Intangibles in a Transfer Pricing Context
Reflections on the Ninth Circuitâ€™s Decision in Amazon.com, Inc. v. Commissioner
What is included when valuing intangibles assets for transfer pricing purposes? This is an issue that was addressed once by the U.S. Tax Court and more recently, the Ninth Circuit Court of Appeals. In a unanimous decision by the U.S. Court of Appeals for the Ninth Circuit (issued on August 16, 2019) the court of appeals affirmed the decision of the U.S. Tax Court in Amazon.com, Inc. v. Commissioner, 148 T.C. 108 (March 23, 2017). The court held that intangible assets under the U.S. transfer pricing regulations, under Section 482 in effect in 2005 and 2006, do not encompass residual business assets such as the value of workforce in place, goodwill, going concern value, and other similar components that are not discrete items of intellectual property. The Ninth Circuit, using â€śtraditional tools,â€ť found they favored Amazonâ€™s interpretation and definition of â€śintangiblesâ€ť as â€ślimited to independently transferrable assets.â€ť
A unanimous decision by the U.S. Court of Appeals for the Ninth Circuit1 on August 16, 2019, affirmed the decision of the U.S. Tax Court in Amazon.com, Inc. v. Commissioner, 148 T.C. 108 (March 23, 2017). The court held that intangible assets under the U.S. transfer pricing regulations under Section 482, in effect in 2005 and 2006, do not encompass residual business assets such as the value of workforce in place, goodwill, going concern value, and other similar components that are not discrete items of intellectual property. The Ninth Circuit, using â€śtraditional tools,â€ť found they favored Amazonâ€™s interpretation and definition of â€śintangiblesâ€ť as â€ślimited to independently transferrable assets.â€ť
Background and Case Specifics
Amazon set up a subsidiary in Luxembourg (Lux) as a holding company to ensure lower tax liabilities for the bulk of Amazonâ€™s European business. In 2005 and 2006, Amazon transferred to Lux three groups of intangible assets through a cost-sharing arrangement (CSA) pursuant to applicable regulations: (1) website-related technology; (2) marketing intangibles, including trademarks, trade names, and domain names relating to the European business; and (3) customer lists and related customer information.
Under the terms of the CSA (and under the applicable transfer pricing regulations), Lux had to make an upfront â€śbuy-in paymentâ€ť for the pre-existing intangible property (IP). Amazon determined a buy-in payment of $255 million to Lux based on an estimated seven-year life for the transferred intangibles. Amazon did not include the value of any residual-business assets in the determination of the buy-in payment. The IRS performed its own calculation and applied a methodology which identified all non-routine/non-benchmarkable income as the income associated with the transferred IP and valued the buy-in at $3.6 billion. The IRS argued that the definition of intangibles under the 1994 transfer pricing regulations was broad and thus, did not specifically exclude residual-business assets from the scope of the buy-in requirement. For the privilege of building out Amazon throughout Europe, the IRS required Lux to pay for Amazonâ€™s U.S. IP, including â€śresidual-business assetsâ€ť such as the value of Amazonâ€™s workforce in place, culture of innovation, going concern value, goodwill, and growth options.
Amazon disagreed and petitioned the Tax Court.
The core argument of the case and its subsequent appeal stems from each partyâ€™s interpretation of what qualifies as an intangible under Section 1.482-4(b) and as referenced in the cost-sharing regulations (Section 1.482-7A(a)(2)) at the time of Amazonâ€™s 2005â€“2006 cost-sharing arrangement. Amazon argued that the IRSâ€™s calculation of the buy-in payment included residual items (e.g., workforce in place, going concern value, goodwill, and certain â€śgrowth optionsâ€ť such as company culture) that were outside the scope of what constitutes an â€śintangibleâ€ť as defined in Section 1.482-4(b).
On March 23, 2017, the Tax Court, in a landmark decision, sided with Amazon and opined that the IRSâ€™s determination of the cost-sharing buy-in payment was arbitrary, capricious, and unreasonable and agreed with Amazon that â€śresidual businessâ€ť intangibles were not subject to the buy-in requirements at the time of Amazonâ€™s 2005â€“2006 cost-sharing arrangement.
However, the IRS took the matter to the Ninth Circuit, arguing that the Tax Courtâ€™s interpretation of Section 1.482-4(b) conflicted with the overall purpose of the armâ€™s-length standard and that its own interpretation of intangibles was supported by the Tax Cuts and Jobs Act (TCJA).
