The Tax Court rejected the IRS's proposed transfer pricing method of re-allocating income between a U.S. parent corporation and its foreign subsidiary and ruled against the Internal Revenue Service's attempt to collect $1.36 billion in tax deficiencies, finding that the assessment did not reflected the economic realities of manufacturing these medical devices. in a case involving licenses for the intellectual property necessary to manufacture and sell high-risk, heavily regulated implantable medical devices in Medtronic, T.C. Memo. 2016-112.
The Tax Court held that Medtronic met its burden of showing the Internal Revenue Service (IRS) abused its discretion by making arbitrary and capricious Internal Revenue Code (IRC) Section 482 reallocations with respect to taxable income of Medtronic’s Puerto Rico subsidiary.
The Court also found that IRS's re-allocations undervalued the role of the licensee in a number of ways, including the skill of its workforce, the high premium on quality control, and the amount of economic risk it assumed.
However, while the Court approved the method used by the taxpayer group, it found that the royalties paid under the licenses had to be significantly adjusted upwards.
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