                           149 T.C. No. 21



                  UNITED STATES TAX COURT



 THE COCA-COLA COMPANY & SUBSIDIARIES, Petitioner v.
   COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 31183-15.                         Filed December 14, 2017.



       P, a U.S. corporation, does business in Mexico through a
branch (Licensee). For taxable years 2007-2009 Licensee paid
royalties to P for the use of P’s intangible property and claimed
deductions for those royalties on its Mexican corporate income tax
returns. P reported all of Licensee’s income on its consolidated
Federal income tax returns for 2007-2009 and claimed foreign tax
credits (FTCs) under I.R.C. sec. 901 for the corporate income taxes
Licensee had paid to Mexico.

       The IRS selected P’s 2007-2009 returns for examination and,
exercising its authority under I.R.C. sec. 482, determined that the
royalties Licensee had paid to P were not at arm’s length, i.e., were
too low. As a corollary of this determination, the IRS determined that
Licensee had claimed insufficient deductions for royalty payments on
its Mexican tax returns and to that extent had overpaid its Mexican
corporate income tax. To the extent of these overpayments, the IRS
determined that the taxes paid to Mexico were not “compulsory” and
                                         -2-

      hence were not “taxes” within the meaning of I.R.C. sec. 901. See
      sec. 1.901-2(a)(2)(i), Income Tax Regs.

              1. Held: P calculated its Mexican tax liabilities “in a manner
      that is consistent with a reasonable interpretation and application of
      the * * * provisions of foreign law (including applicable tax treaties)
      in such a way as to reduce, over time, * * * [its] reasonably expected
      liability under foreign law for tax.” Sec. 1.901-2(e)(5)(i), Income Tax
      Regs.

              2. Held, further, P “exhaust[ed] all effective and practical
      remedies, including invocation of competent authority procedures
      available under applicable tax treaties, to reduce, over time, * * * [its]
      liability for foreign tax.” Sec. 1.901-2(e)(5)(i), Income Tax Regs.

             3. Held, further, the Mexican taxes paid by Licensee for 2007-
      2009 were “compulsory” levies for which P is entitled to FTCs under
      I.R.C. sec. 901(a).



      John B. Magee, Kevin Lee Kenworthy, Sanford W. Stark, Saul Mezei,

Steven R. Dixon, Jarrett Y. Jacinto, Carl T. Ussing, and Lisandra Ortiz, for

petitioner.

      Jill A. Frisch, Anne O’Brien Hintermeister, Julie Ann P. Gasper, Heather L.

Lampert, Curt M. Rubin, Lisa M. Goldberg, and Huong T. Bailie, for respondent.
                                        -3-

                                     OPINION


      LAUBER, Judge: With respect to petitioner’s Federal income tax for 2007-

2009, the Internal Revenue Service (IRS or respondent) determined substantial de-

ficiencies as a result of transfer-pricing adjustments under section 482.1 The case

is calendared for trial in Washington, D.C., beginning March 5, 2018. Currently

before the Court is petitioner’s motion for partial summary judgment with respect

to an issue the parties have labeled “the Mexico Foreign Tax Credit” issue.

During 2007-2009 petitioner did business in Mexico through the Coca-Cola

Export Corp. Sucursal Mexico (Mexico Licensee), a branch of one of its domestic

subsidiaries. The Mexico Licensee paid royalties to petitioner for use of petition-

er’s intangible property. After claiming deductions for these and other expenses,

the Mexico Licensee for 2007-2009 paid income taxes in excess of $250 million to

the Government of Mexico. Petitioner reported the Mexico Licensee’s taxable

income on its consolidated Federal income tax returns and claimed foreign tax

credits (FTCs) under section 901 for the Mexican income taxes paid.




      1
        All statutory references are to the Internal Revenue Code (Code) in effect
for the years at issue, and all Rule references are to the Tax Court Rules of Prac-
tice and Procedure. We round all monetary amounts to the nearest dollar.
                                        -4-

      In 2015 the IRS issued petitioner a notice of deficiency determining (among

other things) that the royalties the Mexico Licensee had paid to petitioner were not

calculated at arm’s length, i.e., were too low. As corollaries of these proposed ad-

justments, the IRS determined that the Mexico Licensee had claimed insufficient

deductions for royalty payments on its Mexican corporate returns and to that ex-

tent had overpaid its Mexican income tax. To the extent of these alleged overpay-

ments the IRS determined that the taxes paid to Mexico were not “compulsory”

and hence were not “taxes” within the meaning of section 901. See sec. 1.901-

2(a)(2)(i), Income Tax Regs. (“A foreign levy is a tax if it requires a compulsory

payment pursuant to the authority of a foreign country to levy taxes.”).

      On the basis of these determinations the IRS disallowed portions of the

FTCs that petitioner had claimed on its 2007-2009 returns. Petitioner contends

that the Mexican taxes it paid were “compulsory” levies and that the IRS erred as a

matter of law in disallowing credits therefor. We agree with petitioner and ac-

cordingly will grant its motion for partial summary judgment.

                                    Background

      The following facts are derived from the parties’ pleadings and motion pa-

pers, including the attached declarations and exhibits. The facts are stated for the

purpose of ruling on petitioner’s motion for partial summary judgment and not as
                                         -5-

findings of fact in this case. See Rule 1(b); Fed. R. Civ. P. 52(a); Cook v. Com-

missioner, 115 T.C. 15, 16 (2000), aff’d, 269 F.3d 854 (7th Cir. 2001). Petitioner

had its principal place of business in Georgia when it petitioned this Court.

