The recent ruling by the Eighth Circuit Court of Appeals in Medtronic, Inc. & Subsidiaries against Commissioner of Internal Revenue (September 2025) marks a new chapter in a dispute that has lasted for over fifteen years. The litigation centers on determining the value of royalties that Medtronic Puerto Rico, a subsidiary, paid to its parent company in the United States for using intangibles related to the production of highly complex medical devices.
Specifically, the case concerns which Transfer Pricing method best reflects an Arm’s Length result for intra-group transactions involving highly valuable intangibles, such as patents, know-how, regulatory approvals, and industrial secrets.
Background
Medtronic employed the Comparable Uncontrolled Transactions (CUT) method, using a licensing agreement with Siemens Pacesetter as a reference. The IRS rejected this approach, claiming that the conditions and scope of the intangibles were different, and instead proposed the Comparable Profits Method (CPM), based on profitability indicators from comparable companies.
The litigation intensified following the disagreement over the 2005 and 2006 fiscal years, with significant adjustments proposed by the tax administration and countered by Medtronic before the U.S. Tax Court.
The Court of Appeals first intervened in 2018, instructing the Tax Court to provide further factual and technical argumentation. Conversely, after the new ruling in 2022, the controversy returned to the Eighth Circuit, which in September 2025 again reversed and remitted the case for further analysis.
Detailed Analysis of the Case
The Central Issue: Choosing the Best Method
Section 482 of the Internal Revenue Code requires the application of the most tailored method for the situation, a principle known as the best method rule in international practice. This principle requires selecting, from among all recognized Transfer Pricing methods, the one that provides the most reliable estimate similar to that agreed by independent parties under Arm’s Length conditions.
- Medtronic supported the CUT method, relying on the contract with Pacesetter. According to the company, this agreement reflected the nature of the intangibl e licenses in question.
- The IRS argued that the differences were substantial: The Pacesetter contract only covered patents, while the licenses to Medtronic Puerto Rico included a much profitable broader range of intangible assets.
The Court agreed with the IRS regarding insufficient comparability in terms of profit potential, which disqualified the CUT in this context.
Rejection of Alternative Methods
Given the lack of comparability of the CUT, the Tax Court had adopted an unspecified method, a hybrid of CUT, CPM, and a residual Profit Split. Conversely, the Court of Appeals concluded that this approach was also inadmissible, relying on data previously deemed inadequate under the comparability analysis (the Pacesetter contract).
On the other hand, the Court did not accept the Tax Court’s rejection of the CPM proposed by the IRS. According to the Eighth Circuit, a too stringent criterion of product and function similarity was applied, when in fact the CPM is more flexible, as it focuses on profitability indicators rather than the identity of the product.
Key Technical Aspects of the Ruling
The ruling addresses several points of technical relevance for Transfer Pricing practices:
1. Comparability of Intangibles
Profit potential is a determining factor. The Court stated that general adjustments are insufficient if the nature of the intangibles differs considerably.
2. Non-specified Methods
Although permitted, they cannot be based on transactions that have been rejected due to a lack of comparability. Data reliability is an essential requirement.
3. CPM Scope
The CPM does not require product identity, but rather functional comparability and possible adjustments. The Court instructed the Tax Court to reconsider in detail the assets, risks, and functions of Medtronic Puerto Rico compared to the reference companies.
4. Risks Assumed
The ruling underscores the importance of objectively quantifying the risks of liability for defective products, essential for appraising the distribution of profits among related parties.
5. Realistic Alternatives
Medtronic is evaluated to determine whether it could have replicated the functions of its subsidiary in Puerto Rico at other owned facilities, which would affect the appraisal of royalties under the principle of realistic alternatives.
Relevance and Transfer Pricing Connection
This case is entirely related to Transfer Pricing. The entire litigation concerns the application of IRC §482 and intangible asset appraisal methods under U.S. Treasury regulations.
Furthermore, it is a paradigmatic case because:
- It tests the limits of comparability in transactions involving complex and unique intangibles.
- It illustrates the tensions between approaches based on comparable transactions (CUT) and those based on profitability indicators (CPM).
- It reinforces the role of the courts as reviewers of the correct application of the best method rule, ensuring that Transfer Pricing determinations are technically grounded and not arbitrary.
Conclusion
The Medtronic case is a paradigmatic example of how Transfer Pricing litigation can shape international practice in appraising intangibles. The Court of Appeals emphasized that the selected method cannot be arbitrary or based on weak contractual references but must be supported by robust comparability, detailed functional analysis, and objective risk quantification.
The decision also reinforces the importance of the best method rule, reminding taxpayers to identify the method that best reflects Arm’s Length conditions, without resorting to unsupported hybrid approaches.
For multinationals, the lesson is clear: Structures involving high-value intangibles-such as patents, technology, and know-how-must be accurately documented, demonstrate true comparability, and be prepared to withstand strict judicial examination. In this regard, the Medtronic case sets a far-reaching precedent not only in the United States but also as a technical reference for other jurisdictions facing similar challenges in their Transfer Pricing audits.
Need Transfer Pricing Support?
TPC Group provides specialized Transfer Pricing advice in both the United States and Latin America, helping multinationals comply with local and international regulations and manage tax risks with greater certainty. Contact us for a customized consultation.
Source: TPCases