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Coca-Cola Co. KO, -1.11% stock was downgraded to neutral from overweight at JPMorgan based on the risk posed by a multibillion-dollar tax court challenge the beverage giant faces.
JPMorgan maintained its $55 price target.
In November 2020, the U.S. Tax Court found in favor of the Internal Revenue Service, and determined that the company owes about $3.4 billion in taxes from the years 2007 to 2009.
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“On top of that, there is a risk that this amount could more than triple should the IRS apply the same tax treatment to Coca-Cola for the tax years after 2009 (about $1 billion a year for about seven years but lower post tax reform),” JPMorgan JPM, +3.28% said.
Two partners at the law firm Taft summed up the issue in a December blog post.
“In its simplest form, the case involved the appropriate split of profits between Coca-Cola’s U.S. group and various foreign affiliates in connection with the manufacture and sale of products outside the U.S.,” partners Todd Lady and Jonathan Polak wrote.
“[I]t serves as a reminder to all companies conducting international business that the IRS has the tools and the will to enforce the ‘arm’s length’ standard with respect to intercompany commercial activities, even where prior understandings with the IRS led to a different result.”
Coca-Cola announced Wednesday that it has named a counselor to the company and its board to advise on tax matters. J. Michael Luttig, a former U.S. federal judge and general counsel to Boeing Co. BA, +0.80%, will focus on the ongoing litigation.
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“American companies cannot run their businesses with the uncertainty of the retroactive application of newly minted IRS tax policies to prior tax years that are contrary to the IRS’ own previously approved policies and then be required to pay billions of dollars in unanticipated increased taxes that result from the retroactive application of these new tax policies,” Luttig said in a statement.
“In an abrupt departure from its established position long after the tax years in question, the IRS reversed its position, disapproved that approved methodology, required a new tax calculation methodology, and now seeks to impose a retroactive tax increase on the company for past tax years. ”
JPMorgan calls a retroactive tax charge “highly debatable,” but says that Luttig’s appointment is cause for concern.
“We believe this tax overhang may linger into a good part of 2021, and the company may be forced to place ~$3.3bn in escrow, which would be a cash outflow, besides a potential accounting provision,” the note said.
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“While we think Coca-Cola has strong defense arguments, we believe risks are rising.”
Still, analysts say Coca-Cola will come out of the coronavirus pandemic in an even stronger position, thanks to measures including the elimination of “zombie brands.”
Coca-Cola stock has tumbled 7.9% over the past year while the Dow Jones Industrial Average DJIA, +0.69% has gained 8.6% for the period.
