turned its back on a transfer pricing method after allowing it for years under an expired agreement. Meanwhile, Amazon.com Inc. and Medtronic Inc. are involved in separate disputes with the agency about how to value contributions from one affiliate to another.

At stake in a long-running fight brought by technology and manufacturing company 3M Co. are tax regulations that disregard foreign legal restrictions in some cases.

Here, Law360 looks at four cases that international tax specialists will be watching in the second half of 2019.

Can Amazon Make an Affiliate Pay for a 'Culture of Relentless Innovation'?

Amazon's dispute centers on a cost-sharing arrangement the Seattle-based company entered into in 2005, under which its Luxembourg affiliate, Amazon Europe Holding Technologies SCS, was granted the right to use certain intangible assets in Europe in exchange for an upfront “buy-in payment.”

The IRS made substantial transfer pricing adjustments that reallocated income from AEHT in Luxembourg to Amazon in the U.S. and accordingly assessed more than $234 million in deficiencies for the 2005 and 2006 tax years. However, the U.S. Tax Court found in March 2017 that the methods Amazon used to determine payments from AEHT for the licensing of intellectual property were reasonable.

The IRS appealed Amazon's win to the Ninth Circuit. During oral arguments in April, an IRS attorney told a three-judge panel that the government should be allowed to apply the discounted cash flow valuation method, or DCF, to more accurately value — and more broadly define — the intangibles Amazon transferred to its Luxembourg subsidiary.

Meanwhile, the tech giant's counsel attacked the government's position that language in a 1994 regulation effectively expanded the definition of intangibles to include “residual business assets.”

The IRS counts Amazon's “corporate culture” among the intangibles that the affiliate should have paid for. This position is inherent to the DCF method, according to Carolyn Frantz, senior counsel at Orrick Herrington & Sutcliffe LLP.

“If the corporate culture in any way contributes to the value of the Amazon enterprise writ large … then that's going to be included in the discounted cash flow valuation,” she said. “But it's still not in the list that's in the regulations.”

During oral arguments, the IRS counsel claimed that corporate culture fell under the phrase “and other similar items” in the regulations.

In addition to corporate culture, the IRS has argued that Amazon's residual business assets include the company's “significant growth options resulting from its culture of relentless innovation,” according to court filings.

Steven Dixon, a member in the tax department at Miller & Chevalier Chtd., said these “far-reaching and abstract intangibles” suggest the government is using the DCF method in an attempt “to capture a portion of any future income that comes out of the cost-sharing arrangement.”

That outcome is not what the law provides, he added.

The panel's questions and remarks during oral arguments, Dixon said, suggested the panel will affirm the Tax Court's decision. He noted the panel was “clearly concerned” about companies relying on the cost-sharing regulations.

“I think that taxpayers have thought of cost sharing as a kind of safe harbor, because that's clearly how it's constructed as long as you've done what is necessary under those cost-sharing regulations,” he said.

The case is Amazon.com Inc. v. Commissioner of Internal Revenue, case number 17-72922, in the U.S. Court of Appeals for the Ninth Circuit.

Has Coca-Cola's Transfer Pricing Agreement Gone Flat?

At stake in Coca-Cola Co.'s transfer pricing case are tax deficiencies of $3.3 billion for the years 2007 to 2009. That amount is based on IRS income allocations of $9.4 billion to the Atlanta-based company from units in seven countries including Mexico, according to a petition filed in December 2015.

The IRS had determined the Mexican unit was paying its parent company a less-than-arm's-length royalty for licensed intangible property, such as beverage bases and other intellectual property used to make the drink. After adjusting that royalty, the IRS found the Mexican licensee had a reduced income and was therefore paying too much in tax to the Mexican government.

However, in granting partial summary judgment to Coca-Cola in December 2017, Tax Court Judge Albert Lauber reinstated the $139 million in foreign tax credits that the IRS had denied the beverage giant. The rest of the case went to trial in March 2018, and the trial lasted roughly two months. The case is currently in the post-trial briefing process.

In his ruling, Judge Lauber noted that the royalty payments were calculated under a method that both the IRS and the Mexican tax authority had signed off on more than two decades ago — a method Coca-Cola's tax adviser recommended using even after the government agreements expired.

