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The Eighth Circuit’s decision in Medtronic v. Commissioner, nos. 23-3281 and 23-3063 (2025) (Medtronic II), doesn’t end the long-running dispute over the best method to price an intercompany license. But it narrows the range of possibilities in a way that strongly favors the government.
The decision, which vacates the Tax Court’s ruling in Medtronic v. Commissioner, T.C. Memo. 2022-84, and remands the case for further proceedings, definitively rejected Medtronic’s attempt to defend the comparable uncontrolled transaction method set out in reg. section 1.482-4(c). Medtronic’s argument was that the CUT method, applied using a settlement agreement with Siemens Pacesetter Inc., provided the most reliable means to price the company’s license of patents, manufacturing know-how, and other intangibles to Medtronic Puerto Rico Operations Co. (MPROC). The Tax Court accepted the CUT method in Medtronic v. Commissioner, T.C. Memo. 2016-112 (Medtronic I), but its decision was vacated by Medtronic v. Commissioner, 900 F.3d 610 (8th Cir. 2018).
The case raises far-reaching questions regarding the comparability standards and reliability conditions associated with the competing methods, including the role of comparability adjustments and the interaction between specified and unspecified methods. The company has insisted throughout the Medtronic I and Medtronic II litigation that the CUT method is the preferred method, both in its case and in general. But if the CUT method isn’t the best method, Medtronic argued, then the best method is the CUT-like unspecified method endorsed by the Tax Court’s 2022 Medtronic II decision. The Tax Court’s method, like the CUT method, used the royalty stipulated in the Pacesetter agreement as its starting point and made a series of upward adjustments.
In no case is the IRS’s favored method, the comparable profits method described in reg. section 1.482-5, the best method, according to Medtronic. As the company said in its June 2024 reply brief, “The Tax Court correctly found the CPM cannot be the best method — and it is not an overstatement to call it the worst one.”
Medtronic’s arguments fared poorly on appeal. The Eighth Circuit’s Medtronic II decision rules out the CUT method and the CUT-like unspecified method, and it directs the Tax Court to reconsider its rejection of the CPM on remand. By doing so, the court rejected every one of the company’s key legal arguments. The Eighth Circuit endorsed the government’s interpretation of the CUT method’s comparability standards, and it ruled out the use of an unspecified method that flouted those standards. It also brushed aside Medtronic’s strenuous objection to the CPM.
The Eighth Circuit’s decision may not have handed the IRS a win in the case, but it dealt a major loss to Medtronic and other taxpayers that favor the CUT method and oppose the CPM. The result and the underlying reasoning will have major repercussions in transfer pricing disputes that concern the choice between the CPM and the CUT method, and in best method cases in general.
Off the Table
The Eighth Circuit’s opinion explicitly eliminated Medtronic’s two favored methods from contention. To the extent that they rely on the Pacesetter agreement as a reference point, the CUT method and the Tax Court’s CUT-like unspecified methods are off the table on remand. By concluding that the CUT method is “not the best method to determine an arm’s length royalty rate,” the Eighth Circuit also made clear that the CUT method’s comparability and reliability standards are as they appear in reg. section 1.482-4(c)(2). And by rejecting the Tax Court’s “use of the Pacesetter Agreement under an unspecified method,” the Eighth Circuit held that these standards cannot be circumvented by invoking reg. section 1.482-4(d).
The Eighth Circuit’s Medtronic II decision confirmed that the comparability standards established by reg. section 1.482-4(c)(2)(iii) for the CUT method cannot be set aside in favor of generalities drawn from reg. section 1.482-1. In particular, the opinion emphasizes that comparability for purposes of the CUT method requires similarity in profit potential under reg. section 1.482-4(c)(2)(iii)(B)(1)(ii). This is a threshold requirement, the opinion explains, and it cannot be satisfied by comparability adjustments:
“Medtronic also asserts that differences in the profit potential between property involved in uncontrolled and controlled transactions does not preclude comparability ‘if the difference can (as here) be accounted for’ by making certain adjustments. Medtronic cites the general comparability standard described in section 1.482-1(d). . . . The regulations specific to transfers of intangible property, however, permit adjustments to account for differences in circumstances of controlled and uncontrolled transactions, not for differences in the intangible property transferred, which ‘must. . . have similar profit potential.’ Id. section 1.482-4(c)(2)(iii)(A), (B)(1)(ii). [Emphasis in original.]”
