Amazon.com, Inc. v. Comm'r , 108 T.C.M. 87 ( 2014 )

T.C. Memo. 2014-149
UNITED STATES TAX COURT
AMAZON.COM, INC. & SUBSIDIARES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 31197-12. Filed July 28, 2014.
John B. Magee, Bryon A. Christensen, Tracey X. Zheng, Andrew Wein-
stein, Sanford W. Stark, Hartman E. Blanchard, Jr., Robert S. Kirschenbaum, Beth
Lee Urich Williams, John G. Ryan, Saul Mezei, Julia Mara Kazaks, Michael D.
Kummer, Christopher P. Murphy, Royce L. Tidwell, Rajiv Madan, and John A.
Polito, for petitioner.
Jill A. Frisch, Melissa D. Lang, Lloyd T. Silberzweig, Anne O’Brien
Hintermeister, and Mary E. Wynne, for respondent.
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[*2] MEMORANDUM OPINION
LAUBER, Judge: This case is calendared for trial in Seattle, Washington,
in November 2014. Respondent determined under section 482 substantial defi-
ciencies in petitioner’s income tax for 2005 and 2006.1 Many of these adjustments
arise in connection with a cost sharing arrangement executed by petitioner and
certain affiliates pursuant to section 1.482-7, Income Tax Regs.2
Currently before the Court is petitioner’s motion for partial summary judg-
ment filed under Rule 121. Petitioner contends that it is entitled to judgment as a
matter of law on two related questions: (1) whether respondent abused his discre-
tion by allocating 100% of the costs in certain cost centers to intangible develop-
ment costs (IDCs) under section 1.482-7(d)(1), Income Tax Regs.; and (2) whether
petitioner is entitled as a matter of law to apply an allocation method to determine
IDCs under the governing regulations.
1
Unless otherwise indicated, all statutory references are to the Internal
Revenue Code in effect for the tax years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
2
Section 1.482-7, Income Tax Regs., was redesignated section 1.482-7A,
Income Tax Regs., with the promulgation of new regulations effective January 5,
2009. See T.D. 9441, 2009-7 I.R.B. 460.
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[*3] On the first question, we find that there are genuine disputes of material fact
that preclude partial summary judgment. On the second question, we conclude
that petitioner must show that the cost centers in question constitute “mixed
costs”--that is, costs benefiting other business activities as well as intangible
development activities--before it can justifiably employ an allocation method to
determine IDCs under section 1.482-7(d)(1), Income Tax Regs. Because there is a
genuine dispute of material fact as to whether, and the extent to which, the cost
centers at issue constitute “mixed costs,” we will deny petitioner’s motion for
partial summary judgment on both questions.
Background
We assume the following facts based on the pleadings, petitioner’s motion
for partial summary judgment, and the attached exhibits. They are stated solely for
the purpose of deciding this motion for partial summary judgment and not as
findings of fact in this case. See Fed. R. Civ. P. 52(a); Rule 1(b); Cook v.
Commissioner, 115 T.C. 15, 16 (2000), aff’d, 269 F.3d 854 (7th Cir. 2001).
Petitioner’s principal place of business was in Seattle, Washington, when it filed
its petition.
Petitioner and its U.S. affiliates executed with Amazon Europe Holdings
Technologies SCS, a Luxembourg affiliate, a cost sharing arrangement (CSA) that
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[*4] was intended to comply with section 1.482-7(b), Income Tax Regs. In
entering into the CSA, the parties agreed to share IDCs. The regulations define
IDCs and provide that costs which contribute both to intangible development
activity and to other business activities must be allocated “on a reasonable basis.”
See sec. 1.482-7(d)(1), Income Tax Regs.
Petitioner’s cost accounting system during 2005-06 did not specifically
segregate IDCs from other operating costs. Petitioner therefore developed a for-
mula and applied it to allocate to IDCs a portion of the costs accumulated in vari-
ous “cost centers” under its method of accounting. “Cost centers” are accounting
classifications that enable petitioner to manage and measure operating expenses.
Petitioner tracked expenses in six broad categories: (1) Cost of Sales, (2)
Fulfillment, (3) Marketing, (4) Technology and Content (T&C), (5) General and
Administrative (G&A), and (6) Other. According to petitioner’s 2005 SEC Form
10-K, Annual Report Pursuant to Section 13 or 15(d) of the Securities and Ex-
change Act of 1934, the T&C category expenses “consist principally of payroll
and related expenses for employees involved in research and development, in-
cluding application development, editorial content, merchandising selection,
systems and telecommunications support, and costs associated with the systems
and telecommunications infrastructure.”
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[*5] Each of the six broad expense categories, including the T&C category, is a
“rollup” of numerous individual cost centers. For some calendar quarters, more
than 200 individual cost centers, each recording a specific type of expense, “rolled
up” into intermediate cost centers and ultimately into the T&C category. For
example, cost center 7710, “Systems and Network Engineering,” rolls up into
C210 (“Product Development”) and C250 (“Technology/External”). All costs
accumulated in “Product Development” and “Technology/External” roll up into
the Technology & Content category.
Petitioner took the position that none of the costs accumulated in Cost of
Sales and Other are allocable to IDCs, and respondent accepts that position. With
few exceptions, petitioner’s operating costs roll up into the Fulfillment, Market-
ing, T&C, and G&A categories. Petitioner treated portions of the costs accumu-
lated in the first three just-mentioned categories as IDCs, using an allocation for-
mula it developed. Petitioner treated a portion of the costs accumulated in the
G&A category as IDCs, on the basis of the IDC outcomes for the other categories.
