In the US the IRS has been aggressively litigating transfer
pricing cases and is likely to continue to aggressively pursue
transfer pricing issues, especially cost sharing buy-in
Former IRS chief economist, Bill Morgan, said the IRS is
trying to take more, and better, cost sharing cases to court.
According to Morgan, the IRS views transfer pricing litigation
as preferable to a lengthy and difficult effort to revise the
cost sharing regulations.
Microsoft is an example of a recent cost sharing buy-in
payment transfer pricing dispute and the company could be
facing a multi-billion-dollar adjustment.
The Microsoft transfer pricing adjustment made headlines
when Microsoft sued to enforce a Freedom of Information Act
(FOIA) request against the IRS for its use of an outside law
firm, Quinn Emanuel Urquhart & Sullivan.
Quinn Emanuel will receive a fee of $2.2 million from the
IRS. The use of an outside law firm demonstrates the IRS's
willingness to more vigorously litigate transfer pricing, even
in the face of a number of significant past losses.
Since the IRS is spending such a large amount of money on
the Quinn Emanuel fees, the stakes for the IRS are high.
Spending more than two million dollars in outside fees is a
significant cost for the IRS, especially if it loses. In
addition, calling in an outside law firm demonstrates that the
IRS is not confident in the ability of its own attorneys.
The IRS's engagement of Quinn Emanuel has been met with
skepticism and Microsoft may claim that the engagement is
inappropriate. Quinn Emanuel will work collaboratively with the
IRS, reviewing key documents (including reports, position
papers, IDR responses, etcetera, prepared by, or on behalf of,
the taxpayer or the IRS).
New, temporary, regulations, which allow private contractors
to participate in the summons process, were issued a month
after the contract with Quinn Emanuel was signed. However, the
new temporary regulations apply retroactively "to summons
interviews conducted on or after June 18 2014," and would
therefore cover the Microsoft summons.
The IRS and Quinn Emanuel will have more time to audit
Microsoft, since the IRS initiated court proceedings to enforce
a designated summons, which automatically suspends the statute
The limitations period will remain open as long as Microsoft
has not fully complied with any district court order resulting
from the designated summons enforcement proceedings.
The IRS also filed a summons enforcement action in a Seattle
federal district court seeking additional information about
The IRS requested:
- value proposition analyses;
- annual revenue and expense budgets and targets;
- return on R&D spending information;
- marketing investment and sales spending;
- brand and image tracking;
- strategic plans and market research;
- performance evaluations and milestone goals for Microsoft
executives and sales personnel;
- and a breakdown of all Microsoft employees worldwide for
each of the fiscal years from 2001 through 2006.
Microsoft objected to the demand for certain documents,
including performance evaluations, strategic plans, and related
external and internal communications. Microsoft characterised
those demands as impermissibly overbroad and overly burdensome.
Microsoft also asserts that the production would be
approximately 4,025 annual performance evaluations. Microsoft
instead committed to produce the annual performance evaluations
for senior vice presidents or higher in each business
The IRS also filed 12 additional petitions enforcing related
summonses. Eight of the related summonses demand testimony from
current and former Microsoft executives, including former CEO,
Steven Ballmer. Two are summonses issued to EY and KPMG.
Microsoft claims that it has been responsive throughout the
audit, producing approximately 1.2 million pages of documents
and making over 50 employees available for interviews, in
response to 220 information document requests from the IRS.
The IRS appears to be developing an argument to adjust the
buy-in price Microsoft used for transferring intangibles to two
offshore affiliates under two different cost-sharing
The CSA in APAC, effective April 3 2004, was entered into
with an affiliated Bermuda corporation, Microsoft Asia Island
Ltd. (MAIL). Under that CSA, Microsoft transferred to MAIL
various rights to both technology and non-technology
intangibles used in its APAC retail business. Microsoft took
the position that it owned only a fraction of the
non-technology intangibles used in its APAC retail business.
The CSA for Americas, effective July 1 2005, transferred to the
offshore affiliate only technology intangibles, such as
software code. The Americas CSA was entered into with a Puerto
Rican entity, Microsoft Operations Puerto Rico LLC (MOPR).
The IRS summons seek details on how Microsoft internally
valued the intangibles it transferred to the offshore
affiliates. The government is looking for information on
Microsoft's valuation techniques and procedures.
Amazon.com, Inc. v. Commissioner, T.C. Dkt.
31197-12, involves a cost sharing agreement with income
adjustments of over $2 billion for the two years in issue.
