Joe McConnell
A decade-long dispute between Coca-Cola and U.S. tax authorities has escalated to the point where the company could owe $16 billion in back taxes, enough to wipe out a year and a half of profits and adding more than $1 billion a year.
The soVscek drink maker hid “astronomical levels” of profits in low-tax countries, including Ireland, to protect itself from the US Internal Revenue Service, according to a scathing court ruling, which the company plans to appeal later this year.
In recent years, the growing stakes have been made visible only in the details of Coca-Cola’s regulatory filings, due to a quirk of accounting rules.
AVsceker the latest in a four-year series of tax court decisions last week, Coca-Cola will soon have to fork over $6 billion in cash to cover unpaid taxes and interest for 2007 through 2009. But neither that sum, nor the $10 billion it may have to pay over the next 15 years, will feel like a hit to its earnings any time soon.
As long as the Atlanta-based company and its longtime auditor EY agree that Coca-Cola has a better than 50-50 chance of winning on appeal, the payments will not have to be accounted for in its profit and loss statement.
If Coca-Cola misjudged its chances of winning, a loss would not only erase the last year and a half of net profit; the IRS could impose a higher U.S. tax for years to come, adding 3.5 percentage points to a global tax rate that the company estimates was 17.4 percent last year.
The stakes are high for the U.S. government, too. The $16 billion could cover the IRS budget for a year, and the standoff with Coca-Cola is a test of the agency’s ability to prosecute complicated cases at a time when it has vowed to get tough on corporate tax evasion.
Alex Martin, a transfer pricing specialist at tax advisory group KBKG, said other firms are watching closely. “This decision could be a template for the IRS to audit other U.S. companies with profitable subsidiaries.”
The dispute involves Coca-Cola subsidiaries in Ireland, Brazil, Eswatini and four other countries that produce concentrate, the syrup that is mixed with carbonated water to make drinks like Coca-Cola, Fanta and Sprite. The subsidiaries are located between the U.S. parent company, which owns the brands, and the bottling companies that make the final product.
The company regularly shiVsceked concentrate production to countries with favorable tax rates, the U.S. tax court found. The subsidiary in Ireland, which had a tax rate as low as 1.4 percent, at one point shipped to bottlers in 90 countries.
Unlike independent contract manufacturers, which typically have low margins, an IRS review found that these Coca-Cola subsidiaries were unusually profitable, with a return on assets two and a half times that of the U.S. parent company that owns the iconic brands. By controlling how much the subsidiaries pay other parts of the Coca-Cola network for trademark use and marketing, and by setting the prices they can charge bottlers, Coca-Cola itself effectively dictated their profitability, the court heard.
Those profit levels were “astronomical,” Judge Albert Lauber wrote in an initial 2020 ruling.
“Why are supply chains, engaged as they are in routine contract manufacturing, the most profitable food and beverage companies in the world?” he asked. “And why does their profitability dwarf that of the Coca-Cola Company, which owns the intangibles on which the company’s profitability depends?”
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The tax treatment of its concentrate producers has been a bone of contention between Coca-Cola and the IRS for decades. A similar dispute was resolved in 1996 by reallocating some of the subsidiaries’ previous profits to the U.S. parent, based on a formula worked out by negotiators.
Coca-Cola used the same formula to calculate its tax returns for another decade without objection, before the IRS ruled in 2015 that it had improperly suppressed U.S. profits. Concentrate producers should not earn higher rates of return than Coca-Cola bottlers, it said, and the excess amounts should be allocated to the parent company and taxed as U.S. income.
Coke’s argument that the IRS acted capriciously in moving the goalposts was dismissed cursorily by Lauber in 2020 and subsequent rulings. In one, he wrote that Coke never asked for, and the IRS never agreed to, that the 1996 settlement apply to all future tax years.
Coca-Cola “chose to try its luck with the IRS examiners, hoping that they would not upset the status quo,” Lauber wrote. “But that was only a hope, and hope is not something that gives rise to legal or constitutional rights.”
Coca-Cola also argues that the new IRS formula does not take into account the valuable intellectual property accumulated by concentrate producers, including the local marketing benefits of Coca-Cola brands.
The company set aside just $456 million in previous financial statements to cover what it actually believes it will owe, and reiterated its assessment that it will likely beat the IRS on all major issues.
Some experts aren’t convinced. “If a seasoned judge is going out of his way to tell Coca-Cola it’s relying on ‘hope,’ I have a hard time seeing why the IRS would settle for pennies on the dollar,” said KBKG’s Martin.
But John Murphy, Coca-Cola’s chief financial officer, told the Financial Times that the valuation had been approved by his advisers.
“We have outside counsel who, every quarter, has continued to evaluate the case based on the facts available to them and continues to offer an opinion that gives us a better than bad chance of prevailing,” he said. “And then EY will do their independent assessment to feel comfortable with that opinion.”
EY wrote in a note to Coca-Cola’s latest annual report that there was a “significant level of subjectivity and judgment” in assessing the company’s tax position, but that it had also consulted its own experts on the matter. EY has been Coca-Cola’s auditor for 103 years, signing off on annual accounts that include provisions Coca-Cola has made for taxes over the years.
EY declined to comment for this article, as did the IRS.
The upcoming $6 billion payment “will not have any impact on the profit and loss statement at this time because of the company’s confidence in victory,” Murphy said, adding that the money “will come back” if Coca-Cola wins the appeal.
The cash outlay will hurt Coca-Cola’s balance sheet, however, limiting its ability to make major acquisitions or buybacks. The check to the IRS will be equal to how much the company pays out in dividends to shareholders over a year and a half.
In May, the company raised $4 billion in new debt to help cover its maturing bills. In Coca-Cola’s earnings call last month, Murphy responded bullishly to a question about the balance sheet: “All in all, it’s going to be an interesting 18 months ahead,” he said, “but we’re very confident that the work we’ve done so far sets us up well.”
