8th Circ. Holds that TC Flubbed its 482 Ruling in Medtronic Case

According to Law360, the Eighth Circuit vacated a favorable U.S. Tax Court decision for Medtronic Inc., in its $1.36 billion tax dispute with the IRS, after finding that the judge in the case had not justified the pricing.

The case will return to the Tax Court, which found in January 2017 that the medical equipment company owed only $14 million in an adjustment over its 2005-2006 tax years, stemming from royalty payments to the company's U.S. headquarters from its Puerto Rican subsidiary.

The Eighth Circuit did not reject the Tax Court's decision outright but ordered U.S. Tax Court Judge Kathleen Kerrigan to justify more extensively her determination that Medtronic's overall transfer pricing method was correct.

In a June 2016 order, Kerrigan agreed with Medtronic that the "comparable uncontrolled transactions" method of transfer pricing was the best method for determining the correct royalty rate for the use of intellectual property by Medtronic Puerto Rico Operations Co., a subsidiary that manufactured medical equipment. In that method, the internal transfers of assets are priced according to transactions of similar products between independent companies.

Using that methodology, Kerrigan found that the royalty rate for medical device pulse generators should be 44 percent, while the rate for pacemaker leads should be 22 percent. Based on those figures, Medtronic and the IRS reached an agreement to reduce Medtronic's tax bill to $14 million while the case remained under appeal.

The IRS argued that because the Puerto Rican subsidiary was merely an assembly arm, the comparable uncontrolled transactions method was inappropriate. The agency used the comparable profits method, which takes into account profits from similar firms, to argue that Medtronic's U.S. entities should have received 90 percent of the income from the transaction, which it used to make an overall adjustment of $1.36 billion for the two years.

Writing the lead opinion for the Eighth Circuit, Judge Roger Wollman said the Tax Court didn't explain how it determined that Medtronic's choice of comparable prices, which used pricing from a 1992 settlement with another supplier, was appropriate. Judge Wollman also said the Tax Court didn't account for significant differences in the transactions, including the types of intellectual properties sold and the nature of the contracts.

In addition, the judge found that the Tax Court did not sufficiently analyze how the Puerto Rican subsidiary assumed risk in the transaction, which Medtronic used to justify its royalty agreement.

"In the absence of such a finding, we lack sufficient information to determine whether the Tax Court’s profit allocation was appropriate," Wollman wrote.

 Fellow Eighth Circuit Judge Bobby Shepherd noted in a concurring opinion that the Tax Court did not account for effects that could potentially distort prices in a legal settlement, including that the parties settled to avoid future litigation costs.

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