IRS Spurns Tax Court’s Analysis in Amazon Transfer Pricing Case

AMAZON.COM, INC. AND SUBSIDIARIES,
Petitioners-Appellees
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant

IN THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

ON APPEAL FROM THE DECISION OF THE
UNITED STATES TAX COURT

BRIEF FOR THE APPELLANT

RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General

TRAVIS A. GREAVES
Deputy Assistant Attorney General

GILBERT S. ROTHENBERG
(202) 514-3361

ARTHUR T. CATTERALL
(202) 514-2937

JUDITH A. HAGLEY
(202) 514-8126

Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

---

TABLE OF CONTENTS

Table of contents

Table of authorities

Glossary

Statement of jurisdiction

Statement of the issue

Applicable statutes and regulations

Statement of the case

Summary of argument

Argument

Conclusion

Statement of related cases

Addendum

Certificate of compliance

Certificate of service

TABLE OF AUTHORITIES

Cases:

Statutes:

Regulations:

Miscellaneous:

GLOSSARY

Amazon-LUX	Amazon's affiliated Luxembourg corporations
Amazon-US	Amazon's affiliated U.S. corporations
CUT	Comparable-uncontrolled-transaction method
DCF	Discounted-cash-flow method
ER	Excerpts of record filed by the Commissioner
IRS	Internal Revenue Service
Op/ER	Tax Court opinion
R&D	Research and development

---

STATEMENT OF JURISDICTION

Amazon.com, Inc. is the common parent of an affiliated group of U.S. corporations (Amazon-US) that filed consolidated federal income tax returns for 2005-2006. On November 9, 2012, the IRS issued a notice of deficiency to Amazon-US for those years. (ER252A.) See I.R.C. § 6212(a). On December 28, 2012, within 90 days of that notice, Amazon-US timely filed a petition for redetermination in the United States Tax Court. (ER832.) See I.R.C. § 6213(a). The Tax Court had jurisdiction under Section 6213(a). See I.R.C. § 7442.

The Tax Court entered a decision on July 5, 2017. (ER208.) That decision constituted a final judgment, disposing of all claims of all parties. See I.R.C. § 7459(a). On September 29, 2017, within 90 days after entry of the decision, the Commissioner timely filed a notice of appeal with the Tax Court. (ER210.) See I.R.C. § 7483. This Court has jurisdiction under I.R.C. § 7482(a)(1).

STATEMENT OF THE ISSUE

This case concerns a U.S. taxpayer that developed highly profitable intangibles and then made them available to a newly created foreign affiliate pursuant to a cost-sharing arrangement for the development of future intangibles. Although the U.S. taxpayer controlled the foreign affiliate, the affiliate's income was not subject to U.S. tax. Section 482 of the Internal Revenue Code and its implementing regulations require the foreign affiliate to pay the U.S. taxpayer an arm's-length amount for the use of the existing intangibles. The question presented is:

Whether the Tax Court wrongly concluded that the method utilized by the Commissioner to determine an arm's-length price for the use of the intangibles at issue violates Section 482's implementing regulations.

APPLICABLE STATUTES AND REGULATIONS

The applicable statutes and regulations are included in this brief's addendum.

STATEMENT OF THE CASE

A. Procedural overview

This case involves a multinational company that priced intercompany transactions in a manner that did not clearly reflect its income subject to U.S. taxation. Section 482 of the Internal Revenue Code is designed to prevent such behavior and grants the Commissioner broad discretion to reallocate income among related parties by determining the arm's-length price for intercompany transactions.

The IRS utilized Section 482 to determine substantial deficiencies in Amazon-US's federal income tax for 2005 and 2006. The deficiencies stem from a cost-sharing arrangement for the development of future intangibles between Amazon-US and a newly formed foreign subsidiary (Amazon-LUX) that was intended to be a “qualified cost sharing arrangement” under Treasury's cost-sharing regulations. In entering into the arrangement, Amazon-US provided Amazon-LUX access to its entire panoply of pre-existing intangible assets. To comply with the regulations, Amazon-LUX was required to pay an arm's-length amount for the use of those pre-existing intangibles (buy-in payment). The IRS determined that Amazon-US's calculation of the buy-in payment, with a present value of $217 million, understated Amazon-LUX's buy-in obligation by over $2.7 billion.¹

Amazon-US filed a petition in the Tax Court challenging the deficiencies. After a trial, the court concluded that neither party had determined an arm's-length price for the buy-in payment. The court determined that the Commissioner's proposed method for computing the buy-in payment was unreasonable because it included items that (in the court's view) were outside the scope of the regulations' buy-in requirement. After making adjustments to Amazon-US's method, the court entered a decision reflecting an increased buy-in payment of $779 million. The Commissioner has appealed.

B. Regulatory overview

1. Transfer pricing

U.S. corporations operating through related enterprises, including affiliated foreign corporations, have long attempted to manipulate their intra-group transactions in order to avoid U.S. tax. For example, a U.S. corporation might allow its foreign subsidiary to operate a business overseas by using valuable intangibles created by the U.S. corporation without charging the foreign subsidiary an arm's-length price for those intangibles. If the use of the intangibles was worth $4 billion, but the U.S. corporation allowed the foreign subsidiary to use them for free, the U.S. corporation's income subject to U.S. taxation would be understated by $4 billion, a clear distortion of income.

To combat such abuse, Congress — for almost 100 years — has given the IRS the “broad authority” to evaluate the pricing of transactions between related parties (Op/ER67), and to allocate certain tax items (including gross income) between or among the parties “if [it] determines that such . . . allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such” entities. I.R.C. § 482. Under regulations implementing Section 482, the taxable income of related parties is determined as if they had conducted their affairs in the manner of unrelated parties “dealing at arm's length.” § 1.482-1(b)(1).² Specifically, a related-party transaction “meets the arm's length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.”

Id. Using the example above, if the U.S. corporation had made its valuable intangibles available to an unrelated party, it would have charged that party $4 billion for such use. Section 482 allows the IRS to place the related taxpayers on par with unrelated parties and allocate $4 billion of income to the U.S. corporation.

Any transfer of property (or the use of property) between related parties must be accompanied by arm's-length consideration. The regulations divide property into two discrete categories — tangible property and intangible property. §§ 1.482-3 and 1.482-4. There is no category of property that can be transferred for free or for less than an arm's-length amount. As the regulations emphasize, the “standard to be applied in every case is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer.” § 1.482-1(b)(1).

This case involves intangible property. The regulations broadly define intangibles to include any asset that “has substantial value independent of the services of any individual” and “derives its value not from its physical attributes but from its intellectual content or other intangibles properties.” § 1.482-4(b)(6). The regulations list 28 examples of intangibles — such as patents, systems, and procedures — but make clear that intangibles are not limited to the items specifically listed but also include “[o]ther” assets that similarly derive their value from their “intangible properties.”³ § 1.482-4(b)(1)-(6).

2. Valuing intangibles

Ensuring that multinationals pay an arm's-length amount for intangibles they create in the United States (often with substantial tax benefits) and then transfer to foreign affiliates is an ongoing problem for tax enforcement. For many years, the arm's-length price for intangible transfers was determined almost exclusively by reference to actual transfers between unrelated parties purportedly involving “the same or similar intangible property under the same or similar circumstances.” 33 Fed. Reg. 5848, 5853 (1968). By the mid-1980s, however, Congress had become concerned that this approach (which depended on identifying comparable transactions) was undervaluing intangible transfers. Joint Committee on Tax'n, Gen'l Explanation of the Tax Reform Act of 1986, JCS-10-87, at 1014-1016 (1987).

In particular, and as relevant to this case, Congress was concerned about U.S. taxpayers “transferring relatively high profit intangibles” to foreign affiliates operating “in a low tax jurisdiction” without requiring the foreign affiliate to pay the U.S. taxpayer a price that was “commensurate with the income attributable to the intangible.” H.R. Rep. No. 99-426, at 423, 425 (1985). To remedy this problem, and prevent U.S.-created intangibles from migrating to foreign affiliates for less than an arm's-length amount, Congress added the following sentence to Section 482 in 1986:

In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.

Tax Reform Act of 1986, P.L. 99-514, § 1231(e)(1) (codified at I.R.C. § 482). The stated “objective” of the 1986 amendment — known as the commensurate-with-income requirement — was to ensure “that the division of income between related parties reasonably reflect the relative economic activity undertaken by each.” H.R. Rep. No. 99-841, at II-637 (1986) (Conf. Rep.). Congress also directed Treasury to evaluate its transfer-pricing regulations and consider “whether [they] could be modified in any respect.” Id. at II-638.

In response, Treasury overhauled its Section 482 regulations, promulgating final transfer-pricing regulations in 1994 (§§ 1.482-1 through 1.482-6, 1.482-8) and final cost-sharing regulations in 1995 (§ 1.482-7), which are the regulations at issue here. To prevent taxpayers from undervaluing intangibles, the 1994 regulations heightened the comparability standards for reliance on purportedly comparable transactions between unrelated parties, referred to as the comparable-uncontrolled-transaction (CUT) method, § 1.482-4(c). The 1994 regulations also provided alternative methods that, in many instances, could more reliably provide an arm's-length price for unique intangible transfers, including (as relevant to this case) “unspecified methods” described in § 1.482-4(d). The regulations require that the “best method” — the method providing the most reliable arm's-length result — be utilized. § 1.482-1(c).

Unlike the CUT method, an unspecified method does not depend on identifying a comparable uncontrolled transaction, which may not exist for any particular intangible or bundle of intangibles. To the contrary, the regulation addressing unspecified methods contemplates that such a method should take into account the economic benefits the transferor could have realized had it not transferred the intangible at all. See § 1.482-4(d)(1). This approach reflects the “principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction and only enter into a particular transaction if none of the alternatives is preferable to it.” Id. For example, if the U.S. owner of an intangible could have reasonably expected to receive $4 billion (net present value) in future cash flows had it exploited the intangible itself in a foreign market, then it would not have licensed that intangible to an uncontrolled party for anything less than $4 billion, which would represent the minimum arm's-length consideration (net present value) for its license of the intangible to a foreign subsidiary.

