The issue in the VERITAS case involved the calculation of the buy-in payment under VERITAS’ cost sharing arrangement with its Irish affiliate.
VERITAS US assigned all of its existing European sales agreements to VERITAS Ireland. Similarly,VERITAS Ireland was given the rights to use the covered intangibles and to use VERITAS US’s trademarks, trade names and service marks in Europe, the Middle East and Africa, and in Asia-Pacific and Japan.
In return, VERITAS Ireland agreed to pay royalties to VERITAS US in exchange for the rights granted. The royalty payment included a prepayment amount (i.e. lump-sum payment) along with running royalties that were subject to revision to maintain an arm’s length rate. Thereafter, VERITAS Ireland began co-developing, manufacturing and selling VERITAS products in the Europe, the Middle East and Africa markets as well as in the Asia-Pacific and Japan markets. These improvements, along with the establishment of new management, allowed VERITAS’ 2004 annual revenues to be five times higher than its 1999 revenues from Europe, the Middle East and Africa, and Asia-Pacific and Japan.
the IRS’s economic expert employed the income method to calculate the buy-in payment (for pre-existing intangibles that were to be used by the parties to develop future technology under the cost sharing arrangement). These calculations were based on the assumption that the transfer of pre-existing intangibles by VERITAS US was “akin to a sale” and should be evaluated as such.
To value the transfer, the IRS expert aggregated the intangibles so that, in effect, he treated the transfer as a sale of VERITAS US’s business, rather than a sale of each separate intangible asset. The aggregation of the intangibles was necessary, in the view of the IRS expert, because the assets collectively (the package of intangibles) possessed synergies and, as a result, the package of intangibles was more valuable than each individual intangible asset standing alone.
The Court rejected the IRS’s method on the following premises:
- The IRS did not differentiate between the value of subsequently developed intangibles and pre-existing intangibles, thus including intangibles beyond what is required for the buy-in payment;
- The IRS included intangibles such as access to VERITAS US’s marketing and R&D teams, which are not among the intangibles recognized by the US transfer pricing rules; and
- The IRS incorrectly assigned a perpetual useful life for transferred intangibles that have a useful life of four years.