In a recent Tax Court Memorandum decision, Medtronic, Inc. et al v. Commissioner, T.C. Memo 2016-112, Judge Kathleen Kerrigan, in a long and detailed opinion, rejected the IRS’ method invoked Section 482, for reallocating over well in excess of one billion dollars in income over a two year period between a U.S. parent corporation, Medtronic U.S., and its wholly owned subsidiary, Medtronic Puerto Rico Operations Co. (MPROC) with respect to revenues from several licenses for intellectual property necessary to manufacture high-risk, heavily regulated implantable medical devices. In particular, there were four intercompany agreements in issue: (i) a components supply agreement; (ii) a distribution agreement; (iii) a trademark license agreement; and (iv) a devices and leads licenses agreement.
The parent corporation filed a petition with the Tax Court in challenging the Service’s notices of deficiencies in the approximate amounts of $548M for 2005 and $810M for 2006. That’s right, the case involved more than $1 billion in proposed deficiencies in tax. The Tax Court held, inter alia, that the IRS’s transfer pricing methodology did not give “appropriate weight” to the many functions that the parent corporation’s Puerto Rico affiliate performed as part of its manufacturing process and that Medtronic had met its burden of showing that the IRS’s allocations were flawed, i.e., unreasonable and arbitrary. For reasons stated in Judge Kerrigan’s analysis, she wasn’t persuaded that Petitioner’s allocations were reasonable either. Therefore the Court determined the arms length pricing amounts.
Summary of Issues
A summary of the issues before the Tax Court were: (i) whether income related to intercompany licenses for the use of intangibles necessary to manufacture medical device pulse generators (devices) and physical therapy delivery devices (leads) should be reallocated to Medtronic US from its Puerto Rican subsidiary, Medtronic Puerto Rico Operations Co. (MPROC) for 2005 and 2006 to clearly reflect income under Section 482; (ii) whether Medtronic Europe, S.a.r.L. (Medtronic Europe) made arm's-length payments to Medtronic US or accrued royalties in excess of arm's length to manufacture devices sold to Medtronic USA, Inc. (Med USA), pursuant to a supply agreement effective as of May 1, 2002, among Medtronic US, MPROC, and Medtronic Europe (Swiss supply agreement issue); and (iii) as an alternative theory, in the event the Court did not rule in favor of the Service for its proposed Section 482 adjustments for 2005 and 2006, whether Medtronic US, Med Rel, Inc., or Medtronic Puerto Rico, Inc., transferred intangible property which would generate the “super-royalty” tax provision contained in Section 367(d) to MPROC when Medtronic US restructured its Puerto Rican operations in 2002.
Medtronic’s position was that the royalty rates on intercompany sales of devices and leads from MRPOC to Medtronic US were greater than the required arm’s length rate. In 2005 the royalty rate was 37.6% for devices and 25.5% for leads in accordance with its profit split computation. In 2006, the royalty rate was 44% for devices and 26% for leads after the profit split calculation. Under the comparable uncontrolled transaction (“CUT”) method, the taxpayer argued, based on its experts’ testimony, that the proper arm’s length royalty rate was 29% for devices and 15% for leads. Since royalties paid were greater than the required arms length amounts, Medtronic argued it is entitled to overpayments in tax under Section 6512(b) of approximately $185M for 2005 and $400M for 2006. It further contended that the Service’s use of the comparable price method (“CPM”) in its notice of deficiency for each year was unreasonable since it yielded outcomes that were much greater than arm’s length pricing outcomes. The CPM method, the taxpayer argued, failed to take into account the separate intercompany transactions between MPROC, Medtronic U.S., and Med U.S.A.
The Service asserted at trial that the CPM method is the best method for determining the royalty rates on the intercompany sales of devices and leads. It argued that Medtronic U.S. and Med U.S.A. performed all but one of the economically significant functions in the entire chain of manufacture. It contended that the only economically significant function that MPROC performed was assembling finished products with the assistance and oversight of Medtronic U.S. The government argued that the Petitioner’s reliance on the CUT method was in error and did not meet the arms length pricing standard in Section 482. It further rejected the taxpayer’s argument that quality is the most important determinant of success in the medical device industry. It also argued that the Petitioner’s experts’ selection of several uncontrolled license arrangements are not comparable to the royalty agreement involving Medtronic U.S. and MPROC.
