148 T.C. No. 8 UNITED STATES TAX COURT AMAZON.COM, INC. & SUBSIDIARIES, PetitionerPetitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 31197-12. Filed March 23,23, 2017.2017. In 2005 P entered into a cost sharing arrangementarrangement (CSA)(CSA) withwith S, its LuxeLuxembourgmbourg subsidiary. Pursuant toto thethe CSA,CSA, PP grantedgranted SS thethe right to use certain pre-existing intangibleintangible assetsassets inin Europe,Europe, includingincluding the intangibles required toto operateoperate PP's’s EuropeanEuropean websitewebsite business.business. This arrangement required S to mmakeake an upfront “"buybuy-in-in paypayment"ment” to compensate P for the value of the intangible assetsassets thatthat werewere toto bebe transferred to S. See sec. 1.482-7(a)(2), (g)(2), IncomeIncome TaxTax Regs.Regs. Thereafter S was required to mmakeake annual costcost sharingsharing paymentspayments toto ccompensateompensate P fforor oongoingngoing intangibleintangible developmentdevelopment costscosts (IDCs), toto the extent those IDCs benefited S.S. SeeSee id.id. paras.paras. (a)(1),(a)(1), (d)(1).(d)(1). AsAs consideration for the transfer ofof pre-existingpre-existing intangibles,intangibles, SS mmadeade aa $254.5 mmillionillion buy-inbuy-in payment to P. Applying a discounted cash-flowcash-flow (DCF) methodology toto thethe eexpectedxpected ccashash fflloowsws ffromrom tthehe EEuropeanuropean bbusiness,usiness, R R determined determined a a buy- buy- in payment of $3.6 billion, later reduced toto $3.468$3.468 billion.billion. PP con-con- tends that RR's’s DCF methodology is substantially similar toto thatthat re-re- jected by this Court in Veritas SoftwareSoftware Corp. v.v. CoCommissioner,mmissioner, 133133 - 2 - T.C. 297 (2009). P contends that RR's’s determinations areare arbitrary,arbitrary, capricious, and unreasonable andand thatthat thethe comparablecomparable uncontrolleduncontrolled transaction (CUT) method is the best mmethodethod toto calculatecalculate thethe requisiterequisite buy- buyin payment.-in payment. P used a multistep allocation system to allocate costscosts fromfrom its variousvarious ccostost centers to IDCs. See sec. 1.482-7(d)(1), IncomeIncome Tax Regs. (providing that costscosts “"mustmust be allocatedallocated betweenbetween thethe intangibleintangible development area and the other areaareass or business activitiesactivities onon aa rea-rea- sonable basis").basis”). While acceacceptingpting PP's’s allocation mmethodethod inin mmanyany re-re- spects, R determined that 100% of the costscosts capturedcaptured inin oneone importantimportant cost center (("Technology“Technology and ContentContent")”) must be allocatedallocated toto IDCs.IDCs. PP contends that RR's’s determination to allocateallocate toto IDCsIDCs 100%100% ofof thethe Technology and Content costs is inconsistentinconsistent withwith thethe regulations.regulations. 1. Held:Held: RR's’s determination with respect to the buy-inbuy-in payment isis arbitrary,arbitrary, ccapricious,apricious, aandnd uunreasonable.nreasonable. Veritas Software Corp. v. CommissionerCommissioner,, 133 T.C. 297, followed. 2. Held,Held, furtherfurther,, PP's’s CUT mmethod,ethod, with appropriate upward ad-ad- justments in numerous respects, is the best mmethodethod toto determinedetermine thethe requisite buybuy-in-in payment. 3.3. Held,Held, further,further, R abusedabused hishis discretiondiscretion in determining that 100% of Technology and Content costscosts constituteconstitute IDCs.IDCs. 4.4. Held,Held, further,further, P'sP’s costcost-allocation-allocation mmethod,ethod, with certain ad- justments, supplies a reasonable basis forfor allocatingallocating costscosts toto IDCs.IDCs. JJohnohn BB.. MMagee,agee, SSanfordanford WW.. SStark,tark, BBryonryon AA.. CChristensen,hristensen, TTraceyracey X. X. Zheng Zheng,, Robert S. KirschenbaumKirschenbaum,, Beth L. WilliamsWilliams,, John G. RyanRyan,, Saul MezeiMezei,, Julia Kazaks,Kazaks, Rajiv MadanMadan,, John A. PolitoPolito,, Michael D.D. KummerKummer,, Christopher P.P. - 3 - Murphy,Murphy, RRoyceoyce LL.. Tidwell,Tidwell, CCarlarl T.T. Ussing,Ussing, HansHans D.D. Gerling-Ritters,Gerling-Ritters, Nicholas A. Zemil,Zemil, and Paul M. McLaughlinMcLaughlin,, for petitioner. Jill A. FrischFrisch,, Anne OO'Brien’Brien HintermeisterHintermeister,, Melissa D. LangLang,, LloydLloyd T. SilberzweigSilberzweig,, Shannon L. CohenCohen,, Melissa L.L. HiltyHilty,, ScottScott W.W. MentinkMentink,, DavidDavid A.A. LeeLee,, My V. Vo,Vo, Jimeel R. Hamud,Hamud, Aaron T. Vaughan,Vaughan, and Mary E. WynneWynne,, for respondent. CONTENTS FINDINGSFINDINGS OOFF FFACTACT. 10 I. Overview of AmazonAmazon's’s European Business . 12 A. Initial Expansion Into Europe . 12 B. Original Structure of European Business . 