Judge Lauber noted that the question of whether a foreign tax is “compulsory” also rests on whether the U.S. company exhausted all remedies to reduce its liability. In siding with Coca-Cola on this matter as well, he pointed out that the IRS had refused to participate in administrative proceedings.

In ruling for Coca-Cola on this issue, “the court got it completely right,” said Philip Cohen, who teaches in the legal studies and taxation department of the Pace University Lubin School of Business.

As he put it, the IRS accused Coca-Cola of failing to exhaust all practical remedies by not taking the case to competent authority proceedings, but the IRS also said it wouldn't participate in the proceedings — which would have involved negotiating with the Mexican government — because it had set the case up for litigation.

“It's a Kafkaesque fact pattern where the service said you have to go to competent authority, but we're not going to allow you to go to competent authority,” Cohen said.

The case is Coca-Cola Co. v. Commissioner, docket number 31183-15, in the U.S. Tax Court.

Do the Regulations in 3M's Case Have Standing?

The $24 million Tax Court case involving 3M Co. centers on royalty payments owed from the company's Brazilian unit of technology and manufacturing in 2006. The amounts were due under trademark license agreements forged in 1998.

While the IRS has allocated net royalty income of $23.6 million from 3M do Brasil Ltda. to the U.S. parent, the amount is actually much lower, just under $166,000, according to Minnesota-based 3M. The company contended that the IRS unlawfully failed to account for restrictions that Brazilian law places on royalty payments.

Because Brazil set a fixed ceiling — in line with tax deductions for royalties — on how much can be paid for the licensing of patents, unpatented technology and trademarks, the IRS can't legally allocate amounts that a taxpayer can't receive, 3M argues.

For its part, the IRS has cited regulations enacted in 1994 that disregard a foreign legal restriction to the extent it “generates an economic outcome that is inconsistent with an arm's-length result.”

The Brazilian legal restrictions that 3M relies on “to avoid an arm's-length result” don't preclude income allocations because there isn't any evidence that the restrictions affected unrelated parties under comparable circumstances, the IRS has said in court filings.

Meanwhile, 3M has argued the regulations are invalid under the Administrative Procedure Act, or APA, because the U.S. Treasury Department “provided no rationale whatsoever.”

Peter Connors, a colleague of Frantz's at Orrick whose practice focuses on cross-border transactions, said the 3M case was similar to chipmaker Altera Corp.'s challenge against cost-sharing regulations.

In that case, Tax Court Judge L. Paige Marvel found in July 2015 that Treasury had failed to adequately explain its contention that the rules were consistent with the arm's-length standard. The Ninth Circuit overturned the Tax Court's ruling in June.

“Given the Tax Court's analysis in Altera of what steps Treasury must take to follow the APA, I'd be surprised if the government won,” Connors said of the 3M dispute. He noted that Judge Marvel's decision had the unanimous agreement of 14 other Tax Court judges.

In 1972, before the enactment of the regulation at issue in 3M's case, the U.S. Supreme Court ruled on income restrictions in Commissioner v. First Security Bank of Utah  . In that decision, the high court ruled that an allocation of income isn't allowed when a legal restriction negates “the complete power” of a company to control the distribution of income among its affiliates.

The Sixth Circuit cited the First Security ruling in a 1990 decision for Procter & Gamble Co. in a case that involved a foreign legal restriction on royalty payments. Cohen, at Pace University, noted that when the decision was issued, there wasn't a conflicting regulation and the appellate court “logically applied the Supreme Court case.”

“I think a regulation that restricts the First Security Bank Supreme Court decision in certain cases with respect to foreign law doesn't make conceptual sense,” he said.

The case is 3M Co. et al. v. Commissioner of Internal Revenue, docket number 5816-13, in the U.S. Tax Court.

Will the Tax Court's Explanation of Its Medtronic Ruling Make the ‘CUT’?

Like the 3M case, Medtronic's transfer pricing dispute stems from accusations that the IRS overstepped its authority.

The Tax Court squarely rejected the IRS' $1.36 billion tax deficiency calculation in June 2016, finding that the agency's calculations for intercompany license royalty rates didn't reflect a Puerto Rican subsidiary's contributions to the medical device maker's profits.

