When court rulings and tax regulations violate them, companies have an effective way to minimize or postpone the bottom line. They don’t count them and announce that they will beat the government in the future.
Coke Co.
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, Whirlpool Corp.
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and Eaton Corp..
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have all lost in the past two years on the Internal Revenue Service of the US Treasury. However, none of the companies deducted the majority of these costs from their publicly reported results.
Instead, they analyzed the law and said they were confident that these losses would eventually be reversed. Coca-Cola, in particular, is preparing for a controversial constitutional war against the government with $ 12 billion at stake.
Others – including Newell Brands Inc.
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and Maxim Integrated Products Inc.
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– You can lose millions under the Treasury Department’s regulations enacted in 2019, but you remain confident that at some point the rules will be scrapped and the cost will not be captured.
“If you say that the tax authorities got it all wrong, that’s pretty bold,” said Jack Ciesielski, accounting expert and owner of RG Associates Inc., an investment research firm. The more conservative approach is to capture the cost, record the litigation, and later reverse the cost if the company prevails, he said.
When filing securities, companies generally argue that they have strong cases and that federal agencies have sometimes used improper practice in enacting regulations. They also say that they and their accountants take care to avoid market and legal ramifications if they ultimately lose.
“There are enough incentives to keep both the accountants and the company from being extremely aggressive,” said Erin Emily Henry, professor of accounting at the University of Arkansas. “Nobody wants the egg in their face or a possible lawsuit.”
The IRS, which does not comment on pending litigation, does not regulate what companies tell their investors about these lawsuits. The Securities and Exchange Commission, which enforces corporate disclosure requirements, declined to comment, as did the Financial Accounting Standards Board, which sets generally accepted US accounting standards.
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It is technically and subjectively to determine whether the result of a tax dispute has to be posted now or whether it can be postponed or ignored. If at any point the company loses beyond the point of appeal, it will have to pay the cost.
Under US accounting rules, companies must conclude that their eventual victory is “more than likely”. This requires executives, lawyers, accountants and auditors to assess the strength of their litigation after losing a court.
“One man’s” most likely “is” less than the most likely “of another man,” said Don Williamson, executive director of the American University’s Kogod Tax Center.
One of the biggest examples is Coca-Cola, which lost its case in the tax court in November. The company hired former federal judge J. Michael Luttig, a leading Conservative lawyer, and just added Harvard professor and liberal scholar Laurence Tribe.
The tax court found that Coca-Cola poured too much profit into low-taxed foreign subsidiaries and too little into the higher-taxed US parent company.
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At first glance, the 2007 through 2009 tax years included taxes of $ 3.3 billion. But Coca-Cola has continued the same practices so an IRS gain would increase tax costs for years to come. Coca-Cola announced this month that the total could reach $ 12 billion, plus a future tax rate increase of 3.5 percentage points.
That $ 12 billion exceeds Coca-Cola’s 2020 earnings. It’s also more than any cash, short-term investments, and marketable securities the company reported on Dec. 31.
In a nearly 1,600-word security filing, Coca-Cola said it had consulted outside advisors and examined the court’s opinion, case law and its own intention to pursue any available appeal. The result: a reserve of $ 438 million was posted, 4% of the total potential cost.
“We intend to make our claims and vigorously defend our position,” CEO James Quincey told analysts earlier this month. “When we put it all together, we believe we will ultimately prevail.”
Coca-Cola argues that the IRS acted unconstitutionally in 2015 by protesting a formula that the company and government agreed upon in 1996 to resolve a tax dispute. “The due process clause of the constitution prohibits the IRS from baiting the Coca-Cola Company, abruptly changing its position on fair tax billing for no legitimate reason, and taxing the company retrospectively for two decades,” Tribe said in a statement issued by the company.
The agreement between the IRS and the company made it clear that Coca-Cola would not receive penalties for continuing to use the calculation, said Reuven Avi-Yonah, a University of Michigan law professor who is investigating the case. However, this does not mean that the IRS is constitutionally bound by this agreement when calculating taxes. “That’s nonsense,” he said. “I do not know how [Coca-Cola] thought that up. “
However, he said the company has some solid technical arguments and could prevail on a number of points in the appeal process. Additionally, companies have often found their way, he said – the IRS victory over Coca-Cola marks the agency’s first major victory in this area of international tax law since 1979.
A hot tub facility in Clyde, Ohio. The device manufacturer assumes that it will successfully challenge a loss in the tax court.
Photo:
Aaron Josefczyk / Reuters
Whirlpool lost in the tax court in May when a judge ruled that income from the Mexican subsidiary of the appliance manufacturer’s Luxembourg subsidiary should have been taxed in the United States. The court ruling increased Whirlpool’s 2009 taxable income by approximately $ 50 million.
The company said it had carefully checked its claims with outside consultants. Whirlpool and the government have filed briefs with the US Sixth Court of Appeals.
“The company believes it will succeed on appeal and has not included the impact of the US Treasury Court decision in its consolidated financial statements,” wrote Whirlpool in its securities filing, without estimating the potential cost.
Eaton, a power management company, lost part of its proceedings in the tax court in 2019. It used similar language to Whirlpool to say that it had not recorded or estimated any costs and declined to comment further.
Newell and Maxim are ignoring an IRS regulation passed as a temporary rule in 2019. This rule sought to fill a loophole in the 2017 Tax Act that could have allowed businesses to earn low-taxed overseas income while avoiding a US-imposed minimum tax on overseas income.
Newell, maker of Krazy Glue and First Alert smoke alarms, said in a securities filing that the regulations were not valid. If the company loses, it could pay $ 180 million to $ 220 million plus interest and penalties, the filing said. That tax, if recognized last year, would have deepened Newell’s net losses of $ 770 million.
Ultimately, tax disputes are settled either by the parties or by the courts, and it becomes clear whether a company’s “more likely than not” analysis was correct. It did so after some companies skipped posting a tax hit while a case involved an Intel Corp.
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Secondary wound by federal courts.
The ninth US appeals court ruled in 2019 for the IRS and then for Facebook Inc.,
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Twitter Inc.
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and google parent alphabet Inc.
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took fees for their tax expenses.
But xilinx Inc.,
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Looking at the same case, he followed the opposite accounting strategy and declared the law unsettled. Xilinx recorded $ 57 million in costs in June 2020 after the Supreme Court dismissed Intel’s appeal.
Write to Richard Rubin at richard.rubin@wsj.com and Theo Francis at theo.francis@wsj.com
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