The main attraction in the US Tax Court (Tax Court) is just a few weeks away. On March 5, 2018, The Coca-Cola Company (TCCC) and the Internal Revenue Service (IRS) square-off for a much anticipated six-week trial before Judge Lauber. The parties recently filed their Pretrial Memoranda in the case, although the IRS’s memorandum was filed under seal. TCCC’s Pretrial Memorandum gives us deep insight into the issues and how the trial will be conducted. The primary issue in the $3 billion transfer pricing case is the proper amount of the arm’s length royalties payable by six foreign licensees to TCCC for the licenses of TCCC’s trademarks and certain other intangible property for exploitation in international markets. In its Pretrial Memorandum, TCCC contends that the IRS’s application of an approximately 45 percent royalty rate using a bottler-based Comparable Profit Margin (CPM) that allocates to TCCC more than 100 percent of the aggregate operating (after accounting for the amounts paid pursuant to the Royalty Closing Agreement) profits of the six foreign licensees is arbitrary and capricious.
Continue Reading

We have written several times about penalty defenses, including substantial authority, issues of first impression and tax reporting disclosures. Additionally, we previously covered  the 2016 case of Graev v. Commissioner, where a divided US Tax Court (Tax Court) held that supervisory approval was not necessary before determining a penalty in a deficiency proceeding because the statutory language of Internal Revenue Code (Code) Section 6751(b)(1) couched such approval in terms of a proposed penalty assessment. For those not well-versed in procedural tax lingo, an “assessment” is merely the formal recording of a tax liability in the records of the Internal Revenue Service (IRS). In cases subject to the deficiency procedures—i.e., where taxpayers have a right to contest the IRS’s position in the Tax Court—no assessment can be made until after the Tax Court’s decision is final.
Continue Reading

The IRS has never won a single litigated case arguing for foreign base company sales income (and has never litigated a foreign base company services income case). Courts have consistently rejected the government’s arguments to expansively apply the definition of Subpart F sales income in order to carry out asserted congressional intent. While the courts

We have previously written about QinetiQ U.S. Holdings. Inc.’s (QinetiQ) fight to apply the Administrative Procedure Act (APA) to notices of deficiency issued by the Internal Revenue Service (IRS). (See below for our recent coverage.)

In short, the Tax Court and the US Court of Appeals for the Fourth Circuit rejected QinetiQ’s argument that a

Wrapping up July—and Looking Forward to August

Tax Controversy Activities in August:

August 7, 2017: Elizabeth Erickson and Kristen Hazel will be representing McDermott Will & Emery at the 2017 US Captive Awards in Burlington, Vermont. McDermott has been shortlisted in the Law Firm category.

August 8, 2017: Tom Jones is presenting an update

Oftentimes, taxpayers rely on various authorities in planning transactions and reporting them for tax purposes, as well as defending them during an Internal Revenue Service (IRS) audit, appeals or in litigation. These sources include authorities like the Internal Revenue Code, legislative history and other legislative materials, Treasury regulations and other IRS published guidance (e.g., revenue rulings, revenue procedures, notices, announcements), IRS private guidance (e.g., chief counsel advice, technical advice memoranda, private letter rulings, etc.), and case law. As we have discussed previously, these authorities are afforded different weight by courts and the IRS, and can serve different purposes in your matter.
Continue Reading

Taxpayers can choose whether to litigate tax disputes with the Internal Revenue Service (IRS) in the US Tax Court (Tax Court), federal district court or the Court of Federal Claims. Claims brought in federal district court and the Court of Federal Claims are tax refund litigation: the taxpayer must first pay the tax, file a claim for refund, and file a complaint against the United States if the claim is not allowed. Claims brought in the Tax Court are deficiency cases: the taxpayer can file a petition against the IRS Commissioner after receiving a notice of deficiency and does not need to pay the tax beforehand.

As demonstrated in the chart below, approximately 97 percent of tax claims are instituted in the Tax Court. It should be noted that, after a taxpayer files a petition in Tax Court, the taxpayer no longer has the option of bringing the claim in any other court for the year(s) at issue.

Tax Court Versus Tax Refund Litigation

Source: https://www.irs.gov/uac/soi-tax-stats-chief-counsel-workload-tax-litigation-cases-by-type-of-case-irs-data-book-table-27


Continue Reading

On April 4, 2017, QinetiQ U.S. Holdings, Inc. petitioned the US Supreme Court to review the US Court of Appeals for the Fourth Circuit’s decision that the Administrative Procedure Act of 1946 (APA) does not apply to the Internal Revenue Service (IRS) Notices of Deficiency. We previously wrote about the case (QinetiQ U.S. Holdings, Inc. v. Commissioner, No. 15-2192) here, here, here and here. To refresh, the taxpayer had argued in the US Tax Court that the Notice of Deficiency issued by the IRS, which contained a one-sentence reason for the deficiency determination, violated the APA because it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The APA provides a general rule that a reviewing court that is subject to the APA must hold unlawful and set aside an agency action unwarranted by the facts to the extent the facts are subject to trial de novo by the reviewing court. The Tax Court disagreed, emphasizing that it was well settled that the court is not subject to the APA and holding that the Notice of Deficiency adequately notified the taxpayer that a deficiency had been determined under relevant case law. The taxpayer appealed to the 4th Circuit, which ultimately affirmed the Tax Court’s decision.
Continue Reading

From 2003 to 2007, Sovereign Bancorp, Inc. (Sovereign) – now known as Santander Holdings USA, Inc. (Santander) – engaged in a so-called STARS transaction with Barclays Bank. According to Santander, “[b]y engaging in the STARS transaction, Sovereign transferred some of its income tax liability from the United States to the United Kingdom,” it “secured a loan of $1.15 billion,” and it received a payment “which effectively reduced its lending costs.” On its Federal corporate income tax returns for those years, Sovereign claimed foreign tax credits (FTCs) for UK taxes it paid in connection with the STARS transaction. It also claimed deductions for the interest paid on the $1.15 billion loan.

In 2009, the Internal Revenue Service (IRS) issued a Notice of Deficiency disallowing Sovereign’s FTCs and its deductions for interest paid on the $1.15 billion loan. The IRS did not challenge Sovereign’s compliance with the statutory and regulatory rules governing FTCs, instead arguing that Sovereign’s STARS transaction lacked “economic substance.” Sovereign paid the deficiency and sued for a refund in the US District Court for the District of Massachusetts. When the district court held for Sovereign on both issues, the IRS appealed to the US Court of Appeals for the First Circuit, but only with respect to the FTC issue. The crux of the issue was how to treat the UK taxes and the related FTCs for purposes of the “economic substance” analysis. Relying on Salem Financial, Inc. v. U.S., 786 F.3d 932 (Fed. Cir. 2015), and Bank of New York Mellon Corp. v. Comm’r, 801 F.3d 104 (2d Cir. 2015), the IRS argued that the UK taxes should be treated as an expense but that the related FTCs should be ignored in determining pre-tax profit. Citing IES Indus., Inc. v. U.S., 253 F.3d 350 (8th Cir. 2001), and Compaq Computer Corp. v. Comm’r, 277 F.3d 778 (5th Cir. 2001), Sovereign argued that either both should be included in the profit analysis or both should be ignored. The First Circuit held that Sovereign’s STARS transaction lacked “economic substance,” and upheld the disallowance of the FTCs at issue. In doing so, it treated the UK taxes as expenses that reduced pre-tax profit and ignored the related FTCs, following the Federal and Second Circuit’s approach. Santander Holdings USA, Inc. v. U.S., 844 F.3d 15 (1st Cir. 2016).


Continue Reading