The Petitioner argued that each of the four intercompany agreements must be valued separately under Section 482. The government disagreed, and applied a functional analysis that looked at all four covered agreements in issue on a combined basis. 
Applicable Statutes and Regulations
Section 482. Under Section 482 Congress granted the Commissioner broad authority to allocate gross income, deductions, credits or allowances between two (or more) related companies or corporations where the allocations are necessary to either prevent the evasion of tax or to clearly reflect the income of the corporations. Seagate Tech., Inc. & Consol. Subs. v. Comm’r, 102 T.C. 149, 163 (1994). The applicable standard is that of arm’s length dealing with an uncontrolled or unaffiliated taxpayer. Treas. Reg. §1.482-1(b)(1). The arm’s-length price is determined under one of the various available methods, which method, under the facts and circumstances involves, provides the most reliable measure of an arms-length result. Treas. Reg. §1.482-1(c).
There are, in general, four methods to determine the arm’s length amount with respect to a controlled transfer of intangible property, i.e., licenses for the devices and leads. Such four methods are: (i) the controlled transfer of intangible property or CUT method; (ii) the comparable price method or CPM method; (iii) the profits split method; and (iv) other methods contained in Treas. Reg. §1.482-4(d). In deciding which method is the most reliable, the two primary factors are the degree of comparability between the controlled transaction and any uncontrolled comparables, and the quality of data and assumptions used in the analysis. Treas. Reg. §1.482-1(c)(2).
The CPM method evaluates whether the amount charged in a controlled transaction is arm's length according to objective measures of profitability (profit level indicators) derived from transactions of uncontrolled taxpayers that engage in similar business activities under similar circumstances. Treas. Reg. §1.482-5(a). The mechanics of applying the CPM involve: (i) determining which controlled party should be the “tested party;” (ii) identifying the comparable uncontrolled parties; (iii) selecting a “profit level indicator;” (iv) adjusting comparable party results to take into account material differences between the comparables and the tested party; and (v) converting the adjusted profit level indicator of the comparables into “comparable operating profits” of the tested party.  Profit level indicators are ratios that measure the relationships between costs incurred or resources employed and profits. All facts and circumstances are to be taken into account in arriving at the appropriate profit level indicator. Treas. Regs. §§1.481-1(e), -1(f).
The CUT method considers whether the amount charged for a controlled transfer of intangible property was arm's length by looking at the amount charged in a comparable uncontrolled transaction. Treas. Reg. §1.482-4(c). If an uncontrolled transaction involves the transfer of the same intangible under the same or substantially the same circumstances as the controlled transaction, the results derived generally will be the most direct and reliable measure of the arm's-length result for the controlled transfer of an intangible. For intangibles to be treated as comparable both must be used in connection with similar products or processes in the same market or industry and have similar profit potential. Profit potential of an intangible is measured by directly calculating the NPV of the benefits to be realized through the use of subsequent transfers of the intangible, taking into account the capital investment, capital costs, start-up costs, risks to assume and other relevant considerations.
The “profit-split method” determines whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm’s length by reference to the relative value of each controlled taxpayer’s contribution to that combined operating profit or loss. Treas. Reg. §1.482-6(a). There are two ways to determine this. First is the “comparable profit split method” and the other is the “residual profit split” method. 
The residual profit split method, as set forth in Treas. Reg. §1.482-6(c)(3), was the method applied by the Tax Court and approved on appeal in the Eli Lilly case. Eli Lilly & Co. v. Commissioner, 84 T.C. 996 (1985), aff’d in part and rev’d in part, 856 F.2d 855 (7th Cir. 1988). The residual profit split method allocates the combined operating profit or loss from the relevant business activity between the controlled taxpayers via a two-step process: (1) allocate income to routine contributions, and (2) allocate residual profit. Routine contributions ordinarily include contributions of tangible property, services, and intangible property that are generally owned by uncontrolled taxpayers engaged in similar activities. A functional analysis is required to identify these contributions according to the functions performed, risks assumed, and resources employed by each of the controlled taxpayers. Where intangible property is involved, there will generally be an unallocated residual profit after the allocation of income, and this residual profit is generally divided among the controlled taxpayers according to the relative value of their contributions of intangible property to the relevant business activity.
