Tax Court Rules Whether IRS’s Transfer Pricing Adjustments Are Arbitrary, Capricious Depends on Facts and Circumstances

By on April 13, 2016

In Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al. v. Commissioner, 146 T.C. No. 5 (Feb. 29, 2016), the taxpayer filed a motion seeking partial summary judgment on the ground that the Internal Revenue Service’s (IRS’s) transfer pricing adjustments were “arbitrary, capricious and unreasonable” as a matter of law. Judge David Laro denied the motion, ruling that “whether the Commissioner abused his discretion … depends on the facts and circumstances of a given case.” The taxpayer’s motion thus presented “a question of fact that should be resolved on the basis of the trial record.”

The case involves transfer pricing adjustments under Section 482 that increased the income of Guidant Corporation and its U.S. subsidiaries by nearly $3.5 billion. Section 482 grants the IRS broad discretion to “distribute, apportion, or allocate gross income, deductions, credits, or allowances” between or among controlled enterprises if it determines that such a re-allocation is “necessary in order to prevent evasion of taxes or clearly to reflect the income” of any of the enterprises. A taxpayer that challenges a Section 482 adjustment has a “dual burden.” First, it must show that the IRS’s adjustments are “arbitrary, capricious, and unreasonable.” The taxpayer must then show that its intercompany transactions reflect arm’s-length dealing.

Guidant sought to satisfy the first burden through a motion for partial summary judgment. While summary judgment “expedites litigation and avoids unnecessary and expensive trials,” a court may grant summary judgment only where there is no dispute as to any material fact and a decision may be rendered as a matter of law. Guidant offered two bases for its claim that the adjustments at issue were “arbitrary, capricious and unreasonable.” Guidant first argued that the IRS had abused its discretion because it had failed to determine the “true separate taxable income” (STI) of each controlled taxpayer. Guidant’s second argument was that the IRS had abused its discretion because it had failed to make a separate Section 482 adjustment with respect to each transaction involved in the case, making its adjustment instead through a “combined groupwide analysis.”

Judge Laro rejected each of Guidant’s arguments. He noted that the determination of whether the IRS abused its discretion by not making Section 482 adjustments at the STI level “depends on the facts and circumstances of a given case” and “remains to be determined on the full record of the case as developed at trial.” He similarly rejected Guidant’s second argument, noting that the regulations permit the IRS to aggregate transactions involving tangibles, intangibles and services “when doing so provides the best means of determining the true taxable income of a controlled taxpayer.” Accordingly, whether the IRS abused its discretion “is a question of fact that should be resolved on the basis of the trial record.”

In denying summary judgment, though, Judge Laro made clear that, “We do not now conclusively hold that respondent’s section 482 adjustments in these cases are not arbitrary, capricious, or unreasonable as a matter of fact. We hold only that respondent’s section 482 adjustments are not arbitrary, capricious, or unreasonable as a matter of law.”

Guidant may thus yet prevail on its claim that the Section 482 adjustments are “arbitrary, capricious, and unreasonable.”

Roger J. Jones
    Roger J. Jones represents clients in tax controversy and litigation matters at all levels of the federal court system, before the Internal Revenue Service (IRS), and before various state courts and tax agencies. He has represented taxpayers, including numerous Fortune 500 companies, in more than 80 docketed cases before the US Supreme Court, most of the US courts of appeals, federal district courts, the US Court of Federal Claims and the US Tax Court. Read Roger Jones' full bio.

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