1166 C. "Project“Project GGoldcrest"oldcrest” . .202 . 0 1.1. Cost Sharing Arrangement . 23 2.2. LLicenseicense Agreement . 24 3.3. AssignmentAssignment Agreement . 24 4.4. European Subsidiary Contribution . 25 55.. European Business Contribution . 25 6.6. FourFour--PartyParty Agreement . 26 D. Life After Project Goldcrest . 26 II. Retail and Technological Environment . 28 A. Internet Retail Environment . 28 B. Evolution of AmazonAmazon's’s Website Architecture . 32 C. Evolution of AmazonAmazon's’s Software Applications . 38 1.1. CCustomerustomer Master Service . 38 2.2. OOrderrder Master Service . 39 3.3. DDynamoynamo . 40 4.4. PPaymentsayments . 41 55.. IItemtem MMasteraster . 42 - 4 - 6.6. Personalization . 43 77.. MMessagingessaging . 45 D. New Products and Services After JanuaryJanuary 1, 2005 . 46 III. Amazon'sAmazon’s ThirdThird-Party-Party Businesses . 47 A. Merchants.comMerchants.com . 47 B. Associates and Syndicated Stores . 49 IV.W. TheThe BBuyuy--InIn PPaymentayment . 51 V. Cost Sharing PayPaymentsments . 57 VI. Stock-BasedStock-Based Compensation . 65 OOPINIONPINION . 67 I. Cost Sharing Background . 69 II. RespondentRespondent's’s Determination of the Buy-InBuy-In PaymentPayment . 7373 III. PetitionerPetitioner's’s Determination of the Buy-InBuy-In PaymentPayment . 89 A. WebsiteWebsite Technology . 91 1.1. RRoyaltyoyalty RRateate . 95 2.2. Useful Life and Decay Curve . 102 a. UsefulUseful LLifeife . 103 b.b. DecayDecay CCurveurve . 107 c. "Tail"“Tail” PPerioderiod . 1117 17 3.3. RRevenueevenue Base . 121 4.4. DDiscountiscount Rate . 124 B. Marketing Intangibles . 127 1.1. RRoyaltyoyalty RRateate . 129 2.2. UsefulUseful LLifeife . 135 3.3. RRevenueevenue Base . 143 4.4. DDiscountiscount Rate . 146 55.. European Portfolio . 147 a. Ownership of the European Portfolio . 148148 b.b. Allocating Value to the European PortfolioPortfolio . 154154 - 5 - C. CCustomerustomer Information . 162 IV.W. CCostost Sharing PayPaymentsments . 173 A. RespondentRespondent's’s Position . 174 B. PetitionerPetitioner's’s Position . 178 C. Stock-BasedStock-Based Compensation . 185 LAUBER, Judge:Judge: The Internal Revenue ServiceService (IRS oorr respondent)respondent) deter-deter- mined, for 2005 and 2006 respectively, deficienciesdeficiencies inin petitionerpetitioner's’s FederalFederal incomeincome tax of $8,380,790 and $225,653,149.$225,653,149.11 TheseThese deficienciesdeficiencies arosearose frofromm aa seriesseries ofof transactions by which AAmazon.com,mazon.com, Inc., and its dodomesticmestic subsidiariessubsidiaries (collective-(collective- ly, AmazonAmazon US) transferred to Amazon Europe Holding TechnologiesTechnologies SCSSCS (AEHT), a Luxembourg subsidiary, the intangible assets requiredrequired toto operateoperate pe-pe- titioner'stitioner’s European website business. InvokingInvoking sectionsection 482,482, thethe IRSIRS mademade substantial transfer-pricingtransfer-pricing adjustmentsadjustments reallocatingreallocating incomeincome toto AAmazonmazon USUS fromfrom AEHT. From its inception through 2005 AAmazonmazon USUS ownedowned thethe intellectualintellectual prop-prop- erty in question. In 2004 AAmazonmazon US andand AEHTAEHT enteredentered intointo aa “"costcost sharingsharing 1lUnless otherwise indicated, allall statutorystatutory referereferencesnces areare toto thethe InternalInternal Revenue Code in effect for the tax years at issue,issue, andand allall RuleRule referereferencesnces areare toto thethe Tax Court Rules of Practice and Procedure. WeWe roundround allall dollardollar amountsamounts toto thethe nearest dollar. - 6 - arrangement."arrangement.” See sec. 1.482-7(a)(1), (b)(1), IncomeIncome Tax Regs.Regs.22 This arrange- ment required AEHT to make an up-frontup-front "buy“buy-in-in paymentpayment"” to compensate Ama- zon US for the value of the intangible assetsassets thatthat werewere toto bebe transferredtransferred toto AEHT.AEHT. See id. paras. (a)(2), (g)(2). Thereafter AEHT was required to mmakeake annualannual costcost sharing payments to compensate Amazon US for ongoing intangibleintangible developmentdevelopment costs (IDCs), to the extent those IDCsIDCs benefited AEHT.AEHT. In a series of transactions inin 2005 andand 20062006 AAmazonmazon USUS transferredtransferred toto AEHT three groups of intangible assets: (1)(1) thethe softwaresoftware andand otherother technologytechnology re-re- quired to operate petitionerpetitioner's’s EuropeanEuropean websites,websites, fulfillmentfulfillment centers,centers, andand relatedrelated business activities; (2)(2) mmarketingarketing intangibles,intangibles, includingincluding trademarks,trademarks, tradenames,tradenames, and domain names relevant to the European business; andand (3)(3) customercustomer listslists andand other information relating