EXPLAINER

Beverage giant is appealing a 2020 ruling that has major implications for how much tax companies pay on overseas profits.

Coca-Cola and the Internal Revenue Service (IRS) of the United States will face off in a Florida court this week in the latest episode of a decades-long legal battle over the beverage giant’s tax liability on overseas profits.

The Atlanta, Georgia-based company and the US tax service will begin oral arguments on Thursday in a dispute that centres on transfer pricing – the practice of setting prices for transactions carried out between a company’s own affiliates – and could result in Coca-Cola facing a tax bill of about $20bn.

The case is being closely watched in corporate circles because the outcome will have implications for the amount of tax US-based multinational corporations must pay on income generated through their foreign subsidiaries.

What is the case about?

Coca-Cola is appealing a 2020 US Tax Court ruling that upheld the IRS’s finding that the soft drink giant underreported profits from transactions between its foreign subsidiaries.

In 2015, the IRS notified Coca-Cola that it owed billions in back taxes after concluding that the company had undercharged its units in Ireland, Brazil, Chile, Mexico, Costa Rica, Egypt and Eswatini, formerly known as Swaziland.

US multinationals often charge low licensing fees for their overseas units to minimise their reportable income in the US, which has a higher corporate tax rate than many of its peers.

“The IRS audited Coca-Cola because the company was earning astronomical profits in Ireland and a few other countries,” Alex Martin, an expert in transfer pricing at the tax consulting firm KBKG, told Al Jazeera.

The IRS first took Coca-Cola to court in 2015, but the origins of the dispute date back to 1996 when the two sides settled a tax audit for liabilities from 1987 to 1995.

Under the pricing formula agreed in that settlement, Coca-Cola’s foreign affiliates were allowed to retain a profit equal to 10 percent of their gross sales with the remaining income split evenly between the US headquarters and the overseas unit.

Coca-Cola argues that it should be able to continue to use this formula from 1996 while the IRS contends the terms of that settlement should have no bearing on the soft drink giant’s tax liabilities arising from audits in 2007, 2008 and 2009.

“The amount of potential exposure is about $20bn, so it is significant,” Reuven Avi-Yonah, an expert in taxation law at the University of Michigan Law School, told Al Jazeera.

Coca-Cola agreed to pay the IRS $6bn in back taxes and interest in 2024 while preparing its appeal but could be liable to pay up to $14bn more if the US Court of Appeals for the Eleventh Circuit sides with the government.

Coca-Cola argues that the IRS “misinterpreted and misapplied the applicable regulations” and has expressed its confidence that it will be successful in its appeal.

Why does the case have implications beyond Coca-Cola?

The case is important because it could serve as a template for the US government to raise more tax revenue from large multinational companies that generate huge profits overseas.

“The IRS designated this case for litigation because this litigation can provide a template for the IRS to audit other US companies with highly profitable subsidiaries,” Martin said.

Under the administration of former US President Joe Biden, the IRS ramped up its tax collection efforts against companies benefitting from transfer pricing arrangements.

In one of the most high-profile transfer pricing cases in recent years, the IRS announced in 2023 that Microsoft owed $28.9bn in back taxes, plus penalties and interest, on income derived from the distribution of software through its subsidiaries in Puerto Rico, Ireland and Singapore.

Microsoft said it disagreed with the IRS’s reasoning and would appeal to the tax service and, if that failed, go to court.

In 2024, the IRS announced that the short-term rental platform Airbnb and Newell Brands, a consumer products manufacturer, had underpaid their taxes to the tune of $1.33bn and $90m, respectively.

Airbnb and Newell Brands have both challenged the IRS’s determinations in the US Tax Court.

The Coca-Cola case is particularly significant because the IRS has historically fared poorly in litigating transfer pricing complaints, losing a string of cases against major corporations through the decades, including Bausch & Lomb, US Steel Corp and Hospital Corp of America.

“It is important because it is the first clear victory of the IRS in this kind of case involving profit shifting out of the US in many decades, so if it is upheld on appeal, more companies may be inclined to settle rather than litigate,” Avi-Yonah said.