      Petitioner is the parent of a group of companies that manufacture, sell, and

distribute nonalcoholic ready-to-drink beverages in more than 200 countries. Pe-

titioner began to expand internationally in the early 20th century. To support its

international operations it established foreign licensees to manufacture Coca-Cola

concentrate for sale to bottlers outside the United States. The parties refer to peti-

tioner’s foreign licensees as supply points.

A.    The Closing Agreement

      Sometime before 1996 the IRS examined petitioner’s Federal income tax re-

turns for 1987-1989 to determine whether its supply points were paying royalties

at arm’s length for the use of petitioner’s intangible property. This examination

resulted in the execution of a closing agreement that covered petitioner’s 1987-

1995 tax years. This agreement established a method--the “10-50-50 method”--for

calculating royalties payable for use of petitioner’s intangible property. Under this

method each supply point would retain 10% of its gross sales as a routine return,

and the residual operating profit (after certain adjustments) would be split 50-50

between the supply point and petitioner.
                                        -6-

      The closing agreement provided penalty protection for petitioner both dur-

ing the term of the agreement and for tax years after 1995. For tax years after

1995 the agreement provided that petitioner would meet the reasonable cause and

good faith exceptions of sections 6664(c) and 6662(e)(3)(D) if its supply points

continued to calculate royalties pursuant to the 10-50-50 method (or other method

to which it and the IRS subsequently agreed). This protection applied to all of

petitioner’s then-existing and future supply points, including supply points operat-

ing as branches of petitioner.

      The closing agreement expired on December 31, 1995. But the IRS exam-

ined petitioner’s returns for each of the ensuing 11 years and concluded that “the

continuing application of the closing agreement’s terms and conditions to post-

1995 years seems appropriate.” Thus, as relevant here, the IRS limited its 1996-

2006 examinations to determining whether the royalty amounts petitioner received

from its supply points were consistent with the closing agreement. With one min-

or exception the IRS answered that question in the affirmative, making no adjust-

ments to the royalty payments that petitioner received from its supply points dur-

ing 1996-2006. All of these royalties were computed under the 10-50-50 method.
                                        -7-

B.    The Mexico Licensee

      Petitioner formed the Mexico Licensee in 1950. For the tax years at issue

the Mexico Licensee was a branch of the Coca-Cola Export Corp., a domestic

subsidiary of petitioner and a member of petitioner’s affiliated group that files

consolidated Federal income tax returns. Starting in 1950 and continuing through

the years at issue, petitioner licensed to the Mexico Licensee the rights to manu-

facture and sell Coca-Cola concentrates, beverage bases, and syrups used in the

preparation of finished beverages and to use petitioner’s trademarks in connection

with the sale of these products. The Mexico Licensee paid Mexican corporate tax

on the net income it derived from its operations.

      Before 1998 Mexican tax law did not include an arm’s-length standard for

related-party transactions, and the Mexico Licensee before that time paid no royal-

ties to petitioner for use of its intangible property. But in 1997 Mexico amended

its tax law to incorporate the arm’s-length principle. In response petitioner and the

Mexico Licensee entered into an agreement, effective January 1, 1998, whereby

the Mexico Licensee agreed to pay petitioner for the use of its intangible property

a royalty calculated under the 10-50-50 method. The Mexico Licensee requested

permission from Mexico’s Federal taxing authority, the Servicio de Administra-

ción Tributaria (SAT), to pay petitioner royalties computed in this manner.
                                        -8-

      In December 2000 the SAT notified the Mexico Licensee that it would per-

mit royalty payments to petitioner under the 10-50-50 method for the 2000 tax

year. On February 6, 2001, the SAT issued a formal Resolution (equivalent to a

U.S. advance pricing agreement) covering the 2000 year, ruling that the 10-50-50

method resulted in an arm’s-length royalty payment for Mexican tax purposes.

      On January 1, 2001, petitioner and the Mexico Licensee executed a supple-

mental agreement, effective that day, stipulating the payment of royalties under the

10-50-50 method.2 In December 2001 the SAT issued a second Resolution, cover-

ing the 2001-2004 tax years. The SAT again concluded that the 10-50-50 method

represented a permissible application of the “residual profit split method” for

Mexican tax purposes and resulted in an arm’s-length royalty payment under Mex-

ican law. The second Resolution expired by its terms on December 31, 2004. But

the Mexico Licensee continued to pay royalties to petitioner consistently with the

10-50-50 method for all subsequent years, including the tax years at issue.

      In continuing to calculate royalties in this manner, the Mexico Licensee and

petitioner relied on advice from Luis Ortiz Hidalgo, a Mexican tax attorney who

had helped obtain the two Resolutions described above. Mr. Ortiz had advised the

      2
       This agreement was amended again in 2005 and 2009. None of the amend-
ments altered the Mexico Licensee’s use of the 10-50-50 method to compute its
royalty payments.
                                         -9-

Mexico Licensee concerning its Mexican tax obligations since 1974. He com-

municated regularly with petitioner’s U.S. tax personnel, including Dennis A.

Carr, petitioner’s executive director for international taxes, to stay abreast of any

changes that might affect the Mexico Licensee’s royalty obligations. Mr. Ortiz

was fully apprised of the IRS’ examinations of petitioner’s 1996-2006 tax years

and the IRS’ ongoing approval of royalties calculated under the 10-50-50 method.

