Compass Lexecon's Client Amazon Prevails in IRS Transfer Pricing Dispute
Compass Lexecon Experts, Professors Bradford Cornell and Robert Willig, Testify Successfully at Trial
In November 2014 Compass Lexecon experts, Professors Bradford Cornell and Robert Willig, testified in United States Tax Court on behalf of Amazon in a highly-publicized billion dollar transfer pricing suit. In its opinion filed on March 23, 2017, the United States Tax Court ruled in favor of Amazon, stating that the IRS' determination as to a buy-in payment "is arbitrary, capricious, and unreasonable." The press has subsequently described the opinion as a huge billion dollar plus victory for Amazon. According to its annual report, had the IRS prevailed, Amazon would have owed additional federal tax for 2005 and 2006 of approximately $1.5 billion plus interest.
This dispute centered around a complex 2005 restructuring transaction between Amazon.com Inc. and one of its European subsidiaries in which the parties entered a cost-sharing agreement and Amazon provided use of its technology, trademarks, customer information and other valuable intangible assets to that subsidiary in exchange for a "buy-in" payment. The IRS and its experts argued that these valuable intangible assets had a perpetual useful life and should be valued using a discounted cash flow ("DCF") model resulting in a buy-in payment of approximately $3.5 billion.
Compass Lexecon valuation expert, Professor Cornell, rebutted the testimony of the IRS' primary transfer pricing expert, arguing that his DCF model and perpetual useful life assumption improperly valued the entire enterprise value of Amazon's European business, not just the transferred IP. Professor Cornell also testified that the IRS's expert's methodology overstated the value attributable to the transferred intangibles by not accounting for the depreciation and economic life of those assets and by incorrectly including value attributable to assets other than those provided under the buy-in payment, such as the value of "growth options."
Compass Lexecon microeconomics expert, Professor Willig, rebutted the testimony of this IRS expert by explaining how the IRS' approach to valuing the transferred intangibles was inconsistent with accepted microeconomic principles because, among other things, the approach failed to account for the useful economic life and decay of the transferred intangible assets, how discounting must be accordingly modified, and how asset value is bounded by the costs of economic substitutes.
The Court concurred with Professors Cornell and Willig, stating that, by assuming a perpetual useful life, the IRS' expert "failed to restrict his valuation to the pre-existing intangible property" by including "many items of value that are not 'intangibles,'" and therefore "his approach violated the cost sharing regulations and must be rejected for that reason."
Professors Cornell and Willig were supported by Rajiv Gokhale, Peter Clayburgh, Eric Madsen, Avisheh Mohsenin, Glenn Mitchell, Marc Huntley, Keming Liang, Margaret Hlebowitsh, Constance Kelly, Kimberly George, and others in Compass Lexecon's Chicago and Pasadena offices. We worked closely with John B. Magee and Sanford W. Stark of Morgan, Lewis & Bockius LLP, Raj Madan and Royce L. Tidwell of Skadden, Arps, Slate, Meagher & Flom LLP, and Bryon Christensen of Amazon.com Inc.