Court Opinion: Foreign Taxes Paid Were Compulsory

Coca Cola Company and Subsidiaries win a small victory in Court prior to the start of the New Year. The Tax Court, in a division opinion, ruled that the taxes paid to a foreign country (Mexico) by the subsidiary of the multinational beverage company were compulsory levies. The Mexican subsidiary calculated its royalty payments based on “transfer-pricing” agreements with the Mexican federal tax authority, which gave rise to legitimate foreign tax credits without the taxpayer required to do more.

The point at which foreign taxes are sufficiently “determined” to justify taking a foreign tax credit is not as exhaustive as the IRS would argue, according to this case in which almost $260 million in foreign tax credits hung in the balance. In this case, since the IRS had refused to participate in a competent-authority proceeding, the taxpayer had “no remedy” left before the foreign authorities.

By the Court’s analysis the Mexican tax authority determined that the “10-50-50” method resulted in arm’s-length royalty payments for Mexican tax purposes. Accordingly, those royalty payments were allowed as a deduction under Mexican law. The IRS had previously approved this same method for determining royalty payments paid by the parent’s supply points. Thus, the Court found that the subsidiary calculated its tax liability using a reasonable interpretation and application of Mexican law. Further, the subsidiary relied in good faith on advice obtained from competent legal tax counsel when calculating the royalties properly payable under Mexican law.

The Court further also found that the subsidiary exhausted its available remedies for foreign tax credit purposes. The IRS’s reliance on Code Sec. 482 adjustments that had not been adjudicated, combined with its refusal to participate in competent authority proceedings left the subsidiary without any administrative remedy. The IRS was free to initiate a competent authority proceeding with Mexico after the transfer-pricing adjustments at issue became final. This is how Congress envisioned the accounts would be squared if and when foreign taxes were refunded, according to the Court.