3. Qualified-cost-sharing arrangements

The transfer of intangibles in this case arose in the context of a cost-sharing arrangement. Under a qualified-cost-sharing arrangement, related parties (typically a U.S. parent and its foreign subsidiary) agree to share intangible-development costs in proportion to their shares of reasonably anticipated benefits from exploiting any resulting intangible assets in their assigned areas (e.g., North America for the U.S. parent; Europe for the foreign subsidiary). See § 1.482-7A(a)(1).⁴ Such arrangements provide taxpayers transfer-pricing certainty because new intangibles need not be valued as they are developed by the parent and licensed to the subsidiary; rather, all cost-sharing participants are considered co-owners of the new intangibles. Because the U.S. parent typically incurs the lion's share of the costs, the foreign subsidiary ends up making a cost-sharing payment to the U.S. parent each year, which increases the U.S. parent's taxable income.

Intangible-development activities that are cost-shared on a going-forward basis typically do not start from scratch; rather, such activities usually benefit from, and build upon, the U.S. parent's existing intangibles. Attempts by cost-sharing participants to utilize these “head-start” pre-existing intangibles without paying arm's-length consideration has been an ongoing challenge for tax enforcement.

Congress highlighted that problem in 1986 when it amended Section 482. to combat multinationals' abuses regarding intangible-property transfers. H.R. Rep. No. 99-841, at II-638. As Congress explained, if “one party [to a cost-sharing arrangement] is actually contributing funds toward research and development at a significantly earlier point in time than the other, or is otherwise effectively putting its funds at risk to a greater extent than the other, it would be expected that an appropriate return would be required to such party to reflect its investment.” Id.

Treasury addressed Congress's concern when it promulgated the 1995 regulations by enacting an explicit buy-in requirement for pre-existing intangibles made available for use in cost-sharing arrangements. Pursuant to these regulations, a foreign subsidiary must pay an “arm's length charge” for the intangibles that its U.S. parent “made available” in the cost-sharing arrangement “for purposes of research in the intangible development area.” § 1.482-7A(g)(2). To determine the amount of that buy-in payment, the 1995 regulations incorporate by reference the definition of intangibles (§ 1.482-4(b)) and the methods for valuing intangibles (§§ 1.482-4 through 1.482-6) provided in the 1994 regulations. § 1.482-7A(a)(2), (g). The buy-in payment also must satisfy the general rules applicable to all transfer pricing (§ 1.482-1), in particular the arm's-length standard. § 1.482-7A(g)(1) (cross-referencing § 1.482-1).

A buy-in payment is required for pre-existing intangibles used in the development of subsequent intangibles, even if the pre-existing intangibles are not formally transferred to the foreign affiliate. If the U.S. parent “makes” intangible property “available” for use in subsequent development, it “will be treated as having transferred” those intangibles, and the foreign subsidiary “must make a buy-in payment” as consideration for the use thereof. § 1.482-7A(g)(1), (2). The buy-in payment can be made in the form of a lump-sum payment, installment payments, or royalties, so long as it results in an “arm's length charge.” § 1.482-7A(g)(2)&(7).

C. Amazon

Amazon.com and its U.S. and foreign subsidiaries (collectively Amazon) operate the world's leading online retail business. (ER409.) Amazon began operations in the United States in 1995 and expanded into Europe in 1998. (Op/ER10-13.) During the tax years at issue (2005-2006), Amazon's European operations (European Business) were limited to the UK, Germany, and France. (Op/ER13.)

From 1999-2005, Amazon-US was the inventory owner and seller of record with respect to Amazon's European Business, which rendered the associated profits/losses reportable on Amazon-US's U.S. income tax return. (Op/ER16-17.) Amazon subsidiaries organized in the UK, Germany, and France (collectively the European Subsidiaries) provided support services to Amazon-US in connection with its European Business. (Op/ER16-17; ER959-961.)

By 2004, Amazon's European Business accounted for one third of its worldwide revenues, with 23-30% annual growth expected from 2005-2011. (ER395, 413.) The key to this expected success was the bundle of intangibles that Amazon-US created during the first decade of its existence. (Op/ER18; ER255-258, 321-329, 657.) Those intangibles included licensable items such as technology and trademarks and — importantly — items traditionally considered inseparable from the business itself such as corporate culture and workforce-in-place. Perhaps the most valuable item in this latter category was Amazon-US's culture of continuous innovation. (Op/ER24, 29.) This corporate culture, which set Amazon apart from other companies, fell under the rubric of what the parties referred to as “growth options.” (ER684-687, 700-714, 749-752, 782.) To develop its bundle of intangibles, Amazon-US spent almost $1.5 billion during its first decade (1995-2004). (ER334.)

D. Amazon's IP Migration Project

In the early 2000s, Amazon decided to restructure the ownership of its European Business by transferring it from Amazon-US to a group of newly formed Luxembourg subsidiaries (collectively Amazon-LUX). (Op/ER20-26; ER219, 225-251.) The restructuring was described as the “IP Migration Project” (later renamed Project Goldcrest) because all of the intangibles that Amazon-US had created to operate the business were transferred, or made available, to Amazon-LUX. (ER669-670, 863-928.)

Because Amazon-US generally was not subject to U.S. federal income tax on foreign income earned by its foreign affiliates (unless that income is repatriated to Amazon-US as a dividend), Amazon expected to significantly lower its worldwide corporate income tax by transferring its European Business to Amazon-LUX. (Op/ER20; ER330-332, 664-666.) Amazon projected that, by implementing the IP Migration Project, it would avoid more than $1 billion in U.S. tax during 2005-2010 alone, with more tax savings expected in subsequent years. (ER656-660, 929-938, 942-943.) In addition, by utilizing a holding company structure with respect to Amazon-LUX — pursuant to which Amazon-US would license the intangibles to the Luxembourg holding company, which would then sub-license the intangibles to the Luxembourg operating company beneath it — Amazon expected to avoid Luxembourg taxation on most of Amazon-LUX's income. (ER252B-252E, 654-655, 661-662, 957-958.) Before implementing the IP Migration Project, Amazon worked out a deal with the Luxembourg taxing authorities whereby they agreed that the royalty payable by the operating company to the holding company would be an amount sufficient to “soak up” almost all of the operating company's income that would otherwise be subject to Luxembourg tax. (Id.) Because the holding company — although treated as a corporation for U.S. tax purposes and therefore not subject to U.S. tax — was treated as a partnership with U.S. partners for Luxembourg tax purposes, the royalty it received from the operating company would not be subject to Luxembourg tax. (ER223, 252B-252E, 330-332, 642-657, 661-663, 957-958.)

Amazon implemented the IP Migration Project through a series of integrated transactions in 2005-2006. (Op/ER22; ER219, 225-251, 863-928.)

• In January 2005, Amazon-US entered into a Cost-Sharing Agreement with Amazon-LUX. (ER259-282.) Through that arrangement, Amazon-LUX would benefit from the full panoply of pre-existing intangibles that Amazon-US brought to bear on the development of subsequent intangibles. (ER684-686, 704-705.) In exchange for its future cost-sharing payments (and a buy-in payment with respect to the pre-existing intangibles), Amazon-LUX obtained the right to exploit any resulting intangible assets in Europe.

• At the same time, Amazon-US and Amazon-LUX entered into a License Agreement whereby Amazon-US licensed its existing technology-related intangibles to Amazon-LUX. (ER283-295.) In exchange, Amazon-LUX agreed to pay $226 million for the use of these intangibles in seven annual installments beginning in 2005. (ER220-222.)

• In July 2005, Amazon-US and Amazon-LUX entered into an Assignment Agreement whereby Amazon-US assigned to Amazon-LUX customer data and certain marketing intangibles (including trademarks, website content, and domain names) relating to the European Business. (ER296-320.) In exchange, Amazon-LUX agreed to pay $28 million for these intangibles in six annual installments beginning in 2006. (ER221-222.)

• In February 2006, Amazon.com transferred the stock of the European Subsidiaries to Amazon-LUX in exchange for consideration worth $196 million. (Op/ER25.) After the transfer, the European Subsidiaries provided Amazon-LUX the same support services in connection with the European Business that they previously had provided Amazon-US. (Op/ER17, 26.)

• In April-May 2006, Amazon-US effected the transfer of the remaining assets related to its European Business (including the inventory) to Amazon-LUX in exchange for consideration worth $200 million. (Op/ER25-26; ER253.)

• At the same time, the European Subsidiaries assigned to Amazon-LUX certain marketing intangibles that they owned (the “European Portfolio”) for $5 million. (Op/ER26, 154; ER609-612.)

Amazon-LUX's buy-in payment

Amazon intended the Cost-Sharing Agreement to be a “qualified cost sharing agreement” within the meaning of § 1.482-7A(a)(1). (ER259.) If it qualified, Amazon-LUX would be able to obtain partial ownership of intangibles subsequently developed by Amazon-US in exchange for paying its share of subsequently incurred intangible-development costs. (Op/ER23.) To qualify for this arrangement, however, Amazon-LUX was required to pay Amazon-US for its pre-existing intangibles made available for developing the subsequent intangibles (a payment that would increase Amazon-US's income for tax purposes). (Op/ER69 (citing § 1.482-7A(g)); ER640-641.)

