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January 21, 2013
Amazon Fighting IRS Over Cost-Sharing Agreements
by Julie Martin

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by Julie Martin

Amazon is battling the IRS in the U.S. Tax Court over adjustments relating to cost-sharing agreements with its European subsidiaries that would increase the online retailer's taxable income by more than $1 billion in 2005 and 2006.

An Amazon logistics center in Koblenz, Germany. The company is contesting IRS calculations of payments relating to cost-sharing agreements with Amazon's European subsidiaries. (Harald Tittel/dapd)In its petition, Docket No. 31197-12, filed December 28, Amazon claims that the IRS incorrectly used the discounted cash flow method to recalculate buy-in payments associated with Amazon's transfer of preexisting intangibles to its European subsidiaries under cost-sharing agreements. Amazon also disputes other IRS calculations relating to the cost-sharing agreements.

Amazon's petition states that the IRS determined deficiencies in the amounts of $8,380,790 and $225,653,149 in 2005 and 2006, respectively. The IRS also increased the amount of Amazon's net operating loss carryover deduction used by $1,064,219,011 and $304,787,954 in 2005 and 2006, respectively, the company said. The company argues that its NOL carryover deductions used for 2005 and 2006 should in fact be decreased by $62,297,000 and $6,951,000, respectively.

The case involves a 2005 cost-sharing agreement between Amazon's U.S. subsidiaries (Amazon) and its European subsidiaries. The parties agreed to share costs associated with research, development, marketing, and other activities related to Amazon websites inside and outside Europe, in proportion to their reasonably anticipated benefits.

Amazon Europe obtained a nonexclusive right and license to the intangibles for purposes of operating the European websites. By the end of 2011, the European subsidiaries incurred research and experimental expenses of over $1.1 billion under the agreement.

Amazon Europe made buy-in payments to Amazon over a seven-year period in consideration for the license and the assignment of rights to Amazon's preexisting technology and marketing intangible property made available through the agreement.

Amazon determined that the present value of the preexisting intangible property obtained by Amazon Europe was $216,711,000 as of January 1, 2005. It based this calculation on the facts that the preexisting intangible property had a limited useful life and the property decayed over its useful life, and that Amazon Europe funded and co-developed the covered intangibles after January 1, 2005. Accordingly, Amazon Europe made buy-in payments to Amazon of $73,220,000 and $82,684,000 for 2005 and 2006 under the agreement.

The IRS, in its notice of deficiency, used the discounted cash flow method to recalculate the buy-in payments, increasing Amazon's income by $1,036,305,000 in 2005 and by $1,170,251,000 in 2006. The IRS relied on a report of an external economics consulting firm that valued the buy-in at $3,605,100,000 as of January 1, 2005. According to the petition, the report used only three inputs: an estimate of future cash flows, the timing of future cash flows, and a discount rate.

In its petition, Amazon argues that the discounted cash flow method is inappropriate because the method was rejected by the Tax Court in Veritas Software v. Commissioner, 133 T.C. 297 (2009), nonacq., AOD 2010-005, 2010-49 IRB (Dec. 6, 2010). Amazon also states that the valuation method fails to separately identify the items that were subject to the buy-in, as required under Treas. reg. section 1.1482-7(g) (1995). Amazon also maintains that the IRS inappropriately retroactively applied valuation methods that are only applicable to years beginning after January 5, 2009, and that it incorrectly valued the preexisting property into perpetuity.

Amazon also argues that the IRS failed to make allocations in quantifying intangible development costs, as required by section 482 and Treas. reg. section 1.482-7(d), (e), and (f) (1995). This resulted in increased cost-sharing payments to Amazon from its European subsidiaries in the amounts of $23,032,018 and $109,889,346 in 2005 and 2006, respectively, Amazon said in its petition.

Further, Amazon has contested the IRS's failure to reduce the amount of cost-sharing payments made by its European subsidiary to reflect the exclusion of stock-based compensation from the pool of intangible development costs subject to the cost-sharing agreement. These amounts resulted in inappropriate increases of $2,545,000 and $6,951,000 to Amazon's income in 2005 and 2006, respectively, the company maintains.

Also in dispute is the IRS's decision to increase Amazon's buy-in income by $4,881,993 in 2005 and $2,548,165 in 2006, on intangible property acquired by Amazon from uncontrolled parties and made available to the cost-sharing agreement.

Julie Martin is a legal editor with Tax Notes International.

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