However, the Eighth Circuit struck a blow to Medtronic in August 2018 when it vacated the Tax Court decision and ordered Judge Kathleen Kerrigan to justify more extensively her determination that Medtronic's overall transfer pricing method was correct.

When arguing before the Eighth Circuit, the IRS contended that Judge Kerrigan had failed to apply the required regulatory analysis in selecting the comparable uncontrolled transaction, or CUT, method for determining the arm's-length royalty rate that the Puerto Rican subsidiary owed Minnesota-based Medtronic for licenses in 2005 and 2006.

According to the agency, Judge Kerrigan had skirted the analysis required under transfer pricing regulations when she concluded that a license agreement between Medtronic and a company that had been its competitor, Siemens Pacesetter Inc., was a CUT.

For its part, Medtronic characterized the IRS' arguments as a challenge to the factual findings that led to the Tax Court's valuation method rather than to the valuation method itself. The medical device maker noted that Judge Kerrigan had found the subsidiary was its own autonomous unit operating at arm's length, which she took into account when valuing the licenses and calculating the royalty rates.

While the narrow issues in this case are specific to Medtronic, the Eight Circuit's decision may encourage the Tax Court to elaborate on its explanations in the future, according to Frantz at Orrick.

But beyond that, “I don't think it's going to have any real effect on transfer pricing law going forward,” she said.

The case is Medtronic Inc. et al. v. Commissioner of Internal Revenue, docket number 6944-11, in the U.S. Tax Court.

--Additional reporting by Vidya Kauri, Molly Moses and Alex M. Parker. Editing by John Oudens and Tim Ruel. 

Read the article.
 

News & Events

Sort/Filter

Filter Newsfeed

News Item

"The Hill and MSN" featured Lubin School of Business associate professor Philip G. Cohen's op-ed "The difference between good and bad tax reform"

04/26/2019

"The Hill and MSN" featured Lubin School of Business associate professor Philip G. Cohen's op-ed "The difference between good and bad tax reform"

Philip G. Cohen is an associate professor of taxation at Pace University's Lubin School of Business. He is the former vice president of tax & general tax counsel for Unilever United States, Inc.

Tax reform done correctly can be very beneficial for the United States and the American people. To be constructive, tax reform should endeavor to promote fairness, efficiency and simplicity. Further, the tax system needs to generate enough revenue to meet the government's requirements. 

Some tax reform measures can do more harm than good. I remain a firm critic of many parts of the Tax Cuts and Jobs Act (TCJA). It remains a poster child for a poorly conceived, incredibly complex (even for a tax act) partisan legislation enacted without due deliberation, that has and will continue to exacerbate the national debt and further drive good jobs and income offshore.

It also punished many residents of blue states like New York, New Jersey and California by capping the itemized deduction for all state taxes to $10,000. This sizably increased the federal income taxes paid by many residents of states with high income and/or property taxes.

While a corporate rate reduction was necessary, the 21-percent rate provided for by the TCJA went too far. Three new tax reform proposals, one from Sen. Ron Wyden (D-Ore.) and two from Sen. Elizabeth Warren (D-Mass.) were recently announced that are intended, in part, to address wealth inequality.

While I have enormous respect for Sen. Wyden and Sen. Warren and recognize the problem of wealth inequality, two of the concepts would make for unsound tax policy.

Wyden has suggested that investment gains be placed on a mark-to-market system (where one is taxed on appreciation even absent sale) and be taxed at ordinary income rates.

The Internal Revenue Code currently includes a very limited mark-to-market approach for securities dealers and securities traders who agree to elect this treatment, as well as for certain financial products known as section 1256 contracts. 

Warren has a proposal to impose a wealth tax on "ultra-millionaires" at an annual rate of 2 percent for those whose net worth is greater than $50 million, and 3 percent on net worth greater than $1 billion.

Finally, Sen. Warren has recently put forth the idea that corporations, which report to shareholders global net income of over $100 million, pay a 7-percent minimum tax on global net reported income over this amount.  While the first two plans should be rejected, the latter is certainly deserving of consideration.

