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I.R.C. § 482 provides, similarly to § 45 of the Revenue Act of 1928 Act, that the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among related organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such entities. In order to set aside such discretionary action by the Commissioner of Internal Revenue, a taxpayer must establish that the Commissioner abused his discretion by making allocations that are arbitrary, capricious, and unreasonable. The Commissioner's § 482 determination must be sustained absent a showing that he has abused his discretion.
The Coca-Cola Co. (TCCC), a U.S. corporation, was the legal owner of the intellectual property (IP) necessary to manufacture, distribute, and sell some of the best-known beverage brands in the world. This IP included trademarks, product names, logos, patents, secret formulas, and proprietary manufacturing processes. TCCC licensed foreign manufacturing affiliates, called "supply points," to use this IP to produce concentrate that they sold to unrelated bottlers, who produced finished beverages for sale to distributors and retailers throughout the world. TCCC’s contracts with its supply points gave them limited rights to use the IP in performing their manufacturing and distribution functions but gave the supply points no ownership interest in that IP. During 2007-2009 the supply points compensated TCCC for use of its IP under a formulary apportionment method to which TCCC and Internal Revenue Service (IRS) had agreed in 1996 when settling the IP tax liabilities for 1987-1995. Under that method the supply points were permitted to satisfy their royalty obligations by paying actual royalties or by remitting dividends. During 2007-2009 the supply points remitted to P dividends of about $1.8 billion in satisfaction of their royalty obligations. The 1996 agreement did not address the transfer pricing methodology to be used for years after 1995. Upon examination of P's 2007-2009 returns IRS determined that TCCC’s methodology did not reflect arm's-length norms because it overcompensated the supply points and undercompensated TCCC for the use of its IP. IRS reallocated income between TCCC and the supply points employing a comparable profits method (CPM) that used TCCC’s unrelated bottlers as comparable parties. These adjustments increased TCCC’s aggregate taxable income for 2007-2009 by more than $9 billion.
Did the Commissioner abuse his discretion under I.R.C. sec. 482 by reallocating income to TCCC by employing a CPM that used the supply points as the tested parties and the bottlers as the uncontrolled comparables?
The court held that the Commissioner did not abuse his discretion by reallocating income between the taxpayer and the supply points, I.R.C. § 482, because the CPM analysis accounted for the nature of the assets owned and the activities performed by the controlled taxpayers, and the Commissioner selected appropriate comparable parties and computed and applied his return on assets (ROA) using reliable data, assumptions, and adjustments. The Commissioner correctly concluded that independent bottlers (IB) served as appropriate comparable parties for purposes of a CPM/ROA analysis because the IB operated in the same industry, faced similar economic risks, had similar contractual and economic relationships with the taxpayer, employed many of the same intangible assets in the same manner, and shared the same income stream from sales of the taxpayer's beverages.