Coca-Cola to Pursue Appeal Following Tax Court Decision

The U.S. Tax Court has issued a decision in the ongoing tax dispute between The Coca-Cola Company and the U.S. Internal Revenue Service (IRS), resulting in a liability of approximately $2.7 billion. Including interest, Coca-Cola anticipates the total amount due will be around $6.0 billion.

The Coca-Cola Company maintains that the IRS and the Tax Court have incorrectly interpreted and applied the relevant regulations. As a result, the company plans to challenge the decision through the appellate process. Coca-Cola has a 90-day window to file a notice of appeal with the U.S. Court of Appeals for the Eleventh Circuit and will pay the agreed-upon liability and interest to the IRS as part of the appeal process.

The dispute began on September 17, 2015, when Coca-Cola received an IRS notice seeking approximately $3.3 billion in additional federal income taxes for the years 2007 through 2009. The IRS aimed to retroactively reallocate over $9 billion of income to Coca-Cola’s U.S. parent company from various foreign affiliates, rejecting a previously agreed-upon methodology without prior notice.

On October 15, 2015, the IRS moved the case to litigation, leaving no alternative resolution methods available outside of court. The Tax Court initially sided with the IRS in an opinion dated November 18, 2020, and reaffirmed this position in a subsequent opinion on November 8, 2023.

Despite the Tax Court's rulings, Coca-Cola remains confident in its case and is determined to prevail on appeal regarding the issues raised in both the 2020 and 2023 opinions. To ensure transparency, the company has provided guidance on potential outcomes if the appeal is unsuccessful. This information is detailed in the company’s Securities and Exchange Commission (SEC) filings, including the Form 10-Q filed on July 29, 2024.

Coca-Cola continues to assert its belief in the strength of its legal arguments and its commitment to defending its position vigorously.

HERE IS THE BACKGROUND OF THE DISPUTE

On September 17, 2015, Coca-Cola received a Statutory Notice of Deficiency from the U.S. Internal Revenue Service (IRS), seeking approximately $3.3 billion in additional federal income taxes for the years 2007 through 2009. The Notice indicated the IRS's intention to reallocate over $9 billion of income to Coca-Cola’s U.S. parent company from its foreign affiliates. These affiliates were licensed by Coca-Cola to manufacture, distribute, sell, market, and promote its products in non-U.S. markets.

The dispute centers around Coca-Cola’s transfer pricing between its U.S. parent company and its foreign affiliates. IRS rules mandate that transactions between related parties must be priced at arm's length. In 1996, Coca-Cola and the IRS reached a Closing Agreement on an arm’s-length methodology to determine U.S. taxable income from foreign licensees for the tax years 1987 through 1995. This agreement stipulated that barring changes in material facts or tax law, Coca-Cola would not be penalized for using this methodology.

The IRS audited and confirmed Coca-Cola’s compliance with this methodology for tax years 1996 through 2006. However, on September 17, 2015, the Notice retroactively rejected this agreed-upon methodology for the years 2007 through 2009, opting for a new methodology without prior notice. The IRS’s reallocation resulted in over $9 billion of income being attributed to the U.S. parent company from its foreign licensees. Notably, the IRS did not impose penalties in this case.

LITIGATION PROCESS

On October 15, 2015, the IRS designated the matter for litigation, eliminating all other resolution options and compelling Coca-Cola to either accept the new tax assessment or pursue legal action. Consequently, Coca-Cola filed a petition with the U.S. Tax Court in December 2015 to challenge the tax adjustments.

Before the trial, the IRS increased its transfer pricing adjustment by $385 million, leading to an additional tax adjustment of $135 million. A summary judgment in Coca-Cola’s favor on a separate issue related to Mexican foreign tax credits reduced the IRS’s potential tax adjustment by $138 million.

The Tax Court trial took place from March to May 2018, with final post-trial briefs exchanged in April 2019. On November 18, 2020, the Tax Court issued an opinion largely siding with the IRS but allowed dividends previously paid by foreign licensees to offset royalties. On November 8, 2023, the Tax Court issued a supplemental opinion upholding the IRS's position regarding certain U.S. tax regulations and their application to Coca-Cola’s Brazilian operations.

COMPANY’S POSITION AND FUTURE ACTIONS

Coca-Cola believes the IRS and the Tax Court misinterpreted the regulations and asserts that the retroactive application of a new tax methodology is unconstitutional. The company plans to appeal these decisions and vigorously defend its position. The company is also evaluating recent U.S. Supreme Court decisions, including Loper Bright v. Raimondo, which overruled the Chevron doctrine, potentially impacting its case.

In determining its tax reserve, Coca-Cola applied the two-step evaluation process under Accounting Standards Codification 740, consulting advisors and reviewing relevant laws, regulations, and court opinions. As of June 28, 2024, Coca-Cola updated its tax reserve to $456 million, reflecting updated calculations and accrued interest.

Coca-Cola remains confident in its legal stance, though it acknowledges the possibility of significant additional liabilities if the IRS's positions are upheld. The company estimates that, assuming the Tax Court Methodology is applied, potential incremental tax and interest liabilities could reach approximately $16 billion as of December 31, 2023, with additional amounts accruing over time.

The company and the IRS were in the process of agreeing on the tax impacts of the court opinions. Following this, Coca-Cola has 90 days to file an appeal with the U.S. Court of Appeals for the Eleventh Circuit. Any payments related to the 2007 through 2009 tax years, estimated to be around $6.0 billion, including accrued interest, will be made in accordance with IRS collection notices, with potential refunds if the company prevails on appeal.

SOURCES/ RECOMMENDED READ: 

• U.S. Tax Court Enters Decision in Ongoing Dispute Between The Coca-Cola Company and the U.S. Internal Revenue Service :: The Coca-Cola Company (KO)

• Quarterly Filings (10-Q) :: The Coca-Cola Company (KO)