Commensurate With Income Standard
In 1986, Congress, having recognized the exodus of U.S. developed intangibles of high exploitative value being transferred overseas, amended Section 482 by adding: “In the case of any transfer (or license) of intangible property (within the meaning of Section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible”. 
The target of this amendment to Section 482 was the transfer of intangibles for a relatively low value to a foreign or possessions corporation at the early stage of the intangibles development. In addition, even where the intangibles being licensed had matured in value, taxpayers were using industry norms as guides for much less profitable items. Instead, Congress was of the view that profitable intangibles had had licensing fees and revenues in excess of the industry norm. Therefore, Congress felt it needed to amend Section 482 to require that the payment made on a transfer of intangibles to a related foreign corporation or possessions corporation be commensurate with the income attributable to the intangible. Corporations resident in Puerto Rico are subject to local tax and do not pay the 35% corporate income tax rate until profits are repatriated.
Medtronic USA’s Burden of Proof
In challenging the government in a Section 482 case, the taxpayer has the burden of proving that the allocations suggested by the government are flawed, i.e., arbitrary, capricious or unreasonable. Bausch & Lomb, Inc. v. Comm’r, 92 T.C. 525 (1989), aff’d 933 F.2d 1084 (2d Cir. 1991). See Sundstrand Corp. & Subs. v. Comm’r, 9 T.C. 226 (1991); Eli Lilly & Co. v. Comm’r, 84 T.C. 996, aff’d on this issue, rev’d in part and remanded, 856 F.2d 855 (7th Cir. 1988). Therefore, the notice of deficiency which contains Section 482 determinations is ‘presumptively correct’.  Where the taxpayer can show the allocation in issue is flawed, it must next show that the allocations it proposes meet the arm’s length standard. Where the evidence shows that neither side is correct, then the Court must determine the proper allocation. Veritas Software Corp. & Subsidiaries v. Comm’r, supra 133 T.C. @318. It was this last scenario that the Court found was to be applied in this case, i.e., where the Court is required to determine the proper arms-length pricing amounts.
Tax Court Finds Government’s Allocation Methodology and Adjustments Under Section 482 Flawed and Unreasonable
After reviewing the factual record and expert testimony proffered during the trial, the Court first found that Petitioner had met its burden of proving that the government’s allocations were arbitrary, capricious or unreasonable.
Taxpayer first alleged that the government effectively abandoned its Section 482 position set forth in its notice of deficiency at trial. Indeed, the Court noted that in prior transfer pricing cases, the Service is treated as having acted capriciously wherein abandoned its prior transfer pricing position at trial. Compaq Computer Corp. v. Comm’r, T.C. Memo. 1999-220; National Semiconductor Corp. v. Comm’r, T.C. Memo. 1994-195. The Court was not persuaded that the government abandoned its Section 482 position at trial.
The government presented expert testimony (which expert’s report was used in making the adjustments reflected in the governments notices of deficiency) that the CPM method is the best method for use in this case and further used a “value chain analysis” which segregates a company’s operations into functional activities in an effort to measure each (related party) participant’s economic contributions to the profits of the consolidated enterprise. The government viewed only Medtronic US and Med USA as having performed most of the functions in the medical device manufacturing process and also bore the related risks. To the government (through its expert’s testimony) MPROC performed only the final manufacturing steps which were completed according to processes approved by Medtronic US. Therefore the government and its expert contended that MPROC’s profits were grossly overstated. The government case was to determine the arms-length returns on operations for MPROC as compared to those of Medtronic U.S. and Med U.S.A. taking into account each party's functions, assets, and risks that were related to the CRDM and Neuro businesses for the U.S. market. In contrast to the four separate arm’s length price analysis used by the taxpayer, the government contended that Section 482 must be applied on the overall U.S. value chain because the transactions are far too fundamentally interrelated to price independently.
Judge Kerrigan reduced the government’s analytical approach as follows:
“For example, if petitioner earned $100 of profit in the CRDM or Neuro value chain, Heimert evaluated how much of the $100 MPROC should have earned versus Medtronic U.S. and Med U.S.A. Heimert testified at trial and submitted an expert report which was generally consistent with the economic analysis in his original report.”