      After the second Resolution expired, Mr. Ortiz advised the Mexico Licensee

to continue paying royalties to petitioner under the 10-50-50 method. He based

this advice on his belief that there had been no changes in petitioner’s operations

or transactional relationship with the Mexico Licensee sufficient to justify a higher

royalty rate. And he believed that the SAT would not have permitted the Mexico

Licensee to reduce its Mexican income tax by paying higher royalties, especially

since all of petitioner’s other supply points continued to pay (with IRS approval)

royalties calculated under the 10-50-50 method.

      On the basis of Mr. Ortiz’s advice, the Mexico Licensee for 2007-2009 paid

petitioner royalties calculated under the 10-50-50 method. It deducted these pay-

ments on its Mexican tax returns and prepared appropriate transfer-pricing docu-

mentation to establish its compliance with the arm’s-length standard in Mexico. It

paid all taxes shown as due on its Mexican tax returns for these years.
                                       - 10 -

      Mr. Ortiz has averred that, for years before 2010, the SAT’s only audit ac-

tivity with respect to royalties paid by the Mexico Licensee was an examination

for its 2008 tax year. During that examination the SAT inquired whether the

Mexico licensee was still making royalty payments calculated under the 10-50-50

method. After receiving confirmation that the answer to this question was “yes,”

the SAT made no adjustments to the royalty payments.

C.    IRS Examination

      Petitioner filed timely Forms 1120, U.S. Corporation Income Tax Return,

for 2007-2009. Because the Mexico Licensee was a branch, all of its taxable in-

come was reported on these consolidated returns. Petitioner included in these re-

turns Forms 1118, Foreign Tax Credit--Corporations, on which it claimed FTCs

for the taxes the Mexico Licensee had paid to Mexico. The FTCs thus claimed

totaled $87,409,718 for 2007, $80,332,190 for 2008, and $86,812,306 for 2009.

      The IRS selected petitioner’s 2007-2009 returns for examination. On Janu-

ary 26, 2011, the IRS informed petitioner that it intended to examine petitioner’s

intercompany royalty payments. On April 12, 2011, it sent petitioner a letter stat-

ing that it was considering adjustments to the royalty payments due from the Mex-

ico Licensee for 2007-2009. Since the Mexico Licensee was a branch, such ad-
                                        - 11 -

justments would produce no net change to petitioner’s U.S. income, only a de-

crease to the claimed FTCs.

      The IRS letter explained that any adjustments to the Mexico Licensee’s roy-

alty payments might result in double taxation for which petitioner would have the

right to seek competent authority relief under the U.S.-Mexico treaty. See Con-

vention for the Avoidance of Double Taxation and the Prevention of Fiscal Eva-

sion with Respect to Taxes on Income, Mex.-U.S., Sept. 18, 1992 (treaty), Treaty

Doc. No. 103-07, reprinted in 2 Tax Treaties (CCH) at 5903. On September 26,

2013, petitioner requested that the United States initiate, pursuant to article

XXVI(2) of the treaty, a competent authority proceeding with Mexico. The Mexi-

co Licensee concurrently requested that the SAT initiate a competent authority

proceeding with the United States.

      On September 15, 2015, the IRS sent petitioner a notice of deficiency that

substantially increased, under section 482, the royalty amounts payable to petition-

er by its supply points, including the Mexico Licensee. The IRS made offsetting

income adjustments, increasing petitioner’s royalty income and decreasing the

Mexico Licensee’s income by the same amounts. Of concern here, the IRS made

“correlative adjustments” decreasing petitioner’s FTCs by $43,457,473 for 2007,

$50,453,126 for 2008, and $44,893,902 for 2009.
                                         - 12 -

      The IRS based its disallowance of the FTCs on the contention that the Mex-

ico Licensee had claimed insufficient deductions for royalty payments on its Mex-

ican corporate returns and to that extent had overpaid Mexican income tax. To the

extent of these alleged overpayments, the IRS determined that the taxes paid to the

Government of Mexico were not “compulsory” and hence were not “taxes” within

the meaning of section 901. On October 15, 2015, the IRS notified petitioner that

it would not participate in competent authority proceedings with Mexico because

it had “designated for litigation the issue pertaining to the transfer pricing adjust-

ments for tax years 2007, 2008, and 2009.” On December 14, 2015, petitioner

timely petitioned this Court to challenge (among other things) the disallowance of

the Mexico FTCs.

                                      Discussion

      Summary judgment is intended to expedite litigation and avoid unnecessary

and expensive trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73,

74 (2001). Either party may move for summary judgment upon all or any part of

the legal issues in controversy. Rule 121(a). A motion for summary judgment or

partial summary judgment will be granted only if it is shown that there is no gen-

uine dispute as to any material fact and that a decision may be rendered as a matter
                                       - 13 -

of law. See Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118 T.C. 226, 238

(2002).

      Petitioner has shown that no genuine dispute exists as to any material fact.

As we explain in greater detail below, the facts respondent alleges to be in dispute

are irrelevant for purposes of determining whether the taxes paid to the Govern-

ment of Mexico were “compulsory.” We conclude that the Mexico Foreign Tax

Issue may appropriately be adjudicated summarily.

