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Earlier this month we heard about the IRS audit of Facebook. Now it is Amazon’s turn.  The Facebook audit is about the transfer of intellectual property to an Irish subsidiary in 2010. Amazon has been in Tax Court since 2012 about transfer of IP to a Luxembourg subsidiary in 2005 and 2006 and related cost-sharing issues.  The Guardian which appears to be covering these matters more aggressively than American media has intervened in the Tax Court case to open up more of the sealed part of the record.

What’s It All About?

The earlier Facebook story prompted me to speak to Timothy Larson who is the Practice Leader International Tax Services at Citrin Cooperman, a top 25 accounting firm headquartered in New York with offices in New Jersey, Pennsylvania, Connecticut, and Maryland.  As he explained it sending your IP offshore is a long-range strategy.  It requires that your company have significant foreign sales to be a viable strategy.

The problem with these transactions is they are supposed to be treated as if they were at arms length, but they are not in any way arms-length transactions since they are between parent and subsidiary or among subsidiaries.  The essence is that IP attributable to international sales is parked in a tax-friendly jurisdiction.  Amazon chose Luxembourg. Facebook went with a convoluted structure that involves two Irish companies with a Dutch company in between, with one of the Irish companies being resident in the Caymans.

Mr. Larson indicated that these plans are only as good as their execution (See Reilly’s Fourth Law of Tax Planning).  And they require continual maintenance.  The IRS has been challenging them on valuation.  In principle, there are two avenues.  The royalty paid to the offshore company might be considered too high or the amount charged the offshore subsidiary for the initial transfer might be too low.

The IRS finds it easier to attack on the latter ground.  In mounting the attack, IRS has the benefit of hindsight, but Mr. Larson indicated that they have done a really good job in engaging first-rate experts to really look into the guts of the transaction. At the heart of the Amazon fight is a 155-page report by economist Daniel Frisch.

Details, Details

You can get a bit of a sense of what is at stake in the Amazon case from Amazon’s 10-K.

For instance, the IRS is seeking to increase our U.S. taxable income related to transfer pricing with our foreign subsidiaries for transactions undertaken in 2005 and 2006, and we are currently contesting the matter in U.S. Tax Court. In addition to the risk of additional tax for 2005 and 2006 transactions, if this litigation is adversely determined or if the IRS were to seek transfer pricing adjustments of a similar nature for transactions in subsequent years, we could be subject to significant additional tax liabilities.

The Guardian, on the other hand, fleshed things out quite a bit in this story.

Newly emerged documents seen by the Guardian show precisely how Amazon embarked on a complex 28-step scheme, which took more than two years to complete, and fundamentally reordered its global business in Europe using a maze of offshore entities and intercompany agreements.

Amazon’s move to Luxembourg has been well documented, but the company has never publicly disclosed full details of Project Goldcrest, which it brazenly named after Luxembourg’s national bird. The tax arrangements came into effect in 2006 and largely remain in place today.

One of the first steps in the litigation on the 2005 and 2006 transfers was a protective order to prevent release of information used by the Tax Court in deciding the case. That’s what has motivated Guardian’s intervention in the case.

Wait And See

In the typical Tax Court case, you have the petitioner, who has received a notice of deficiency from the IRS, and the respondent, the IRS. The only time I have noted an “intervenor” is in innocent spouse cases where the alledgedly guilty spouse gets to weigh in.  I thought maybe I hadn’t been paying enough attention, but it turns out that a media outlet intervening in Tax Court is unprecedented.

Guardian has not cited, and our own research has not discovered, any instance in which this Court, or any other court, has been asked to decide whether a media organization should be allowed to intervene in a pending Federal tax controversy. Guardian’s motion presents novel questions, both as to the proper standards for intervention in the absence of any Rule governing the subject, and as to whether the IRS, as an agency of the United States, adequately represents Guardian’s interest in public disclosure.

The Tax Court notes that the IRS usually fights for an open record. Regardless, it will be another two months before it is determined what, if anything, that Guardian is looking for will be sealed.

Once this process has been completed, the documents Guardian seeks may become available for public inspection, by agreement of the parties or by order of the Court, and Guardian’s motion may become moot.

Is The Game Worth The Candle?

According to its 10-K, Amazon has $1.5 billion in earnings stashed offshore and it is “impracticable” to determine how much in federal income tax is deferred from that.  It is hard to see how it could be much more than half a billion in tax which seems like an awful lot of money, but compared to market capitalization over $350 billion is maybe not so much.

Other Coverage

Lew Taishoff has a post referring to Guardians coverage of the Snowden affair- Snow(den) Job? Lorraine Bailey also has a nice summary in Courthouse News Service.