Amazon.com Inc. and the IRS will square off in court for a second time in a dispute involving more than $2 billion in tax adjustments the agency imposed on the company for its international tax arrangements.

In April 12 oral arguments before the Ninth Circuit, the Internal Revenue Service is appealing a 2017 U.S. Tax Court decision in Amazon’s favor, in a dispute over the value of intangibles—such as intellectual property, patents, and trade names—that Amazon transferred to its European business in Luxembourg.

The IRS had adjusted Amazon’s tax liability for 2005 and 2006 by $2.2 billion, arguing that Amazon undervalued the assets. That adjustment would result in a tax bill of about $230 million.

Amazon argues that the IRS was trying to apply regulations retroactively to make its case.

The Case

When Amazon was restructuring its operations in Europe in 2004, it used a cost-sharing arrangement to transfer intangible assets like intellectual property to its subsidiary in Luxembourg. In a cost-sharing arrangement, related parties—two entities in the same company—agree to share the cost of developing intangibles, then share the benefits proportionally.

To arrive at its own valuation of the assets, Amazon looked at how a comparable third-party transaction would have priced them.

The IRS said Amazon didn’t take into account all the resources the U.S. parent company contributed to the cost-sharing agreement, including considering the future value those intangibles could bring. Amazon’s method for calculating the value of the intangibles leaves much of that value unaccounted for—and untaxed, the IRS said.

But to make its valuation, the IRS relied on arguments that appeared in regulations that came out after the tax years in question, the company argued.

“It really is a fundamental clash of economic theory versus a legal approach,” said John Warner, a shareholder at Buchanan Ingersoll & Rooney PC in Washington.

The appeal will center on questions that have been central to some of the highest-profile transfer pricing court cases in recent years: How should multinational companies value intangible assets when they transfer those assets to their other entities? And how much authority does the IRS have to write and interpret rules?

Several other pending cases hinge on similar questions about how and whether the IRS can revalue a company’s transferred intangibles. Coca-Cola Co.'s challenge to an IRS transfer pricing adjustment went to trial at the U.S. Tax Court in 2018, and a Facebook Inc. case will go to trial in 2020.

“If the IRS were to win Amazon, Coke and Facebook are in for a long ride,” said William Byrnes, a professor at Texas A&M University School of Law. But that seems unlikely, he said, because courts have decided in the taxpayers’ favor on similar questions in previous cases.

The Arguments

Amazon and the IRS used different transfer pricing methods—ways of calculating the value of intercompany transfers—to value the intangibles Amazon transferred to its Luxembourg subsidiary, and the court sided with Amazon’s method.

The IRS had argued that the U.S. parent should be compensated for the returns it would have gotten if it exploited the intangibles itself, Warner said.

To do so, the IRS looked at factors like the aggregate value a bundle of intangibles has when used together—which may be higher than the sum of each asset’s value calculated separately. The IRS’s valuation also incorporated the value of goodwill, going-concern value, and workforce in place as compensable intangibles. A company’s goodwill is its intangible assets, while going concern is the cash value of its assets. Workforce in place refers to the value of employees’ experience, education, and training.

The 2017 tax overhaul broadened the definition of intangibles to match arguments the IRS had been making in court and in regulations about how to value those assets. The new law specifically includes goodwill, going concern, and workforce-in-place as intangibles, for example.

“Recent legislation confirms that the IRS’s interpretation is reasonable,” the agency said in its March 30, 2018, brief, pointing to the amended definition of intangible property.

Taxpayers can also argue that the “reason the IRS had to go to Congress and get it codified is because it’s not the law,” Byrnes said.

Amazon said the principles the IRS relied on weren’t in the statute or in the relevant regulations at the time, arguing that the IRS is applying regulations retroactively. Amazon’s July 2, 2018, brief said the IRS cited regulations adopted after Amazon and its European subsidiary executed their cost-sharing agreement.

Why It Matters

The 2017 tax law codifies many of the concepts the IRS has been arguing for in transfer pricing cases, including a version of the aggregation concept and the expanded definition of intangibles.

But while the IRS argues that Congress was merely clarifying the interpretation of language that was already in regulations, taxpayers have argued that the 2017 tax overhaul represents a change in law.

The IRS’s adjustment in the Amazon case would have a “pretty good” chance of standing up if it had been made for a tax year after the law was enacted, Warner said. “Each pillar to the income method the IRS applied seems to be in place: realistic alternatives, aggregate value, and 482"—the IRS tax code section that describes how to value transferred intangibles.

The government is hoping the court acknowledges that some of its interpretations of concepts in its own regulations should stand up, even if it doesn’t win the case outright, Warner said.

The IRS has been doggedly defending its interpretation of these concepts, in the face of repeated defeats in court. IRS Commissioner Charles Rettig recently vowed to keep pursuing transfer pricing cases.

“This is not a commissioner who believes that the IRS loses because a judge rules against us in a transfer pricing case. It’s a commissioner who thinks the IRS loses if it doesn’t keep bringing those cases,” he said April 1 during a Tax Executives Institute conference in Washington.

Amazon and the IRS declined requests for comment.

The case is Amazon.com, Inc. v. Commissioner, 148 T.C. No. 8, T.C., No. 31197-12, 3/23/17.