The full appeal case is here:
In this edition: the U.S. Court of Appeals for the Eighth Circuit remands the Medtronic case back to the Tax Court for comparability analysis; the U.S. Tax Court found in favor of Illinois Tool Works Inc. in an intercompany debt dispute with the Internal Revenue Service; the U.S. Court of Appeals for the Ninth Circuit overturned the earlier Tax Court decision in the Altera case but then withdraws its opinion; the Australian Taxation Office published draft schedule 2 on related party derivative arrangements; and the Inland Revenue Authority of Singapore published the third edition of the e-tax guide on Country-by-Country reporting guidance.
- U.S. Appellate Court Vacates and Remands Medtronic Tax Court Decision
- ITW Prevails in Intercompany Debt Case
- Ninth Circuit Appellate Court Overturns Tax Court in Altera Case, but then Withdraws Opinion
- Release of Schedule 2 to PCG 2017/4 on Related Party Derivative Financial Agreements
- Singapore Releases Third Edition of Guidance on Country-by-Country Reporting
U.S. Appellate Court Vacates and Remands Medtronic Tax Court Decision
On August 16, 2018, the U.S. Court of Appeals for the Eight Circuit (the “Appellate Court”) released its opinion, No. 17-1866, vacating the U.S. Tax Court’s (the “Tax Court”) January 25, 2017 order in the Medtronic Case and remanded further proceedings. The original case pertained to 2005 and 2006 royalty rates paid by Medtronic Puerto Rico Operations Co. (“MPROC”) to Medtronic US for the intercompany license of intangibles, including technical information and trademarks, to manufacture medical devices and leads.
In June 2016, the Tax Court found that the best method to determine an arm’s length royalty rate for intercompany license agreements between Medtronic US and Medtronic Puerto Rico was the comparable uncontrolled transaction (“CUT”) method and relied on certain agreements that the taxpayer had identified in their own application of the CUT method. Specifically, in its application of the CUT method, the Tax Court used a 1992 agreement between Medtronic and Pacesetter, which was entered into as part of a litigation settlement, as an appropriate CUT. The Tax Court made several substantial adjustments to the base royalty rate identified in the Pacesetter agreement in its application of the CUT.
In the tax court case, the IRS had argued that the CUT method could not be reliably applied to the intangible transactions between Medtronic US and MPROC and instead applied a CPM to establish arm’s length returns to MPROC. The IRS had argued that all of the agreements used by the taxpayer in their application of the CUT had differences relative to the intercompany intangible license which made them inappropriate for the reliable application of the CUT method. On June 21, 2017, the IRS filed a Petitioner Brief with the Appellate Court alleging that the adjustments ordered by the Tax Court were inadequate, that the comparable profits method (“CPM”) was the best method rather than the CUT method, and that the royalty rate from the Pacesetter agreement was not commensurate with the income attributable to the intangibles covered in the license.
In its review, the Appellate Court determined that the U.S. Tax Court’s finding that the Pacesetter agreement could be used in the application of the CUT method was based on an insufficient factual record. The appellate opinion found that the Tax Court did not conduct the comparability analysis for the Pacesetter agreement relative to the intercompany intangible license that was required by the regulations under Section 482.
The Appellate Courts’ opinion found the following facts potentially affecting the comparability of the Pacesetter Agreement were not addressed:
- The Pacesetter agreement stemmed from litigation rather than the ordinary course of business, which could affect the use of this agreement as reflecting arrangements entered into in the ordinary course of business;
- The Pacesetter agreement included substantial lump sum payments that would be expected to affect the royalty rate. The intercompany license between Medtronic US and MPROC did not have similar payments;
- The Pacesetter agreement included cross-licensing provisions that were not featured in the intercompany licensing agreement; and
- The intangibles licensed in the intercompany agreement included intellectual property beyond patents (including know-how), whereas the Pacesetter agreements provided strictly for the license of patents.
These four factors cited by the Appellate Court raised comparability considerations that must be addressed in the application of the CUT method.
In addition to the concerns expressed about the Tax Court’s application of the CUT method, the Appellate Court noted that the Tax Court rejected the IRS’ position in part on the basis that it hadn’t given proper recognition or weighting to the risks incurred by MPROC, but did not itself make a specific finding on the amount of risk and product liability expense that would be properly attributable to MPROC. The Appellate Court’s opinion stated that such a factual finding would be necessary to evaluate the Tax Court’s findings on this point.
The Appellate Court remanded the case back to the Tax Court “for further consideration in light of the views set forth in this opinion.”
1 The Tax Court case was Medtronic, Inc. & Consolidated Subsidiaries (“Medtronic”) v. Com’r, The original Tax Court decision can be found here. The Appellate Court’s full opinion can be found here.