To compute the buy-in payment, Amazon-US relied on a transfer-pricing study performed by Deloitte LLP. (Op/ER51-52; ER641.) Deloitte concluded that an income-based unspecified method contemplated in § 1.482-4(d) was the most reliable measure of an arm's-length price for the intangibles. (Op/ER52; ER683.) Applying that method, Deloitte first computed Amazon-LUX's expected profit for 2005-2011, relying on Amazon-US's profit projections for the European Business, and then allocated a portion of that profit to the pre-existing intangibles. (Op/ER53.) Deloitte limited its profit analysis to 2005-2011 because it assumed that the pre-existing intangibles would contribute to Amazon-LUX's profits for only 7 years. (Op/ER7, 53; ER356-370, 746-748.) Deloitte concluded that the pre-existing intangibles were worth $217 million, a buy-in amount representing the present value of the installment payments due from Amazon-LUX under the License Agreement ($226 million) and Assignment Agreement ($28 million). (Op/ER53; ER222.)

The Commissioner rejected Amazon-US's buy-in calculation, determining that it grossly undervalued the bundle of intangibles that Amazon-US made available to Amazon-LUX in conjunction with the parties' cost-sharing arrangement. (Op/ER7.) Amazon-US then sought review of that determination in the Tax Court.

F. Tax Court proceedings

During the Tax Court proceedings, the parties disputed which of the regulatory methods for valuing intangibles provided for in § 1.482-4 was the best method for determining an arm's-length price for the bundle of intangibles that Amazon-US made available to Amazon-LUX: an income-based unspecified method (as the Commissioner argued) or the CUT method (as Amazon-US argued).⁵ That dispute was predicated, in significant part, on the parties' interpretation of the regulatory definition of intangibles set out in § 1.482-4(b) and incorporated by reference in § 1.482-7A(a)(2).

1. The Commissioner's transfer-pricing method (DCF)

The Commissioner determined that an unspecified method — the discounted-cash-flow method (DCF) — was the best method for valuing the bundle of intangibles that Amazon-US made available to the cost-sharing arrangement. (ER373-374, 453-456.)

The DCF is commonly used by economists and businesses (including Amazon itself) to value intangibles, and is based on the principle that an asset's current value is equal to the present value of the net cash flows that it is expected to generate in the future. (ER456, 542-543, 772-777, 955-956.) Because future cash flows are subject to risk, the DCF discounts the estimated future cash flows to a present value using a discount rate that reflects not only the time value of money, but also the riskiness of the assets — the higher the risk, the higher the discount rate, and the lower the present value. (ER380-381, 772.) The appropriate discount rate is the rate of return that market participants would require for similar investments, that is, their cost of capital. (ER560, 695-700.) As long as one has access to reliable projections of expected future cash flows and the associated cost of capital, the DCF is viewed as an accurate estimate of value. (ER544.) In this case, the Commissioner's expert (Frisch) had access to Amazon's own revenue projections for the European Business, as well as Amazon's weighted average cost of capital. (ER468-473, 718-720.) The goal was to establish the expected cash flows of the European Business and then determine the portion thereof attributable to Amazon-US's pre-existing intangibles.

Frisch began by projecting Amazon-LUX's cash flows for 20 years (2005-2024) and calculating a terminal value⁶ to account for subsequent cash flows. (ER718-719, 953.) For 2005-2011, Frisch utilized Amazon management's projections that the European Business would experience 23-30% annual growth; for 2012-2024, he assumed only 3.8% annual growth. (ER374-378, 721-722.)

Frisch made several adjustments to the European Business's projected cash flows to isolate the cash flows attributable to Amazon-US's pre-existing intangibles. First, he subtracted Amazon-LUX's contributions to the business, including its tangible assets, its projected cost-sharing payments to Amazon-US, and the contributions of the European Subsidiaries (which, after the restructuring, were owned by Amazon-LUX). (ER468-469, 724-725, 735-736.) He then applied an 18% discount rate to the remaining net cash flows to compute the present value of the pre-existing intangibles. (ER473-474.) Frisch explained that, after adjusting the cash flows to account for Amazon-LUX's contributions, the remaining projected cash flows are necessarily attributable to Amazon-US's pre-existing intangibles. (ER457-465, 474-475.)

Frisch's largest adjustment related to the cost-sharing payments that management projected Amazon-LUX would make in the future. (ER708.) This adjustment was designed to ensure that Amazon-LUX did not pay twice for the subsequently developed intangibles (that is, once through the cost-sharing payments and once through the buy-in payment). (ER725-727, 730.) The adjustment had the effect (for purposes of computing the buy-in payment) of giving Amazon-LUX a projected 18% return on its projected cost-sharing payments. (ER708.) The projected 18% return was the market rate of return that an unrelated party would have expected to earn on its cost-sharing payments had it entered into a cost-sharing arrangement with Amazon-US under the same circumstances as those presented here. (ER380-381, 573-578, 723, 737-740.) But, as Frisch emphasized, his DCF did not cap Amazon-LUX's returns at 18%; under his model, any actual returns that exceeded projected returns would redound entirely to Amazon-LUX's benefit. (ER740-744, 759-763.)

Frisch concluded that an unrelated party in Amazon-LUX's position would have been willing to make a buy-in payment of $2.9 billion.⁷ (ER381-384, 953.) The bulk of that amount ($2.6 billion) was the value that the pre-existing intangibles added to the European Business during the first 20 years; the remaining $300 million was their terminal value. (ER953.)

The Commissioner argued that Frisch's DCF analysis was supported by the realistic-alternatives principle set forth in the transfer-pricing regulations, §§ 1.482-1(f)(2)(ii), 1.482-4(d)(1). As Frisch explained, $2.9 billion was the present value of the cash flows that Amazon-US would have expected its pre-existing intangibles to generate in the European Business over time had it opted for its realistic alternative of not entering into the cost-sharing arrangement and continuing to operate the European Business as it had before. (ER363-370, 433, 953.)

Amazon-US argued that the Commissioner's DCF method was foreclosed as a matter of law because it “includes in the buy-in substantial value attributable to residual values that are not compensable.” (ER801.) In particular, Amazon-US argued that “growth options” are “non-compensable” intangibles under § 1.482-4(b). (ER796, 801-803.) Amazon-US's expert (Cornell) acknowledged that “Amazon's significant growth options (i.e., its unique business attributes and expectancies)” (ER340-341) were immensely valuable intangibles that parties dealing at arm's length would have paid for (ER685-686). He nevertheless opined that Frisch's DCF valuation was not the best method because — based on instructions from Amazon-US's counsel (ER688-690) — he understood that growth options “were not subject to a buy-in payment” under the regulations (ER340-341) but could instead be transferred “for free” (ER693).⁸

2. Amazon-US's transfer-pricing method (CUT)

Amazon-US argued that the best method for valuing the specific intangibles that it agreed were compensable — technology intangibles, marketing intangibles, and customer information — was the CUT method. (Op/ER89.) The CUT method determines an arm's-length price for a controlled transaction by reference to the price in a comparable uncontrolled transaction. § 1.482-4(c)(1). The experts were unable to locate a comparable transaction that involved the full bundle of intangibles. (ER691-692, 753-754, 771.) Instead, they determined a buy-in price for the website technology, marketing intangibles, and European customer information as if they had been transferred separately. (Op/ER89-90.) Amazon-US's CUT analysis resulted in a buy-in payment of $350 million. (ER798.)

The Commissioner's experts applied an alternative CUT method (in support of his primary DCF method) to value the same discrete set of intangibles and concluded that Amazon-US's CUT analysis grossly undervalued those intangibles. (Op/ER90-173.) In particular, the Commissioner argued that Amazon-US's analysis incorrectly limited the value of the three sets of intangibles on the basis of their purported useful lives and decay rates. (ER807, 816-817.) That limitation, the Commissioner contended, disregarded the role that the pre-existing intangibles played in the development of future intangibles — a significant value-driver that (in the Commissioner's view) was part of § 1.482-7A(g)'s buy-in requirement. (ER572-578, 783-785.)

3. Tax Court's opinion

The Tax Court determined that neither party's transfer-pricing analysis was reasonable. (Op/ER89-90.) The court first addressed the Commissioner's DCF method. (Op/ER73-88.) It accepted Frisch's primary inputs, finding (i) that the 18% discount rate utilized by Frisch was “appropriate” (Op/ER126), and (ii) that Frisch's projections that the “revenue, expenses, and operating income of the European business would grow at 3.8% per year” after 2011 was “conservative and reasonable” (Op/ER74 & n.15). The court nevertheless agreed with Amazon-US that the Commissioner's DCF method was foreclosed by the regulations. (Op/ER88 & n.22.) The court identified two legal reasons why (in its view) the Commissioner had abused his discretion in using the DCF method to calculate the buy-in payment.

First, the Tax Court found that the DCF's “enterprise valuation of a business includes many items of value that are not 'intangibles' as defined [in § 1.482-4(b)]. These include workforce in place, going concern value, goodwill, and what trial witnesses described as 'growth options' and corporate 'resources' or 'opportunities.'” (Op/ER79.) The court determined that such “residual business assets” do “not constitute 'pre-existing intangible property' under the cost-sharing regulations in effect during 2005-2006.” (Op/ER82.) The court did not address whether a company entering into a cost-sharing arrangement with an unrelated party would make these “items of value” available to the other party without any charge. (Op/ER73-88.)

Second, the Tax Court determined that the DCF method “improperly aggregates pre-existing intangibles (which are subject to the buy-in payment) and subsequently developed intangibles (which are not)” by calculating the value of the pre-existing intangibles by reference (in part) to future cash flows associated with subsequently developed intangibles. (Op/ER82.) The court rejected the Commissioner's argument that this approach was necessitated by § 1.482-7A(g)(2), which requires arm's-length consideration for the use of pre-existing intangibles “for purposes of research in the intangible development area.” (Op/ER87-88.) The court also rejected the Commissioner's reliance on the realistic-alternatives principle, holding that his analysis conflicted with the regulations. (Op/ER83-84.)