The Eighth Circuit also rejected the attempt to circumvent this requirement using reg. section 1.482-4(d). Like the CUT method accepted in Medtronic I, the unspecified method applied in Medtronic II began with the Pacesetter royalty rate. Both methods then tried to account for the differences between the Pacesetter agreement and the MPROC license by making a series of royalty rate adjustments. In the case of the unspecified method, these adjustments more than quadrupled the 7 percent royalty stipulated in the Pacesetter agreement.
The principal substantive distinction between the Tax Court’s unspecified method and the CUT method was that the unspecified method included a more exotic and complex series of adjustments, including for profit potential. But the regulations provide multiple ways to extend the CUT method’s comparability and reliability standards to CUT-like unspecified methods. The link that persuaded the Eighth Circuit was reg. section 1.482-4(d)’s framing of the CUT method, arm’s length with all other specified methods, as an application of the realistic alternatives principle. As provided in reg. section 1.482-4(d)(1):
“Consistent with the specified methods, an unspecified method should take into account the general principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction, and only enter into a particular transaction if none of the alternatives is preferable to it. For example, the comparable uncontrolled transaction method compares a controlled transaction to similar uncontrolled transactions to provide a direct estimate of the price the parties would have agreed to had they resorted directly to a market alternative to the controlled transaction. [Emphasis added.]”
In other words, entering a comparable arm’s-length transaction represents the taxpayer’s realistic alternative to the controlled transaction. Whether an uncontrolled transaction reliably reflects the taxpayer’s realistic alternative turns on comparability. The CUT regulations’ definition of comparable intangible property, the Eighth Circuit held, is the regulatory standard that dictates when an uncontrolled intangible transfer reliably reflects the taxpayer’s realistic alternative.
Recognizing that every valid method, specified or unspecified, is an application of the same concept means that the regulatory standard established by reg. section 1.482-4(c)(2) applies equally to reg. section 1.482-4(d). As the Eighth Circuit explained:
“Section 1.482-4(c)(2)(iii)(B)(1)(ii) specifies that an uncontrolled transaction constitutes reliable data with which to evaluate a controlled transaction — i.e., it is a realistic alternative to which the controlled taxpayer could have resorted directly in the free market — only if the property involved in the uncontrolled transaction has ‘similar profit potential’ to the property involved in the controlled transaction.”
Although the opinion doesn’t expressly reject other applications of the CUT method, it’s hard to imagine that Medtronic would have a better comparable on hand without mentioning it over the last 15 years. On remand, the CUT method and CUT-like variants are effectively off the table.
Back in the Running
The other method identified by the Eighth Circuit as relevant to the case is the CPM. The Eighth Circuit didn’t compel the Tax Court to accept the CPM, but it devoted much of its opinion to correcting the Tax Court’s legally erroneous and inappropriately strict comparability standards:
“The tax court should reconsider its conclusion that the Commissioner’s allocation of 12-14 percent of the profit from the devices and leads to Medtronic Puerto Rico was ‘unreasonable.’ The tax court reached that conclusion ‘for the same reasons’ given in its 2017 opinion after observing that ‘the five comparables are not identified as solely class III products.’ The court should reassess its conclusion after reevaluating the comparable companies under the comparable profits method as discussed above. [Emphasis added.]”
The Tax Court’s Medtronic II opinion relied heavily on the testimony of economist Glenn Hubbard, who claimed at trial that the CPM is generally inferior to the CUT method on theoretical grounds. (Prior analysis: Tax Notes Int’l, Jan. 1, 2024, p. 51.) Hubbard’s case against the CPM in Medtronic II largely rested on the Food and Drug Administration’s medical device classifications and their purported consequences for MPROC’s asset mix and risks.
