MDT Medtronic PLC

By Richard Rubin and Jeanne Whalen 

The U.S. Tax Court handed Medtronic Plc a victory in a $1.4 billion dispute with the Internal Revenue Service over how much of the medical device maker's profits should be taxed by Puerto Rico and how much should face higher federal taxes instead.

In a 144-page ruling, Judge Kathleen Kerrigan agreed with the company, saying it had proved the government's "allocations were arbitrary, capricious, or unreasonable." The Puerto Rican subsidiary, she wrote, "was involved in every aspect of the manufacturing process" and thus was making significant contributions to the overall company's profits.

The dispute dates back to the 2005 and 2006 tax years, before Medtronic merged with Covidien PLC and moved its legal address to Ireland.

The case involved transfer pricing, or the rules that govern transactions between different arms of the same company. Corporations must make such transactions as if they were engaged in arm's length deals between unrelated companies, and allocate income where it is earned, depending on which entity truly generates the profits.

But those standards frequently lead to fact-intensive disputes with the IRS. In this case, the company and the government were arguing about the proper methods for determining how profits should be split between foreign and domestic operations.

Although Puerto Rico is part of the U.S., companies based there are considered foreign corporations for U.S. corporate income-tax purposes. That means companies pay the local tax and don't have to pay the full 35% U.S. tax rate until they repatriate the money.

Medtronic's Puerto Rican subsidiary manufactured medical devices, and the company said it was attributing an appropriate amount of the profits to its U.S. operations.

Judge Kerrigan, who was also critical of some parts of the company's analysis, determined precise income allocations that were different from what the IRS or Medtronic contended. Her findings, however, were close to what Medtronic had initially proposed.

The exact amount Medtronic will owe hasn't been determined at this stage of the case.

The IRS and Medtronic didn't immediately respond to requests for comment Thursday.

Write to Richard Rubin at richard.rubin@wsj.com and Jeanne Whalen at jeanne.whalen@wsj.com

(END) Dow Jones Newswires

June 09, 2016 17:51 ET (21:51 GMT)

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