Tax Notes Quotes Clark Armitage on Coca-Cola Opinion and DEMPE
The Coca-Cola opinion suggests that the Tax Court may now interpret U.S. law in a way that incorporates OECD guidance on control over risk and intangible development, enhancement, maintenance, protection, and exploitation (DEMPE) functions.
According to J. Clark Armitage of Caplin & Drysdale, Judge Albert G. Lauber’s opinion in The Coca-Cola Co. v. Commissioner, 155 T.C. No. 10 (2020) — which handed the IRS a rare major victory in a transfer pricing case — contains language that bears a striking resemblance to the analysis of control and DEMPE functions endorsed by the current OECD transfer pricing guidelines. Since the 2015 base erosion and profit-shifting project's report on actions 8-10 was formally adopted, the OECD transfer pricing guidelines have tied controlled parties’ rights to the residual returns associated with intangible property to the level of control they exercise over DEMPE-related functions and risks. Under this approach, which has no clear equivalent in the U.S. section 482 regulations, bearing the costs of intangible development without also exercising some form of control entitles a party to no more than a risk-free return on capital.
Although not identified by name, the DEMPE analysis features prominently in the Coca-Cola opinion, according to Armitage. “I think the court almost intentionally developed a DEMPE position without ever stating the words ‘OECD’ or ‘DEMPE’ anywhere in the opinion,” Armitage said during a May 20 webinar held by the International Fiscal Association. “I do think that probably DEMPE is part of the U.S. law if anyone follows the [Coca-Cola] case as precedent.”
According to Armitage, the overlap between the Coca-Cola opinion and the OECD’s DEMPE guidance appears in the court’s rejection of the claim that marketing expenditures borne by Coca-Cola’s foreign supply points gave rise to local marketing intangibles. Coca-Cola claimed that ownership of these marketing intangibles entitled the supply points to more than a routine return and consequently that the IRS’s selection of the comparable profits method was inappropriate.
Armitage cited multiple excerpts from the Coca-Cola opinion emphasizing that the supply points did not perform or control the activities associated with these marketing expenditures, including the court’s characterization of the supply points as “passive recipients of charges” allocated to them by global or regional management. He also noted the court’s conclusion that “there is no evidence that the supply points received invoices for these [marketing] services, reviewed the propriety of the amounts they were charged, or had any role in selecting or evaluating the services for which they were made financially responsible.”
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Another significant trend evident in the Coca-Cola opinion concerns the Tax Court’s approach to the selection of method, according to Armitage. Although the Tax Court has historically favored transactional methods, like the comparable uncontrolled transaction method, over others, this no longer appears to be the case, he noted.
“In recent cases, maybe for the last 40 years or so in the U.S., there's been what I think most people have interpreted as a disdain for profits-based methods, including the CPM [and] the profit split. And I think Judge Lauber did away with that in one 244-page decision,” Armitage said.
Armitage argued that Coca-Cola represents the continuation of a trend toward greater judicial scrutiny of taxpayers’ selection of transactional comparables that began with another Tax Court opinion written by Lauber: Amazon.com v. Commissioner, 148 T.C. No. 8 (2017), aff’d, 934 F.3d 976 (9th Cir. 2019). Despite the outcome in Amazon, the Tax Court performed a more intensive review of the comparables and adjustments used in the taxpayer’s CUT method analysis, Armitage said.
“If you look at Judge Lauber’s Amazon decision, it's very rigorous, and it sort of sets a new standard for [the] judicial approach to a transfer pricing case. It's not OK to just put your thumb in the air and make a decision,” Armitage said. “I think you really have to bring rigor to the analysis, and that's what Judge Lauber brought, and I think that's what we're going to see in the U.S. going forward.”
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