Coca-Cola’s Tax Trial: What We Know So Far and What’s Next

Photographer: Carla Gottgens/Bloomberg

Coca-Cola Co.’s court battle with the IRS is about to get even more technical, as both sides pull in specialists to wrangle fine points of transfer pricing and profit-split methods in the company’s effort to fend off a $3.3 billion tax bill.

When the trial resumes April 2 for another three-week round of arguments in U.S. Tax Court, Coca-Cola lead attorney John B. Magee is to call the company’s lead transfer pricing expert, Michael I. Cragg, to the stand to further the company’s position: that the beverage giant’s profit-creating functions—local marketing and concentrate production—are housed mostly in foreign business units, not in the Atlanta headquarters.

As a result, Coca-Cola says, the profits aren’t subject to U.S. tax for transfer pricing purposes.

Cragg, the first witness, is expected to testify that the residual profit split method is most reliable for determining the appropriate royalties for the inter-company licenses in question, and that the six foreign licensees at issue are autonomous from Atlanta, are distinct from bottlers, and bear the risk of developing their markets.

The Internal Revenue Service’s argument is that the Coca-Cola headquarters and the bottlers—not the business units—create value. That’s why the agency shifted $9.4 billion of income from overseas to Atlanta for the company’s 2007 to 2009 tax years and assessed the tax bill.

Jill A. Frisch, special trial attorney at the IRS’s Large Business and International Division, has chipped away at testimony by Coca-Cola’s witnesses by painting a starkly different picture from theirs: The Atlanta headquarters and the independent bottlers are responsible for significant profit-producing decisions, meaning more taxable profit should be attributed to the U.S.

Discredited Witness
Magee, a veteran litigator and partner at Morgan Lewis & Bockius LLP in Washington, has called more than 20 current and former company officials to tell the story of the Coca-Cola System—but the testimony of one witness proved to be detrimental.

Coca-Cola lost a fact witness when Judge Albert G. Lauber dismissed Russell Kisling for dodging the IRS’s questions. “I did not find him to be a credible witness,” Lauber said March 12 in an unusual move to strike the testimony. “I found him to be evasive.”

Kisling has been the director of supply point strategy for the company’s commercial products supply (CPS) group in Atlanta since 2005.

Lauber questioned Kisling’s credibility, saying he failed to directly address the IRS’s questions on concentrate plant closures, risk assessments, and contingency plans, and the extent of the CPS group’s involvement in those activities. At one point during cross-examination, Lauber raised his voice and asked Kisling, “Why aren’t you answering the question?”

IRS counsel has tried to get Kisling and other witnesses to testify that Coca-Cola’s supply points—part of the company’s organizational business units—bear the same, if not fewer, risks than bottlers. The supply points pay Coca-Cola royalties for the use of its trademarks and formulas, and then sell concentrates to independent bottling companies that manufacture and stock the final products.

Expert Testimony Begins
In the second segment of the trial, the parties are set to present expert testimony from some of the top transfer pricing economists on how to apply highly technical transfer pricing methods to the facts at hand.

Cragg, Coca-Cola’s first transfer pricing expert, is principal and chairman of the Brattle Group, an economic consulting firm, and has been an expert in transfer pricing cases for power management company Eaton Corp. and pharmaceutical company GlaxoSmithKline plc.

Following Cragg’s testimony, marketing experts Robert J. Dolan and Kevin Lane Keller are to present their views that the local business units made the company’s key consumer and marketing strategy decisions and were responsible for building the company’s brand equity.

Dolan is Baker Foundation Professor of Business Administration at Harvard Business School. His expertise focuses on pricing and new product development, according to the school’s website. Dolan has consulted with General Electric Co., IBM Corp., and Henkel AG & Co.

Keller is E.B. Osborn Professor of Marketing at the Tuck School of Business at Dartmouth College. He is a leading thinker on branding and strategic brand development, the college’s website says. He has consulted for marketers for well-known brands such as American Express Co., The Walt Disney Co., Intel Corp., Starbucks Corp., and General Mills Inc.

The IRS’s experts haven’t been scheduled, but the agency listed 12 expert witnesses in its pre-trial memo, including T. Scott Newlon, managing director at Horst Frisch Inc. in Washington and a Princeton University Ph.D. economist. Newlon is to testify on his view that the comparable profits method using independent bottlers as comparables is the best transfer pricing method. Newlon also is to rebut Cragg’s testimony as well as that of several other Coca-Cola experts who critiqued his report.

Familiar Characters
Ultimately, Lauber will decide facts of the Coca-Cola transfer pricing arrangement, weigh the experts’ testimony, apply the law, and decide whether Coca-Cola owes the IRS $3.3 billion, some other amount, or nothing at all.

Lauber, Magee, and Frisch previously met in court during a trial on Amazon.com Inc.’s tax woes that concluded in December 2014. Lauber sided with the online retailer in a March 2017 opinion that said the IRS abused its discretion in making a $2 billion adjustment to Amazon’s income tax returns. That case involves a cost-sharing arrangement in which Amazon transferred intellectual property to a European subsidiary. The IRS has appealed the decision to the U.S. Court of Appeals for the Ninth Circuit.

Morgan, Lewis & Bockius LLP and Miller & Chevalier Chartered represent Coca-Cola.

The case is Coca-Cola Co. v. Commissioner, T.C., No. 31183-15, trial resumes 4/2/18.