Respondent has not challenged petitioner’s use of its allocation method, or
the amounts of IDCs that it determined, for the Fulfillment and Marketing cate-
gories. Respondent does, however, dispute petitioner’s allocation to IDCs of
costs accumulated in the T&C category. In the notice of deficiency respondent
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[*6] determined that 100% of T&C category costs constitute IDCs. As a corollary
of that determination, respondent adjusted the percentage of G&A costs that peti-
tioner had allocated to IDCs.
On June 13, 2014, respondent filed a motion to compel production of docu-
ments relating to petitioner’s cost allocations under section 1.482-7(d)(1), Income
Tax Regs. Petitioner objected to this request as unduly burdensome and, on July
2, 2014, we denied respondent’s motion in its then-current form. Our order stated,
however, that “respondent is entitled to discovery as to the facts underlying peti-
tioner’s cost allocations, as to whether costs within the T&C category are ‘mixed’
as petitioner contends, and as to the appropriateness of the formula petitioner has
used to allocate T&C category costs to IDC.”
Discussion
I. Summary Judgment Standard
Summary judgment is intended to expedite litigation and avoid unnecessary
and expensive trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73,
74 (2001). Either party may move for summary judgment upon all or any part of
the legal issues in controversy. Rule 121(a). A motion for summary judgment or
partial summary judgment will be granted only if it is shown that there is no
genuine dispute as to any material fact and that a decision may be rendered as a
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[*7] matter of law. See Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118 T.C.
226, 238 (2002).
II. Analysis
A CSA is an agreement whereby the parties “agree to share the costs of de-
velopment of one or more intangibles in proportion to their shares of reasonably
anticipated benefits from their individual exploitation of the interests in the intan-
gibles assigned to them under the arrangement.” Sec. 1.482-7(a)(1), Income Tax
Regs. A participant must calculate its share of IDCs on the basis of factors that
can reasonably be expected to reflect that participant’s share of anticipated bene-
fits. Sec. 1.482-7(b)(2), (f)(1), Income Tax Regs. A participant’s “costs of devel-
oping intangibles * * * mean all of the costs incurred * * * related to the intan-
gible development area.” Sec. 1.482-7(d)(1), Income Tax Regs. “If a particular
cost contributes to the intangible development area and other areas or other
business activities, the cost must be allocated between the intangible development
area and the other areas or business activities on a reasonable basis.” Ibid.
Petitioner contends that respondent’s determination to allocate to IDCs
100% of the costs in the T&C cost centers is inconsistent with these regulations.
According to petitioner, the regulations require that the Commissioner “specifical-
ly identify costs ‘related to the intangible development area’” or “reasonably allo-
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[*8] cat[e] mixed costs.” By “simply taking all of the T&C cost centers and
including 100 percent of those costs,” respondent has allegedly violated the regu-
latory command that “[c]osts that do not contribute to the intangible development
area are not taken into account.” See sec. 1.482-7(d)(1), Income Tax Regs. Re-
spondent replies that petitioner “has not provided sufficient information to sub-
stantiate” that the costs in question are mixed, i.e., that any of the T&C category
costs contribute to business activities or areas other than the intangible develop-
ment area. That being so, respondent contends, petitioner has not laid the neces-
sary predicate for application of an allocation formula.
We agree with respondent. Petitioner has yet to demonstrate that the T&C
category contains nontrivial costs that are properly characterized as something
other than IDCs. Respondent has sought discovery on this issue and was seeking
additional discovery at the time this motion was filed. At the moment, therefore, it
is a disputed question of material fact whether the T&C category contains “mixed”
costs. Until petitioner establishes that the T&C category contains a nontrivial
amount of “mixed” costs, we cannot rule as to whether respondent abused his dis-
cretion in determining that 100% of T&C category costs constitute IDCs.
Petitioner contends that it is not required by the regulations to show that its
T&C costs are “mixed” before applying an allocation formula. In petitioner’s
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[*9] view, it need only prove that the allocation formula it developed and applied
is “reasonable.” If that formula is “reasonable,” petitioner contends, the formula
necessarily allocates costs correctly as between the intangible development
activity and other business activities.
Petitioner’s argument puts the cart before the horse. The regulations permit
costs to be allocated only “[i]f a particular cost contributes to the intangible devel-
opment area and other areas or other business activities.” Sec. 1.482-7(d)(1), In-
come Tax Regs. The status of costs as “mixed,” in other words, is a precondition
to the application of an allocation formula. Petitioner must show that this condi-
tion has been satisfied before it can proceed to the next step, which is to show that
its allocation formula reasonably allocates mixed costs. At this stage of the litiga-
tion, we cannot rule as to whether respondent abused his discretion in declining to
permit the use of an allocation formula with respect to T&C category costs.
Petitioner evidently sought partial summary judgment on this issue in part
because it believes that establishing the “mixed” nature of T&C category costs
could be tedious and time-consuming. We do not see why this should be so. It is
not necessary that the parties painstakingly examine each cost in the 200-plus
baseline cost centers in order to determine whether a nontrivial portion of T&C
category costs are “mixed.” Sampling techniques or a review of critical cost
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[*10] centers may help answer this question. The facts established by this
exercise, moreover, may shed light on the reasonableness of petitioner’s allocation
formula as applied to T&C category costs. One way or another, petitioner must
establish that it has T&C category costs requiring allocation before the Court will
permit petitioner to allocate such costs.
For these reasons, we will deny petitioner’s motion for partial summary
judgment.
An appropriate order will be issued.