Hubbard emphasized that Class III medical devices generally carry the greatest risk to patients, and MPROC exclusively manufactured finished Class III medical devices. The comparables used by the IRS to apply the CPM, in contrast, produced a range of implantable Class I, Class II, and Class III medical devices. The level of manufacturing and quality control expertise necessary to produce Class III medical devices, and the risk associated with any product failures, allegedly distinguished MPROC from any of the comparables.
Hubbard also criticized the CPM for blending the returns attributable to different functions. MPROC manufactured finished devices without performing any distribution, marketing, research and development, or components manufacturing functions. The CPM comparables, on the other hand, performed multiple functions other than finished device manufacturing. The return-blending effect made it impossible to reliably isolate the returns associated strictly with MPROC’s functions, according to Hubbard.
According to the Tax Court’s summary of his testimony, Hubbard essentially rejected the CPM because none of the comparables was a “pure-play manufacturer of [finished] class III medical devices.” By accepting Hubbard’s testimony, the Tax Court had in effect demanded almost complete product and functional alignment. This, according to the Eighth Circuit, applied the wrong legal standard. Regarding product characteristics, the Eighth Circuit explained:
“In rejecting the Commissioner’s proposed comparable companies because they ‘did not make solely class III medical devices,’ the tax court overemphasized the importance of product similarity under the comparable profits method. On remand, the tax court should apply the correct legal standard, and consider whether the proposed comparable companies were ‘sufficiently similar’ to Medtronic Puerto Rico and, if not, whether adjustments can be made to account reliably for any material differences.”
The Eighth Circuit also held that the functional differences highlighted by Hubbard’s return-blending critique were legally insufficient to justify rejection of the CPM. Citing reg. sections 1.482-5(c)(2)(ii) and 1.482-8, Example 6, the Eighth Circuit’s opinion observes that the CPM can account for “significant functional differences.” The court thus held that using comparables with “functions other than finished-product manufacturing does not render the comparable profits method inapplicable.”
The appeals court rejected the seemingly unsubstantiated premise that a Class III medical device designation necessarily translates into a significantly different asset mix. MPROC’s manufacturing and quality control expertise may have been significant, but the Tax Court never corroborated its assumption that the comparables lacked similar know-how. As the Eighth Circuit’s opinion explained:
“Medtronic also contends that the tax court found that Medtronic Puerto Rico ‘had specialized, valuable intangible assets related to its expertise in manufacturing class III medical devices, while the proposed comparables did not.’ That assertion is not supported by the record. Although the tax court found that Medtronic Puerto Rico had a ‘highly skilled workforce,’ the court made no finding that the Commissioner’s five proposed comparable companies did not.”
The opinion further criticizes the Tax Court for failing to consider whether the differences in asset mix, if material, could be resolved by adjustments in accordance with reg. section 1.482-5(c)(2)(iv).
The Eighth Circuit reached a similar conclusion regarding risk profile, faulting the Tax Court for failing to “make sufficient findings to support its implicit conclusion that any difference in risks borne by the proposed comparable companies and those borne by Medtronic Puerto Rico was material.” In essence, the Tax Court assumed that finished Class III medical device manufacturing must translate into a material difference in risk profile. It also failed to quantify the effect of any such difference or attempt to adjust for it.
The Tax Court thus gave undue weight to product and functional differences and failed to confirm or adjust for any material difference between MPROC and the comparables in asset mix or risk profile.
Medtronic III
The Eighth Circuit’s instructions to the Tax Court on remand are to “apply the correct legal standard” when considering product differences, which requires only sufficient similarity, and to “apply the approach to functional differences envisioned by the regulations.” For assets and risks, the Tax Court must confirm that the purported asset and risk differences between MPROC and the comparables exist, quantify their effects, and attempt to adjust for them. The implication is that only confirmed, material, adjustment-resistant differences that distort the CPM’s return-on-asset comparison justify the method’s rejection.
