The taxes paid to a foreign country (Mexico) by the subsidiary of a multinational beverage company were compulsory levies. The Mexican subsidiary calculated its royalty payments based on “transfer-pricing” agreements with the Mexican federal tax authority (SAT).
After an audit, the IRS determined that the foreign subsidiary’s payments to license the parent’s intellectual property were too low. Since the license payments were too low, the subsidiary’s deduction for royalty payments was also too low. Thus, the subsidiary overpaid its Mexican income tax. The IRS then reasoned that the overpayments were not “compulsory” and, therefore, not taxes for purposes of Code Sec. 901. Accordingly, the IRS disallowed portions of the foreign tax credits the parent claimed on its consolidated returns.
For a foreign tax payment to be compulsory, the payment must be determined in a manner that is consistent with a reasonable interpretation and application of the provisions of the foreign tax law (including tax treaties). In addition, the taxpayer must exhaust all effective remedies, including invoking competent authority procedures to reduce, over time, the taxpayer’s liability for foreign taxes. A tax payment is not compulsory if the amount paid exceeds the proper tax liability under the foreign country’s law.
Transfer Pricing Agreements
The SAT determined that the 10-50-50 method resulted in arm’s-length royalty payments for Mexican tax purposes. Accordingly, the 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 subsidiary calculated its tax liability using a reasonable interpretation and application of Mexican law. Also, the subsidiary relied in good faith on advice it obtained from competent tax counsel when calculating the royalties properly payable under Mexican law. The subsidiary did not have actual or constructive notice that its counsel’s interpretation of Mexican law was likely to be erroneous.
Exhausted Administrative Remedies
Further, 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. Moreover, a taxpayer is not required to take futile additional administrative steps to satisfy the exhaustion requirement. Since the subsidiary had no effective and practical remedies in Mexico, its only possible remedy was a competent authority proceeding. However, the IRS refused to initiate or participate in a such a proceeding,
Finally, under Code Sec. 905(c), the subsidiary’s ultimate liability for Mexican tax could not be determined because: (1) the IRS’s Code Sec. 482 adjustments have not yet been adjudicated; and (2) if those adjustments are sustained in whole or in part, the subsidiary may or may not receive a refund of Mexican taxes. However, 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.
The Coca-Cola Company & Subsidiaries, 149 TC —, No. 21, Dec. 61,092
Code Sec. 482
CCH Reference – 2017FED ¶22,283.44
Code Sec. 901
CCH Reference – 2017FED ¶27,826.2645
CCH Reference – 2017FED ¶27,826.298
Tax Research Consultant
CCH Reference – TRC INTL: 15,104
CCH Reference – TRC INTLOUT: 3,254.10
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