      A.     Governing Legal Framework

      The United States taxes its citizens and domestic corporations on their

worldwide income. See, e.g., Cook v. Tait, 265 U.S. 47, 56 (1924); Huff v. Com-

missioner, 135 T.C. 222, 230 (2010). Because this policy creates the potential for

double taxation, the Code since 1918 has allowed U.S. citizens and domestic cor-

porations a credit for income taxes paid to a foreign country. Sec. 901(a); Am.

Chicle Co. v. United States, 316 U.S. 450 (1942); Vento v. Commissioner, 147

T.C. 198, 203-204 (2016). The extent to which a taxpayer is entitled to FTCs is

determined by applying domestic tax law. United States v. Goodyear Tire & Rub-

ber Co., 493 U.S. 132 (1989); Phillips Petroleum Co. v. Commissioner, 104 T.C.

256, 295 (1995).
                                        - 14 -

      Section 901(b) allows a credit for “the amount of any income * * * taxes

paid or accrued during the taxable year to any foreign country.” A foreign levy is

creditable under section 901 only if its “predominant character * * * is that of an

income tax in the U.S. sense.” Sec. 1.901-2(a)(3), Income Tax Regs. The parties

agree that the Mexican corporate income taxes paid by the Mexico Licensee dur-

ing 2007-2009 met this requirement.

      In order to be creditable, a foreign levy must also be a “compulsory payment

pursuant to the authority of a foreign country to levy taxes.” Sec. 1.901-2(a)(2)(i),

Income Tax Regs. “Whether a foreign levy requires a compulsory payment pur-

suant to a foreign country’s authority to levy taxes is determined by principles of

U.S. law and not by principles of law of the foreign country.” Ibid. A tax pay-

ment is not considered compulsory to the extent “the amount paid exceeds the

amount of liability under foreign law for tax.” Id. para. (e)(5)(i).

      Two requirements must be satisfied in order for a foreign tax payment to be

considered “compulsory.” First, the payment must be “determined by the taxpayer

in a manner that is consistent with a reasonable interpretation and application of

the * * * provisions of foreign law (including applicable tax treaties) in such a way

as to reduce, over time, the taxpayer’s reasonably expected liability under foreign

law for tax.” Ibid. Second, “the taxpayer [must] exhaust[] all effective and prac-
                                         - 15 -

tical remedies, including invocation of competent authority procedures available

under applicable tax treaties, to reduce, over time, the taxpayer’s liability for for-

eign tax.” Ibid.

      B.       Analysis

      Respondent’s disallowance of the Mexican FTCs is based on the transfer-

pricing adjustments set forth in the notice of deficiency. The IRS contends that

the effect of these adjustments, proposed in 2015, is to convert into noncompul-

sory payments more than half the taxes petitioner paid to the Government of Mexi-

co for 2007-2009. We evaluate this argument under the regulatory standards out-

lined above.

               1.   Reasonable Interpretation of Foreign Law

      In ascertaining whether the amounts of tax petitioner paid to Mexico “ex-

ceed[ ] the amount[s] of liability under foreign law for tax,” we first consider

whether petitioner calculated its Mexican tax liabilities “in a manner that is con-

sistent with a reasonable interpretation and application” of Mexican law, so as to

minimize its reasonably expected liabilities for Mexican corporate income tax. See

sec. 1.901-2(e)(5)(i), Income Tax Regs. The regulations do not specify what con-

stitutes a “reasonable interpretation and application” of foreign law. But they do

provide a safe harbor by allowing taxpayers to rely on good-faith advice from a
                                        - 16 -

competent tax professional. “In interpreting foreign tax law, a taxpayer may gen-

erally rely on advice obtained in good faith from competent foreign tax advisors to

whom the taxpayer has disclosed the relevant facts.” Ibid. However, “[a]n inter-

pretation or application of foreign law is not reasonable if there is actual notice or

constructive notice * * * to the taxpayer that the interpretation or application is

likely to be erroneous.” Ibid.

      In calculating the deductions for royalty payments that would be allowable

to the Mexico Licensee under Mexican law, petitioner relied on the advice of Mr.

Ortiz. There is no dispute that he is a competent and experienced tax lawyer who

has advised the Mexico Licensee for many years regarding its Mexican tax obliga-

tions. When Mexico adopted the arm’s-length standard in 1997, Mr. Ortiz assisted

the Mexico Licensee in securing two Resolutions from the SAT. In both instances

the SAT ruled that the 10-50-50 method resulted in arm’s-length royalty payments

for Mexican tax purposes and hence that the royalty payments were allowable

deductions under Mexican law.

      After the second Resolution expired, Mr. Ortiz advised the Mexico Licensee

to continue paying royalties to petitioner under the 10-50-50 method. He based

this advice on his belief, derived from regular communications with petitioner’s

tax personnel, that there had been no change in petitioner’s operations or transac-
                                        - 17 -

tional relationship with the Mexico Licensee sufficient to justify a higher royalty

rate. Mr. Ortiz likewise concluded that the SAT would not have permitted the

Mexico Licensee to reduce its Mexican corporate income tax by paying higher

royalties, especially since all of petitioner’s other supply points continued to pay

royalties (with evident IRS approval) calculated under the 10-50-50 method. The

SAT in fact made no adjustments to the Mexico licensee’s royalty payments for

2007-2009 after confirming that those payments continued to be made in accord-

ance with the 10-50-50 method.

