Page 13 - Altera And Cost-Sharing Requirements Under Section 482 By Jerald David August

1. The expected economic life of the intangibles.
2. The annual rate at which the value of the intangibles declines as a function of time and new software replace- ments (i.e., the rate of obsolescence).
3. The parameter value selected to determine the value of the licenses (e.g., royalty rates as a percent of rev- enues, list price, or profits).
4. The appropriate discount rate.
In 1999 VERITAS Ireland paid
VERITAS US $6.3 million and agreed to prepay VERITAS US, in 2000, the remaining consideration relating to the preexisting intangibles. In 2000 VER- ITAS Ireland made a $166 million lump-sum buy-in payment to VERI- TAS US, and in 2002 VERITAS Ireland and VERITAS US adjusted the pay- ment to $118 million. The buy-in pay- ments of $166 million and $118 million were included in VERITAS US’ taxable income for 2000 and 2002 respective- ly. The amount of the buy-in payments were based on the “comparable uncon-
trolled transaction method.”
The Service, in auditing VERITAS
US’ 2000 and 2001 returns, concluded that the cost-sharing allocations, and in
36 567 F.3d 482, 489, (CA-9, 2009), rev’g and rem’g 125 TC 37 (2005).
37 592 F.3d. 1017, 105 AFTR2d 2010-536 (CA-9, 2010).
38 67 Fed. Reg. 48997 (7/29/02).
particular, the buy-in payments, did not clearly reflect VERITAS US’ income. A statutory notice of deficien- cy was issued in spring 2006 and in its notice, the government claimed that the buy-in payments should have been $2.5 billion. The Service proposed defi- ciencies in federal income tax of $704 million for 2000 and $54 million for 2001 as well as accuracy-related penal- ties of $281 million and $22 million.
The taxpayer filed a petition with the Tax Court, and in an amendment to answer, the Service reduced the imputed income amount allocation from $2.5 to $1.675 billion. The gov- ernment further determined that the required buy-in payment must take into account access to the taxpayer’s research and development team; access to the taxpayer’s marketing team, dis- tribution channels, customer lists, trademarks, trade names, brand names, and sales agreements. VERITAS US argued that the government’s buy-in payment amount was arbitrary and unreasonable and that there was no resulting deficiency in income tax. 54
Primary Issue. The primary issue before the court was whether VERI-
to the 2005 proposed regulations explained the need for applying the investor model, i.e., parties at arm’s length would not invest, along with their ongoing cost contributions, in the absence of a total anticipated return that exceeds the project- ed costs. In August 2009, the Service issued final regulations on transfers of intangible property replacing the 1995 Final Regulations and the 2005 proposed regulations. The hypothetical investor model adopted in the 2005 proposed regulations was retained and the regulations were issued to provide greater guidance on the scope, allocations, and content of the CSA in making the proper “arms length,” risk/benefit analysis. Temp. Reg. 1.482-7T(l) became generally applicable for cost-sharing arrangements com- mencing on or after 1/5/2009. Transition rules allowed a pre-existing qualified cost-sharing arrangement under former rules to be considered a CSA under the 2009 temporary regulations, but only if the participants amended the written con- tract to conform with, and carried on activities in substantial compliance with, the 2009 temporary regulations by 7/6/2009. See Temp. Reg. 1.482- 7T(m)(1). The current final regulations to Reg. 1.482-7 were issued on 12/16/2011.
46 Reg. 1.482-7(e)(1).
47 Reg. 1.482-7(a)(2).
48 Regs. 1.482–7(g)(1) and (2). 49 Regs. 1.482–7(g)(2), (7).
50 Reg. 1.482–7(g)(1).
TAS Ireland made an arm’s-length buy- in payment to VERITAS US as con- sideration for the intangibles transferred to its Irish subsidiary under the CSA. The Court found that the government could not justify a $1.675 billion allocation only to pre-existing intangibles. The Tax Court further crit- icized the government for its failure to take into account to the cost-sharing arrangement for research and devel-
51 Reg. 1.482–7(a)(2).
52 See generally Augustyn, “Tax Analysis of
Research and Development Cost-Sharing Arrangements,” 42 Tax Law. 961 (Summer 1989)
53 133 TC 297 (2009), nonacq., AOD 2010-005, 2010- 49 IRB.
54 The notices of deficiencies also set forth that the CSA should take into account stock-based com- pensation costs and the parties, by stipulation, agreed that whether such costs must be included in the cost-sharing pool would be controlled by the final decision in Xilinx, Inc., 125 TC 37 (2005), which at that time had appeals pending before the Ninth Circuit Court of Appeals.
55 The Service did not acquiesce in either the result or the reasoning of the Tax Court in the Veritas case. See 2010-49 IRB, AOD 2010-05. See also Blough, Cope and Zolo, “Veritas Vincit,” 126 Tax Notes 839 (2/15/2010); Greenwald, “Veritas v. Comr.: Tax Court Finds IRS’s § 482 Allocations to be ‘Arbitrary, Capricious, and Unreasonable,’” 39 Tax Mgmt. Int’l J. 256 (2010); Oates & O’Brien, “Lux et Veritas: IRS’s Actions Speak Louder Than its Words,” 37 Int’l Tax J. 9 (January-February 2011); Oates and O’Brien, “IRS Economists Say the Darndest Things!,” 39 Int’l Tax J. 5 (November- December 2013); Oates and O’Brien, “Tax Court Rejects IRS CIP on Cost Sharing Buy-Ins in Veritas,” 36 Int’l Tax J. 17 (January-February 2010); Silverman, Kidder, and Gordon, “Considering Veritas and Future Transfer Pricing Litigation,” 145 Tax Notes 225 (10/13/2014).
39
Details of those submitting contents and the information provided are summarized by the Tax Court in the Altera Corp. decision.
40 68 Fed. Reg. 51171 (8/26/03), corrected at 68 Fed. Reg. 63986 (11/12/03) and 69 Fed. Reg. 13473 (3/23/04).
41 TD 9088, 8/25/2003.
42
43 See H. Rep’t No. 99–481, 99th Cong., 2d Sess.
Reg. 1.482–7(d)(3)(iii)(B)(2). [Vol. II], at II–638 (1986).
44 See H. Rep’t No. 99–426, 99th Cong. at 423 (1985).
45 Shortly thereafter, the IRS issued proposed regu- lations on the treatment of services that specified certain allocation methods including a compara- ble uncontrolled services price method, a gross services margin method, a cost plus method, a comparable profits method, a simplified cost- based method for low margin services, and a profit-split method. The IRS proposed regulations further revising the cost-sharing regulations in August 2005. These proposed regulations contin- ued to stress use of the independent investor model in evaluating the contributions and rights of controlled participants in a CSA. The Preamble
COST-SHARING
16 BUSINESS ENTITIES
January/February 2016