Affirmatively establishing that MPROC’s manufacturing know-how sets it apart from all other manufacturers of implantable medical devices, and demonstrating that the difference has a material effect that cannot be adjusted for, will be challenging. Self-developed intangibles are generally not reflected on the comparables’ balance sheets, and it’s unlikely that the Tax Court will have the information necessary to reliably determine their value.
Perhaps the composition of the comparables’ asset bases could be determined by dissecting their balance sheets and SEC filings, or by comparing their market capitalization with the value of their tangible assets. Regardless, proving that MPROC materially surpasses all the implantable device comparables in manufacturing know-how will be an uphill battle. And if this can be proven, then there’s a good chance that its effect is sufficiently quantifiable to be reliably accounted for with an adjustment.
Establishing that adjustments can’t account for any material differences in risk will likely be difficult as well. Differences in risk profile, including in product liability risk, may be easier to confirm and reliably estimate based on historical product recall and financial data. But if they are, then they’ll probably be easier to adjust for as well.
Another possibility on remand could be for Medtronic to prepare a CPM analysis of its own that would justify higher returns for MPROC, in which case the dispute would be about the relative reliability of competing applications of the CPM. It’s unclear what alternative comparables Medtronic, which has insisted that no valid comparables exist, could identify as more appropriate for a CPM analysis. But it’s one of the few possible options available to Medtronic on remand.
If the Tax Court can confirm that there are material, adjustment-resistant differences in assets or risks, the solution might be to apply some kind of residual profit split. The Eighth Circuit’s opinion doesn’t expressly recognize the profit-split method as relevant, and it doesn’t direct the Tax Court to consider its reliability. But the opinion doesn’t rule out a residual profit split if it’s possible to justify rejection of the comparables after a reassessment of the CPM using the correct comparability standards.
The Eighth Circuit also left open the possibility of an unspecified method compliant with reg. section 1.482-4(d). However, as the opinion explains, that method would have to be supported by specific findings regarding Medtronic’s realistic alternatives:
“The tax court, however, made no findings about how much time and cost Medtronic would have to incur to replicate Medtronic Puerto Rico’s role in the conglomerate’s structure. On remand, the tax court should make those findings and determine whether manufacturing the devices and leads in a different Medtronic facility or building a new manufacturing facility was a realistic alternative to the Technology Licenses.”
Limiting the CUT Method, Legitimizing the CPM
Medtronic II will also have major consequences for other best method disputes under section 482. The decision clearly contradicts the contention that the CUT method enjoys a categorical preference other than in the circumstances identified in the regulations. As provided by reg. section 1.482-4(c)(2)(ii):
“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 from applying the comparable uncontrolled transaction method will generally be the most direct and reliable measure of the arm’s length result. [Emphasis added.]”
However, Medtronic has consistently claimed throughout the litigation that the CUT method’s preferred status extends beyond the rare scenario described in reg. section 1.482-4(c)(2)(ii). By rejecting the CUT method and directing the Tax Court to reconsider the CPM’s reliability, the Eighth Circuit’s decision tacitly contradicts this interpretation. It also largely moots the issue by applying the CUT method’s reliability conditions. A method’s generally preferred status doesn’t mean much if the regulations devoted to that method expressly disqualify it.
The Eighth Circuit’s decision also sets an important precedent regarding the interaction of the regulations’ method-specific rules and the general provisions of reg. section 1.482-1. Medtronic has largely built its case on the general standards for comparability and adjustments in reg. section 1.482-1(d), which are less prescriptive and exacting than the CUT-specific standards established in reg. section 1.482-4(c)(2). But the opinion makes a point of distinguishing “the regulations specific to transfers of intangible property,” which govern in the case, from the general provisions of reg. section 1.482-1.
It’s clear enough from reg. section 1.482-4(c)(2)(iii)’s precise definition of comparability that, for the CUT method, any more flexible standards applicable to other methods do not apply. Judicial confirmation of this interpretation knocks out a linchpin of Medtronic’s argument, and it will likely undermine the arguments of other taxpayers that favor the CUT method as well.