      These facts show that petitioner, in interpreting Mexican tax law, “rel[ied]

on advice obtained in good faith from [a] competent foreign tax advisor[]” as to

the appropriate amounts of the royalty payments. See sec. 1.901-2(e)(5)(i), In-

come Tax Regs. At the time petitioner received this advice, moreover, it did not

have “actual notice or constructive notice” that Mr. Ortiz’s interpretation of

Mexican law was “likely to be erroneous.” Ibid. Petitioner received Mr. Ortiz’s

advice during 2007-2009; at that time, the IRS continued to approve royalty pay-

ments calculated under the 10-50-50 method, having informed petitioner that “the

continuing application of the closing agreement’s terms and conditions to post-

1995 years seems appropriate.” The earliest date on which the IRS could be
                                         - 18 -

thought to have informed petitioner that it might take a different view was January

26, 2011, well after petitioner filed its tax returns for 2007-2009.3

      These facts establish that petitioner determined its Mexican tax liability for

2007-2009 in a manner consistent with a reasonable interpretation and application

of the provisions of foreign law. Respondent’s principal argument against this

conclusion is that there exists a dispute of fact as to whether Mr. Ortiz based his

advice on facts that were fully disclosed to him. See sec. 1.901-2(e)(5)(i), Income

Tax Regs. (allowing taxpayer to rely on advice from an adviser “to whom the tax-

payer has disclosed the relevant facts”).

      Relying on one of his own declarations, respondent notes that petitioner be-

tween 2001 and 2006 shifted a significant portion of the Mexico Licensee’s manu-

facturing operation to a supply point in Ireland. Partly as a result of this shift, the

      3
        Respondent contends that the timing of his notice to petitioner is irrelevant
and that, when he provided notice of possible section 482 adjustments to petitioner
in 2011, petitioner was retroactively “on notice” as of 2007-2009. This argument
is hard to take seriously. The regulations clearly indicate that the judgment as to
whether an interpretation of foreign law “is likely to be erroneous” is to be made at
the time the foreign tax is paid. Petitioner cannot have had actual or constructive
notice of a fact during 2007-2009 when the communication that put it on notice of
that fact did not occur until 2011. See sec. 1.901-2(e)(5)(ii), Example (2), Income
Tax Regs. (concluding that taxpayers lacked notice that their interpretation of for-
eign law was likely to be erroneous until the IRS made a section 482 reallocation);
cf. Vento, 147 T.C. at 209-210 (concluding that taxpayers were notified that their
interpretation of foreign law was likely erroneous when they received an IRS com-
munication to that effect).
                                        - 19 -

Irish supply point’s sales of concentrate to the Mexican market increased from

zero in 2000 to $377.8 million in 2006, whereas the Mexico Licensee’s sales de-

creased from $889.6 million in 2002 to $395.5 million in 2004. Respondent as-

serts that there is a dispute of material fact about whether and how Mr. Ortiz took

this production shift into account when rendering his advice.

      We are not persuaded by this argument. Explicitly or implicitly, the IRS ap-

proved use of the 10-50-50 method by all of petitioner’s supply points throughout

the world from 1987 through 2006. During this 20-year period the revenues and

profits of petitioner’s supply points may have undergone significant year-to-year

changes owing (among other things) to local economic recessions, worldwide fi-

nancial crises, and variations in production and efficiency. There is nothing in the

original closing agreement or in subsequent IRS audit activity to suggest that the

10-50-50 formula was supposed to change depending on such variables.

      To the contrary, given how the 10-50-50 formula worked, the production

shifts cited by respondent are wholly irrelevant. The formula operated the same

way regardless of a particular supply point’s economic results: The supply point

kept 10% of gross sales (whatever they were) and split with petitioner the residual

operating profit (whatever it was). As a result of the production shifts cited by re-

spondent, the royalties payable by the Mexico Licensee went down, and the royal-
                                        - 20 -

ties payable by the Irish supply point presumably went up. If a particular supply

point departed from the 10-50-50 method without other supply points’ making ad-

justments in the opposite direction, the whole system would quickly go entropic.

It seems obvious that the 10-50-50 method that the IRS embraced before 2011 did

not countenance such ad hoc adjustments.

      Mr. Ortiz was required to provide petitioner with a “reasonable interpreta-

tion and application” of Mexican law. See sec. 1.901-2(e)(5)(i), Income Tax Regs.

Mexican law required royalty payments to be made at arm’s length, and Mr. Ortiz

advised petitioner that royalties calculated using the 10-50-50 method would meet

Mexico’s arm’s-length standard. Annual variations in a supply point’s revenues or

profits were irrelevant under the 10-50-50 method. Whether Mr. Ortiz was in-

formed of, or evaluated the effect of, the production shift to Ireland is thus not a

material fact.

      Respondent also contends that the descriptions of the Mexico Licensee’s

functions, assets, and risks that petitioner supplied to the SAT when obtaining the

two Resolutions may differ from the facts ultimately found at trial. This dispute

conceivably may affect the merits of the section 482 adjustments that the IRS has

proposed. But we fail to see the relevance of this dispute in ascertaining whether
                                        - 21 -

petitioner “disclosed the relevant facts” to Mr. Ortiz about the ongoing appropri-

ateness of the 10-50-50 method. See ibid.

      Mr. Ortiz advised petitioner on several occasions that the SAT would not

have permitted the Mexico Licensee to pay royalties higher than those computed

under the 10-50-50 method. Especially was that so when all of petitioner’s other

supply points were paying (with evident IRS approval) royalties computed under

the 10-50-50 method. This advice was sufficient for petitioner to conclude that an

attempt by the Mexico Licensee to pay higher royalties would not enable it “to

reduce, over time, * * * [its] reasonably expected liability under foreign law for

tax.” Ibid.

