United States

Tax court rules in favor of Amazon in transfer pricing case

Court rejects DCF approach to valuing buy-in

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In a ruling released March 23, 2017, the U.S. Tax Court held the IRS position in Amazon.com v. Commissioner was arbitrary, capricious and unreasonable. The IRS had asserted Amazon undervalued the pre-existing intangible assets it transferred to its Luxembourg subsidiary.

Amazon entered into a cost sharing arrangement with its Luxembourg affiliate in 2004, giving the Luxembourg affiliate access to the intangible assets necessary to operate Amazon’s European website business. The arrangement included both a buy-in payment for pre-existing intangible assets and annual, post buy-in payments for on-going intangible development costs (IDCs).

Amazon applied the comparable uncontrolled transaction (CUT) method to calculate the buy-in payment and determined the transferred assets (website technology, marketing intangibles and customer information) had a seven-year useful life that decayed in value over time. The IRS applied a discounted cash-flow (DCF) method to calculate the buy-in payment. Amazon valued the assets at $254.5 million. The IRS determined the asset value was $3.468 billion. Amazon argued that the DCF method overinflated the buy-in payment by including the value of subsequently developed intangible property in contravention of existing regulatory guidance.

The two sides also differed regarding the cost allocation method used to determine the annual, post buy-in cost sharing payments. Amazon used a multistep allocation system that included costs from various cost centers to determine the annual cost sharing payment. The IRS largely accepted the multistep allocation system, but adjusted certain allocation determinations.

The Tax Court ruled in favor of Amazon indicating:

  • Amazon’s CUT method, with appropriate upward adjustments, was the best method to determine the requisite buy-in payment for pre-existing intangible assets
  • The DCF method applied by the IRS was substantially similar to the position rejected in Veritas
  • Amazon’s multistep allocation system for on-going IDCs, with certain adjustments, was reasonable
  • The IRS abused its discretion in adjustments made to the multistep allocation system

The ruling relieves Amazon of paying up to $1.5 billion in back taxes over a seven-year period.

Though the ruling may be appealed, taxpayers should take note as to how Amazon and Veritas are considered in future cost sharing cases. Taxpayers should also consider the cases in future cost sharing arrangements and endeavors, especially taxpayers encountering similar facts and circumstances.

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