Specifically confirming that reg. section 1.482-4(c)(2)(iii)(B) has binding effect, and thus that the CUT method requires intrinsic profit-potential similarity, brings clarity to another hotly disputed issue. The government pressed the argument that profit-potential adjustments, which relate to the transferred intangible’s defining characteristics, cannot be reliably adjusted for under reg. section 1.482-4(c)(2)(iii). This argument prompted Medtronic to object in its June 2024 reply brief that:
“The Commissioner identifies no authority categorically prohibiting adjustments that account for differences in property or profit potential, and nothing in the regulations or any court decision limits adjustments to particular aspects of comparability. [Emphasis added.]”
At the time, the authority identified by the commissioner was the text of reg. section 1.482-4(c)(2)(iii). But with the Eighth Circuit’s decision, the judicial precedent Medtronic demanded is now in place. As the opinion explains, the regulations “permit adjustments to account for differences in circumstances . . . not for differences in the intangible property transferred.” Excluding the possibility of profit-potential comparability adjustments in this way further narrows the scope of the CUT method.
The Eighth Circuit’s decision also rejects the use of unspecified methods as a means of circumventing the rules associated with specified methods. In Medtronic II, the unspecified method’s failure to satisfy the CUT method’s comparability and reliability standards was what made it an unspecified method. Interpreting reg. section 1.482-4(d) to accommodate a method that differs from a specified method only by violating one of its reliability conditions would introduce a massive loophole into the regulations. Taxpayers, the IRS, and judges could simply ignore the regulatory requirements associated with each specified method by relabeling it an “unspecified method.”
Medtronic vigorously defended this destructive interpretation, which the regulations do not expressly contradict, in its reply brief:
“The Commissioner’s primary contention is that incorporating the Pacesetter Agreement violates the regulations applicable to CUTs and, assertedly, the regulations on unspecified methods forbid that. That is plainly wrong . . . the Commissioner identifies no court that has ever adopted his illogical reading of the regulations, nor anything in the regulatory text supporting such a view. [Emphasis added.]”
That this reading of the regulations was ever illogical is, at the very least, debatable. But with the Eighth Circuit’s Medtronic II decision, a court has unambiguously adopted it. Directly referring to the government’s argument on this point, the Eighth Circuit opinion states that “We find merit in the commissioner’s position.” The decision also confirms that unspecified methods are subject to the standards set out in reg. section 1.482-4(d) and not licensed to cobble together methods with no economic or legal basis.
Another important implication of Medtronic II is that the CPM’s comparability factors require actual comparisons. In other words, it’s not enough to prove that the tested party has valuable assets, performs complex functions, or bears significant risks. The tested party’s assets, functions, or risks must set it apart from the comparables in a material and adjustment-resistant way. Any failure to corroborate such differences is, in the Eighth Circuit’s view, grounds for vacating a Tax Court decision and remanding the case.
More generally, the Eighth Circuit’s Medtronic II decision is a major setback to participants in the newly reenergized campaign by taxpayers against the CPM. Coca-Cola, for example, has also made an all-out attack on the CPM’s legitimacy central to its appeal of Coca-Cola Co. v. Commissioner, 155 T.C. 145 (2020). It and similarly situated taxpayers will now have to portray the CPM as an economic absurdity against the backdrop of both Coca-Cola and a unanimous Eighth Circuit decision, both of which confirm the CPM’s general legitimacy as a method.
Medtronic II also confirms that interpreting the section 482 regulations’ comparability and reliability standards involves questions of law. The facts of the case often determine whether a transaction or enterprise is comparable and whether a method is reliable, but they do not dictate the meaning of comparability and reliability under the regulations. The Eighth Circuit confirmed this by repeatedly referring to the “legal standard” applied by the Tax Court and reviewing its conclusions de novo.
The most direct consequence of this principle concerns the standard of review in an appeal, but it should also affect the general approach taken by Tax Court judges. The Eighth Circuit’s Medtronic II decision makes clear that judges may not decide for themselves which factors determine comparability and reliability. When they do, it is reversible legal error. This has important implications for all best method disputes, not just those involving the CUT method and the CPM.