      The gist of respondent’s submission concerns a possible dispute at trial as to

whether the Mexico Licensee held more valuable assets (or retained more signifi-

cant risks) than the SAT understood in 2000. It is hard to see how this factual un-

certainty, if known to the SAT back then, would have supported the payment of

higher royalties to petitioner. In any event, the determination of whether Mr. Or-

tiz’s interpretation of Mexican law was reasonable must be made on a prospective
                                         - 22 -

basis. He obviously could not have known during 2007-2009 what facts would be

established at trial in 2018.4

      In sum, we find that petitioner relied in good faith on advice that it obtained

from Mr. Ortiz in determining the royalties properly payable under Mexican law

for 2007-2009. At the time petitioner received this advice, it did not have “actual

notice or constructive notice” that the interpretation of Mexican law adopted by

Mr. Ortiz was “likely to be erroneous.” See sec. 1.901-2(e)(5)(i), Income Tax

Regs. And we find, contrary to respondent’s submission, that petitioner disclosed

to Mr. Ortiz all facts relevant to his assessment of the appropriateness under Mexi-

can law of royalties calculated under the 10-50-50 method. We thus conclude that

petitioner has satisfied the first half of the regulatory test by showing that it deter-

mined its Mexican tax liability “in a manner that is consistent with a reasonable

interpretation and application” of Mexican law. See ibid.




      4
       Respondent also contends that the penalty protection provision of the clos-
ing agreement “is irrelevant as a matter of law.” In considering whether the Mexi-
can taxes were “compulsory” we do not rely on the penalty protection provision.
Rather, we rely on the fact (upon which Mr. Ortiz also relied) that the IRS for a
20-year period had explicitly or implicitly approved calculation of royalties using
the 10-50-50 method. To the extent respondent contends that the closing agree-
ment as a whole is irrelevant, we rejected that argument in our September 7, 2017,
order denying respondent’s motion for partial summary judgment.
                                         - 23 -

             2.     Exhaustion of Remedies

      The second half of the regulatory test for a “compulsory” tax requires that

the taxpayer must “exhaust[] all effective and practical remedies, including invo-

cation of competent authority procedures available under applicable tax treaties, to

reduce, over time, the taxpayer’s liability for foreign tax.” Sec. 1.901-2(e)(5)(i),

Income Tax Regs.; see Rev. Rul. 76-508, 1976-2 C.B. 225, 226. A remedy is con-

sidered effective and practical “only if the cost thereof * * * is reasonable in light

of the amount at issue and the likelihood of success.” Sec. 1.901-2(e)(5)(i), In-

come Tax Regs.

      Petitioner contends that respondent’s reliance on section 482 adjustments

that have not yet been adjudicated, combined with his refusal to participate in

competent authority proceedings, means that petitioner has exhausted its available

remedies for FTC purposes. We agree with petitioner. Respondent cannot point

to any effective and practical remedy that petitioner could now pursue to reduce its

liability for Mexican tax. If the Mexico Licensee were to file a refund claim in

Mexico, that claim would be premature because respondent’s proposed section

482 adjustments have not yet been adjudicated. Cf. Rev. Rul. 92-75, 1992-2 C.B.

197; Rev. Rul. 80-231, 1980-2 C.B. 219 (holding that a taxpayer generally must

file a foreign refund claim in order to exhaust administrative remedies).
                                       - 24 -

      Even if a refund claim were not premature, there is no reason to believe that

the Mexican Government would agree with the IRS’ reallocation of income. In-

deed, the SAT has issued two Resolutions ruling that the 10-50-50 method yielded

royalty payments that were consistent with the arm’s-length requirement of Mexi-

can tax law. Mr. Ortiz opined that Mexico would not have allowed the Mexico

Licensee to pay higher royalties under these circumstances.

      A taxpayer “is not required to take futile additional administrative steps” in

order to satisfy the exhaustion-of-remedies requirement. Schering Corp. v. Com-

missioner, 69 T.C. 579, 602 (1978) (holding Swiss income tax creditable notwith-

standing disagreement between Switzerland and the United States concerning the

underlying tax issue). Whether a remedy is “effective and practical” must be

judged considering “the likelihood of success.” Sec. 1.901-2(e)(5)(i), Income Tax

Regs.; see id. subdiv. (ii), Example (3) (finding foreign tax payment compulsory

where pursuing a judicial refund remedy in foreign country “would be unreason-

able in light of the amount at issue and the likelihood of * * * success”). We con-

clude that petitioner’s pursuit of a refund claim in Mexico before respondent’s

section 482 claims have been adjudicated would be futile.

