Amazon Wins $1.5 Billion Tax Battle with IRS

accounting, IRS, Amazon, tax battle

Whew! We made it through another tax season, Profit Planners. Whether you had an assist or went the DIY route, we hope you spent the last week breathing deeply, letting the stress melt away, and enjoying the things in life that are free. (We hear these are the best things.)

I have to say, the silver lining of doing taxes is seeing how well my profit planning efforts have worked over the past year. I don't know about you, but I was amazed when I tallied up my gross income. I haven't even been in business for myself that long, and already I'm making more per year than I ever made in a regular job?

Dare I say it's worth slogging through the receipts to find that out? Yes, yes I dare.

The other thing that felt good, though in a different way, was actually having the money saved to pay the tax bill. There were a couple years where I freaked out over where to find the scratch to pay Uncle Sam. But thanks to the Profit Planning model, I was able to write out the check this year knowing that it would cash.

All that said, I cannot tell a lie–it sucks seeing that amount leave my savings account. Even thought that's why it was there…it's just hard to say goodbye, you know?

If you've been suffering the postpartum tax blues, here's a little story that might cheer you up:

Amazon Wins $1.5 Billion Tax Battle Against the IRS

When we heard this headline, it caught our eye…and not only because so many in our Profit Planner community are Amazon sellers.

Amazon is an intriguing business in that it's a giant international corporation that, in many ways, still operates like a small online business.

  • They're constantly finding ways to “niche” their offerings.
  • They place extreme priority on customer service.
  • They favor maximizing company growth over personal profit–the company had its very first profitable quarter only last year! (Yes, you read that right.)
  • And founder Jeff Bezos, despite being the second richest person in the world, is not the highest paid employee in his own company. Bezos draws just a tiny fraction of his salary as cash, and takes the rest in stock.

So when Amazon gets in the news, we pay attention to see what kind of lessons their exploits can offer to real life small businesses.

And boy, did this tax showdown ever deliver.

The Big Issue in Amazon Case: Transfer Pricing

Here's what happened in simple English:

Back in 2005 or so, Amazon set up a cost-sharing arrangement with a subsidiary company in the tiny European nation of Luxembourg (famous for medieval castles, Michelin-starred cuisine, and having one of the world's highest GDPs per capita).

This arrangement, known as a CSA, essentially meant that the smaller company would “buy” the right to use Amazon's software and technology to operate Amazon's business in Europe. (If you've ever belonged to a CSA with a local farm, it's…kind of the same thing? But way more complicated because it's dealing with intellectual property, not heirloom cauliflower.)

But because a CSA is not an outright purchase, the money being earned by the parent company–Amazon, in this case–doesn't get taxed the same way as other consumer goods.

When different units of multinational companies transact with each other, it's called “transfer pricing.” Taxation of transfer pricing is tricky–the rules have been changed more than once.

Tax Problems When You're Amazon = Millions vs. Billions

There are a lot of complex accounting terms that come into play here, but the big issue was that Amazon's accounting method put the value of the European company's buy-in at $245 million, while the IRS used an accounting method that valued it at $1.5 billion.

Pretty big difference, especially in terms of what Amazon would owe in taxes.

The IRS essentially treated the smaller company's buy-in as the sale of a business from Amazon to the smaller company.

Amazon's argument was that the buy-in price was offset by their ongoing provision of new software, technology and trademarks to the smaller company.

Amazon Fights Back

So Amazon fought back. For a long time. This case has been going on since 2009. And it wasn't just the 2005-2006 tax year at stake. The outcome would also set a precedent for tax liabilities in later years, not just for Amazon but for all companies involved in transfer pricing, which is becoming more and more common in the global economy.

According to Fortune magazine,

Judge Albert Lauber of the U.S. Tax Court rejected a variety of IRS arguments, and found that on several occasions the agency abused its discretion, or acted arbitrarily or capriciously.

(If there's one way you don't want the IRS to act, it's arbitrarily or capriciously…am I right?)

Other sources indicate that this might have been the IRS trying to relitigate a similar case with another software company called Veritas. If they'd won their case with Amazon, they could have not only got more money in back taxes from Amazon, but maybe even gone back and got more money from Veritas.

Whew! Makes you glad you run a small business, doesn't it?

Amazon Outcome Sets a Precedent for Future Online Business

Speaking of small businesses, I know this whole thing is probably starting to sound like Goliath vs. Goliath. What does this have to do with you and me?

For one thing, analysts have said that this win is a good thing for businesses in general, since it reaffirms a company's ability to license intellectual property (like software and trademarks) to subsidiaries.

If you ever want to branch your business into a company overseas, this ruling could end up applying to you!

They've also said that the IRS needs to catch up with the changing time–it keeps applying an outdated accounting method to a new paradigm of business costs. Cases like these cost taxpayers like you and me a lot of money, especially when they battle in court for almost a decade. So our fingers are crossed that this Amazon case settles things once and for all.

Most of all, it sends a strong message to anybody who has ever received a bone-chilling message from the IRS, saying that you owe more taxes:

Don't just assume they're right.

As Marilyn often says, the default mindset of the IRS is to assume that you owe more tax than you actually do. So keep your records, get professional advice, and respond promptly to show them where they're wrong. Chances are good that your situation will get resolved a lot quicker than Amazon's did.

Unless you're making $1.5 billion on the reg. (In which case, wanna share your secret with the rest of us?)

The Bottom Line

You gotta pay Uncle Sam his due. But you don't have to pay him more than you owe. If you're keeping your records, doing your diligence, and have a knowledgeable CPA in your corner (hint hint), you can go into tax season confidently.


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