The Tax Court decided in favor of Amazon.com in an expensive transfer pricing dispute with the Internal Revenue Service involving intellectual property that the e-commerce giant assigned to a European subsidiary in Luxembourg.

The IRS had charged Amazon with a deficiency in its federal income taxes of nearly $8.4 million for 2005 and over $225.6 million for 2006, disagreeing with how Amazon had accounted for the intangible assets required to run its European website business. The IRS made substantial transfer pricing adjustments reallocating income to Amazon’s U.S. business from the subsidiary in low-tax Luxembourg.

Sign at Amazon.com fulfillment center in Hemel Hempstead, U.K.
A sign at an Amazon.com fulfillment center in Hemel Hempstead, U.K. Chris Ratcliffe/Bloomberg

In a series of transactions in 2005 and 2006, Amazon had transferred three groups of intangible assets to the Luxembourg subsidiary, including the software and technology used to run its European websites, fulfillment centers and related businesses; marketing intangibles such as trademarks and domain names for the European business; and customer lists and other information relating to Amazon’s European customers.

The court had to decide on the proper amounts of Amazon’s “buy-in obligation” for the assets it had transferred, along with the proper amount of intangible development costs.

Amazon had originally reported a buy-in payment from the European subsidiary of $254.5 million, to be paid over seven years. However, in its examination of Amazon’s returns, the IRS concluded the buy-in payment had not been determined at arm’s length. The IRS contended that the transferred property had an indeterminate useful life and had to be valued not as three separate groups of assets, but as integrated components of the same operating business. In applying a discounted cash flow methodology to the cash flows anticipated from the European business, the IRS determined a buy-in payment of $3.6 billion, which was later reduced to $3.468 billion.

However, Amazon argued that the discounted cash flow methodology used by the IRS was substantially the same as one the Tax Court had rejected in a 2009 case involving Veritas Software. It disputed the conceptual soundness of the IRS’s methodology, contending that it treated short-lived intangibles as if they had perpetual useful lives. Amazon argued the IRS was inflating the buy-in payment by improperly including the value of subsequently developed intangible property in it.

The Tax Court sided with Amazon, concluding Thursday that the IRS’s valuation approach was “arbitrary and capricious.”

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.