Medtronic Transfer Pricing Dispute: Eighth Circuit Remands Again with Critical Guidance for Puerto Rico Operations

US Court of Appeals for the Eighth Circuit has vacated and remanded the Medtronic v. Commissioner transfer pricing controversy for the second time, delivering crucial guidance for multinational corporations with Puerto Rico manufacturing subsidiaries. This September 3, 2025 decision addresses how to properly value intercompany licenses when a Puerto Rico affiliate manufactures high-value medical devices using a comprehensive bundle of intellectual property.

The Core Controversy

Medtronic Puerto Rico Operations Co. manufactures Class III medical devices and cardiac leads under Technology Licenses that grant exclusive rights to patents, know-how, regulatory approvals, trade secrets, and other intangible property from its U.S. parent. The IRS challenged the royalty rates for tax years 2005 and 2006, proposing under its comparable profits method (CPM) that the Puerto Rico subsidiary retain only 12 to 14 percent of the profits from devices and leads, versus the significantly higher allocation Medtronic claimed.

After fifteen years of litigation, the fundamental question persists: what constitutes an arm's length price under Section 482 when the tested transaction involves a complex bundle of intangibles with no perfect market comparable?

The Pacesetter Agreement Fails as a Comparable

The court definitively rejected Medtronic's reliance on its Siemens Pacesetter agreement as a comparable uncontrolled transaction (CUT). The critical distinction lies in profit potential. While Pacesetter licensed only patents with 29 percent profit margins, the Puerto Rico Technology Licenses encompassed the full suite of intangibles necessary for manufacturing and averaged a 54% product profit margin in 2005–2006. The court emphasized that regulatory approvals and manufacturing know-how added substantial value beyond bare patent rights.

Significantly, the Eighth Circuit extended this rejection to any unspecified method attempting to use the Pacesetter data. Under 26 C.F.R. § 1.482-4(d)(1), unspecified methods must rely on realistic market alternatives supported by reliable data. Since the Pacesetter agreement lacks similar profit potential, it cannot serve as a foundation for any transfer pricing methodology.

Correcting the Comparable Profits Method Analysis

The court faulted the Tax Court for applying an overly restrictive standard when evaluating the Commissioner's comparable profits method. The Tax Court had rejected proposed comparables because they manufactured different medical device classes and performed additional functions beyond finished-product manufacturing.

The Eighth Circuit clarified that CPM does not require product identity or functional sameness. Operating profit is less sensitive to product differences than gross profit, making CPM particularly suitable when comparables are "sufficiently similar" and material differences can be reliably adjusted. The court specifically noted that companies performing different functions often have varying gross margins but similar operating profit levels due to differences reflected in operating expenses.

Critical Factual Findings Required on Remand

The appellate court identified several factual gaps requiring resolution:

Asset Base Differences: The Tax Court must specify what constitutes "fundamentally different asset bases" between Medtronic Puerto Rico and proposed comparables, quantify the profit impact, and determine whether reliable adjustments are possible.
Product Liability Risk: Despite evidence suggesting Medtronic Puerto Rico bore between $25 million and $235 million in annual product liability risk, the Tax Court made no specific findings. This quantification is essential for evaluating whether Class III device manufacturers necessarily bear materially different risk levels than mixed-class manufacturers.
Realistic Alternatives: The court must determine whether Medtronic could have realistically replaced its Puerto Rico manufacturing through another facility or new construction, including specific time and cost estimates.

The Vacated Tax Court Decision

The Tax Court's now-vacated decision had applied a three-step unspecified method that resulted in a wholesale royalty rate of 48.8 percent for both devices and leads, producing an overall profit split of 68.7 percent to Medtronic US/Med USA and 31.3 percent to Medtronic Puerto Rico. This allocation, which created tax deficiencies for both 2005 and 2006, no longer stands following the Eighth Circuit's remand.

Practical Takeaways for Puerto Rico Tax Planning

Patent-only agreements are poor comparables when the tested license bundles know-how and regulatory approvals with higher profit potential. If you apply CPM, document functions and assets, quantify product liability risk, and analyze realistic alternatives, since those findings drive both method selection and profit allocation. Courts will favor economic substance over formal similarity and expect granular, data-backed analysis in disputes involving Puerto Rico manufacturing operations.

Editorial notice

This article is for informational purposes and does not constitute legal advice. For specific cases, consult your legal counsel.

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Medtronic Transfer Pricing Dispute: Eighth Circuit Remands Again with Critical Guidance for Puerto Rico Operations