Coca-Cola vs IRS – does a long-standing transfer pricing model really provide protection?

The dispute between Coca-Cola and the US Internal Revenue Service (IRS) is one of the most high-profile transfer pricing cases in recent years.

While media coverage has largely focused on the amount at stake – exceeding USD 20 billion – finance directors, tax leaders and transfer pricing professionals are asking a different question.

Does a transfer pricing model that has remained unchallenged by the tax authorities for many years genuinely provide tax certainty?

The answer could be highly relevant for many multinational groups, including those operating in Poland.

This is not merely a dispute over methodology

For many years, Coca-Cola applied a profit allocation model between the US parent company and its overseas manufacturing entities (the so-called supply points). The arrangements were based on the IRS-approved 10-50-50 model, under which the foreign entities were allocated a routine return, while the residual profit was shared between the US company and the supply points.

Years later, however, the IRS challenged this approach, arguing that the exclusive rights to the group’s key intangible assets belonged to the US company, while the foreign entities essentially performed service functions. As a result, the IRS replaced the existing methodology with the Comparable Profits Method (CPM), leading to a multi-billion-dollar upward adjustment to taxable income in the United States.

At the appellate stage, the dispute is no longer limited to determining which method best reflects the arm’s length principle. Increasingly, the key issue is whether a tax authority may fundamentally change its position, after many years, in relation to a model that it had previously accepted.

1. Legitimate expectations

Coca-Cola argues that its previous agreements with the IRS created a legitimate expectation. In the absence of any material change in circumstances, the same transfer pricing model should not later be challenged in a way that produces a fundamentally different tax outcome.

From a taxpayer’s perspective, this dispute extends well beyond transfer pricing methodology. It raises broader questions regarding the predictability of tax administration and the extent of protection arising from the long-standing acceptance of a particular transfer pricing model.

2. Stability of the transfer pricing system

A retrospective change in methodology undermines the predictability of the transfer pricing framework, under which business decisions are made on the basis of available analyses, market data and the established practice of the tax authorities.

The risk is particularly significant for multinational groups where the revised approach is applied only to selected entities or jurisdictions (as in the Coca-Cola case), while the same transfer pricing model continues to operate elsewhere within the group.

DEMPE still matters

The case once again highlights the importance of the DEMPE analysis in transactions involving intangible assets.

According to the IRS, although Coca-Cola’s foreign subsidiaries incurred substantial marketing expenditure, they did not perform functions that justified allocating to them a significant share of the profits derived from the brand. The key functions relating to the development, enhancement, maintenance, protection and exploitation (DEMPE) of the intangible assets remained with the US company.

The case serves as a reminder that:

• incurring marketing expenditure does not automatically entitle an entity to profits attributable to intangible assets;
• funding particular activities does not, in itself, create economic ownership of a brand; and
• the decisive factors are the functions actually performed, control over risk, and a robust DEMPE analysis.

What does this mean for Polish taxpayers?

Although the proceedings are based on US tax law, the conclusions are equally relevant for Polish taxpayers and multinational groups conducting cross-border business.

1. A long-standing transfer pricing model does not guarantee protection

The mere fact that a transfer pricing model has been applied consistently for many years, or has not previously been questioned by the tax authorities, does not eliminate the risk of future challenge. Tax authorities may reassess an existing model if they conclude that it no longer reflects the current allocation of functions, assets and risks.

For this reason, transfer pricing models should be reviewed and monitor regularly against the commercial reality of the business.

2. DEMPE is more than a formal documentation requirement

Tax authorities are increasingly focusing not on contractual arrangements alone, but on the actual allocation of functions, risks and responsibilities relating to the creation and management of intangible assets.

The critical questions remain:

• Who makes the strategic decisions?
• Who controls the key risks?
• Who develops and protects the intangible assets?
• Who ultimately benefits from the value created?

3. Documentation and analysis should reflect commercial reality

A qualitative transfer pricing benchmark should reflect the group’s actual operating model, taking into account the functional analysis, the allocation of risks and the way in which the business is conducted.

Only after such verification can genuinely comparable companies be identified. In practice, a benchmark should not be regarded merely as a technical appendix to the transfer pricing documentation, but rather as a tool for assessing whether the level of remuneration genuinely reflects the role that a particular entity plays in creating value within the group.

Risk Alert

The Coca-Cola case demonstrates that particular attention should be paid where:

• a transfer pricing model has been in place for many years without being re-evaluated;
• functions or responsibilities within the group have changed;
• transactions involve intangible assets;
• the benchmark relies on historical or inappropriate assumptions; or
• no DEMPE analysis has been performed.

Summary

The Coca-Cola v IRS case demonstrates that a transfer pricing model is not a solution that can simply be implemented once and left unchanged. Even a long-established model may be challenged if business circumstances evolve or the tax authorities adopt a different approach. This does not automatically mean that the previous arrangements were incorrect. Equally important is whether the tax authority can justify departing from a position that it had previously accepted without objection.

For tax leaders, the case serves as a reminder that transfer pricing management should be an ongoing process. Regular reviews of transfer pricing policies, DEMPE analyses and benchmarking studies not only reduce tax risk but also place organisations in a stronger position should a tax audit arise.