The government’s expert, Heimert, used four steps to determine the arms’-length allocations for the covered transactions.
- Determine the “value chain operating profit”.
- Determine the profits Medtronic U.S. would earn for its contributions as a manufacturer of device and lead components, using the CPM method and Medtronic U.S. as the “tested party” for Section 482 purposes.
- Apply the CPM to MPROC’s sale of finished devices and leads to Med U.S.A. in the U.S.
- Apply the CPM to the devices and leads licenses to the trademark license to obtain the technology royalty rate.
The quantitative analysis was obviously detailed and beyond the scope of this post. But Heimert concluded that MPROC incurred only 8.7% and 11.7% of the value-added costs in the U.S. for 2005 and 2006 but earned 60.7% and 64.7% of the operating profits in those years. Such was 4 to 5 times greater profits returns then Medtronic US and its competitors over the past 10 years. The government attempted to persuade the Court, by invoking its authority under Section 482, to increase the tax liability of Medtronics U.S. (consolidated group) by over $1 billion for the two years in issue.
The Petitioner countered that the Respondent and its expert grossly underestimated the quality control procedures that MPROC performed inasmuch as it assembled the final product. In other words, MPROC took all of the components and supplies received from its affiliates and third party suppliers and incorporated them into finished medical devices for the purpose of saving or at least improving lives. MRPOC had the responsibility of making sure every component was combined to provide repeated and reliable patient therapy each time. In addition to assembly it also used its systems engineering expertise to make manufacturing design improvements.
The Court disagreed with the use of the residual profit method as the best method. It further criticized the government’s expert’s use of the proper return on asset calculations and ignored the value of licensed intangibles. Judge Kerrigan further disagreed that the covered transactions in issue should be aggregated in accordance with Treas. Reg. §1.482-1(f)(2)(i)(A), (iv) and accompanying examples, particularly Example 4 (foreign subsidiary provides affiliates unique and invaluable intangibles and the products are manufactured in its foreign subsidiary). See Guidant LLC v. Comm’r, 146 T.C. No. 5 (2/29/2016). The Court found that aggregating the transactions was unreasonable under the facts of the case. The government allocated an unreasonably small percentage of the profits to MPROC. Therefore aggregation was not the most reliable means of determining arms-length consideration for the controlled transactions.
The Court further found that the government did not give appropriate weight to the role of MPROC in the manufacturing of devices and leads as well as the adjusted royalty rate used by the Service. Therefore the Petitioner met its burden of proving that the government’s allocations were arbitrary, capricious or unreasonable. The Court further discounted application of the commensurate with income standard as the best method in this case. Indeed, the commensurate with income standard does not replace the arm’s length standard which the Tax Court recently reiterated in Altera Corp. v. Comm’r, 145 T.C. No. 3 (2015). See also Xilinx Inc. v. Comm’r, 125 T.C. 37 (2005), aff’d 598 F.3d 1191 (9th Cir. 2010).
Tax Court Next Assesses The Petitioners Allocations Under the Four Covered Agreements
After having climbed over the large “first wall” of proving that the government’s allocations are flawed, Medtronics U..S had to prove next that its allocations met the arm's-length standard, Were the taxpayer to not meet its burden under this “second wall”, then the Court must determine the proper allocations. Medtronics U.S. made two primary allocations: (1) for the devices and leads licenses royalties of 29% and 15%, respectively, and (2) for the trademark license royalties of 8%.
The taxpayer argued that MPROC paid Medtronic U.S. arm’s-length royalties for the intangible property licensed to MPROC under the devices and leads licenses. It assumed that MPROC was acting as a “full-fledged entrepreneurial licensee responsible for its own success”. Using the CUT method, petitioner contends that royalties of 29% of net device intercompany sales and 15% of net leads intercompany sales under the devices and leads licenses are arm's length. It used as the best comparable transaction its agreement with Pacesetter.  The taxpayer’s expert, Berneman testified that the arm’s length royalty rate for the devices and leads licenses in his view is between .5% and 20%.