      Since petitioner has no effective and practical remedies in Mexico, its only

possible remedy would be a competent authority proceeding. Depending on the
                                        - 25 -

facts and circumstances, a taxpayer may be required to invoke available competent

authority relief to demonstrate exhaustion of remedies for purposes of section

901.5 But petitioner did invoke competent authority procedures. It and the Mexi-

can Licensee both requested that the IRS initiate or participate in such a proceed-

ing, but the IRS refused to do so. Respondent is in a poor position to contend that

petitioner has failed to exhaust its remedies when respondent, by his unilateral ac-

tion, has made it impossible for petitioner to pursue the only remedy that exists.6




      5
        See, e.g., Proctor & Gamble Co. v. United States, 2010 WL 2925099, at
*10 (S.D. Ohio July 6, 2010) (disallowing certain FTCs for failure to seek relief
from the Japanese tax authority and to invoke competent authority proceeding in
Japan); Rev. Rul. 92-75, 1992-2 C.B. 197 (ruling foreign tax noncompulsory
where taxpayer was aware of, but failed to invoke, competent authority proceed-
ing); Rev. Proc. 2015-40, secs. 1.04, 2.03, 6.04(3)(a), 2015-35 I.R.B. 236, 237,
241, 249. But see Schering Corp., 69 T.C. at 602-603 (holding that taxpayer’s
failure to seek competent authority relief was not fatal where arguably “there was
no double taxation from which it might have sought relief”).
      6
         Respondent errs in relying on Rev. Proc. 2006-54, 2006-2 C.B. 1035,
superseded by Rev. Proc. 2015-40, 2015-35 I.R.B. 236, for the proposition that
invocation of competent authority procedures, by itself, is insufficient to demon-
strate exhaustion of remedies. The regulations explicitly list “invocation of com-
petent authority procedures” as an example of exhaustion of remedies. Sec. 1.901-
2(e)(5)(i), Income Tax Regs. Under the facts hypothesized in Rev. Proc. 2006-54,
sec. 11, “the taxpayer ha[d] sought competent authority assistance but obtained no
relief, either because the competent authorities failed to reach an agreement or
because the taxpayer rejected an agreement reached by the competent authorities.”
2006-2 C.B. at 1046. Here, the reason petitioner could obtain no relief is that the
IRS unilaterally refused to participate.
                                         - 26 -

      Lacking any plausible argument that petitioner has effective remedies avail-

able to it now, respondent contends that the Mexican taxes were not “compulsory”

because petitioner may have remedies available to it years from now. In respond-

ent’s view, petitioner must first litigate this case to conclusion. If this Court sus-

tains the proposed transfer-pricing adjustments in whole or in part, with corres-

ponding downward adjustments to the Mexican FTCs, petitioner must then seek

relief through a competent authority proceeding. If, as a result of that proceeding,

petitioner’s Mexican tax bill for 2007-2009 ends up being higher than the liability

presupposed by this Court’s Opinion, petitioner would be allowed a credit for the

incremental Mexican tax at that time.

      This is not the procedure that Congress envisioned when it enacted the

Code. Congress anticipated the difficulty of ascertaining, at the time a taxpayer

files its U.S. return, the exact amount of foreign tax that will ultimately be allow-

able as a credit. It accordingly provided, in section 905(c), a special procedure for

adjusting the credit when the taxpayer’s ultimate foreign tax liability varies from

the amount claimed. Section 905(c)(1) specifies three situations, sometimes re-

ferred to as “foreign tax redeterminations,” in which a U.S. taxpayer’s foreign tax

credit must be adjusted. One of these situations is where “any tax paid is refunded

in whole or in part.” Sec. 905(c)(1)(C).
                                           - 27 -

       If any foreign tax paid is refunded in whole or in part, the U.S. taxpayer

generally must file an amended return. See sec. 1.905-4T(b)(1), Temporary In-

come Tax Regs., 72 Fed. Reg. 62784 (Nov. 7, 2007).7 The taxpayer must include

with this amended return a revised Form 1118 and information sufficient to enable

the IRS to redetermine the taxpayer’s U.S. tax liability. Id. paras. (b)(1), (3), (c).

Any U.S. tax due as a result of the Secretary’s redetermination is not subject to de-

ficiency procedures but “shall be paid by the taxpayer on notice and demand by

the Secretary.” Secs. 905(c)(3), 6213(h)(2)(A); see Sotiropoulos v. Commission-

er, 142 T.C. 269 (2014); Sotiropoulos v. Commissioner, T.C. Memo. 2017-75, 113

T.C.M. (CCH) 1370, 1373-1374.

       The Court of Federal Claims recognized the availability of this procedure in

IBM Corp. v. United States, 38 Fed. Cl. 661 (1997). Resolution of the question

there, whether an Italian corporate tax was a “compulsory” levy, depended in part

on whether the taxpayer had “exhaust[ed] all effective and practical remedies” to

reduce its Italian tax. Sec. 1.901-2(e)(5)(i), Income Tax Regs. The taxpayer had

initiated litigation in the Italian courts to determine its liability, but that litigation

was still ongoing. See IBM Corp., 38 Fed. Cl. at 664.

       7
        Because this temporary regulation was issued before November 20, 1988, it
is not subject to section 7805(e)(2), which prescribes that temporary regulations
issued after that date expire within three years from the date of issuance.
                                        - 28 -

      The Government contended that the taxpayer should be deemed not to have

exhausted its available remedies until the Italian courts had conclusively deter-

mined its Italian tax liability. The Court of Federal Claims rejected that argument:

      [A] taxpayer may claim a foreign tax credit for the year in which it
      pays the foreign tax, notwithstanding that the taxpayer continues to
      contest its liability in the foreign country. Should the taxpayer
      ultimately receive a refund from the foreign government, the taxpayer
      must reimburse the Secretary for the amount originally credited
      pursuant to I.R.C. § 905(c). [Id. at 674.]

Although the taxpayer’s ultimate Italian tax liability remained uncertain, the court

held that the taxpayer had satisfied the “exhaustion of remedies” requirement and

was entitled to FTCs for the Italian taxes paid.

