## Facts

- Veritas Software Corp. (U.S.) developed and sold storage-management software in a competitive market; product intangibles had an average useful life of about four years.
- On November 3, 1999, Veritas U.S. and its wholly owned Irish subsidiary entered into a cost-sharing agreement (CSA) to share R&D costs for future intangibles based on reasonably anticipated benefits, with Veritas Ireland serving non-U.S. territories.
- They also executed a technology license agreement granting Veritas Ireland rights to manufacture and sell existing software in the territory, use Veritas trademarks and related marks, and receive certain European sales agreements.
- Veritas Ireland paid royalties, including a lump-sum “buy-in” for pre-existing intangibles: $6.3 million in 1999 and $166 million in 2000; Veritas later reported a reduced buy-in of $118 million on an amended return.
- The IRS issued a notice of deficiency asserting that the reported buy-in did not reflect arm’s-length pricing and initially claimed an arm’s-length buy-in of about $2.5 billion, producing large deficiencies and penalties.
- At trial, the IRS changed its position and presented an expert valuation asserting a $1.675 billion buy-in using a discounted-cash-flow aggregate “income method” that treated the arrangement as akin to a sale or geographic spin-off and included items such as marketing and R&D workforce access, channels, customer relationships, and trademarks/brand.
- Veritas defended its pricing using a comparable uncontrolled transaction (CUT) method relying primarily on third-party OEM software license agreements, emphasizing unbundled OEM licenses and proposing adjustments for differences.

## Issues

1. Whether the IRS’s § 482 buy-in allocations based on an aggregate income method were arbitrary, capricious, or unreasonable.
2. Under the applicable § 482 regulations, what method was the “best method” to determine an arm’s-length buy-in for pre-existing intangibles contributed to a software CSA (CUT with adjustments versus income method).

## Decision

- The Tax Court held the IRS’s income-method buy-in determinations were arbitrary, capricious, and unreasonable.
- The court held an adjusted CUT method, grounded in third-party OEM software licenses (especially unbundled agreements), was the best method to determine the arm’s-length buy-in for pre-existing intangibles.
- The court rejected the IRS’s attempt to value the transaction as a de facto sale of the non-U.S. business and to include value attributable to items outside the defined buy-in property.
- The court accepted a roughly four-year useful life for the relevant software intangibles, contributing to rejection of the IRS’s much higher valuation.
- Because the IRS’s primary § 482 adjustment largely failed, the court rejected the related accuracy-related penalties.

## Legal Principles

- A CSA buy-in under the governing regulations compensates for the use of pre-existing intangible property contributed to the CSA, not for the full future profit stream of the business or the value of subsequently developed intangibles.
- Under the “best method” rule, the method producing the most reliable arm’s-length result given available data controls; transaction-based comparables may be preferred over model-based valuations when comparables are sufficiently reliable and can be adjusted.
- An income-method valuation may be rejected where it departs from the actual transaction structure, aggregates items beyond the required buy-in property, or relies on unsupported assumptions (including unrealistic economic lives for software intangibles).
- Third-party license agreements can serve as CUTs for software intangibles, and differences in scope and terms may be addressed through targeted comparability adjustments rather than abandonment of the CUT framework.

## Conclusion

The Tax Court held that the IRS’s aggregate income-method buy-in for Veritas Ireland was arbitrary and that an adjusted CUT method based on comparable third-party OEM licenses provided the most reliable arm’s-length measure of the buy-in for pre-existing software intangibles under I.R.C. § 482 and the applicable CSA regulations.


Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009)