Medtronic victorious in $1.4B tax case over 'transfer pricing'

A federal judge delivered a win for Medtronic ($MDT) in its $1.4 billion lawsuit against the Internal Revenue Service over how much of its profits should be taxed federally and how much should face lower taxes in Puerto Rico.

The dispute surrounds the device giant's 2005 and 2006 tax returns, made before the devicemaker merged with Covidien. "Transfer pricing" allows companies to assign profits from goods made and sold in the U.S. to a business unit in another country; in this case, Medtronic attributed profits to its Puerto Rican subsidiary. Though Puerto Rico is part of the U.S., it is considered foreign for tax purposes. Its tax rate is lower than the federal rate. The IRS disagreed with the way Medtronic allocated its profits and demanded the devicemaker pay $548 million in federal taxes for 2005 and $810 million for 2006.

Judge Kathleen Kerrigan wrote in a 144-page opinion that the IRS interpreted Medtronic's "transfer pricing" in an "arbitrary, capricious, and unreasonable" way. Medtronic's Puerto Rican subsidiary was "involved in every aspect of the manufacturing process," including the performance of some processes that required skilled workers because they could not be automated, Kerrigan wrote. She found that the Puerto Rican unit was contributing significantly to the company's profits.

While Kerrigan ruled in Medtronic's favor, she did not specify at the time how much Medtronic will end up forking over to the IRS. According to The Wall Street Journal, Medtronic will evaluate the ruling and said it could take several months or longer if an appeal is made.

Medtronic, which switched its tax domicile to Ireland following its merger with Covidien, can breathe a sigh of relief at the finding. Had the court taken the IRS's side, every tax return from 2007 forward could come into question, and the IRS could conceivably have shaken the company down for billions more in taxes, the WSJ reported.

- here's the court's opinion
- read more from The Wall Street Journal (sub. req.)

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