Tue, Jul 9, 2019

Dispute Between IRS and Medtronic Over IP Valuation Heading Back to Court

The Medtronic case is slated to head back to court in April of 2020 in accordance with an order from the tax court. This case involves a $1.4 billion transfer pricing adjustment made by the IRS associated with the value of intellectual property (IP) Medtronic licensed to an offshore affiliate in association with restructuring undertaken to address the end of certain tax benefits under Section 936. The specific transactions at issue focused on intercompany transactions between Medtronic’s U.S. affiliates and a Puerto Rican branch (Medtronic Puerto Rico Operations Co (“MPROC”)) of a Swiss subsidiary related to the manufacture and sale of neurological stimulators and cardiac rhythm management product lines for the U.S. market.

In the original tax court case and again in appeals, the IRS argued that Medtronic’s CUT-based IP transfer pricing approach yielded allocations of income that were inconsistent with arm’s length pricing, allocating too much income to MPROC. The IRS instead implemented a CPM-based pricing approach (with MPROC as the tested party), yielding a $1.4 billion in transfer pricing adjustments related to the subject transactions. In June 2016, U.S. Tax Court Judge Kathleen Kerrigan partly rejected the IRS’s position and found the IRS erred in its characterization of the relationship between Medtronic and MPROC. While Judge Kerrigan’s decision ultimately deviated from both Medtronic’s and the IRS’s pricing method, it did rely on a CUT approach using the same license agreement between Medtronic and a competitor (the “Pacesetter” agreement) that formed the basis of the taxpayer’s method. The CUT method nonetheless yielded different results in the tax court opinion than under the taxpayer’s application due to different adjustments made by the tax court.

The IRS appealed the judgement to the U.S. Court of Appeals for the Eighth Circuit, which found that the U.S. Tax Court had not undertaken an appropriate comparability analysis for the Pacesetter agreement. As such, the case was vacated and remanded back to the Tax Court for further factual development on specific matters which are intended to better allow evaluation of both the Pacesetter agreement under the CUT method as well as the determination of the best method (i.e. the CUT or the CPM approach employed by the IRS).

The April 2020 hearings will allow additional expert testimony to address the following:

  1. Whether the Pacesetter agreement is a CUT;
  2. Whether the Tax Court made appropriate adjustments to the Pacesetter agreement as a CUT;
  3. Whether the circumstances between Pacesetter and Medtronic were comparable to the licensing agreement between Medtronic and MPROC, and whether the Pacesetter agreement was created in the ordinary course of business;
  4. An analysis of the degree of comparability of the Pacesetter agreement’s contractual terms and those of the MPROC licensing agreement
  5. An evaluation of how the different intangibles affected the comparability of the Pacesetter agreement and the MPROC licensing agreement; and
  6. An analysis that contrasts and compares the CUT method using the Pacesetter agreement with or without adjustments and the CPM, including which method is the best method.

The Eighth Circuit deems findings related to the aforementioned items as essential to its review of the Tax Court’s original June 2016 decision.

Read Transfer Pricing Times – June 2019



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