The Tax Court next addressed the CUT method. The court agreed with Amazon-US that it was the best method because it was limited to the three categories of intangibles that the court determined were compensable under the regulations. (Op/ER89-90.) The court, however, rejected both parties' CUT analyses. (Op/ER89-173.) The court's CUT analysis resulted in a buy-in payment of $779 million.⁹ (ER217.)

SUMMARY OF ARGUMENT

This case involves a multinational company (Amazon) that shifted a substantial amount of its income from its U.S. consolidated group (Amazon-US) to its foreign affiliate (Amazon-LUX) in a manner that did not clearly reflect Amazon-US's true income. That income-shifting resulted from an artificially low buy-in payment that Amazon-US charged for the extraordinarily valuable pre-existing intangibles it made available to Amazon-LUX in conjunction with a cost-sharing arrangement.

Section 482 and its implementing regulations require that participants in a cost-sharing arrangement pay arm's-length consideration for the use of pre-existing intangibles that other participants make available to the arrangement. Applying those regulations, the Commissioner determined that the best method to calculate the mandatory arm's-length charge was the discounted-cash-flow (DCF) method, a method commonly used to value intangibles. It further determined that Amazon-US had undervalued its pre-existing intangibles by $2.7 billion. The Tax Court disagreed, holding that the Commissioner's DCF method violates the relevant Treasury regulations because it (i) includes intangibles that were not (in the court's view) compensable under those regulations and (ii) values the pre-existing intangibles in part by reference to future cash flows associated with subsequently developed intangibles.

1. The Tax Court erred as a matter of law in failing to require Amazon-LUX to compensate Amazon-US for the valuable growth options and other residual-business assets it made available to the cost-sharing arrangement. The Treasury regulations broadly define intangibles and do not exclude residual-business assets from the scope of the buy-in requirement. The court's narrow interpretation of the regulations is supported by neither their language nor their history. Moreover, that interpretation would allow U.S. corporations to provide access to intangibles worth billions of dollars to offshore affiliates for free, even though it is undisputed that parties dealing at arm's length would have required payment. Because this interpretation would “stultify” Section 482's “purpose” — which is “to ensure that taxpayers clearly reflect income attributable to controlled transactions,” § 1.482-1(a)(1) — it should be rejected. Xilinx, Inc. v. Commissioner, 598 F.3d 1191, 1195-1196 (9th Cir. 2010).

2. The Tax Court further erred as a matter of law in holding that the regulations prohibit the Commissioner from determining the arm's-length buy-in payment by reference (in part) to projected cash flows associated with future intangibles the parties anticipate will result from the cost-sharing arrangement. The court's holding in that regard fails to acknowledge that Amazon-US's pre-existing intangibles — as well as the parties' intangible-development expenditures — contributed to the development of new intangibles under the arrangement. And Treasury regulations require that arm's-length consideration be paid for that contribution to value. The court's contrary determination — that such value could be transferred for free — runs counter to the raison d'être of Section 482 and the regulations thereunder.

3. Because the Commissioner's DCF method accounts for the full value of all the pre-existing intangibles — as defined in § 1.482-4(b) — that Amazon-US made available to the cost-sharing arrangement, he could not have abused his discretion in selecting that method to determine the arm's-length buy-in payment. Moreover, the Tax Court's CUT analysis necessarily is unreasonable because it indisputably did not include the value of Amazon-US's residual-business intangibles. This Court should therefore vacate the Tax Court's decision and remand the case for a proper application of the Commissioner's DCF method to the facts of this case.

ARGUMENT

Standard of review

This case concerns whether Section 482 and the related regulations require Amazon-LUX to compensate Amazon-US (i) for all of the valuable intangibles Amazon-US made available to the parties' cost-sharing arrangement, including those that may not be separable from the business itself (“residual-business assets”), and (ii) for the full value of the use of those intangibles in conjunction with that arrangement. Those issues raise legal questions, which are reviewed “de novo.” DHL Corp. v. Commissioner, 285 F.3d 1210, 1216 (9th Cir. 2002). The Commissioner raised these issues during the Tax Court proceedings. E.g., ER808-830.

A. Introduction

“Section 482 gives the Commissioner broad discretion to place controlled taxpayers in the same position as uncontrolled taxpayers dealing at arms-length.” Peck v. Commissioner, 752 F.2d 469, 472 (9th Cir. 1985). The Commissioner's broad discretion is particularly important in the context of U.S.-based multinational companies, given their ability to erode the U.S. tax base by transferring or licensing income-producing property to foreign affiliates operating in low-tax jurisdictions through pricing that does not reflect an arm's-length result. See Jane Gravelle, Tax Havens: International Tax Avoidance & Evasion, Cong. Research Serv. No. R40623 at 1 (2015) (estimating U.S. revenue loss from “corporate profit shifting” as $10-90 billion per year). The problem is most acute with regard to intangibles, the valuation of which is easily manipulated by taxpayers. Id. at 12; see Franklin Foer, World Without Mind: The Existential Threat of Big Tech 196-197 (2017) (observing how in “Project Goldcrest,” Amazon “drastically understated the value of the assets it shifted to Luxembourg”); Harry Davies, Revealed: How Project Goldcrest Helped Amazon Avoid Huge Sums in Tax, Guardian, Feb. 18, 2016 (observing how “technology giants minimise their tax bills by shifting valuable — but difficult to value — intellectual property into offshore havens”); Simon Marks, Amazon: How the World's Largest Retailer Keeps Tax Collectors at Bay, Newsweek, July 13, 2016 (describing how Amazon “undervalue[d]” the intangibles transferred in “Project Goldcrest” for U.S.-tax purposes and, at the same time, “inflated” their value for Luxembourg-tax purposes in order to avoid tax in both jurisdictions); ER330-332, 642-663, 929-938, 957-958.

As detailed above, since 1986, Congress and Treasury have taken steps to prevent such manipulations. See Statement of the Case § B. The regulations at issue in this appeal — the 1994 (§§ 1.482-1, 1.482-4) and 1995 (§ 1.482-7A) transfer-pricing regulations — implement Congress's reform initiative.

The Tax Court's decision thwarts these remedial efforts. The court's rejection of the Commissioner's DCF method, and its reliance on the CUT method to value only part of the bundle of intangibles that Amazon-US made available to Amazon-LUX in conjunction with the cost-sharing arrangement, violate the 1994 and 1995 regulations. Those regulations require Amazon-LUX to compensate Amazon-US (i) for all pre-existing intangibles made available to Amazon-LUX, including Amazon-US's growth options, see, below, § C, and (ii) for the full value of the use of those pre-existing intangibles in the context of the cost-sharing arrangement, see, below, § D.

In reaching a contrary conclusion, the Tax Court not only misinterpreted the regulations, but also failed to construe them in light of their “purpose,” in contradiction to binding precedent. Xilinx, 598 F.3d at 1195-1196. The purpose of the Section 482 regulations is “to ensure that taxpayers clearly reflect income attributable to controlled transactions.” § 1.482-1(a)(1). Although Amazon-US took the position that the regulations permitted it to provide its foreign subsidiary free access to valuable intangibles (ER693), parties dealing at arm's length generally do not transfer valuable property for free. See Likins-Foster Honolulu Corp. v. Commissioner, 840 F.2d 642, 647 (9th Cir. 1988) (holding that “unrelated parties dealing at arm's length would not customarily loan large sums without interest”). In this case, the record establishes that a company dealing at arm's length would have required compensation for the full value of the pre-existing intangibles, including residual-business assets. See, below, § B.

B. It is undisputed that a company dealing at arm's length would have required compensation for all of the intangibles Amazon-US made available to the cost-sharing arrangement, including residual-business assets

We begin with the foundational principle that applies in every transfer-pricing case: if a company dealing at arm's length would have charged for the full value of the intangibles Amazon-US made available to the cost-sharing arrangement, then Amazon-LUX is required to pay that amount as well.¹⁰ The Tax Court was not free to disregard this principle; it is mandatory and applies “'in every case.'” Xilinx, 598 F.3d at 1196 (quoting § 1.482-1(b)(1)).

Both parties' experts agreed that an uncontrolled party would pay for access to Amazon-US's valuable residual-business assets, including its significant growth options resulting from its culture of relentless innovation. (ER340, 578-581, 684-686, 700-703, 780-781.) As Amazon-US's expert (Cornell) acknowledged, parties dealing at arm's length “[d]efinitely” pay for “growth options” (ER686) because “[n]o company is going to give away something of value without compensation” (ER703). He explained that he excluded them from his valuation analysis only because he was informed by Amazon-US's counsel that the regulations permitted Amazon-US to provide Amazon-LUX access to them “for free.” (ER693.) He conceded that if growth options were compensable intangibles under the regulations, it would “change the legal conclusion in this case.” (ER716.)

Indeed, Cornell agreed that if “all” of the valuable intangibles were compensable, he would compute their value exactly as Frisch did — he would “value the entire business and take out the tangibles.” (ER716-717.) But, because Frisch's valuation “includes substantial value attributable to Amazon-US's significant growth options (i.e., its unique business attributes and expectancies)” that Cornell understood from Amazon-US's counsel could be transferred “for free” and “were not subject to a buy-in payment under the applicable tax regulations” (ER340, 693), his ultimate analysis diverged from Frisch's valuation.

As demonstrated below, neither the 1994 nor the 1995 transfer-pricing regulations exempt any specific intangible from the scope of Section 482. If a company entering into the same transaction under the same circumstances with an unrelated party would have included the value of a particular intangible in the buy-in payment, then — by definition — the buy-in payment here would have to include the value of that intangible in order to achieve an arm's-length result. Any other interpretation of the regulations would “stultify [their] purpose” and should be rejected. Xilinx, 598 F.3d at 1196.

