Earlier this year in Amazon v. Commissioner, 148 T.C. No. 8 (March 23, 2017), the U.S. Tax Court issued a 207-page decision largely upholding Amazon’s tax treatment of an intellectual property transfer in 2005 and 2006 from the U.S. to a related European corporation. Contesting Amazon’s valuation of the transferred intangibles, the Internal Revenue Service (IRS) assessed deficiencies in Amazon’s Federal income tax of $8.4 and $225.6 million, respectively. Moreover, according to Amazon, its liability exposure could have been up to $1.5 billion when following tax years were taken into account, should the IRS’ position prevailed in court.
In this case, the dispute focused on a series of transactions in 2005 and 2006, by which Amazon.com, Inc., and its domestic subsidiaries (collectively, Amazon US) established an EU headquarters entity that would serve as the holding company for all of the European businesses. By establishing a European headquarters, Amazon’s income connected with its European businesses would benefit from Luxembourg’s corporate income tax rate, which was significantly lower than the United States rate.
Prior to Amazon’s “European reorganization,” Amazon US was the inventory owner and seller of record for its European businesses. In addition, it owned most of the intellectual property required to operate its European businesses and licensed this intellectual property to its European subsidiaries. This intellectual property included the underlying website technology, all of which had been developed in the United States; all of the European customer information; and most of the marketing intangibles, including trademarks and domain names.
As part of its “European reorganization,” Amazon US and Amazon Europe Holding Technologies SCS (AEHT) entered into a cost sharing agreement whereby AEHT would pay a “buy-in” amount to obtain rights in Amazon US’ pre-existing intangible property. Under the cost sharing agreement, AEHT would have rights in future intangible property developed by Amazon US by paying Amazon US a share of the development costs. The IRS argued that Amazon underpaid their US Federal income tax by undervaluing the “buy-in” payment. Specifically, the IRS argued that the “buy-in” amount should have been $3.6 billion (later $3.5 billion), rather than the $254.5 million buy-in payment that AEHT actually made.
The IRS arrived at this $3.6 billion “buy-in” amount by determining the enterprise value for Amazon’s entire European business, and then subtracting the value of its initial tangible assets. To determine the enterprise value of Amazon’s European business, the IRS applied a discounted cash-flow methodology to the expected cash flows. To support its methodology, the IRS argued that the transactions were in essence “akin to a sale” of Amazon’s European business, not merely a transfer of specific intangible assets.
The Tax Court rejected the IRS’ approach. In doing so, the Court explained:
“An enterprise valuation of a business includes many items of value that are not “intangibles” as defined above. These include workforce in place, going concern value, goodwill, and what trial witnesses described as “growth options” and corporate “resources” or “opportunities.” Unlike the “intangibles” listed in the statutory and regulatory definitions, these items cannot be bought and sold independently; they are an inseparable component of an enterprise’s residual business value.”
Accordingly, the Tax Court held that the IRS’ “akin to a sale” theory erroneously included such value contributors in determining the “buy-in” amount for pre-existing intangibles.
Although this decision was a resounding defeat for the IRS and a major victory for Amazon, other taxpayers should not be too quick to rejoice. This is because on January 17, 2017, the IRS issued Treasury Decision 9803 (“T.D. 9803”), setting forth final regulations under Internal Revenue Code (“IRC”) Section 367. Under the final regulations (which adopted the approach of the proposed regulations published on September 16, 2015), transfers of foreign goodwill and going concern value to foreign corporations is considered a taxable event. In contrast, when Amazon conducted its “European reorganization” between 2004 and 2006, the temporary regulations (published on May 16, 1986) for IRC Section 367 allowed transfers of foreign goodwill and going concern value to be a non-taxable event under the “the active conduct of a trade or business” exception. Thus, if Amazon had undertaken these same transactions under the final regulations, it likely would have been taxed on a $3.6 billion transaction, rather than a $255 million transaction.