by Julie Martin, MNE Tax
A US federal appeals court on Friday affirmed the Tax Court’s decision in Amazon, ruling that cost sharing buy-in payments made by Amazon’s Luxembourg subsidiary in exchange for Amazon’s transfer of intangible property should not include compensation for transferred residual business assets such as workforce in place, goodwill, and going concern value.
The definition of “intangibles” subject to compensation under the pre-2009 transfer pricing regulations includes only independently transferable assets, the Court of Appeals for the Ninth Circuit concluded, rejecting the IRS’s preferred transfer pricing approach.
The decision means a loss to the US Treasury of $1.5 billion of additional tax revenue from Amazon for transactions that took place in 2005 and 2006. The decision could affect many other cases.
The Court noted that, in reaching its decision, it was required to apply “now outdated” transfer pricing laws and regulations that were effect at the time of the transactions.
“If this case were governed by the 2009 regulations or by the 2017 statutory amendment, there is no doubt the Commissioner’s position would be correct,” Judge Consuelo M. Callahan said in a footnote.
CUT vs discounted cash flow
The case concerns a 2005 cost sharing agreement under which Amazon.Com, Inc., and its domestic subsidiaries transferred to an Amazon Luxembourg subsidiary all intangible assets developed in the US that were required to operate Amazon’s European website business.
Amazon used the comparable uncontrolled transaction (CUT) method to separately value three groups of assets transferred to the Luxembourg subsidiary: website technology, marketing intangibles, and European-customer information.
Using this method, Amazon set the buy-in price for the transfer under the cost sharing agreement at $217 million.
On audit, the IRS determined that Amazon significantly undervalued the transfer. Using the discounted cash-flow method, the IRS concluded that a buy-in payment of $3.6 billion was required. The IRS also increased significantly the amount of Amazon’s ongoing cost sharing payments.
IRS determined deficiencies for 2005 and 2006 of $8.4 million and $225.7 million, respectively. The IRS increased the amount of Amazon’s net operating loss carryover deduction used by just over $1 billion in 2005 and by $304.8 million in 2006.
Amazon Tax Court win
In a March 2017 opinion, the Tax Court ruled mostly in favor of Amazon. The Tax Court rejected the IRS’s recalculation of the buy-in payment, concluding it was arbitrary, capricious, and unreasonable. The CUT method, used by Amazon, was the best method to calculate the cost sharing agreement buy-in payment, the Court said.
The Tax Court relied on several grounds to reach its conclusion, including that items such as workforce in place, going concern value, and goodwill are unlike the intangibles listed in the statutory and regulatory definition of “intangibles” because they cannot be bought and sold independently.
IRS’s method was inappropriate, the Tax Court said, because contrary to the regulations, the IRS method “necessarily sweeps into [the] calculation assets that were not transferred under the [cost sharing arrangement] and assets that were not compensable ‘intangibles’ to begin with.”
Ninth Circuit agrees
The Ninth Circuit has now affirmed the Tax Court’s decision, stating that although the language of the intangibles definition is ambiguous, the drafting history of the regulations shows that “intangible” was understood to be limited to independently transferable assets.
The IRS’s discounted cash-flow method is inappropriate because the selection of the best method turns on the regulatory definition of an “intangible.” The IRS’s method inappropriately added to the buy-in amount the cost of residual business assets which are not intangibles within the meaning of those rules, the Court said.
Application to future transactions
The cost sharing regulations applicable to Amazon’s transactions were substantially modified in 2009 temporary regulations that were finalized in 2011. Further, the 2017 Tax Cuts and Jobs Act altered the definition of “intangible property” for transfer pricing purposes.
The Ninth Circuit made the following observations with respect to these changes:
“This case is governed by regulations promulgated in 1994 and
1995. In 2009, more than three years after the tax years at issue here, the
Department of Treasury issued temporary regulations broadening the
scope of contributions for which compensation must be made as part of
the buy-in payment. See 74 Fed. Reg. 340 (Jan. 5, 2009). In 2017,
Congress amended the definition of “intangible property” in 26 U.S.C.
§ 936(h)(3)(B) (which is incorporated by reference in 26 U.S.C. § 482).
Tax Cuts and Jobs Act of 2017, Pub. L. 115-97, § 14221(a), 131 Stat.
2054, 2218 (2017). If this case were governed by the 2009 regulations
or by the 2017 statutory amendment, there is no doubt the
Commissioner’s position would be correct.”
The Court said in another footnote that its decision should not be construed as an outright rejection of any particular valuation methodology.
Julie Martin
Julie Martin is the founder of MNE Tax. She edits the publication and regularly contributes articles on new developments in cross-border business taxation.
Julie has worked as a tax journalist and editor for more than 13 years. Prior to that, she worked as an in-house tax attorney in New York. She also holds an LLM in taxation from New York University School of Law.
Julie can be reached at [email protected].
Latest posts by Julie Martin (see all)
- UN committee considers updates to model tax treaty, developing nation tax guidance - April 21, 2021
- UN Committee of Experts approves new digital tax article for model treaty - April 20, 2021
- Leaked copy of US proposal for Pillar One and Two multinational group tax reforms available - April 12, 2021
- US offers new “Pillar One” compromise plan for taxing large multinationals - April 8, 2021
- UN tax committee releases updated model treaty language on automated digital services - April 7, 2021
A very rational judgement against backdoor backdating of implementation date of amendments of TP regulations.
The genesis of the judgement is very important to be understood. A taxpayer can at best be assessed on the basis of the tax law prevalent during the year the IC transactions where undertaken, any change in the law subsequently, albeit retrospectively, cannot be forced on the taxpayer to challenge the methodology adopted to value the IC transactions which in hindsight were correctly applied.