On March 23, in Amazon.com, Inc. & Subsidiaries v. Commissioner 148 T.C. No. 8 (2017) the Tax Court held that the IRS’s approach to valuing an upfront cost sharing buy-in payment was arbitrary, capricious and unreasonable. The Tax Court also held that the IRS abused its discretion in determining that 100% of certain costs associated with a technology and content cost center constituted intangible development costs.
The case involved more than $234 million in tax deficiencies for 2005 and 2006. In the decision, the court agreed that the comparable uncontrolled transaction (CUT) method (with appropriate upward adjustments) used by the taxpayer, e-commerce giant Amazon, Inc., was the best method for determining the upfront cost sharing buy-in payment, and also agreed with Amazon’s methodology for allocating its technology and content cost center.
In 2005, Amazon entered into a cost sharing agreement (CSA) with a Luxembourg subsidiary. The CSA granted the Luxembourg subsidiary the right to use certain pre-existing assets in Europe, namely the intangibles required to operate the European website business. The CSA required that the Luxembourg subsidiary pay an upfront cost sharing buy-in payment, and also make annual cost sharing payments to compensate Amazon for the ongoing intangible development.
The regulations under Section 482 require the application of the “best method” when determining the arm’s length price for related party transactions such as the buy-in payment. Amazon believed that the CUT method was the best method under the regulations, and determined that the upfront cost sharing buy-in payment should be $254.5 million by applying such a method. As part of the CSA computations, Amazon determined the allocable costs from its cost centers to the intangible development costs by using a multistep allocation system.
The IRS disagreed with Amazon’s approach and determined that the upfront cost sharing buy-in payment should be $3.6 billion by applying a discounted cash-flow method, which the government believed was the best method. The IRS also disagreed with Amazon’s allocation of certain costs related to technology and content, finding that such costs should be intangible development costs.
The Tax Court’s decision reinforces a previous Tax Court decision, in Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009). However, both cases addressed the issue under the 1995 cost sharing regulations. The IRS and Treasury released temporary regulations on Jan. 5, 2009, which were finalized on Dec. 22, 2011. The final and temporary regulations replaced the “buy-in” payments with “platform contributions,” which expanded the scope of what constituted a contribution under the 1995 regulations. Taxpayers should be cognizant that, although parts of the decision do have broader applications to transactions occurring after the temporary and final regulations, the decision is addressing transactions under the 1995 cost sharing regulations.
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