BDO Transfer Pricing Alert - May 2017

May 2017

Court Delivers Prime Ruling for Amazon

On March 23, the United Sates Tax Court ruled in, Inc. & Subsidiaries v. Commissioner of Internal Revenue in favor of the taxpayer.  The IRS had argued that Amazon undervalued its intangible property (“IP”) and applied a $1.5 billion adjustment to the taxpayer’s income, but the court ruled that the IRS acted arbitrarily or capriciously in applying the cost sharing regulations.[1] The case is a major ruling in favor of corporations that hold IP abroad and may serve as a significant precedent for future transfer pricing litigation.


In 2005, Amazon entered into a cost sharing arrangement (“CSA”) with its subsidiary in Luxembourg (“Subsidiary”) that permitted the Subsidiary to use pre-existing intangibles required to operate Amazon’s European website business.[2] A CSA is an agreement under which related parties agree to share the intangible development costs (“IDCs”) in proportion to their shares of reasonably anticipated benefits of the developed intangibles.  When one participant (here, Amazon) makes pre-existing IP available for the purposes of research under a CSA, that party is deemed to have transferred a property interest to the other CSA participant.  To complete the acquisition, the other participant (here, Subsidiary) must make a “buy-in payment” for the value of the IP to Amazon.

Amazon sought to act in accordance with the parameters for a CSA under the transfer pricing regulations.  Under Treas. Reg. Section 1.482-7, the Subsidiary was required to make a buy-in payment and then compensate Amazon annually for ongoing IDCs, which included research, development, marketing, and other activities relating to maintaining, improving, enhancing, or extending the intangibles.  According to the CSA, the Subsidiary would assist, by way of financial contribution only, in the ongoing development of technology required to operate the European websites and related activities.  The regulations further required Amazon to allocate the costs to the Subsidiary on a reasonable basis.  Therefore, Amazon developed a formula and applied it to allocate a portion of the costs accumulated in various cost centers to the IDCs to satisfy this criteria.[3]

During 2005 and 2006, Amazon transferred three groups of IP to its Subsidiary in a series of transactions including: the software and other technology required to operate its European websites, fulfillment centers, and related business activities; marketing intangibles, including trademarks, tradenames, and domain names relevant to the European business; and customer lists and other information relating to its European clientele.

IRS Stance

The IRS challenged the Petitioner’s buy-in payment and applied a discounted cash flow (“DCF”) methodology to value the IP.  The IRS valued the IP at $3.6 billion, which starkly contrasted Amazon’s $254.5 million valuation.[4] The cause of the disparate conclusions was the contrasting assumptions over the IP’s useful life; the IRS opined that the IP had an indefinite useful life, whereas Amazon applied a useful life of seven years.  The DCF methodology determines a value for an asset today, by discounting forecasted future earnings over its useful life.  Therefore, extending the assets’ useful life also extends its earnings, and in turn, its value.

For the annual contributions to maintain the IP, Amazon used a multistep system to allocate costs from the cost centers to IDCs.  While generally accepting Amazon’s allocation method, a contentious point in the IRS’s argument was that 100 percent of the costs captured in a cost center named Technology and Content should be allocated to IDCs.  The result of this determination was to increase the Subsidiary’s cost sharing payments by $23.0 million and $109.9 million in 2005 and 2006, respectively. 

The total adjustment resulted in an estimated $1.5 billion tax bill, plus interest, for transactions in 2005 and 2006.

Amazon Stance

For the buy-in payment, Amazon contended that each group of transferred assets—the website technology, the marketing intangibles, and the European customer information—must be valued separately, and chose a transfer pricing method called comparable uncontrolled transaction (“CUT”) method to value the IP.[5] In the original cost sharing arrangement, a third-party accounting firm determined that the appropriate buy-in price was $254.5 million, to be paid over a seven-year period commencing in 2005.  An essential argument for Amazon was that the transferred intangibles had a limited useful life of seven years, which was amortized over time.  Amazon argued that the software supporting the European operations website was in a fragile state when it first established the Subsidiary, and therefore could support a finite useful life. 


The court held on four points:
  • First, the IRS’s determination with respect to the buy-in payment was arbitrary, capricious, and unreasonable;
  • Second, Amazon’s CUT method, with appropriate upward adjustments in numerous respects, was the best method to determine the requisite buy-in payment;
  • Third, the IRS abused its discretion in determining that 100 percent of Technology and Content costs constituted IDCs; and
  • Fourth, Amazon’s original cost-allocation method, with certain adjustments, supplied a reasonable basis for allocating costs to the IDCs.
The court considered Amazon's expert witnesses' useful life estimates of between eight years and 20 years and concluded that the marketing intangibles did not have a perpetual useful life, but rather a life of 20 years.  In addition, the court agreed with Amazon that the IRS’s determination that all Technology and Content costs should be allocated was arbitrary and capricious, and that only about half of the costs should be allocated to IDCs.

The court's opinion rests primarily on the conclusion that the Subsidiary “assumed sole responsibility to maintain and develop the marketing intangibles,” and that it contributed to the technology improvements needed to maintain the IP’s value.  The decision was also based on Amazon's assertions that the Internet retail industry had yet to mature and that Amazon's success depended on technological assets subject to frequent market disruptions.

BDO Insights

Amazon successfully contended that the IRS’s DCF methodology was substantially similar to that applied in Veritas Software Corp. v. Commissioner, where the Tax Court had already held that the specific application of the DCF was arbitrary and capricious.  The Amazon case was widely regarded as an opportunity for the IRS to reverse its position and set a precedent for future transfer pricing disputes.  The court agreed with Amazon and cited Veritas as a precedent for its ruling on the buy-in payment.  The Amazon case could end up costing the IRS billions of dollars if the ruling inspires other companies to contest similar issues.  However, the Amazon ruling was based on the application of the regulations in effect in 2005 and 2006.  The IRS issued new cost sharing regulations on December 16, 2011, after issuing temporary and proposed regulations on December 31, 2008.  While the court ruled in favor of the taxpayer on the aforementioned points in Amazon., future cost sharing litigation may be subject to different rules, depending on the tax years in question.

  1. “Tax Court Holds for Amazon in Transfer Pricing Case,” BNA, March 23, Dolores Gregory and Sony Kassam.
  2. “Amazon wins multimillion dollar transfer pricing dispute with IRS,” Journal of Accountancy, March 23, Alistair Nevius.
  3. “Amazon Just Won a $1.5 Billion Tax Fight,”, March 23, Reuters.
  4. Amazon v. Comm’r¸148 T.C. 8 (2017).
  5. Veritas Software Corp. v. Comm’r, 133 T.C. 297 (2009).

For more information, please contact one of the following practice leaders: 
Mark Schuette
  Kirk Hesser
Managing Director

Veena Parrikar
  Sean Kim
Managing Director

Michiko Hamada
Managing Director
  Noyan Tulmen
Managing Director
[1] Inc. is referred to as “Amazon” or “Petitioner,” and the Commissioner of Internal Revenue is referred to as “IRS” or “Respondent.”
[2] The legal name for the Subsidiary is Amazon Europe Holding Technologies SCS.
[3] Petitioner tracked expenses in six high-level cost centers: (1) Cost of Sales, (2) Fulfillment, (3) Marketing, (4) Technology and Content, (5) General and Administrative (G&A), and (6) Other.
[4] The IRS valuation was later reduced to $3.5 billion.
[5] In accordance with Treasury Regulation section 1.482-4