The Coca-Cola Company announced today that it may owe $3.3 billion in additional federal income taxes. In a form 8-K filed with the U.S. Securities and Exchange Commission, the company revealed that following a five year audit for the tax years 2007 – 2009, the Internal Revenue Service (IRS) issued a Notice of Deficiency claiming an additional federal income tax liability of approximately $3.3 billion plus interest. No penalties have been assessed.
Coca-Cola stated that the additional tax is related to a transfer pricing dispute. Transfer pricing is a tricky concept affecting multinational corporations. In a typical scenario, a parent company may set up a number of subsidiary companies all over the world and move goods, services and assets from one to another. That’s completely okay. However, transactions between those companies are supposed to be at “arm’s length” meaning that the goods, services and assets are transferred for the same price as they would have been between unrelated parties. But often, that’s not what happens. With a wink and a nudge, transactions are often structured in order to shift profits from high tax countries to low tax countries to cut their tax bills.
The most popular target for transfer pricing abuse is intangible property. Intangible property includes assets that can help market and promote the company’s goods or services such as licenses for manufacturing, distribution, sale, marketing and promotion of products in overseas markets. Those can be easy to move around in a global market: unlike a factory that pumps out a product, there may be no clear “home” for intangible assets for tax purposes. When assets are easy to move around, it can be easy to manipulating pricing and, subsequently, tax bills.
That’s what IRS says happened here. IRS claims that Coca-Cola under-reported income from the foreign licensing of manufacturing, distribution, sale, marketing and promotion of its products in overseas markets. The company, however, says that it has “followed the same transfer pricing methodology for these licenses since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987.” That agreement, says Coca-Cola, is supposed to be applicable so long as the company follows the same procedures moving forward, which it claims it has done.
Coca-Cola also acknowledged that it has been notified by the IRS that the matter has been recommended to the Chief Counsel of the IRS and designated for litigation. That’s a complicated way of saying that Coca-Cola believes that it is likely the matter will end up in court. In response, Coca-Cola has requested a meeting with Chief Counsel to resolve the matter.
For its part, Coca-Cola says that it “firmly believes that the assessments are without merit and plans to pursue all administrative and judicial remedies necessary to resolve this matter.” That includes filing a petition in U.S. Tax Court to challenge the deficiency.
How will this affect the company? Coca-Cola says it shouldn’t have a material impact on the company’s finances. Like many large companies, it has a reserve for tax matters. In this case, it says that the reserve is “adequate” though it warned that “the ultimate outcome of disputes of this nature is uncertain, and if the IRS were to prevail on its assertions, the assessed tax and deficiency interest could have a material adverse impact on the Company’s financial position, results of operations or cash flows.”
Last year, the company reported $45.91 billion in sales last year, landing it at #4 in Forbes’ list of World’s Most Valuable Brands (behind tech companies Apple, Microsoft, and Google) and #93 on the Global 2000, a list of the World’s Biggest Companies.
Shares of Coca Cola stock closed slightly down today at $38.98 from a high of $39.30.
