Transfer pricing adjustments under section 482 are supposed to assure that the Secretary can "distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among [organizations owned or controlled directly or indirectly by the same interests] if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect thye income of any of such organizations, trades or businesses." That statutory provisions gives considerable discretion to the government to determine whether a company's allocation is a "clear reflection of income." It is not supposed to permit companies to short-change the government by working out "transfer pricing" deals with subsidiaries that low-ball the figure in order to shortchange the tax revenues.
It looks like Symantec may get away with just that--"selling" a supported intangible property developed in the US for a lowball figure of a not even 200 million when the income stream (to the now-foreign owner) will be worth billions, based on the taxpayer's claim that its method of determining the worth of the product is better than the Service's income method. See Veritas Software, 133 TC No. 14 (2009), Download Veritas Software transfer pricing case.121009 (BNA).
Folks, the primary (and often only) reason US software companies established two-tier Bermuda and Irish subsidiaries like Veritas did--i.e., Bermuda-resident subsidiaries incorporated in Ireland's low-tax jurisdiction that have Irish-resident and incorporated subsidiaries-- was to offload income from their products to that area from the US and avoid US taxes. If they could "sell" their software cheap, and then have a hefty royalty income stream going directly to the foreign subsidiary, they could substantially reduce US taxes. Veritas established the subsidiaries and then assigned "exclusive and permanent rights" its existing sales agreements with European subsidiares and to various "covered intangibles" (inventions, patents, copyrights, computer programs, updates, translations, adaptations, specifications, etc.) to the Irish subsidiary of the Bermuda-resident Irish corporation, while still agreeing by contract to provide R&D and technology support for the product to its subsidiaries and the right to use "trademarks, trade names, service marks". This deal was done for an initial $166 million lump sum buy-in (later adjusted to $118 million) and royalties.
The IRS thought the buy-in payment should be somewhere between $1.9 billion and $4 billion, settling on $2.5 billion in the notice of deficiency, based on the forgone profits and market capitalization methods applied by Brian Becker. But in the court, the IRS indicated that it would no longer use Becker as a witness or rely on the market capitalization method, but rather, based on actual income figures, assert a new forgone income amount of $1.67 billion, developed by cost-sharing expert John Hatch using a discounted cashflow analysis.
The company assserted that its "comparable uncontrolled transaction method" was appropriate and that the IRS's new determination was arbitrary and capricious. The tax court agreed, arguing that the IRS's mechanism was inappropriate because it did not refer only to preexisting intangibles in disregard of Reg. section 1.482-7(g)(2) and because it valued short-lived intangibles as though they had a perpetual useful life and because the court found Hatch's determinations "unsupported, unreliable, and thoroughly unconvincing."
This opinion illustrates yet again the problem with offering multinational corporations various "elections" about how to determine a matter relevant to their taxable income and in the variability of numbers that financial "experts" can come up with. The opinion appears to rely very heavily on the company's description of its industry and mode of operation, resulting in a very low figure for the value of the intangible transferred. Of course, the lack of credibility of the IRS's expert is problematic as well--the IRS needs to better prepare its cases at the early stages and the DOJ and Treasury need to work together to make sure that litigation strategies are implemented appropriately. The Tax Court also refused to consider new regulations as relevant, when the old regulations did not explicitly cover workforce, goodwill or going concern value.
In the long run, it would be reasonable for sales of intangibles to affiliates to apply a uniform hind-sight calculation based on present valuing expected future income streams, so that the full value of an asset is taxed when it is transferred to another country. Congress, and the Treasury, need to reconsider the value of "flexibility" in the Code and regulations. The Tax Court ought generally to grant greater deference to the Secretary in these transfer pricing cases--the Code makes it clear that the Secretary has authority to reallocate.