After going through the various points made by Berneman, the Court criticized Berneman’s analysis as “unacceptably lacks an examination of the profit potential of his comparable transactions, including the Pacesetter agreement”. Judge Kerrimen founds Berneman's broad range of 0.5%-20% as “unconvincing and vague.” She took issue with the taxpayer’s expert’s comparables. It found Berneman’s direct testimony, i.e., his report as well as his in court testimony, however, failed to state what an appropriate range would be for the each of the devices and leads licenses. Only adjustments were made to the Pacesetter agreement, and Berneman made those adjustments during his testimony. His report and his testimony failed to explain how his conclusions specifically apply to the devices and leads licenses.
The devices and leads licenses define know-how as all technical information presently available that relates to the product or improvements and information useful for the development, manufacture, or effectiveness of the product. Pacesetter, which later became St. Jude, made and sold products covered by the Pacesetter agreement. The evidence in the case at bar does not support an ongoing relationship between petitioner and Pacesetter whereas the evidence supports an ongoing relationship between Medtronic U.S. and MPROC. Berneman failed to make a sufficient adjustment for know-how.
Under Treas. Reg. §1.482-4(c)(2)(ii), if an uncontrolled transaction involves the same transfer of the same intangible under the same, or substantially the same, circumstances as the controlled transaction, the result derived under the CUT method will generally be the most direct and reliable measure of arm's length. The Pacesetter agreement included some of the same intangibles, but the devices and leads licenses included additional intangibles. The Berneman report did not show which intangibles from the Pacesetter agreement were included in the devices and leads licenses.
Where If an uncontrolled transaction of the same intangibles cannot be found, the Court stated that a comparable intangible can be used. The CUT method requires that in order for the intangible property involved in an uncontrolled transaction to be considered comparable to the property involved in the controlled transaction, certain factors must be considered, including profit potential. Id. Profit potential is most reliably measured by a net present value calculation of the benefits to be realized (based on prospective profits to be realized or costs to be saved) through the use or transfer of the intangible. Berneman's analysis did not include this analysis and merely that market and product are proxies for profit potential. He did not explain how these proxies work or provide detail of which markets and products were considered in his comparables.
The Court found that the royalty rates petitioner proposed are not arm's length because, along with all of the concerns addressed above, appropriate adjustments were not made to the CUT method to account for variations in profit potential. Therefore, petitioner has not met its burden.
As to the trademark license allocations, which used 5.3% royalty rate, the Court ruled that this agreement met the requirements under Section 482.
Tax Court’s Selection of Proper Method for Finding the Arms Length Pricing Amount
The Tax Court rejected the residual profit split method used by the Service based on the CPM method and using the value chain method and by refusing to suggest adjustments to the taxpayer’s CUT method for devices and leads licenses. The Court similarly rejected the Petitioner’s evidence and expert testimony. Thus, the Court had to determine the proper transfer pricing method.  In doing so, it felt the proper methodology was closer to the Petitioner’s use of the CUT method.
The taxpayer, as mentioned, looked to the Pacesetter agreement as an appropriate CUT. It includes some of the same patents that which Medtronic U.S. licensed to MPROC. The taxpayer’s expert report stated that he thought the requirements set forth under Treas. Reg. §1.482-4 were consistent with his screening criteria or do not materially affect his determination. The Court agreed that the Pacesetter agreement is an appropriate CUT because it involved some of the same intangibles and had comparable circumstances. If the same intangibles are involved, it is usually the most direct and reliable measure of an arm's-length transfer of an intangible. But in this case, the devices and leads licenses include more intangibles than the Pacesetter agreement. Therefore, the Tax Court concluded that transactions not identical to controlled transactions may be sufficiently similar to provide a reliable measure of an arm's-length result.
As to the royalty rate, and factoring in a “know-how” increase, the Court felt that the starting royalty rate should be 17%. Then, due to MRPOC’s extremely close relationship with Medtronic and its access to the know-how of Medtronic, which the Court found to be equivalent to an exclusivity in the devices and leads licenses, it increased the Pacesetter royalty comparable rate by 7%.
As for profit potential, it was not taken into account by the taxpayer. Profit potential looks at the benefits to be realized on the basis prospective profits. The Court made an upward adjustment of 3.5% for this factor noting however that exclusivity and know-how have a greater impact on the value of the licenses. Without exclusivity, the licenses would have significantly less value. MPROC was able to make a product of superior quality because of know-how received from Medtronic U.S. For this reason, we halve the amount of the adjustment for exclusivity and know-how to adjust for profit potential.
