Apr 04, 2017
Guy Sanschagrin, Principal and Leader of WTP Advisors' Transfer Pricing Practice was quoted in the recent Tax Analyst piece analyzing the Tax Court decision in the Amazon.com vs Commissioner, 148 T.C. (no. 8) 2017. The Tax Analysts breakdown by Ryan Finley addresses the March 23 decision by the Tax Court in Amazon.com v. Commissioner, 148 T.C. No. 8 (2017). The Tax Court, once again ruled in favor of the taxpayer. This is the same result as in Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009), where the IRS made the same arguments on its approach for the valuation for cost sharing arrangements (CSA).
The court ruled that “at least under the cost-sharing regulations in force before 2009, the IRS’s income-based valuation approach was the wrong method, the value of transferred intangibles -- technology in particular -- decays over the course of their relatively short useful lives, and the taxpayer's transactions with unrelated parties are valid comparables for pricing a transfer of the core intangibles associated with the group's operations in a specified geographic territory. Also, the IRS's attempt to allocate 100 percent of the costs of certain departments to the shared intangible development cost pool was rejected.”
The Back Story
Amazon and its Luxembourg subsidiary (AEHT) formed a CSA. This transferred the technology and marketing intangibles from the European operations to AEHT. As part of the CSA, AEHT made a buy-in payment of $255 million for the rights to the transferred intangibles and would share in the intangible development costs based on its portion of the projected sales.
In the IRS audit, a discounted cash flow (DCF) analysis was used, as well as discounted profit projections for AEHT through 2024, determining the buy-in should have been $3.6 billion. This was the same approach the IRS used in Veritas. And once again, the court dismissed nearly all assumptions and the DCF method.
“Although we found several deficiencies in [the IRS expert’s] methodology, his core error was to value ‘short-lived intangibles’ as if they have a perpetual life,” the opinion says. “It was unreasonable, we concluded, for respondent to determine the buy-in payment by assuming that a third party, acting at arm's length, would pay royalties in perpetuity for use of these short-lived assets.”
Another argument from the IRS centered on how the intangibles should be valued. The IRS argued the intangibles should be valued jointly under the aggregation principles set in Treas. reg section 1.482-1(f)(2)(i). While, the court’s opinion was that aggregation is inappropriate as this would combine an enterprise’s assets that qualify as intangibles under its definition in section 936(h)(3)(B) and those that don’t, such as “workforce in place, going concern value, goodwill, and what trial witnesses described as 'growth options' and corporate 'resources' or 'opportunities’.”
Thus, the IRS was attempting include assets for which no compensation is required in its DCF calculation.
In the Tax Analyst article, Guy Sanschagrin noted the IRS took an unreasonably aggressive approach on this case.
“The IRS has clearly overreached in this ‘akin to a sale’ theory in Veritas and now Amazon,” said Guy Sanschagrin of WTP Advisors.
“For example, goodwill, which can represent a significant percentage of enterprise value, is not defined as an intangible in Treas. reg. section 1.482-4(b)(6). The IRS should have removed goodwill value from their enterprise valuation,” Sanschagrin said. “Moreover, as stated in the opinion, a significant portion of the value of the European business was already offshore since the European subsidiaries were already in operations for six years prior to the CSA.”
“If they continue to steadfastly follow their current ‘akin to a sale’ approach without significant modifications, they will continue to be viewed by the court as unreasonable, even under the new cost-sharing rules,” he added.
To access the tax court opinion, click here.