The Tax Court approved a software company’s method of valuing a buy-in payment for the transfer of intangible assets to a subsidiary, calling the IRS’ redetermination of the buy-in payment amount “arbitrary, capricious and unreasonable.”
The case concerned tax years 1999 through 2001 of VERITAS Software Corp. (VERITAS U.S.), which in 2005 was acquired by Symantec Corp. In 1999, VERITAS U.S. entered into a cost-sharing arrangement with one if its foreign subsidiaries, VERITAS Ireland, to develop, manufacture and market storage management software products. In it, VERITAS U.S. granted VERITAS Ireland the right to use certain previously developed intangibles in various foreign markets. In exchange for these pre-existing intangibles, VERITAS Ireland made a $166 million buy-in payment to VERITAS U.S. The payment amount was calculated by the “comparable uncontrolled transaction” (CUT) method, which determines whether the amount charged for the transfer of intangible property between controlled entities is at arm’s length (as required by Treas. Reg. § 1.482-1(b)) by comparing it with amounts charged for comparable transfers between uncontrolled entities.
Using a different method, the “forgone profits method,” the IRS determined that the buy-in agreement should have taken into account access to VERITAS U.S.’ research and development team, access to its marketing team and its distribution channels, customer lists, trademarks, trade names, brand names and sales agreements, increasing the buy-in payment to $2.5 billion. Under IRC § 482, the IRS may allocate income, deductions, credits or allowances between controlled entities to prevent the evasion of taxes or to clearly reflect income. Thus, the IRS made an income allocation to VERITAS U.S. for $2.5 billion and issued a corresponding notice of deficiency totaling $758 million for tax years 2000 and 2001. The IRS later reduced the allocation to $1.675 billion.
The issue before the court was whether the buy-in payment was at arm’s length, as determined by the best method, under criteria and rules of Treas. Reg. § 1.482-1. A pretrial settlement stipulating some issues limited the government’s justification of its higher allocation to valuation of the preexisting intangibles, the Tax Court said.
Testimony to that end by a government expert witness was “unsupported, unreliable and thoroughly unconvincing,” the court said. As a result, the court held that the IRS’ determinations were in fact arbitrary, capricious and unreasonable, and VERITAS U.S.’ CUT method was, with appropriate adjustment, the best method to determine the buy-in payment.
VERITAS Software Corp. & Subs. , 133 TC no. 14
By Karen M. Cooley, CPA, MBA, instructor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.