C. The Tax Court's determination that Amazon-LUX need not compensate Amazon-US for all of the pre-existing intangibles, including residual-business assets, is wrong as a matter of law

As noted above, the Tax Court failed to address whether a company dealing at arm's length would have required compensation for Amazon-US's valuable residual-business assets, including its growth options. Instead, the court simply concluded that the buy-in payment need not provide such compensation because (in its view) such assets “were not compensable 'intangibles' to begin with” under the 1994 regulations. (Op/ER78-79.) That conclusion conflicts with § 1.482-4(b)'s broad definition of intangibles, other aspects of the regulatory scheme (including § 1.482-1's arm's-length standard), and the regulation's history.

1. The Tax Court's determination that residual-business assets like growth options are not compensable intangibles conflicts with a plain reading of § 1.482-4(b)

The Tax Court's interpretation of “intangibles” conflicts with the plain language of § 1.482-4(b). See DHL, 285 F.3d at 1221 (reversing Tax Court determination that conflicted with the “plain language” of the Section 482 regulations). Section 1.482-4(b) broadly defines intangibles and reads in its entirety as follows:

(b) Definition of intangible. For purposes of section 482, an intangible is an asset that comprises any of the following items and has substantial value independent of the services of any individual —

(1) Patents, inventions, formulae, processes, designs, patterns, or know-how;

(2) Copyrights and literary, musical, or artistic compositions;

(3) Trademarks, trade names, or brand names;

(4) Franchises, licenses, or contracts;

(5) Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and

(6) Other similar items. For purposes of section 482, an item is considered similar to those listed in paragraph (b)(1) through (5) of this section if it derives its value not from its physical attributes but from its intellectual content or other intangible properties.

By its terms, § 1.482-4(b) does not exclude any particular asset. Rather, an asset fits within § 1.482-4(b)'s definition of intangible if it (i) “has substantial value independent of the services of any individual” and (ii) comprises any of the items in the regulation's six described categories. The sixth category — the “similar items” category — is a catch-all provision that includes any asset that “derives its value” from “intangible properties” rather than “physical attributes.” § 1.482-4(b)(6). Thus, under the plain language of the regulation, growth options are “intangibles” for purposes of § 1.482-4(b) (and thus for purposes of § 1.482-7A(g)'s buy-in requirement) if they derive their value from intangible, rather than physical, attributes, and have substantial value independent of the services of any individual.

Growth options satisfy both components of the regulatory definition of intangible. First, growth options — a concededly valuable asset (Op/ER79) — derive their value from intangible, rather than physical, attributes. Amazon-US's expert (Cornell) described the intangible (but valuable) nature of growth options as primarily attributable to Amazon-US's culture of innovation:

I see [growth options] as being embedded in the what I call “the culture” of the company. It's people and how they interrelate, and do you have a mechanism by which creative ideas can bubble up and be utilized or are you held down by a bureaucracy that doesn't allow creativity to flourish?

. . .

. . . [T]he corporate culture is so important. It's not just throwing money at something, it's having an organization in place that promotes and makes possible creative innovation. That in itself is such a valuable asset in my mind.

. . . [W]hat really seems to set the Apples and the Amazons apart is that they have developed these unique innovative cultures that keep churning out new products. . . .

(ER704-705, 715.) Growth options, he concluded, are “rooted in the culture of the firm” and are “not totally separate” from Amazon-US's other intangibles. (ER712.)

Second, growth options' substantial value is independent of the services of any individual. (ER686-688, 712-713.) As indicated above, they are “part of the culture of Amazon to be able to have creative ideas bubble up in their organization and actually use them.” (ER713.) The value of that innovative culture is independent of the services of any one Amazon-US employee, and is interrelated with all of Amazon-US's pre-existing intangibles, including its “systems” and business “processes.” (ER498, 575, 684-686, 780-781.)

We recognize that the Tax Court held to the contrary, asserting (without explanation) that residual-business assets (including growth options) “do not derive their value from their 'intellectual content or other intangible properties.'” (Op/ER80.) But that bald assertion is clearly wrong, given that growth options and other residual-business assets — which indisputably are not tangible assets — could only derive their value from their intangible properties. Indeed, Amazon-US's own expert acknowledged that a “broad definition of intangibles” would include “growth options.” (ER338.)

Similarly misconceived is the Tax Court's rationale that residual-business assets (including growth options) are not compensable because, unlike items specifically listed in § 1.482-4(b), they “cannot be bought and sold independently; they are an inseparable component of an enterprise's residual business value.” (Op/ER79-80.) The regulations, however, do not limit intangibles to those that can be “bought and sold independently.” That a valuable item cannot be bought and sold independently does not mean that it cannot be transferred as part of a bundle of intangibles or made available to a cost-sharing arrangement. The court's re-writing of the regulation to include such a limitation was legal error. See DHL, 285 F.3d at 1221.

Moreover, the Tax Court failed to appreciate the significant overlap between growth options and the specifically identified intangibles listed in § 1.482-4(b)(1)-(5). As the experts explained, growth options are created by pre-existing intangibles such as “systems and processes” and “everything that makes the business valuable” (ER686-687) and, as such, are “attached to the ownership of existing” intangibles (ER778-779, 782). Such “systems” and “processes” are intangibles specifically listed in § 1.482-4(b)(1) and (5). Section 1.482-4(b) defines intangibles to include property that “comprises” any of the specifically listed intangibles, which growth options — comprising, in part, Amazon-US's systems and processes (ER498, 686) — indisputably do.

Given that growth options fit comfortably within the scope of § 1.482-4(b)(6), and comprise intangibles specifically listed in § 1.482-4(b)(1)-(5), the Tax Court erred as a matter of law in concluding that Amazon-US could provide Amazon-LUX access to its valuable growth options in connection with the cost-sharing arrangement “for free.” (ER693.)

2. The Tax Court's interpretation of § 1.482-4(b) conflicts with the overall transfer-pricing regulatory scheme

Consideration of the overall regulatory scheme further supports an interpretation of § 1.482-4(b) that encompasses residual-business assets like growth options.

a. Section 1.482-7A

Section 1.482-4(b) must be read in conjunction with the cost-sharing regulations (§ 1.482-7A) that incorporate it by cross-reference. Section 1.482-7A does not exclude any item of intangible property from the buy-in requirement. To the contrary, the explicit “buy-in” requirement encompasses any intangible “made available” to the arrangement, § 1.482-7A(g)(2), and was added to the cost-sharing regulations to implement Congress's mandate that participants in the arrangement pay for such items. H.R. Rep. No. 99-841, at II-638.

The language of § 1.482-7A(g) also precludes the Tax Court's grafting an “independently transferrable” requirement onto § 1.482-4(b)'s definition of intangible (Op/ER79-80). In this regard, § 1.482-7A(g)(1) expressly provides that a party that “makes” intangible property “available to” a qualified-cost-sharing arrangement is “treated as having transferred” an interest in that property to the other participants in the arrangement. § 1.482-7A(g)(1). Thus, while it is true that residual-business assets generally cannot be transferred independently from the business enterprise with which they are associated, § 1.482-7A(g)(1) mandates that such assets be paid for even if they are made “available” to the cost-sharing participants without actually being transferred to them; the transfer is deemed to have occurred. The Tax Court's re-writing of § 1.482-4(b) cannot be squared with the express language of the cost-sharing regulations.

b. Section 1.482-1's arm's-length standard

Second, and most fundamentally, § 1.482-4(b) must be read in conjunction with § 1.482-1's arm's-length standard. Pursuant to that standard, if unrelated parties entering into the same transaction under the same circumstances would have accounted for intangibles like growth options, then related parties must do so as well. That is the raison d'être of Section 482 and its implementing regulations. The regulations emphasize that the arm's-length standard applies in “every case.” § 1.482-1(b)(1). Nothing in § 1.482-4(b) modifies or overrides this basic principle of transfer pricing.

This Court has held that the transfer-pricing regulations must be interpreted according to their “purpose,” which is “to ensure that taxpayers clearly reflect income attributable to controlled transactions.” § 1.482-1(a)(1); see Xilinx, 598 F.3d at 1195-1196. Any interpretation of a transfer-pricing regulation that is inconsistent with the arm's-length standard must be rejected, as this Court has emphasized: the “regulations are not to be construed to stultify th[eir] purpose.” Id. at 1196.¹¹ By allowing Amazon-US to provide Amazon-LUX access to a valuable subset of its intangibles “for free” (ER693) when it is undisputed that a company entering into the same transaction under the same circumstances with an unrelated party would have required compensation, the Tax Court's narrowing interpretation of § 1.482-4(b) stultifies the regulations' purpose.

Ignoring this binding precedent, the Tax Court lost sight of the bigger picture. Under Section 482, anything of value that is made available between related parties must be paid for — nothing gets transferred for free (absent a regulatory safe harbor, of which there are none for buy-in payments). Taxpayers should not be permitted to conjure loopholes that simply do not exist. If § 1.482-4(b) were never promulgated, or was withdrawn tomorrow, that would not — and could not — imply that controlled taxpayers could transfer valuable assets “for free,” whether defined as intangibles or otherwise.

3. The Tax Court's interpretation of § 1.482-4(b)'s definition of “intangibles” is not supported by the regulatory history

The Tax Court concluded that its narrow interpretation of § 1.482-4(b) was “supported by the regulations' history.” (Op/ER80 n.18.) That is incorrect. The regulatory history supports the broadest definition of intangible property. To demonstrate the error in the court's conclusion, we provide some context for the 1994 regulations at issue here.