      The Secretary himself took the same position in an earlier revenue ruling.

See Rev. Rul. 70-290, 1970-1 C.B. 160. The taxpayer there had been assessed for-

eign income tax but had filed claims for overassessment with the foreign govern-

ment. Those claims were still pending. In stark contrast to respondent’s current

position, which asserts that “effective and practical remedies must be pursued to a

final conclusion,” the IRS ruled that the taxpayer was entitled to an FTC even

though its ultimate foreign tax liability remained uncertain:

      It is not the intention of the law to deprive the taxpayer of the right to
      obtain credit for foreign taxes because of the fact that the taxpayer
      * * * protests the assessment and has made application for a refund.
      The tax assessed constitutes a liability against the taxpayer. In the
                                         - 29 -

      instant case such liability was met by actual cash disbursements. If
      the protest by the taxpayers against the original assessment prevails,
      any difference can readily be adjusted pursuant to the provisions of
      section 905(c) of the Code. [1970-1 C.B. at 161.]

      Respondent replies that petitioner “would have no incentive * * * to seek

correlative relief from Mexico” regardless of how the transfer-pricing adjustments

are ultimately resolved. If petitioner were to get a refund of Mexican tax, that re-

fund would likely be offset dollar-for-dollar by a reduction in its FTCs pursuant to

section 905(c). Since petitioner might find nothing to be gained by seeking com-

petent authority relief, respondent urges that petitioner’s position “would force the

United States to cede taxing rights to Mexico even if the Court were to uphold re-

spondent’s adjustments in full.”

      We find this argument unpersuasive for at least two reasons. First, respond-

ent need not rely on petitioner or its Mexican branch to seek competent authority

relief. The IRS is perfectly capable of initiating competent authority proceedings

with the SAT directly if it believes that such proceedings are necessary to correct a

fiscal imbalance under the treaty. See treaty art. XVI(3) (“The competent auth-

orities of the Contracting States shall endeavor to resolve by mutual agreement

any difficulties or doubts arising as to the interpretation or application” of the

treaty); Rev. Proc. 2015-40, sec. 2.01(2), 2015-35 I.R.B. 236 (stating that U.S.
                                         - 30 -

competent authority may “consult generally with foreign competent authorities to

resolve difficulties or doubts regarding treaty interpretation or application, irre-

spective of whether the consultation relates to a current matter involving a specific

taxpayer”).

      Second, the argument respondent is advancing is a policy argument that de-

rives no support from the text of section 901, the governing regulations, or prior

IRS rulings. The Mexican corporate income taxes petitioner paid for 2007-2009

were “compulsory” because petitioner determined its liability “in a manner that is

consistent with a reasonable interpretation and application” of Mexican law and

has “exhaust[ed] all effective and practical remedies * * * to reduce” its Mexican

tax liability. Sec. 1.901-2(e)(5)(i), Income Tax Regs. Nothing in the regulatory

framework requires petitioner to wait until the instant litigation and its aftermath

have finally concluded in order to claim FTCs for foreign taxes it has paid. “If the

IRS considers that protection of the public fisc requires prohibiting foreign tax

credits until the taxpayer exhausts its litigation remedies, the IRS should seek an

amendment to the final regulations. That is a task for the Secretary of the Treasu-

ry, not this court.” IBM Corp., 38 Fed. Cl. at 675.

      This case presents a scenario that Congress anticipated when it enacted sec-

tion 905(c). Petitioner’s ultimate liability for Mexican tax cannot now be deter-
                                        - 31 -

mined because: (1) respondent’s section 482 adjustments have not yet been ad-

judicated and (2) if those adjustments are sustained in whole or in part, petitioner

may or may not receive a refund of Mexican tax. The U.S. competent authority

may seek correlative relief from a treaty partner after “a U.S. federal court’s final

determination” of the taxpayer’s tax liability. Rev. Proc. 2015-40, sec. 6.05(2).

The Secretary would be free to initiate a competent authority proceeding with

Mexico after the transfer-pricing adjustments at issue in this case have become

final. See sec. 7481(a).

      If, as the result of a future competent authority proceeding, the Mexican tax

petitioner paid for 2007-2009 is ultimately “refunded in whole or in part,” sec.

905(c)(1)(C), the IRS will redetermine petitioner’s U.S. tax liability for those

years. The additional tax due will then be paid by petitioner “on notice and de-

mand by the Secretary.” See sec. 905(c)(3); Sotiropoulos, 113 T.C.M. (CCH) at

1373-1374. Congress did not intend that FTCs would be denied up front because

of the possibility that foreign taxes might in the future be refunded. Rather, Con-

gress envisioned that the accounts would be squared if and when foreign taxes are

in fact refunded.

      In sum, we conclude that petitioner has exhausted all “effective and prac-

tical remedies” to reduce its liability for Mexican tax. See sec. 1.901-2(e)(5)(i),
                                      - 32 -

Income Tax Regs. Because respondent’s section 482 adjustments have not yet

been adjudicated, petitioner currently has no remedy before the Mexican tax

authorities. The only remedy that would be “effective and practical” at the moment

would be a competent authority proceeding, in which the IRS has refused to

participate. We accordingly hold that the Mexican taxes paid by the Mexico

Licensee for 2007-2009 were “compulsory” levies for which petitioner is entitled

to FTCs under section 901(a).

      To reflect the foregoing,


                                               An order will be issued granting

                                     petitioner’s motion for partial summary

                                     judgment.
