Bad blood exists between the I.R.S. and Medtronic Inc. when it comes to transfer pricing matters. Regarding the tax years 2005 and 2006, the I.R.S. challenged a transfer pricing methodology it approved in an M.O.U. settlement with Medtronic involving the same transactions and issues in the context of an earlier year. The I.R.S. lost in an earlier case, appealed to the 8th Circuit Court of Appeals, which sent the matter back to the Tax Court to address several factual issues. In a recent decision, the Tax Court modified its earlier finding by adjusting the comparable uncontrolled transaction (“C.U.T.”) in a subjective way to obtain a result that seemed to be fair in the view of the court. Michael Peggs suggests that the second trial did not produce practical guidance that was any better than the very limited guidance in the original decision.

MOVING INTANGIBLE PPROPERTY ASSETS OVERSEAS PRESENTS BOTH BUSINESS AND TAX ISSUES

The movement of intangible property (“I.P.”) offshore by U.S. multinational corporations has always been subject to high levels of I.R.S. scrutiny. This remains true in the current tax environment. It is a given that U.S. multinational companies are subject to a high level of U.S. corporate income tax at federal and state levels and their non-U.S. business operations are typically subject to lower tax rates abroad. As a result, U.S. multinationals can lower their global tax expense by transferring I.P. to an offshore subsidiary company (“I.P. Company”), when it is appropriate and consistent with the conduct of their international business operations.

In a typical arrangement within a group, the I.P. Company licenses the use of the I.P. to other members. Royalties paid by the other group members (including the U.S. parent, if total ownership of the I.P. is assumed by the I.P. Company) is claimed as a deduction in the tax jurisdictions of each member that is a licensee. If an I.P. Box Company arrangement is in place or a special ruling obtained, the royalties received by the I.P. Company will be subject to a low tax rate. Assuming that arrangements are in place to remove the royalty income from the category of Foreign Personal Holding Company Income for purposes of Subpart F, the net result is reduced tax for book and tax purposes. This yields greater profits for the multinational group and increased value for its shareholders.

Two cases that are currently in litigation illustrate the I.R.S. scrutiny given to transfers of I.P. to an I.P. Company and the resulting U.S. tax issues that are encountered. The cases involve Zimmer Holdings and Medtronic.