Section 482 itself originally did not define intangibles (by cross-reference or otherwise). The original Treasury regulations issued pursuant to Section 482 likewise did not define intangibles. Indeed, these regulations provided little guidance beyond the requirement that the “arm's length” standard be applied “in every case.” 27 Fed. Reg. 3595, 3598 (1962). Under that governing standard, if a company entering into the same transaction under the same circumstances with an unrelated party would have paid for something of value — whether it be tangible, intangible, or in the form of services — then that company must pay for it as well in the related-party transaction.¹²

Specific guidance for applying the arm's-length standard to distinct transactions, such as transfers of money (loans), services, tangible property, and intangible property, was promulgated in 1968. 33 Fed. Reg. 5848. Pursuant to those regulations, a controlled party that “made available in any manner” any “intangible property” to another controlled party must receive “arm's length consideration” for such property. Id. at 5852. The regulations broadly defined intangible property by reference to 27 specific types of intangible property (such as patents, brand names, methods, and programs) and “other similar items.” Id. at 5854. The regulations did not limit the scope of “other similar items,” so long as such “items have substantial value independent of the services of individual persons.” Id. Importantly, no specific type of intangible was carved out from the regulations' requirement for arm's-length consideration.

Congress has long understood Treasury's definition of intangibles to be inclusive. In 1982, Congress adopted Treasury's definition of intangibles from the 1968 regulations when it amended Section 936 (which provides tax credits for corporations operating in Puerto Rico) to add a provision that addressed the tax treatment of intangible-property income (Section 936(h)). Tax Equity & Fiscal Responsibility Act of 1982, P.L. 97-248, § 213(a)(2). As enacted in 1982, Section 936(h) listed 28 specific types of intangible property¹³ and a catch-all provision for “any similar item, which has substantial value independent of the services of any individual.” I.R.C. § 936(h)(3)(B)(i)-(vi). Reflecting the breadth of that definition, the legislative history emphasized that the amendment “defines intangible assets broadly.” S. Rep. No. 97-494, at I-161 (1982). Like the 1968 transfer-pricing regulations, Section 936(h)(3)(B) contains no carve-out for particular types of intangible property.

Section 936(h)(3)(B)'s definition of intangibles was incorporated into Section 482 by cross-reference when Congress amended Section 482 in 1986 to add the commensurate-with-income requirement for intangibles. There is no indication in the legislative history to this anti-abuse amendment that Congress intended to narrow the scope of intangibles for transfer-pricing purposes. To the contrary, in that history, Congress directed that intangibles migrating to low-tax jurisdictions, or made available in a cost-sharing arrangement, be fully paid for to prevent erosion of the U.S. tax base. H.R. Rep. No. 99-841, at II-637-638.

In the early 1990's, and in response to Congress's directive, Treasury overhauled its transfer-pricing regulations, providing new methods for valuing intangibles as alternatives to the CUT method and providing more guidance for cost-sharing arrangements. See, above, at ap. 9-13. As part of that overhaul, Treasury “clarified” its prior definition of intangibles by explaining the breadth of what § 1.482-4(b)(6)'s catch-all provision for “other similar items” includes. 59 Fed. Reg. 34971, 34983 (1994). The 1994 regulations define the category “other similar items” to mean “items that derive their value from intellectual content or other intangible properties rather than physical attributes.” Id. Like the 1968 regulations, the 1994 regulations do not carve out any type of intangible from the scope of the definition.

The Tax Court relied on the regulatory history leading up to the 1994 regulations to support its interpretation of § 1.482-4(b) as excluding residual-business assets such as growth options and goodwill. (Op/ER80 n.18.) The court misreads the history. In this regard, the court cites the preamble to the temporary transfer-pricing regulations promulgated in 1993 in which the IRS requested comments “as to whether the definition of intangible property incorporated in § 1.482-4T(b) should be expanded to include items not normally considered to be items of intellectual property, such as work force in place, goodwill or going concern value.”¹⁴ 58 Fed. Reg. 5310, 5312 (1993). The final regulations issued in 1994 did not expand the number of specifically named intangibles by adding goodwill, going concern, and workforce-in-place to the list; instead, the regulations clarified the catch-all provision in a way that would include those items. 59 Fed. Reg. at 34983. Pursuant to that clarification, which resolved any prior ambiguity, an applicable asset is a “similar” item, and therefore within the scope of § 1.482-4(b)'s intangibles, if it “derives its value not from its physical attributes but from its intellectual content or other intangible properties.” § 1.482-4(b)(6).

Nothing in § 1.482-4(b)'s history suggests that growth options, goodwill, or any other intangible property that has substantial value independent of the services of any individual is exempt from Section 482's arm's-length requirements. Indeed, on the exact same day that the temporary regulations cited by the Tax Court (§ 1.482-4T) were promulgated (January 21, 1993), Treasury also issued proposed regulations implementing Section 6662(e)'s accuracy-related penalty for valuation misstatements attributable to Section 482 allocations, and those proposed regulations specifically identified “goodwill” as an example of “intangible property.” 58 Fed. Reg. 5304, 5306 (1993). The following year, Treasury promulgated a temporary regulation, § 1.6662-5T(e)(3), that specified that “goodwill” was “intangible property” for purposes of Section 482 transactions. 59 Fed. Reg. 4791, 4795 (1994). This regulation — which was in effect when the final 1994 transfer-pricing regulations were promulgated — undermines the Tax Court's determination that Treasury viewed “goodwill” and other residual-business assets to be outside the scope of intangible property for purposes of Section 482.

The Tax Court is correct that the final 1994 transfer-pricing regulations do not expressly name goodwill, going concern, or workforce-in-place as intangibles, and therefore did not expand the list of specific intangibles set out in § 1.482-4(b)(1)-(5). Rather, the regulations obviated the need to continuously expand the list of specific intangibles by, instead, expanding the definition of “similar items” in a way that makes clear that it covers the full range of intangibles, including intangibles that are not normally considered intellectual property. As relevant here, that clarification is broad enough to include growth options, which — like goodwill, going-concern value, workforce-in-place, and other residual-business assets — derive their value from intangible properties rather than physical attributes.

4. To the extent there is any doubt, the IRS's interpretation of its own regulations — recently endorsed by Congress — is conclusive

To the extent that there is any doubt regarding the breadth of the definition of intangibles set out in § 1.482-4(b), the Tax Court should have deferred to the IRS's interpretation of its own regulations. An agency's interpretation of its own regulations “must be given 'controlling weight'” if it is not “'plainly erroneous or inconsistent with the regulation.'” Stinson v. United States, 508 U.S. 36, 45 (1993) (citation omitted); see Auer v. Robbins, 519 U.S. 452, 461-462 (1997) (holding that an agency's reasonable interpretation of its own regulation is entitled to controlling weight even where its interpretation is “in the form of a legal brief”). Given that the regulations do not expressly exclude growth options or residual-business assets from § 1.482-4(b)'s definition of intangibles, the IRS's interpretation is not plainly erroneous. To the contrary, the IRS's interpretation is not only compelled by the plain language of the regulation, but it is also the only interpretation that does not “stultify” the purpose of the regulations, as it requires Amazon-LUX to pay for access to assets that a party entering into the same transaction under the same circumstances with an unrelated party would have paid for. Xilinx, 598 F.3d at 1195-1196. The Tax Court's interpretation, in contrast, unreasonably allows valuable assets to be accessed “for free” (ER693), in violation of the governing arm's-length standard.

Indeed, recent legislation confirms that the IRS's interpretation is reasonable. In the Tax Cuts and Jobs Act of 2017 (Pub. L. 115-97), Congress amended the definition of “intangible property” in Section 936(h)(3)(B) (which is incorporated by reference in Section 482) to “clarif[y]” the “[s]cope of the definition of intangible property.” Joint Committee on Taxation, Comparison of the House- & Senate-Passed Versions of the Tax Cuts and Jobs Act, JCX-64-17, at 48 (Dec. 7, 2017). As noted above, prior to the amendment, Section 936(h)(3)(B) defined “intangible property” in terms of 28 specific types of intangibles — the same 28 items listed in § 1.482-4(b)(1)-(5) — and “any similar item, which has substantial value independent of the services of any individual.” The 2017 legislation amended that definition in two ways. First, it added “goodwill, going concern value, or workforce in place” to the list of specific items included in the definition of “intangible property.” Pub. L. 115-97, § 14221(a), 131 Stat. 2054, 2218 (codified at I.R.C. § 936(h)(3)(B)(vi)). Second, it clarified the catch-all category by replacing “any similar item, which has substantial value independent of the services of any individual” with “any other item the value or potential value of which is not attributable to tangible property or the services of any individual.” Id. (codified at I.R.C. § 936(h)(3)(B)(vii)).

Because the amendment only clarifies — but does not change — the existing definition of intangibles, it “does not modify the basic approach of the existing transfer pricing rules with regard to income from intangible property,” as Congress emphasized in the Conference Report. H.R. Rep. No. 115-466, at 661. That the amendment aligns so exactly with the IRS's position in this case is no coincidence. Congress was prompted to act by the Tax Court's contrary interpretation of the regulatory definition of intangible property, as evidenced by a footnote reference to the Amazon Tax Court decision in the Conference Report. Id. at 661 n.1552. Congress's express reference to an ongoing “'dispute'” regarding the meaning of intangible indicates that the “'subsequent amendment is intended to clarify, rather than change, the existing law.'”¹⁵ Callejas v. McMahon, 750 F.2d 729, 731 (9th Cir. 1985) (citation omitted).

In sum, the Tax Court's first rationale for rejecting the Commissioner's DCF method is unfounded.

D. The Tax Court's holding that the Commissioner may not determine the arm's-length buy-in payment in this case by reference (in part) to projected cash flows associated with future intangibles is wrong as a matter of common sense and as a matter of law

The Tax Court's second rationale for rejecting the Commissioner's DCF method is also unfounded. In this regard, the court concluded that the method is “irreconcilable with the governing regulations” (Op/ER88) because it values the pre-existing intangibles by reference to cash flows expected to result, in part, from subsequently developed intangibles. (Op/ER82-88.) As demonstrated below, that conclusion (i) erroneously assumes that the subsequently developed intangibles resulted solely from the parties' intangible-development expenditures under the cost-sharing arrangement, and (ii) is based on a misreading of § 1.482-7A(g)(2).

