Veritas Scores a Major Transfer-Pricing Victory

The tax court sides with the software company against the IRS.

The IRS contended that the transfer of preexisting intangibles by Veritas Software was “akin to a sale” and should be evaluated as such. The court disagreed. It concluded that the IRS’s theory does not produce the most reliable result. To be sure, the agency’s akin-to-a-sale theory encompasses short-lived intangibles valued as if they had perpetual life and takes into account intangibles that were subsequently developed rather than preexisting.

Regulation Section 1.482-7(g)(2) requires a buy-in payment with respect to transfers of preexisting intangible property: no payment is required for subsequently developed intangibles. Moreover, in calculating the buy-in payment, the IRS assigned a perpetual useful life for the transferred intangibles.

The court found, however, that the useful life of the product intangibles was, on average, four years, and was certainly not perpetual. Moreover, the court found that the IRS used the wrong “beta,” the wrong equity risk premium, and therefore the wrong discount rate, to calculate the buy-in. The IRS also used — erroneously — large and unrealistic growth rates into perpetuity. Thus, the court had no difficulty concluding that the IRS’s allocations were arbitrary, capricious, and unreasonable.

CUT Method Preferable
The taxpayer employed the CUT method to arrive at an arm’s-length buy-in amount. In its CUT valuation, the taxpayer referenced, as comparables, agreements between Veritas Software and certain original equipment manufacturers (OEMs). The IRS contended that the OEM agreements involve substantially different intangibles. But the court disagreed: it concluded that, collectively, the more than 90 “unbundled” OEM agreements the parties stipulated were sufficiently comparable to the controlled transaction.

In noting the comparability, the court also pointed out the following: (1) Veritas Ireland and the OEMs undertook similar activities and employed similar resources in conjunction with such activities, (2) there were no significant differences in contractual terms, (3) the parties to the controlled and uncontrolled transactions bore similar market risks and other risks, and (4) there were no significant differences in property or services provided.

As a result, the court was satisfied that the unbundled OEM agreements were sufficiently comparable to the controlled transaction with the result that the CUT method is the best method to determine the appropriate buy-in price. The buy-in payment actually charged met the arm’s-length standard with the result that the IRS commissioner’s conception of what the buy-in payment should be was summarily rejected.

Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

Footnote
1 See Veritas Software Corporation & Subsidiaries v. Commissioner, 133 T.C. No. 14 (2009).

 

 

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