In Uncategorized on 06/10/2016 at 00:12

The Tax Court website, presumably vetted by the Court, states: “Generally, a Memorandum Opinion is issued in a regular case that does not involve a novel legal issue. A Memorandum Opinion addresses cases where the law is settled or factually driven. A Memorandum Opinion can be cited as legal authority, and the decision can be appealed.

“Generally, a Tax Court Opinion is issued in a regular case when the Tax Court believes it involves a sufficiently important legal issue or principle.”

The “law is settled,” huh? Well, what price 144 (count ‘em, 144) pages of Judge Kerrigan’s prose in Medtronic, Inc. and Consolidated Subsidiaries, 2016 T. C. Memo. 112, filed 6/9/16.

There are eight lawyers for Medtronic, et al., and eleven (count ‘em, eleven) for IRS.

And there’s a billion, three hundred fifty million or so in deficiencies.

The Meds US sent IP to Meds Puerto Rico (PR) for purposes of manufacturing various medical devices. Should payments to PR be reallocated to Meds US per Section 482?

Meds US also entered into manufacturing deals with Meds Suisse; IRS claims either excess accrued royalties stashed in Switzerland or Meds US made payments in excess of arms’-length for goods manufactured in Switzerland by Meds Suisse. If not, IRS claims when Meds US restructured, it made transfers compensable per Section 367(c).

Thoroughly confused? If not, stand by.

Meds US made implantable medical devices, like pacemakers. If these go wrong, people die.  Meds US therefore had heavy-duty regulatory exposure and products liability exposure. It takes years to develop a product and get FDA benison. If the product thereafter maims or slays the patient, monumental liability falls on Meds US’s head, and there is no third-party insurance, so Meds US self-insured.

Meds US had a bunch of siblings, subsidiaries and related companies, all involved in this stuff.

Meds US set up first-tier subsidiaries in PR to take advantage of Section 936. When Congress phased out this unguided largesse (incidentally bankrupting the Commonwealth of Puerto Rico), US Meds organized a Swiss subsidiary to grab whatever PR had that wasn’t tax-advantaged.

PR had a lot of freedom, and ran the manufacturing operation with nearly a free hand. But FDA and foreign regulators watched them closely.

Meds US licensed its IP to PR when it set up PR. Meds US got into an infringement jumpball with Siemens, and settled by cross-licensing IP with negotiated royalty payments.

Meds US hammered out an arms’-length royalty arrangement with Siemens, which Meds US modified after entering into a Memorandum of Understanding with IRS.

PR was responsible for products liability issues. And this stuff involved ultrahazardous risk if the stuff didn’t work, and the bad will engendered thereby would trash the company’s brand.

Meantime the Swiss were manufacturing any stuff PR couldn’t, and paying royalty at same rate PR would have paid.

But various recalls affected PR, and Meds US’s competitors, chiefly Guidant (remember them?).

The IRS Memorandum of Understanding aforesaid settled IRS’s claim that the royalty arrangement with PR was too sweet. So US Meds adopted IRS’s numbers, took heavy tax hits per Section 367(d), and went forward.

Then IRS tried again, claiming the Memorandum of Understanding numbers generated excessively cheap profits to PR.

IRS and Meds US agree about arms’-length manufacturing numbers, but not about IP.

However, at close of play, it’s all about arms’-length. The critical question is how much product quality plays in determining what PR brought to the deal. IRS says PR brought little, and marketing controls; PR and Meds US says it’s all about quality and marketing means nothing without quality.

The recall evidence sinks IRS. Past recalls murdered both Meds US and Guidant, because doctors fled each time.

Judge Kerrigan: “Respondent [IRS] does not place enough emphasis on the importance of quality in the industry. The final product is the key to success. Product quality is the foundation for which implantable medical devices can be successful. A recall could make it very difficult for a company to continue to compete in the industry at the same level. A company can have a strong sales force and a creative marketing department, but these will not make a difference if the underlying product is unsafe and ineffective.” 2016 T. C. Memo. 112, at p. 102.

OK, says IRS, but quality is spread over the entire intercompany setup. PR is just the last link in the chain. Roger that, says Meds US, PR is goalkeeper, the last defense against unreliable, dangerous pacemakers that maim and slay. And blow up everyone connected therewith.

Meds US shows PR ran all the quality control ends of the show.

IRS’s expert downplayed PR’s contribution, mismatched its operations with those of the comparables he provided, and aggregated all the functions of producing Meds US’s products unnecessarily, ignoring the facts-and-circumstances test that places great value on PR’s goalkeeping functions.

Ultimately, though, neither IRS’s expert nor Meds US’s expert provided Tax Court with a meaningful method for fixing an arms’-length royalty for the IP Meds US gave PR.

So Judge Kerrigan goes with the comparable uncontrolled transaction, or CUT method. But Meds US’s expert didn’t account for variation in profit potential. So Meds US doesn’t show IRS was arbitrary, capricious or unreasonable in its adjustment of royalty rates.

Judge Kerrigan does the usual mix-and-match, and comes out with a number that matches the Memorandum of Understanding number Meds US hammered out with Siemens, but she claims it’s coincidental. And she applies the same number to the Swiss deal.

And whatever intangibles IRS claims were transferred to PR in an outward bound transaction that renders taxable that which Section 351 exempts from tax were given to PR before the restructuring, so no Section 367(d) taxation.

IRS loses a big one.

But is this really just facts-and-circumstances? Is the law really so “settled”?

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