1. The pre-existing and subsequently developed intangibles in this case are not wholly independent of each other

To begin with, the Tax Court's critique of the Commissioner's DCF method proceeds from the false premise that the pre-existing intangibles Amazon-US made available to the cost-sharing arrangement, on one hand, and the new intangibles developed under that arrangement, on the other, are wholly independent of each other. (Op/ER78, 82.) They are not. For instance, by gaining access to Amazon-US's existing technology-related intangibles in the context of a cost-sharing arrangement, Amazon-LUX gained access to such intangibles not merely for use in operating its business, but also for use in the ongoing development of new intangibles with Amazon-US. And in that capacity, those pre-existing intangibles unquestionably contributed to the development of new technology-related intangibles — technology that Amazon-LUX would co-own going forward — by giving the parties a head start in their research and development activities. (ER369-370, 441-448, 539, 573-578, 634-636, 638-639, 677-678.) Quite simply, existing technology begets new technology.

More importantly, through the ongoing collaboration that a cost-sharing arrangement entails, Amazon-LUX gained access to the residual-business assets that Amazon-US brought to bear on the arrangement, such as its culture of relentless product innovation and its R&D workforce-in-place. As Cornell (Amazon-US's expert) emphasized in discussing the importance of these types of assets in the intangible-development process, “It's not just throwing money at something, it's having an organization in place that promotes and makes possible creative innovation. . . . [W]hat really seems to set the Apples and the Amazons apart is that they have developed these unique innovative cultures that keep churning out new products.” (ER715.) If existing technology begets new technology, then product innovation begets the need for new technology, and R&D workforce-in-place — along with ongoing intangible-development expenditures (the “throwing money at it” factor) — contributes to the conversion of existing technology into new technology.

Amazon-US's own experts acknowledged this overlap between pre-existing and subsequent intangibles. (ER673-678, 709-710.) Cornell conceded that new intangibles generated through the cost-sharing arrangement were attributable not only to intangible-development expenditures, but also in part to the more discrete categories of Amazon-US's pre-existing intangibles (i.e., the technology-related intangibles) and in part to “the more nebulous intangibles such as growth options.” (ER710.) Given that relationship, some portion of the cash flows expected to result from the new intangibles would necessarily be attributable to the pre-existing intangibles, making it appropriate to determine the buy-in payment by reference to those cash flows.

2. The Tax Court's valuation-limitation rule derives from a misreading of § 1.482-7A(g)(2)

Appeals to common sense aside, nothing in the 1995 cost-sharing regulations prohibits the IRS from determining the amount of the buy-in payment by reference to projected economic benefits associated with the intangibles expected to be developed under the cost-sharing arrangement. The Tax Court's conclusion to the contrary, first adopted in 2009, is premised on a misreading of § 1.482-7A(g)(2).

The Tax Court's valuation-limitation rule derives from Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009), nonacq., 2010-49 I.R.B. (Dec. 6, 2010), in which the court likewise held that the Commissioner's determination of the buy-in payment there violated the 1995 cost-sharing regulations by taking into account the anticipated value of subsequently developed intangibles. In support of that conclusion, the Veritas court merely pointed to the first sentence of § 1.482-7A(g)(2), which recites the general circumstances under which a buy-in payment must be made:

If a controlled participant makes pre-existing intangible property in which it owns an interest available to other controlled participants for purposes of research in the intangible development area under a qualified cost sharing arrangement, then each such other controlled participant must make a buy-in payment to the owner. * * *

133 T.C. at 323. Although that sentence says nothing about how the pre-existing intangible property is to be valued, the Veritas court nonetheless construed it as precluding any valuation that takes into account anticipated income from subsequently developed intangibles, i.e., any valuation that treats the existing intangible property as one of the factors giving rise to the subsequently developed intangibles. Id. at 323-324.

The Tax Court here, relying heavily on Veritas, likewise construed the first sentence of § 1.482-7A(g)(2) as a valuation-limitation rule. (Op/ER70.) But the valuation rule applicable to buy-in payments is found in the second sentence of § 1.482-7A(g)(2):

The buy-in payment by each such other controlled participant is the arm's length charge for the use of the intangible under the rules of §§ 1.482-1 and 1.482-4 through 1.482-6, multiplied by the controlled participant's share of reasonably anticipated benefits (as defined in paragraph (f)(3) of this section). * * *

And the benchmark under those rules is the amount that Amazon-US would have charged an unrelated party had it “engaged in the same transaction under the same circumstances” with that party, i.e., had it provided the use of its pre-existing intangibles in conjunction with a cost-sharing arrangement entered into with that party under the same circumstances. § 1.482-1(b)(1). In that situation, Amazon-US would not have accepted a buy-in payment that was based on the wholly artificial valuation-limitation rule that the Tax Court read into the first sentence of § 1.482-7A(g)(2).

E. The Tax Court misinterpreted the regulations' realistic-alternatives principle

The Tax Court's rejection of the DCF method also conflicts with the realistic-alternatives principle set forth in § 1.482-1(f)(2)(ii). Pursuant to that principle, the Commissioner may determine the arm's-length price for a related-party transaction by “consider[ing] the alternatives available to the taxpayer.” Id. The regulations further emphasize that unspecified methods — such as the transfer-pricing method utilized by the Commissioner here — implement this principle by “provid[ing] information on the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction.” § 1.482-4(d)(1). The realistic-alternatives principle is incorporated by reference in the cost-sharing regulations' buy-in requirement. § 1.482-7A(g)(1).

By expressly adopting the realistic-alternatives principle, the regulations codify the fundamental economic concept of opportunity cost. (ER433 (citing § 1.482-4(d)(1)), 787-789.) Pursuant to that concept, it is understood that uncontrolled parties acting rationally consider all choices realistically available to them and only enter into transactions that are preferable to the alternatives. (ER621-623, 787-794.) An intangibles transaction with a related party that provides less economic benefit to the owner of the intangibles than the owner could have realized under its realistic alternatives does not achieve an arm's-length result. § 1.482-4(d)(1). As Frisch explained, it would be “inconsistent with arm's length” for a company considering a cost-sharing arrangement to “ignore” how much money it could make if it maintained exclusive access to its pre-existing intangibles and exclusive ownership of its subsequently developed intangibles. (ER757-758.)

As suggested in the preceding paragraph, one alternative available to Amazon-US at the time it entered into the cost-sharing arrangement with Amazon-LUX was to simply maintain the status quo and continue to receive the net cash flows from its European Business. (ER627-630.) The opportunity cost of entering into the cost-sharing arrangement with Amazon-LUX is measured by the long-term expected net cash flows related to the European Business that Amazon-US gave up. (ER628.) If Amazon-US had maintained the status quo, it would have expected cash flows of $2.9 billion net of the projected intangible-development costs and other expected outlays. (ER363-365, 746-748, 953.)

The realistic-alternatives principle is not a novel concept. Indeed, this Court applied the same common-sense analysis animating that principle long before it was incorporated into the 1994 regulations. See Kerry Inv. Co. v. Commissioner, 500 F.2d 108, 109-110 (9th Cir. 1974). In Kerry, this Court reversed the Tax Court's rejection of the Commissioner's Section 482 adjustment to an interest-free loan between related parties, reasoning that, if the lender had provided an unrelated party a loan, it would have been able to charge interest. Id. As this Court explained, when “a taxpayer lends $500,000 to a wholly owned subsidiary without interest, it is obvious that the lender is likely divesting itself of interest income that it could have earned by making interest-bearing loans in a competitive market.” Id. Like the interest income that the lender in Kerry could have earned, the cash flows that Amazon-US could have realized from the European Business had it forgone the cost-sharing arrangement with Amazon-LUX is a valid consideration when pricing the buy-in payment at issue.

The Tax Court misapprehended the realistic-alternatives principle. (Op/ER82-85.) The court concluded that the principle has no role in this case because the IRS may not (i) “restructure” the parties' transaction or (ii) deny Amazon-US the right to enter into a cost-sharing arrangement. (Op/ER84.) Both observations miss the mark.¹⁶

The realistic-alternatives principle does not restructure a transaction. Rather, it re-prices a transaction just as the taxpayer has structured it by examining the taxpayer's alternatives. See §§ 1.482-1(f)(2)(ii)(B) (example), 1.482-4(d)(2) (example). Here, Frisch did not restructure the parties' cost-sharing arrangement into a realistic alternative. Rather, he evaluated the buy-in price for the cost-sharing arrangement as elected by the taxpayer by reference to Amazon-US's realistic alternative — that is, by reference to the cash flows Amazon-US could have realized from the European Business had it not entered into the cost-sharing arrangement.

The Tax Court's “restructure” critique conflicts with § 1.482-1(f)(2)(ii)(A). The third sentence of that section explains that the realistic-alternatives principle does not operate to restructure the controlled transaction itself but merely provides a benchmark price for evaluating the price charged in the controlled transaction. In this regard, if the controlled price is less than the benchmark price, the regulation directs the IRS to “adjust the consideration charged in the controlled transaction” to align with the “profit of an alternative.” Id. But — as the regulation makes clear — adjusting the price does not result in “restructur[ing] the transaction as if the alternative had been adopted by the taxpayer.” Id.

Nor does the realistic-alternatives principle deny Amazon the right to enter into a cost-sharing arrangement. It only denies Amazon-US's attempt to enter into a cost-sharing arrangement without having its foreign affiliate pay an arm's-length price for access to its pre-existing intangibles. Amazon is not “entitled” (Op/ER84) to move a portion of the benefits flowing from its U.S.-created intangibles beyond the reach of the U.S. tax system for anything less than an arm's-length consideration. And requiring an arm's-length buy-in payment does not make the cost-sharing election “altogether meaningless” (Op/ER83). Once the arm's-length amount of the buy-in payment is established, Amazon enjoys all the benefits of the cost-sharing arrangement, including the sweetheart deal with the Luxembourg taxing authorities and avoidance of future transfer-pricing disputes with the U.S. taxing authorities regarding the value of any subsequently developed intangibles.