Amazon involves the same "perpetual useful life" issue that
was litigated in Veritas v. Commissioner, 133 T.C. 297
(2009). The IRS lost in Veritas. It is difficult for
the IRS to argue for a perpetual life for technology
intangibles. Technology is constantly evolving and is usually
seen as becoming obsolete quickly. The Amazon trial took place
in November of 2014 and was closed to the public.
The IRS valued the preexisting technology and marketing
intangibles buy-in at more than 20 times the amount paid by
Amazon's Luxembourg subsidiary to Amazon. A study performed for
the IRS by Horst Frisch found that the intangibles contributed
had a value of $3.6 billion using a discounted cash flow with
an 18% discount rate and a perpetual life.
The judge stated that he rejected an assumption of a 5%
increase in the intangible development costs (IDCs) a year. He
said that a higher projected IDC, perhaps as high as projected
revenues, is the right number. The larger the IDC that is
required the smaller the initial buy-in value should be, which
is good for Amazon.
The judge also said that ongoing investments would be needed
to keep the "technology up to snuff." These statements by the
judge would seem to undermine the IRS's perpetual life argument
and diminish the IRS's chance of success in this case.
In Zimmer Holdings, Inc. v. Commissioner, T.C. No.
19073-14, the IRS presented three different alternative
positions in its Notice of Deficiency.
First, section 482 applies and Zimmer's income should be
increased by just over $100 million for each of two years.
Second, in the alternative if the first argument is not
successful, the IRS asserts that Zimmer's income should be
increased by amounts over $100 million (more than under the
section 482 adjustments) based on transfers of intangible
property to its Dutch subsidiary under section 367(d).
In the third and final alternative if the first two
arguments are not successful, the IRS asserts that Zimmer's
taxable income should be increased by nearly $1 billion under
section 367(a) based on the value of a licensing agreement,
workforce-in-place and goodwill, allegedly transferred to a
Medtronic v. Commissioner, T.C. Dkt. 6944-11,
involves sections 482 and 367(d). The company is challenging
income adjustments for tax years 2005 and 2006.
The IRS is asserting a $1.35 billion transfer pricing
adjustment related to the value of the intangibles and the
resulting royalties owed by Medtronic's Puerto Rican entity to
In the alternative, the IRS claims that if the royalty
payments are found to be at arm's-length, then there was a
transfer of intangible property under section 367(d). Medtronic
maintains that no such transfer occurred because the
intangibles always remained with the US parent.
Also at issue is a $793 million dividends-received deduction
under section 965. The parties have agreed to hold that issue
until the primary transfer pricing issue is resolved.
Medtronic had an expert witness testify that because
Medtronic makes medical devices, quality is a matter of life
and death, therefore, the manufacturing process it critical and
justifies the higher return that the Puerto Rican entity
IRS training slides
The IRS made public a number of international training
slides developed by LB&I's international practice
The "Section 482 Fundamentals" slide states that the IRS
examiner should consider the "functions performed, assets
employed, and risks assumed". They refer to the recent
transfer pricing roadmap. The slides state that the
arm's-length range can be determined "either on a full range or
an interquartile range", depending on the application of
certain criteria. The slides also recommend interviews of key
Transfer pricing audit roadmap
In 2014 the IRS issued the transfer pricing audit roadmap,
which is intended to be a guide to international examiners in
developing a transfer pricing case.
According to the roadmap, the key in transfer pricing cases
is to put together a compelling story of what drives the
taxpayer's financial success, based on a thorough analysis of
functions, assets, and risks, and an accurate understanding of
the relevant financial information. The roadmap states that
fact-development is the "bread and butter" of exam teams
– it is what they are trained for and good at. An
effective story explains the taxpayer's value chain,
competitive position in its industry, and financial results, in
a clear and compelling fashion.
The roadmap emphasises that even a strong position may not
be sustained on review if it is not presented clearly and
persuasively. A notice of proposed adjustment (NOPA) should
have logical structure, and should weave the facts and
applicable legal and economic principles together in a
story-line that resonates with the reader. All the relevant
facts – good and bad – should be addressed.
The conclusion should come across as "inevitable".
This sort of presentation lends credibility to the proposed
adjustment, and increases the odds of early resolution or
sustention on review.
The roadmap lists a number of items that Exam should review
in developing a transfer pricing case, including:
- Form 5471 – Information Return of US Person with
Respect to Certain Foreign Corporations;?
- Form 5472 – Information Return of a 25%
Foreign-Owned US Corporation or a Foreign Corporation Engaged
in a US Trade or Business;
- Form 8833 – Treaty-Based Return Position
- Form 8858 – Information Return of US Persons
with Respect to Foreign Disregarded Entities;?
