Appeals court shoots down Medtronic win in IRS feud

A federal appeals court yesterday shot down a U.S. Tax Court decision in a longrunning transfer prcing dispute between Medtronic (NYSE:MDT) and the Internal Revenue Service.

The IRS maintains that Fridley, Minn.-based Medtronic owes $1.4 billion in back taxes for transfer pricing arrangements among the company’s various units during the tax years 2005 and 2006. In transfer pricing, income is allocated among branches in different countries. It’s a legal tax maneuver companies can use to attribute profits from a product made and sold in the U.S. to a unit in a foreign country.

The federal tax bureau claimed Medtronic owed income tax of $548.2 million for 2005 and $810.3 million for 2006; Medtronic disputed the $1.34 billion bill and took the case to the U.S. Tax Court. In June 2016, a federal tax judge found for the company, ruling that Medtronic proved that the IRS was “arbitrary, capricious, or unreasonable” in its interpretation of the transfer pricing for its Puerto Rico subsidiary. Medtronic has said it expects to repatriate between $500 million and $4.5 billion in overseas cash once the dispute is put to bed.

The tax court later ruled that Medtronic owed some $26.7 million for the 2005 tax year but had overpaid by nearly $12.5 million the next year, leaving a tax tab of just $14.3 million. IRS commissioner John Koskinen’s office appealed to the U.S. Court of Appeals for the Eighth Circuit, arguing that the tax court was mistaken to use Medtronic’s transfer pricing technique rather than the IRS’s.

Yesterday the appeals court overturned the tax court’s decision, ruling that the judge there didn’t adequately justify her reasoning in calculating Medtronic’s bill using the comparable uncontrolled transactions transfer pricing method rather than the comparable profits method.

The tax court used the terms of a 1991 Medtronic settlement with Pacesetter, which included cross-licensing provisions and a lump-sum payment – unlike the deal between the company and its Puerto Rican subsidiary.

“The tax court did not address in sufficient detail whether the circumstances of the settlement between Pacesetter and Medtronic US were comparable to the licensing agreement between Medtronic and Medtronic Puerto Rico. The Pacesetter agreement resolved litigation between the parties, and the tax court did not decide whether it was one created in the ordinary course of business,” the Eighth Circuit ruled.

“In the absence of findings regarding the degree of comparability between the controlled and uncontrolled transactions, we cannot determine whether the Pacesetter agreement constituted an appropriate CUT,” the appeals court ruled. “We deem such findings to be essential to our review of the tax court’s determination that the Pacesetter agreement was a CUT, as well as necessary to our determination whether the tax court applied the best transfer pricing method for calculating an arm’s length result or whether it made proper adjustments under its chosen method.”

The Eight Circuit vacated the tax court ruling and sent the case back to that court for reconsideration under its guidelines.

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