On August 16, 2019, the Ninth Circuit issued its opinion in favor of Amazon.
Definition of Intangibles Versus the Valuation of Intangibles
The Ninth Circuit was laser focused on one key issue: Did Treas. Reg. Â§ 1.482-4(b), which was in effect for this case, require Amazon to include the value of residual-business assets in its buy-in valuation?
The IRS argued that the armâ€™s-length standard itself means that residual-business assets are compensable because â€śit is undisputed that a company entering into the same transaction under the same circumstances with an unrelated party would have required compensation.â€ť
The Ninth Circuit panel addressed that argument in a footnote, holding that the IRSâ€™s argument â€śmisses the markâ€ť and that while the armâ€™s-length standard â€śgoverns the valuation of intangibles, it doesnâ€™t answer whether an item is an intangible.â€ť
The implication of the Ninth Circuitâ€™s statement is that, without showing that the transfer within the cost-sharing arrangement was done through a limited license which is the substantive equivalent of a sale of the business, the IRS cannot characterize the assets transferred as if the license transfer were a sale. The key point in the Ninth Circuitâ€™s analysis involved recognition that the transfer of assets in a CSA is not necessarily the economic equivalent of a sale of business.
Cost-Sharing Regulationsâ€”Timing Matters
The Ninth Circuit pointed out that its opinion interprets the definition of â€śintangible propertyâ€ť under Treas. Reg. 1.482-4(b) promulgated in 1994 and 1995, and not the subsequently issued 2009 regulations or the statutory amendment introduced with the TCJA in 2017.
Temporary cost-sharing regulations were issued by the U.S. Treasury to replace the 1994 and 1995 regulations, and in 2017, Congress amended the definition of intangible property as part of the TCJA. The temporary regulations effectively expanded the definition of intangibles for cost-sharing purposes to include residual assets such as going concern value and goodwill. The TCJA expanded the definition of intangibles in Section 482 to include residual-business assets when such intangibles are transferred to a related party. Thus, if the question is, â€śWhat are intangibles for the purposes of determining what a transferee must pay for?â€ť, then the newly expanded definition would be applied, consistent with the IRSâ€™s attempt to retroactively expand that definition. However, where a transfer would not, at armâ€™s length, include such intangibles, then the transferee should not be required to pay for them.
The Ninth Circuit also noted that the cost-sharing regulations in effect in 2005 and 2006 identified intangibles that were the product of research and development efforts, which indicated that the regulations contemplated a meaning of â€śintangibleâ€ť that excluded items that are generated by earning income, not by incurring deductions, such as goodwill and going concern value.
The Ninth Circuitâ€™s opinion is limited to issues arising under the 1995 cost-sharing regulation. The subsequent cost-sharing regulations replaced the reference to buy-in payment with the concept of a platform contribution transaction, which includes any resource, capability or right that is reasonably anticipated to contribute to developing cost-shared intangibles. The TCJA amended the definition of intangible property to include workforce in place, goodwill, and going concern value. It remains unclear how courts might decide a similar case involving a post-2009 transaction. Nonetheless, U.S. practitioners and taxpayers alike should familiarize themselves with this case as its consequences for the relevant time period are significant.Â
Implications Going Forward
The Amazon case has far-reaching implications for many multinational enterprises (MNEs) with an abundance of IP and CSAs going back more than a decade, and that took similar approaches to the definition of intangibles and the determinations of buy-ins when they entered into (or augmented) similar CSAs. Many MNEs with similar IP structures as Amazon and CSAs established between 1994 and 2009 may breathe a sigh of relief. However, the definition of intangibles has changed post-2009 and post-2017, and this means certain IP structures face greater scrutiny and litigation than in the past. The Amazon case will have a large impact on the scope of the IRSâ€™s discretion in adjusting based on its interpretation of broad language within the U.S. Tax Code. Not only will the IRS be emboldened, but the U.S. courts will likely be less forgiving for post-2017 structures.
This article was previously published in Morison KSiâ€™s Global Tax Insights Q1 2020 and is republished here with permission.
Angela Sadang, CFA, ASA, ABV, is a Principal at Marks Paneth LLP. She is a designated Chartered Financial Analyst charter holder, an Accredited Senior Appraiser in Business Valuation and Intangible Assets Valuation from the American Society of Appraisers, and Accredited in Business Valuation (ABV) from the AICPA. She has been involved in numerous transfer pricing and valuation projects.
Ms. Sadang can be contacted at (212) 201-3012 or by e-mail to email@example.com.