The transfer pricing disputes often involve transfers of property offshore. Taxpayers make these transfers so that the post-transfer profits earned from the offshored property are not subject to tax in the U.S. or, in many cases, not subject to tax in the foreign countries either. The U.S. Tax Court recently decided Amazon Inc. v. Commissioner, 148 T.C. No. 8, which many corporate tax departments were watching closely to see how it would impact their own tax positions.
The facts in Amazon case involve a structure that has been widely used by U.S. Fortune 500 companies. The structure looks something like this:
- the company forms a legal entity in Europe and elects to have it treated as a controlled foreign corporation (“CFC”),
- the company transfers property (including intellectual property–such as trade names, know-how, computer software, contracts–and other intangibles) to the CFC,
- the company engages a valuation expert to value the assets that are transferred and reports and pays tax to the IRS on the sale of the assets to the CFC (the tax is paid for the CFC’s buy-in payment),
- the company enters into a cost sharing agreement (“CSA”) with the CFC so that each party contributes their assets to the CSA and is liable for the expenses they make to use/develop the assets in their respective jurisdictions,
- the CFC transfers or licenses the assets to an entity in another country that does not tax income from the assets or enters into service agreements to pull the profits to another country and obtains a favorable letter ruling from the foreign countries that allow the CFC to pay little to no tax on the income from the assets.
The IRS challenges this structure is by challenging the valuation and amount of the buy-in payment that is subject to tax in the U.S. and/or the expenses in the CSA payments. This is what the IRS did in the Amazon case.
The IRS determined the buy-in payment should have been $3.468 billion. The taxpayer’s valuation experts had determined the buy-in payment was $254.5 million. So there was more than a $3 billion difference in the valuations. This difference was attributable to the royalty rate, the useful life and decay curve, the revenue base, and discount rate each party used.
The court largely sided with the taxpayer on these issues. The case serves as yet another transfer pricing case that the IRS lost. Given the amounts at stake, the IRS will continue to make this type of challenge its top priority. Taxpayers who have buy-ins and CSAs should read the case and compare these variables to their own positions to see how they stack up.