Another 2.5 upward adjustment was made for additional products included in the devices licenses. We have .-third of the Pacesetter royalty rate, is a proper adjustment.
Therefore the Court concluded that the revised royalty rate was 30% on retail converted to reflect wholesale sales at 44%. Therefore, an appropriate arm's-length rate for devices would be 44% for the devises. The Court further concluded that a reasonable royalty rate for the leads licenses would be 22%, half of the 44% that we determined for the devices licenses. The same rate for royalty payments was set for the Swiss Supply Agreement.
Alternative Theory of Government Under Section 367(d)
The notice of deficiency issued by the Service make an alternative (allocation) argument under Section 367(d) were the Court to not sustain the Service’s Section 482 allocation in their entirety. Thus, were the transfer price less than the total amount that the government felt should have been reflected in the payments back to Medtronic U.S., then there was in fact value transferred for the use of the intangibles to MPROC which is taxable under Section 367(d). The notice of deficiency further states that "Medtronic must include in taxable income amounts not to exceed $496,529,306 for the taxable year ended April 29, 2005, and $750,741,381 for the taxable years ended April 28, 2006.” Intangible property for purposes of Section 367(d) includes patents, inventions, formulas, know-how, copyrights, trademarks, trade names, etc. See §936(h)(3)(B).
Section 367(a) provides general rules for the taxation of outbound transfers of property by U.S. persons to foreign corporation transferees in transactions that would otherwise qualify as nonrecognition transfers, such as section 351 transfers. There are exceptions to this rule, and section 367(d) provides special rules for the taxation of outbound transfers of intangible property.
The government’s argument in this area was somewhat simple. Let’s see. “If the Court finds that our allocations under Section 482 are too high, then the Court must find, that intangible property subject to Section 367(d) must have been transferred to MPROC in 2002 when it was formed”. Yet, the Court noted that the government had not identified or alleged that any specific intangibles were transferred to MPROC by the Section 936 possession corporations. What the Court found as present on the record was that as part of the 2002 business restructuring, the Section 936 possession corporations contributed their operational assets to MPROC in exchange for MPROC stock in a Section 351 transaction. Therefore, the argument failed as the Court found that no intangibles were transferred that should be the subject of Section 367(d).
Let’s start off by stating that Medtronic is a big Section 482 case. The government wanted taxes and interest in excess of $1 billion for just two years. That’s a lot of tax owed to the fisc. But the government thought it could win by using the residual profit split method which in many cases will prove to show that the related parties underpriced the cost of using or licensing intangibles. That clearly happened in Medtronics.
Two, it is interesting that the Court carefully went through the business model of the taxpayer and the actual functions of the possessions corporation. While the taxpayer’s expert had pointed this out to the Court, it is obvious in reading the Court’s lengthy opinion, that it clearly wanted to “get it right” itself and not simply rely on the parties’ experts.
And that leads to the third point about the case. Both parties failed to meet their required burden of proof in establishing that its allocations were proper. While the taxpayer “won” in proving the government’s allocations were arbitrary, it could not “win” on its own allocations reflected on its tax returns.
Finally, the meticulous and well-reasoned opinion by Judge Kerrigan drives home the point that the Court will carefully review the taxpayer and the Service’s positions, the testimony of its experts and the evidence submitted on the record.
 Medtronic US is a Minnesota corporation with its principal place of business in Minneapolis, Minnesota. During 2005 and 2006 Medtronic US was the parent corporation of a group of consolidated corporations and multinational affiliated subsidiaries (collectively, petitioner).
 The years involved predated Medtronic’s merger with Covidien PLC and change of legal address to Ireland as part of a inversion transaction.
 Generally, transactions will be aggregated only when they involve related products or services as defined in Treas. Reg. §§ 1.6038A-3(c)(7)(vii), 1.482-1(f)(2)(i)(A). Related products or services are defined as groupings of products and types of services that reflect reasonable accounting, marketing, or other business practices within the industries in which the related party group operates. Treas. Reg. § 1.6038A-3(c)(7)(vii).
