One of the mystifying trends in transfer pricing litigation has been the vast differences in the values of intangibles arrived at by economic experts for the IRS and the taxpayer. This was especially true in Amazon’s transfer pricing dispute, which was decided by the U.S. Tax Court in March.
In Amazon.com, Inc. v. Commissioner, 148 T.C. No. 8 (Mar. 23, 2017), the company’s expert maintained that intangibles transferred by the U.S. parent to a Luxembourg affiliate in 2010 were worth $216 million. That included the value of Amazon’s website technology and marketing intangibles – the company’s world-famous brand. The IRS expert argued that those same intangibles were worth $3.6 billion in 2010.
How can two economists be so far apart on such a fundamental point? In a paper published in a recent issue of the TM International Journal, Clark Chandler of Economics Partners LLC zeroes in on one reason why: Because the experts are valuing very different things. And the number you come up with, Chandler says, can vary widely depending on a fundamental assumption: Which party will fund the future development of the transferred technology – the licensee or the licensor?
In the Amazon dispute, the IRS expert used a discounted cash flow analysis to determine the value of the business that was supported by the company’s intangibles at the time of transfer. He included business opportunities as well as goodwill and going concern, valued all intangibles in aggregate, and presumed that the intangibles could be expected to have a perpetual life.
The taxpayer’s expert determined the value of specifically defined pre-existing technology as it existed at the time of transfer and whose value was expected to erode over time.
“I think that it is relatively common for taxpayers and tax authorities to take fairly fundamentally different views of key assumptions in transfer pricing cases,” Chandler says. “In some cases, such as Amazon, this deals with the definition of the property that has to be valued. In other cases, it may be who owns the property or who bore the key risk for the success or failure of an investment. For example, while it is common to focus on high-profit transactions, transactions that lead to substantial losses for both parties to the transaction are also often difficult to resolve as the taxpayer and the tax authority often have a fundamentally different view on which entity is the risk-taker that should bear the loss.”
In Amazon, the Tax Court determined that the buy-in payment for the cost sharing arrangement between Amazon US and its Luxembourg affiliate covered only the pre-existing value of the intangibles, as “explicitly enumerated” in the §482 regulations – and those did not include business opportunities, goodwill, or going concern. The court also determined that the intangibles had a limited life of seven years for Amazon’s website technology and 20 years for its marketing intangibles. Having reached this conclusion, Chandler said, the court rejected the discounted cash flow method used by the IRS expert because it incorporated at least three items of value over and above the intangibles that had to be covered by the cost sharing buy-in.
While the Amazon ruling was long awaited, Chandler says he was not really surprised by the outcome, given that the facts were so similar to those of an earlier case, Veritas, in which the court also ruled for the taxpayer.
The unanswered question is how a change in cost-sharing regulations adopted in 2011 will affect such disputes going forward, he says. Under the new regulations, elements such as workforce, goodwill or going concern value, or business opportunity, will have to be accounted for as compensable intangibles. But Chandler notes that these changes apply explicitly only to cost sharing arrangements.
“Therefore,” he writes, “there is – at least in my mind – a considerable amount of uncertainty as to their impact on a traditional Reg. §1.482-4 transfer of intangibles.”
Chandler’s article is online in the Tax Management International Journal, Nov. 10, 2017, Vol. 46, No. 11 .
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