If an investor buys stock in what is known as a "C" corporation (all publicly traded corporations are "C" corporations) and the shares appreciate but are not sold, requiring he/she pay tax on this unrealized gain would fail a fundamental tenet of U.S. tax policy, which is to not impose tax on those who do not have the wherewithal to pay the tax from the deemed profit because it is simply unfair.

Removing long-term capital gain incentives would further add acid to the wound. While there is something arguably unjust with Warren Buffet paying tax at a marginal rate lower than his secretary because of the tax incentives for capital gains and qualified dividends, this is not the solution.

Neither is creating a very hard-to-administer new tax on wealth in an environment where the Internal Revenue Service does not have the resources to administer the current tax laws. Perhaps starting with eliminating many estate tax loopholes, as Andrew Ross Sorkin recently suggested in the New York Times, would be a better approach.

Warren's other proposal is known as "The Real Corporate Profits Tax." lt would be based on publicly reported book income. This may be an appropriate fix to some of the TCJA corporate largess and a step, albeit minor, in the right direction regarding addressing an out-of-control national debt. 

The TCJA reduced the federal corporate tax rate precipitously from a top rate of 35 percent to 21 percent, eliminated the corporate minimum tax and exempted much foreign-source dividend income of U.S. multinational corporations from tax.

Paying a relatively small tax on worldwide income where a corporation has reported $100 million-plus in profits to its shareholders is consistent with the notion of fairness, which is critical element of a good tax system.

Read the Hill article.

News & Events

Sort/Filter

Filter Newsfeed

News Item

"The Hill" featured Lubin Professor Philip G. Cohen's opinion piece in "Tax reform postmortem reveals lethal dose of crony capitalism"

05/22/2018

"The Hill" featured Lubin Professor Philip G. Cohen's opinion piece in "Tax reform postmortem reveals lethal dose of crony capitalism"

Philip G. Cohen is an associate professor of taxation at Pace University Lubin School of Business and a retired vice president – tax and general tax counsel at Unilever United States, Inc. The views expressed herein do not necessarily represent those of any organization to which the author is or was associated with.

On Wednesday, the House Ways and Means Committee held a hearing regarding the impact of P.L. 115-97, informally referred to as the Tax Cuts and Jobs Act (TCJA) enacted in December 2017.

While Chairman Kevin Brady (R-Texas) undoubtedly viewed this as an opportunity for a curtain call, TCJA is a poster child for poorly conceived, incredibly complex (even for a tax act) partisan legislation enacted without due deliberation, that will exacerbate the deficit and undoubtedly further drive good jobs and income off-shore.

It also punished blue states like New York, New Jersey and California by capping the itemized deduction for all state taxes at a mere $10,000, but managed to reduce the top individual tax rate from 39.6 percent to 37 percent.

Even Sen. Bob Corker (R-Tenn.), who voted for TCJA, has expressed regrets when faced with a Congressional Budget Office estimate that TCJA will increase the federal budget deficit by $1.85 trillion in 2018-2028. Sen. Corker stated, "If it ends up costing what has been laid out here, it could well be one of the worst votes I've made."

Another TCJA supporter, Sen. Marco Rubio (R-Fla.), also articulated remorse over TCJA, albeit for a different reason: "They [big corporations with the tax cuts] bought back shares; a few gave out bonuses; there's no evidence whatsoever that the money's been massively poured back into the American worker." 

This latter comment was reinforced by a survey of economists by the National Association for Business Economics, which found that "two-thirds of business economists [indicated that] the 2017 tax law isn't changing their firms' and industries hiring or investment plans."

While there was somewhat widespread belief that the pre-TCJA top corporate statutory rate of 35 percent needed to be reduced, what was the rationale for slashing the rate to 21 percent?

Furthermore, why was untaxed pre-TCJA offshore earnings of U.S. multinationals only taxed at rates of 15.5 percent for cash and cash equivalents and 8 percent for other assets, coupled with the tax being spread over eight years and heavily back-loaded? 

In addition, why has the nation's tax laws moved in the direction of quasi-territoriality, wherein most foreign-sourced dividends received by 10 percent or more domestic corporate shareholders will get 100 percent dividends received deduction, i.e., they pay no federal income tax.

The answer to all three questions is that this was a pay-off to major campaign contributors, where their interests prevailed over those of the nation.

Read the full article.