 The CPM is applied to the financial data of the tested party which is not necessarily the taxpayer whose income is subject to adjustment under §482. The selection of the tested party is based on looking at which party to the transaction can yield the best set of comparables. This requires a balance of pragmatic considerations, including the reliability of internal data, the number and reliability of adjustments required of potential comparables, and the availability of reliable data for potential comparables. In general, the tested party is usually the controlled party that has the least complex structure and functions and does not own valuable intangible property or “unique assets” not characteristic of potential comparable parties. Treas. Reg. §1.482-6(b).
 Transactions will be aggregated only when they pertain to related products or services. See Treas. Regs. §§1.6038A-3(c)(7)(vii), 1.482-1(f)(2)(i)(A).
 In Eli Lilly, supra, the U.S. developer of pharmaceutical patents and secret formulas and processes transferred all of its substantial interests in such intangibles, i.e., “manufacturing intangibles”, to possessions affiliates carrying on manufacturing in Puerto Rico in nontaxable §351 exchanges. The affiliates sold the products back to the U.S. parent corporation, which distributed and marketed them under its well-known trade name (i.e., the U.S. parent company owned and utilized the marketing intangibles). For two of the years involved in Lilly, one of the issues raised was whether the manufacturing affiliates charged the taxpayer an arm's-length price for the products. Neither the taxpayer nor the IRS produced any useful comparable uncontrolled sales. The Tax Court therefore applied a fourth method. The court arrived at its result by first deducting from the combined net profit reasonable returns attributable solely to the manufacturing and distribution functions (allowing the possessions affiliate “location savings” because the cost of operating in the possession were lower than in the U.S.). The court viewed the remaining profit as attributable to the intangibles. This was then split between Lilly (45%) and the possessions manufacturer (55%) based on the court's conclusion that the manufacturing intangibles contributed more to the net income than did the marketing intangibles. This fourth method was upheld on appeal. The Tax Court rejected the taxpayer’s argument that the resale price method could be used based on the petitioner’s sales of other products.
 Tax Reform Act of 1986, P.L. No. 99-514, §1231(e)(1).
 The Court noted that prior to trial, the Service amended its answer to exclude royalty payments paid by MPROC for non-U.S. sales, that meant the adjustments in its notice of deficiency were understated by $51.6M for 2005 and $59.6M for 2006.
 Petitioners-U.S. corporations filed consolidated Federal income tax returns for the subject years. During those years Petitioners, primarily through the group's U.S. subsidiaries, consummated transactions with their foreign affiliates including the licensing of intangibles, the purchase and sale of manufactured property, and services. The government, invoked §482 to adjust the reported prices at which items were transferred between Petitioners and their foreign affiliates. The government then determined the group's true consolidated taxable income (CTI) by posting all of the adjustments to the separate taxable income of the group's parent (which increased pro tanto the group's CTI) and without making any specific adjustment to any subsidiary's separate taxable income. The government also did not determine any portion of the adjustments that related solely to tangibles, to intangibles, or to services. The taxpayer contended that the Service’s adjustments are arbitrary, capricious, and unreasonable as a matter of law because it did not determine the “true separate taxable income” of each controlled taxpayer within the meaning of Treas. Reg. §. 1.482-1(f)(1)(iv), and did not make specific adjustments with respect to each transaction involving an intangible, a purchase and sale of property, or a provision of services. The Tax Court held that neither §482 nor the regulations thereunder required the government to always determine the true taxable income of each controlled taxpayer in a consolidated group concurrently with the making of the resulting adjustments under §482. Further, §482 and the regulations thereunder do allow the government in exercising its authority under §482, to aggregate one or more related transactions instead of making specific adjustments with respect to each type of transaction.
 Pacesetter agreed to pay Medtronic US $50M up front and $25M in royalty prepayments upon execution of the agreement. Pacesetter agreed to pay Medtronic a 7% royalty on the retail sale in the United States of all cardiac stimulation devices or components. The initial term of the agreement was for 10 years, but it was extended through petitioner's 2005 fiscal year.
 Perkin-Elmer Corp. & Subs. v. Comm’r, T.C. Memo. 1993-414; Sundstrand Corp. & Subs. v. Comm’r, 96 T.C. @393; Veritas Software Corp. & Subs. v. Comm’r, 133 T.C. @335. Treas. Reg. §1.481-1(e)(2)(ii)).
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