On March 23, 2017, the U.S. Tax Court issued its long-awaited opinion in a transfer pricing dispute involving Amazon's cost sharing arrangement ("CSA") with its Luxembourg subsidiary.
Amazon contributed software and other preexisting intellectual property ("IP") to a CSA, under which a Luxembourg subsidiary ("Luxco") agreed to share the costs of developing future IP for use in Amazon's European operations. Consistent with the pre-2009 transfer pricing regulations' requirement that the parties make buy-in payments for use of IP contributed to CSAs, Luxco paid $255 million to Amazon.
The IRS challenged Amazon's valuation method, claiming that Luxco's buy-in payment was not arm's length. The IRS asserted that the contributed IP had an indefinite useful life (because it served as the basis for future IP development) and used a discounted cash flow valuation method. This approach increased the buy-in payment to approximately $3.5 billion.
The Tax Court seemed taken aback that the IRS was making essentially the same arguments that the court had emphatically rejected in Veritas v. Commissioner, a 2009 case. In Amazon, the court noted that the IRS formulation of "indefinite" useful life was in substance identical to the "perpetual" life it had argued in Veritas. In both cases, the IRS valuation method included the present value of income projected to be derived from future IP not yet developed. This violated the regulations' prescription that a buy-in payment equal the value of only the existing IP contributed to the CSA.
The IRS arguments can be seen as an attempt—soundly rejected—to impose the more stringent valuation methods of the new, post-2009 CSA regulations on pre-2009 cases. We don't know yet whether the IRS will appeal the Amazon decision, but in our experience, the IRS has been settling CSA buy-in cases under the old regulations on favorable terms.