Finally, the Commissioner's reliance on the realistic-alternatives principle in this case was not an “attempt to apply the [2009/2011 cost-sharing] regulations retroactively,” as the Tax Court wrongly supposed (Op/ER85 n.21). As noted above, the realistic-alternatives principle is a key provision in the 1994 transfer-pricing regulations, §§ 1.482-1(f)(2)(ii), 1.482-4(d)(1), which are expressly incorporated in the 1995 cost-sharing regulations. See § 1.482-7A(a)(2), (g)(2). Although the 2009/2011 regulations also refer to the realistic-alternatives principle, the principle was well established in the earlier regulations that apply here.

F. The Tax Court's remaining criticisms of the Commissioner's DCF method are unfounded

1. The Commissioner's DCF method does not charge Amazon-LUX twice for the subsequently developed intangibles

The DCF method is designed to capture all of the projected value of the European Business attributable to the pre-existing intangibles. Moreover, it is designed to capture only that value; it does not require Amazon-LUX to pay “twice” for the subsequently developed intangibles, as the Tax Court incorrectly assumed. (Op/ER78, 108.) The mechanics of Frisch's DCF analysis preclude such double billing, as explained below.

The DCF method is a mathematical formula that can be arranged to solve for any variable. (ER459.) Frisch arranged the formula so as to solve for the present value of the pre-existing intangible assets that Amazon-US made available to Amazon-LUX. As the experts explained, the European Business's expected future cash flows are attributable to the following:

• Amazon-US's pre-existing intangibles,

• Amazon-LUX's anticipated cost-sharing payments,

• Amazon-LUX's tangible assets, and

• the operating efforts of Amazon's European Subsidiaries. (ER378-384, 461, 467-469, 502-504, 546, 561.) Frisch's DCF method isolated the first category by subtracting the remaining categories (which had known expected values) from the projected cash flows, and thereby backed into the unknown value of the pre-existing intangibles. (Id.)

Because Frisch's DCF method computes value net of Amazon-LUX's cost-sharing payments and other expenses (including its payments to the European Subsidiaries for their operating efforts), Amazon-LUX's contributions are factored out of Frisch's analysis. (ER363-365, 461, 468, 634-636, 694, 724-726, 746-748.) If the future revenues are not attributable to Amazon-LUX's anticipated contributions, which are eliminated from the DCF analysis, then the revenues must be attributable to Amazon-US's pre-existing intangibles. (ER369.) As Cornell conceded, projected income cannot be generated from thin air — it has to “come from something.” (ER709.) See ER457-465 (extended example illustrating how Frisch's DCF analysis isolates the pre-existing intangibles). The only “something” left is the pre-existing intangibles.

Given the mechanics of the DCF computation, the Commissioner's DCF method does not require Amazon-LUX to pay twice for the same intangibles. (ER730.) As explained above, there is no overlap between the initial buy-in payment and the on-going cost-sharing payments because Amazon-LUX's projected cost-sharing payments are subtracted from the projected cash flows before the net cash flows are discounted to compute the amount of the buy-in payment. (ER461, 468.)

Nor does the Commissioner's DCF method include in the buy-in payment the value of the European Subsidiaries' goodwill, going-concern-value, and workforce-in-place, as the Tax Court wrongly assumed (Op/ER80-81 n.19). That value was excluded by (i) calculating an arm's-length return to those subsidiaries for the services that they provided (derived from Amazon-US's own transfer-pricing analysis (ER724-725, 785-786)), and then (ii) subtracting that amount from the cash flows in the DCF computation before the net cash flows were discounted to calculate the buy-in payment.¹⁷(ER469, 667-668, 724-725, 764-770, 785-786.)

That Frisch assumed that some of the intangibles that Amazon-US made available to Amazon-LUX for research and development had an indefinite useful life does not mean that he “failed to restrict his valuation to the 'pre-existing intangible property,'” as the Tax Court concluded (Op/ER76). Although the court found that some of the intangibles had a useful life of 20 years or less, the court did not — and could not — find that Amazon-US's residual-business assets had such a limited useful life.¹⁸ Moreover, because the DCF method backs into the value of the pre-existing intangibles, it is unnecessary to determine the useful life of any specific intangible in the bundle made available to Amazon-LUX; as long as the present value of the projected cash flows for the European Business exceeds the present value of Amazon-LUX's contributions, it necessarily follows that the excess amount is attributable to some portion of the bundle of pre-existing intangibles.

In short, Frisch did “limit his buy-in payment to the value of the pre-existing intangibles transferred pursuant to the [cost-sharing arrangement]” (Op/ER84-85), but that value derives in part from their contribution to the development of future intangibles.

2. The Commissioner's DCF method does not “artificially cap” Amazon-LUX's profits

Similarly misconceived is the Tax Court's suggestion that the DCF method provides Amazon-US — through the buy-in payment — the economic benefit of “all future European business profits” generated by the subsequently developed intangibles in excess of Amazon-LUX's cost-sharing payments plus an arm's-length return thereon (Op/ER87 (emphasis added)). To the contrary, because the buy-in payment — a one-time toll charge — is determined by reference to projected cash flows, all future cash flows of the European Business that exceed the projected cash flows redound solely to the economic benefit of Amazon-LUX. (ER740-744.) Thus, the DCF method does not limit the actual economic benefit that Amazon-LUX may ultimately realize as the co-owner of the future intangibles; it only sets the maximum price that Amazon-LUX would be willing to pay “up front” for that unlimited upside, based on the European Business's projected cash flows, Amazon-LUX's projected cost-sharing payments, and the arm's-length rate of return on those payments. (ER679-682, 740-744, 759-763.)

Nor does the DCF method place an “artificial cap” on Amazon-LUX's “expected return[ ]” on its cost-sharing payments, as the Tax Court incorrectly supposed (Op/ER87 (emphasis added)). Rather, the DCF method provides Amazon-LUX an expected rate of return on those payments based on the maximum expected rate of return that Amazon-US, in determining the amount to charge as the buy-in payment, would be willing to provide an unrelated party in Amazon-LUX's situation on that party's projected cost-sharing payments. In other words, the purported “cap” on expected returns is in no sense “artificial” but is instead the market rate of return (18%) that the court found was appropriate for Amazon-LUX's investment. (Op/ER126; ER695-696.) And, as explained above, there is no cap whatsoever on the actual returns that Amazon-LUX may enjoy. (ER742-744, 755-756.) The court's contrary finding that the Commissioner “allocat[ed] to [Amazon-US] all of [Amazon-LUX's] future profits in excess of the [18%] discount rate” (Op/ER88) is clearly erroneous.

G. Because the Commissioner's DCF method is the only method that accounts for the full value of all the pre-existing intangibles, and is fully compliant with the regulations, he could not have abused his discretion in selecting that method

As demonstrated above, the definition of “intangible” in § 1.482-4(b) encompasses “residual business assets” (Op/ER82), including growth options, and therefore the IRS could not have abused its discretion in selecting an enterprise-based valuation method for determining the arm's-length buy-in payment in this case, as the Tax Court erroneously concluded. The experts agreed that, if all of the intangibles made available to Amazon-LUX were to be valued — and not merely a subset as the court erroneously concluded — then a DCF method was the most reliable way to value all of those intangibles. (ER455, 590-591, 716-717.) It was within the Commissioner's “broad discretion” to select the DCF method as the best method (Op/ER68), and the Tax Court's rationale for rejecting that method is wrong as a matter of law (as demonstrated above). Moreover, it was unreasonable for the Tax Court to utilize the CUT method to value the intangibles made available to Amazon-LUX in the cost-sharing arrangement because it is undisputed that the purportedly comparable transactions utilized by the court did not include access to Amazon-US's residual-business assets, particularly its growth options. (ER691-692.)

In light of the foregoing, this Court should hold that the Commissioner did not abuse his discretion in selecting the (unspecified) DCF method as the best method for determining the arm's-length buy-in payment in this case, vacate the Tax Court's decision on that ground, and remand with instructions for the Tax Court to determine the proper application of the DCF method to the facts of this case. In that regard, certain adjustments to the Commissioner's DCF method may be required. First, the Tax Court found (and the Commissioner has not appealed) that some of the marketing intangibles were not made available by Amazon-US through the cost-sharing arrangement but were instead owned by Amazon's European Subsidiaries, which transferred them directly to Amazon-LUX. (Op/ER147-153.) As noted above (n.17), the Tax Court should adjust Frisch's buy-in payment downward on remand to reflect the value of those intangibles. Second, in the Tax Court, Amazon made several arguments regarding how (in its view) Frisch's DCF computations required certain adjustments. The Tax Court expressly did not address those arguments (Op/ER88-89 n.22) but should do so on remand.

CONCLUSION

The decision of the Tax Court should be vacated, and the case remanded for the court to determine an arm's-length buy-in payment utilizing the DCF method.

Respectfully submitted,

RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General

TRAVIS A. GREAVES
Deputy Assistant Attorney General

Judith A. Hagley

GILBERT S. ROTHENBERG
(202) 514-3321

ARTHUR T. CATTERALL
(202) 514-2937

JUDITH A. HAGLEY
(202) 514-8126
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

MARCH 2018

STATEMENT OF RELATED CASES

Pursuant to Ninth Circuit Rule 28-2.6, counsel for the Commissioner respectfully inform the Court that they are not aware of any cases related to the instant appeal that are pending in this Court.

ADDENDUM

Statute or Regulation (as in effect 2005-2006)

Internal Revenue Code § 482 (26 U.S.C.)

Treasury Regulations (26 C.F.R.):

26 C.F.R. § 1.482-1

26 C.F.R. § 1.482-4

26 C.F.R. § 1.482-7A