Coca-Cola is embroiled in a decade-long dispute with the US tax authorities that has escalated dramatically, with the company potentially owing $16 billion (€14.7 billion) in back taxes. This amount is substantial enough to wipe out a year and a half of Coca-Cola’s profits, and the figure is increasing by over $1 billion each year.
The IRS has accused Coca-Cola of hiding significant profits in low-tax countries, including Ireland, to shield them from US taxes. This allegation was supported by a stringent court judgment, which Coca-Cola plans to appeal later this year. Despite the growing stakes, the details have largely remained in the background of Coca-Cola’s regulatory filings due to specific accounting rules.
Initial $6 Billion Payment Due
Following the latest in a series of tax court decisions last week, Coca-Cola must soon pay an initial $6 billion in cash to cover unpaid taxes and interest for the years 2007 to 2009. However, this amount, along with the $10 billion it could owe for the following 15 years, will not immediately impact its earnings.
This is because, as long as Coca-Cola and its long-time auditor EY believe there is a better than 50:50 chance of winning the appeal, these payments do not need to be included in the profit and loss account. If Coca-Cola miscalculates its chances and loses, the IRS could impose higher US tax bills for future years, adding 3.5 percentage points to its global tax rate, which was 17.4 percent last year.
High Stakes for Both Sides
The stakes are also high for the US government. The $16 billion could cover the IRS budget for a year, and this case serves as a crucial test of the agency’s ability to pursue complex cases amid its pledge to tackle corporate tax avoidance.
Alex Martin, a transfer pricing specialist at the tax advisory group KBKG, noted that other companies are closely watching this case. He suggested this decision could set a precedent for the IRS to audit other US companies with profitable subsidiaries.
Details of the Dispute
The dispute revolves around Coca-Cola subsidiaries in countries like Ireland, Brazil, Eswatini, and four others that produce concentrate, the syrup used to make drinks like Coca-Cola, Fanta, and Sprite. These subsidiaries operate between the US parent company, which owns the brands, and the bottling companies that manufacture the final product.
The IRS found that Coca-Cola shifted concentrate production to countries with favorable tax rates. The Irish subsidiary, which had a tax rate as low as 1.4 percent, once shipped to bottlers in 90 countries. An IRS analysis revealed these subsidiaries were highly profitable, earning a return on assets 2.5 times higher than the US parent company. Coca-Cola controlled the subsidiaries’ profitability by setting the prices they could charge bottlers and determining what they must pay other parts of the network for the use of brands and marketing.
Judge Albert Lauber described these profit levels as “astronomical” in an initial ruling in 2020. He questioned why these subsidiaries, engaged in routine contract manufacturing, were the most profitable food and beverage companies globally and why their profitability dwarfed that of the Coca-Cola Company, which owns the valuable intangibles driving the company’s profitability.
History of the Dispute
The tax treatment of its concentrate manufacturers has been a contentious issue between Coca-Cola and the IRS for decades. A similar dispute in 1996 was settled by reallocating some of the subsidiaries’ profits to the US parent company based on a negotiated formula. Coca-Cola continued using this formula for another decade without objection until the IRS decided in 2015 that the company had improperly suppressed US profits. The IRS argued that the concentrate manufacturers should not be making higher percentage returns than Coca-Cola’s bottlers, and amounts beyond that should be taxed as US income.
Judge Lauber dismissed Coca-Cola’s argument that the IRS acted capriciously by changing the rules, noting that the 1996 settlement was not intended to apply indefinitely. Coca-Cola “chose to take its chances with the IRS examiners,” Lauber wrote, “but that was only a hope, and hope is not something that gives rise to legal or constitutional entitlements.”
Coca-Cola’s Position and the Road Ahead
Coca-Cola has provisioned just $456 million in previous earnings statements for what it believes it will actually owe, maintaining confidence in winning the case. However, some experts are skeptical. “If an experienced judge goes out of his way to tell Coca-Cola they are relying on ‘hope’, I struggle to see why the IRS would settle for pennies on the dollar,” said KBKG’s Martin.
John Murphy, Coca-Cola’s chief financial officer, stated that outside counsel has consistently evaluated the case and provided an opinion supporting a greater-than-not chance of prevailing. EY, Coca-Cola’s auditor for 103 years, also consults its own experts on the matter.
The upcoming $6 billion payment will not impact Coca-Cola’s profit and loss account due to its confidence in winning. However, this cash outlay will affect the company’s balance sheet, limiting its capacity for large acquisitions or share buybacks. The payment to the IRS will be equivalent to what Coca-Cola distributes in shareholder dividends over a year and a half.
To cover upcoming bills, Coca-Cola raised $4 billion in new debt in May. Murphy expressed confidence during the last earnings call, stating that the work done to date prepares them well for the challenges ahead.
The outcome of this dispute will not only impact Coca-Cola’s financial strategies but also set a precedent for how the IRS handles similar cases in the future.
Source: Irish Times
