The dispute involves “transfer pricing” among the company’s various units during the tax years 2005 and 2006. The tax bureau claimed Medtronic owed income tax of $548.2 million for 2005 and $810.3 million for 2006; the Fridley, Minn.-based company disputed the bill and took the case to the U.S. Tax Court.
Yesterday Judge Kathleen Kerrigan found that Medtronic proved that the IRS was “arbitrary, capricious, or unreasonable” in its interpretation of the transfer pricing for its Puerto Rico subsidiary.
“[Medtronic Puerto Rico Operations Co.] was involved in every aspect of the manufacturing process. The manufacturing processes for both devices and leads was very detailed and took a week or longer. The products were made in an FDA-regulated ‘cleanroom’ environment. Some processes could not be done automatically but required skilled workers to complete them by hand,” Kerrigan wrote in her 144-page opinion. “MPROC was not only concerned with being able to produce products at a high volume; it was also concerned that each product be of the highest quality and suitable to place inside a patient. It was difficult to manufacture sensitive medical equipment at a high volume and maintain quality. MPROC employees would participate in core teams where they would partner with Medtronic US through each development phase of new products to ensure that newly developed products were manufacturable at commercial scale. The bottom line was that if a finished product could not be made, it could not be sold.”
In transfer pricing, income is allocated among branches in different countries. It’s a legal tax maneuver companies can use to attribute profits from a product made and sold in the U.S. to a unit in a foreign country. If Kerrigan’s ruling had gone the other way, the IRS could have dunned Medtronic for extra taxes from 2007 on, according to the Wall Street Journal. Medtronic has said it expects to repatriate between $500 million and $4.5 billion in overseas cash once the dispute is put to bed.
“The Tax Court completely rejected the IRS’s position,” Medtronic lawyer Thomas Linguanti told the newspaper.
Medtronic said its preliminary review of the ruling “indicates that this decision appears to be favorable to Medtronic on many key aspects of the case, and it appears to be generally consistent with the company’s most likely scenario for resolution that has previously been communicated to investors,” according to the Journal. “We will continue to assess the 144-page ruling and will provide any additional guidance as required. Final resolution could take several months or longer if appealed.”
The IRS didn’t respond to the paper’s request for comment.