AOD Heralds IRS Push-Back on Tax Court's Veritas Case Ruling

In an Action on Decision, the Service announced that it would not acquiesce in the tax court's ruling in Veritas Software Corporation v. Commissioner, 2009 U.S. Tax Ct. LEXIS 34, 133 T.C. No. 14 (Dec. 10, 2009), in which the Tax Court held that the taxpayer's use of the comparable uncontrolled transaction (CUT) method, with certain adjustments by the tax court, was the best method to determine the requisite buy-in payment pursuant to a cost-sharing arrangement (CSA) between a domestic corporation and its foreign subsidiary. See AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010); TAFCR Explanation § 994(a).

In the case, the taxpayer, Veritas Software Corporation, a domestic corporation, entered into a CSA with its foreign subsidiary, Veritas Ireland, consisting of a research and development agreement and a technology license agreement in order to develop and manufacture storage management software products. See Veritas Software Corp., 2009 U.S. Tax Ct. LEXIS 34, * at 1-2. Pursuant to the CSA, the taxpayer transferred certain intangibles to its foreign subsidiary, which, in turn, made a buy-in payment to the taxpayer. See Veritas Software Corp., 2009 U.S. Tax Ct. LEXIS 34, * at 21. A subsequent audit resulted in the Service finding that the taxpayer's cost-sharing allocations did not clearly reflect the taxpayer's income. See Veritas Software Corp., 2009 U.S. Tax Ct. LEXIS 34, * at 25. In the notice of deficiency, the Service allocated income and deductions based on the calculations of an expert, who had used the forgone profits and market capitalization methods and had analyzed the taxpayer's arm's-length acquisitions to determine a range of values for the lump-sum buy-in payment, before determining an amount for the buy-in payment. See Veritas Software Corp., 2009 U.S. Tax Ct. LEXIS 34, * at 25. The tax court held that the Service's allocation of income and deductions pursuant to the inter-company pricing rules of IRC Section 482 was arbitrary, capricious, and unreasonable and that the taxpayer's use of the CUT method, with minor adjustments, was the best method to calculate the buy-in payment. See Veritas Software Corp., 2009 U.S. Tax Ct. LEXIS 34, * at 58-83; TAFT Ch. 4A:18.05; TAFCR Explanation § 994(a).

In the AOD, announcing the Service's intention to not acquiesce in the result or reasoning of the tax court, the Service notes that the "the facts found by the Court materially differed from the determinations made by the Service." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010); TAFCR Explanation § 994(a). Specifically, the AOD points out the tax court and Service's disagreement as to the ongoing research and development value of the pre-existing technology that the taxpayer had transferred to the foreign subsidiary pursuant to the CSA. AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010). As to the factual determinations providing the basis for the Service's transfer pricing analysis, the Service notes that it determined that intangibles transferred "were expected to contribute not only to income anticipated from sales of existing products . . . but also to income anticipated from sales of future products that would incorporate the new intangibles resulting from the R&D pursuant to the CSA." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010). The AOD further states that the Service had also "determined that [the foreign subsidiary] expected to significantly benefit from all the elements of the intangibles and services package" and that the "combined effect of these interrelated transactions could be most reliably valued in the aggregate, rather than separately." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010).

As to the factual determinations made by the tax court, the AOD states that the court "found that the pre-existing technology had no ongoing R&D value and that the value of the technology developed under the CSA was not attributable to such pre-existing technology." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010). The AOD further states that "[t]he facts as found by the Court would remove the underpinnings of the Service's valuation" and that "[t]he only matter left to value, under the Court's fact findings, was the make-sell rights for whose valuation the adjusted CUT was suited." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010). The AOD states that, as a consequence of the tax court's factual determinations, the court "eliminated the basis for the Service's valuation" and "correspondingly supported the Court's valuation," and that, therefore, the court unnecessarily made "broad assertions" about the governing law. AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010).

As to the pertinent regulations, the Service notes in the AOD that Regulations Section 1.482-7(g)(2) "requires that the buy-in payment compensate for the value of making available the 'pre-existing intangible property. . . for purposes of research in the intangible development area" and that under the regulations, "a valuation method must take into account the income from intangibles resulting from the pre-existing intangibles made available for R&D purposes." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010); TAFCR Explanation § 994(a).

Finally, in the AOD, the Service defends its use of an aggregate valuation of the interrelated intangibles and services transactions, noting that the tax court's opinion suggested that the court did not believe that the factual record provided a sufficient basis for an aggregate valuation. AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010); TAFCR Explanation § 994(a). The Service states that it "will continue to apply an aggregate valuation to interrelated transactions related to a CSA where, under the facts and circumstances, such valuation provides the most reliable measure of an arm's length result." AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010); TAFCR Explanation § 994(a).

The Veritas decision and AOD provide insight into the Service's and tax court's evaluation of buy-in payments under cost-sharing arrangements between controlled entities under the IRC Section 482 and Regulations Section 1.482-7(g)(2), and the decision and AOD also demonstrate how, based upon differing factual determinations, the Service and tax court can come to conflicting positions on the best method for determining whether a buy-in payment under the cost-sharing arrangement was at arm's length. In addition, the AOD is noteworthy, considering that since the issuance of the AOD, the Service has informally indicated its ongoing interest in cost-sharing arrangements as subjects for examination. See 2010 WTD 237-6, "Following Veritas, Cost-Sharing Arrangements Remain a Top Priority, IRS Official Says," Worldwide Tax Daily, Tax Analysts (Dec. 10, 2010).

 

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For more information, please see:

Veritas Software Corporation v. Commissioner, 2009 U.S. Tax Ct. LEXIS 34, 133 T.C. No. 14 (Dec. 10, 2009)

2009 U.S. Tax Ct. LEXIS 34

AOD 2010-49, 2010 AOD LEXIS 4, * (I.R.S. 2010)

TAFCR Explanation § 994(a)

TAFT Ch. 4A:18.05

TAFT Ch. 4A:18.08

 

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