Tax Court applies unspecified TP method in Medtronic


The Tax Court recently issued its second opinion in Medtronic v. Commissioner (T.C. Memo. 2022-84), rejecting the comparable profits method (CPM) approach proposed by the IRS in the case, and also rejecting the profit split method proposed by Medtronic. The Tax Court instead applied an unspecified method.


Medtronic is a global medical device company that makes and sells implantable medical devices. Medtronic, Inc. (“Medtronic U.S.”) owns the intangibles, manufactures proprietary components and distributes the products. A Puerto Rican subsidiary (“Medtronic P.R.”) assembles the products using a complex multi-step process with extensive quality control procedures. The issue addressed by the Tax Court was the appropriate intercompany royalty paid from Medtronic P.R. to Medtronic U.S.


In the initial Medtronic opinion (“Medtronic 1”), the Tax Court rejected the CPM approach proposed by the IRS, which would have resulted in a tax deficiency of approximately $1.4 billion. Instead, the Tax Court used a comparable uncontrolled transaction (CUT) approach that relied in part on a patent settlement and resulting license agreement. The Tax Court found a tax deficiency of approximately $14 million.


On appeal in “Medtronic 2,” the Eighth Circuit questioned the comparability of the patent-settlement-derived royalty because it was not made in the ordinary course of business and remanded the case to the Tax Court.


Upon receiving the case for a second time, the Tax Court applied an unspecified method in the recently issued “Medtronic 3.” The court again rejected the IRS’ CUT arguments, finding that Medtronic P.R.’s manufacturing was not routine, and that the IRS method did not compensate Medtronic P.R. for its quality-control function and product liability risk. The court ultimately applied a three-step, unspecified method to determine the appropriate royalties payable. Step one was a modified CUT as a starting point for an appropriate royalty. Step two was a CPM, modified for the asset intensity of Medtronic operations. Step three imposed an 80/20 split of the remaining profit between Medtronic U.S. and Medtronic P.R., respectively. This method substantially increases the tax deficiency from Medtronic 1 — but the deficiency has not yet been calculated.


The fact-specific nature of transfer pricing and the Tax Court’s choice of an unspecified method limit the conclusions that can be drawn from this opinion. However, despite the Tax Court’s rejection of the IRS’ CPM approach in this case, many commenters see this case as a partial win for the IRS.




Tax professional standards statement

This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.


More tax hot topics