- Form 8865 – Return of US Persons with Respect to
Certain Foreign Partnerships;?
- Form 926 – Return by a U.S. Transferor of
Property to a Foreign Corporation;
- Uncertain Tax Positions (UTP) Disclosures; and?
- Schedule M-3 analysis
In addition, the roadmap states that, because transfer
pricing studies are generally based on book financial
information, it is helpful to become familiar with qualitative
and quantitative information found in publicly available
documents, such as SEC Form 10-Ks.
Other detailed information particularly useful for a
transfer pricing review includes:
- research and development activity and location;
- descriptions of patents,
- trademarks and other IP;
- geographic and organisational structure;
- segmented operational and profitability level; and
- section 6662 documentation.
Exam is instructed to hold a transfer pricing orientation
with the taxpayer to include discussions of:
- the taxpayer's background and the history of intercompany
- all intercompany transactions in the year(s) under
- the taxpayer's rationale for entering into the
- the taxpayer's value chain(s) associated with the
intangible, services and/or tangible goods;
- whether the intercompany transaction is associated with
the transfer of an income stream, or contribution to the
value, of any intangible; the functions performed, assets
employed, and risks assumed by each controlled party of the
respective intercompany transaction;
- how the preparer of the transfer pricing study gained
knowledge of each controlled party's functions performed,
assets employed and risks assumed; and
- request supporting documents (interview notes,
Practice group leader
Fenwick & West
Tel: +1 650 335 7254
Fax: +1 650 938 5200
David Forst is the practice group leader of the tax
group of Fenwick & West. He is included in
Euromoney's Guide to the World's Leading Tax
Advisers. He is also included in Law and Business
Research's International Who's Who of
Corporate Tax Lawyers (for the last six years).
David was named one of the top tax advisers in the
western US by International Tax Review, is
listed in Chambers USA America's Leading Lawyers
for Business (2011-2014), and has been named a
Northern California Super Lawyer in Tax by San
David's practice focuses on international corporate
and partnership taxation. He is a lecturer at Stanford
Law School on international taxation. He is an editor
of and regular contributor to the Journal of
Taxation, where his publications have included
articles on international joint ventures, international
tax aspects of M&A, the dual consolidated loss
regulations, and foreign currency issues. He is a
regular contributor to the Journal of Passthrough
Entities, where he writes a column on
international issues. David is a frequent chair and
speaker at tax conferences, including the NYU Tax
Institute, the Tax Executives Institute, and the
International Fiscal Association.
David graduated with an AB, cum laude, Phi
Beta Kappa, from Princeton University's Woodrow Wilson
School of Public and International Affairs, and
received his JD, with distinction, from Stanford Law
Fenwick & West
Tel: +1 650 335 7253
Larissa Neumann focuses her practice on US tax
planning, tax controversy, and tax litigation for
corporations, with an emphasis on international
transactions. She has broad experience advising US
companies and foreign-based clients on the taxation of
cross-border operations, acquisitions, dispositions,
restructurings and transfer pricing issues. She has
successfully represented clients in federal tax
controversies at all levels and has substantial
experience managing complex tax controversies. She
represents clients from a diverse set of industries and
geographic areas. Her clients range in size from high
technology start-ups to large Fortune 500
In 2014, Euromoney selected Larissa for
inclusion in the "Americas Women in Business Law
Awards" shortlist for Best in Tax Dispute Resolution.
Larissa appears as a rising star in Euromoney's
"World's Leading Tax Advisers."
Larissa received her J.D. from the University of
California, Berkeley, School of Law in 2005. She
received her M.A. in public health from Yale University
in 2002 and her B.S. in molecular cell biology from
University of California, Berkeley, in 2000.
Larissa frequently speaks on US corporate and
international tax issues at conferences for
professional tax groups, including Tax Executives
Institute, International Fiscal Association, Pacific
Rim Tax Institute, Bloomberg BNA, and the American Bar
Association. She is a member of the ABA Section of
Taxation and the International Fiscal Association.
Larissa has published several articles, including
- US Tax Developments, International Tax
- US International Tax Developments, The
Euromoney Corporate Tax Handbook 2012
- Character and Source of Income from Internet
Business Activities, The Contemporary Tax
Journal (July 2011)
Fenwick & West has one of the World's Top Tax
Planning and Tax Transactional Practices, according to
International Tax Review (2014), and is first
tier in tax, according to World Tax 2014.
International Tax Review gave Fenwick &
West its San Francisco Tax Firm of the Year Award a
total of five times and its US Tax Litigation Firm of
the Year Award a total of three times.