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Software Company Seeks Redetermination of Deficiencies and Penalties

JUN. 26, 2006

Veritas Software Corporation & Subsidiaries et al. v. Commissioner

DATED JUN. 26, 2006
DOCUMENT ATTRIBUTES
  • Case Name
    VERITAS SOFTWARE CORPORATION & SUBSIDIARIES, SYMANTEC CORPORATION (SUCCESSOR IN INTEREST TO VERITAS SOFTWARE CORPORATION & SUBSIDIARIES), Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
  • Court
    United States Tax Court
  • Docket
    No. 12075-06
  • Authors
    Crousore, Andrew P.
    Williams, Beth L.
    Frewing, Scott H.
    O'Brien, James M.
    Oates, Mark A.
  • Institutional Authors
    Baker & McKenzie
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2007-1327
  • Tax Analysts Electronic Citation
    2007 TNT 14-27

Veritas Software Corporation & Subsidiaries et al. v. Commissioner

 

UNITED STATES TAX COURT

 

 

PETITION

 

 

Pursuant to Tax Ct. R. 34, VERITAS Software Corporation ("VERITAS US") hereby petitions for a redetermination of the deficiencies in income tax and penalties determined by Respondent in the Notice of Deficiency dated March 29, 2006. As a basis for its case, VERITAS US alleges as follows:

1. Petitioner. VERITAS US, a Delaware corporation, has its principal place of business at 20330 Stevens Creek Blvd., Cupertino, California, 95014. Petitioner's employer identification number is 77-0507675.

1.a. Prior to July 2, 2005, VERITAS US was a publicly held corporation. On July 2, 2005, Carmel Acquisition Corp., a Delaware Corporation merged with and into VERITAS US and VERITAS US continued as the surviving corporation of the merger. Thereafter, VERITAS US became a wholly owned subsidiary of Symantec Corporation ("Symantec") employer identification number 77-0181864, a Delaware Corporation. Symantec's principal place of business is located at 20330 Stevens Creek Blvd., Cupertino, California, 95014.

1.b. VERITAS US timely filed federal income tax returns for the taxable years ended December 31, 2000 ("2000"), and December 31, 2001 ("2001"), with the Internal Revenue Service Centers in Fresno, California and in Ogden, Utah, respectively.

2. Notice of Deficiency. The Notice of Deficiency (a copy of which is attached as Exhibit A) was mailed to VERITAS US on, or about, March 29, 2006, by the Technical Services Territory Manager of the Internal Revenue Service, Oakland, California, 94612.

3. Amounts in Dispute. Respondent determined deficiencies in income tax and asserted penalties in the following amounts:

      _____________________________________________

 

      Year           Deficiency          Penalty

 

      _____________________________________________

 

      2000          $703,619,959      $281,447,984

 

      2001          $ 53,930,363      $ 21,572,145

 

      TOTAL         $757,550,322      $303,020,129

 

      _____________________________________________

 

 

See Exhibit A at page 1. All of the above deficiencies and penalties are in dispute.

4. Assignments of Error. The determination of deficiencies in income tax and assertion of penalties are based upon the following errors:

4.a. Income from Transfer/License of Pre-existing Intangibles (the "Buy-in Issue"). Respondent erred in allocating taxable income in the amount of $2,376,126,139 for 2000 as a lump-sum buy-in payment under section 4821 to VERITAS US from VERITAS Software International Ltd. ("VERITAS Ireland"), a wholly owned Irish subsidiary. See Exhibit A at Form 4549-B. VERITAS Ireland's buy-in payments in 2000 and 2001 were arm's length under section 482. Respondent's income allocation ignores the arm's length standard, the commensurate with income requirement of section 482, and the regulations promulgated thereunder. Respondent's income allocation is arbitrary, capricious, and unreasonable.

4.b. Cost Sharing Allocation -- Stock-based Compensation. Respondent erred in allocating income under section 482 to VERITAS US from VERITAS Software Holdings Ltd. ("VERITAS Ltd."), a wholly owned Irish subsidiary, in the following amounts:

      ______________________________________

 

      Taxable Year         Income Adjustment

 

      ______________________________________

 

          2000                 $5,710,914

 

          2001                 $4,157,527

 

      ______________________________________

 

 

Respondent made the above allocations to include the alleged cost of stock based compensation in the research and development cost sharing pool. See Exhibit A at Form 4549-B. The exclusion of stock based compensation from the research and development cost pool was arm's length under section 482. Respondent's allocations violate the arm's length standard, are arbitrary, capricious, and unreasonable, and contrary to the Court's decision in Xilinx v. Commissioner, 125 T.C. 37 (2005).

4.c. Cost Sharing Allocation -- Other Costs. Respondent erred in allocating income to VERITAS US from VERITAS Ltd. under section 482 with respect to the parties' cost sharing arrangement in the following amounts:

      _____________________________________

 

      Taxable Year        Income Allocation

 

      _____________________________________

 

          2000                $25,283,147

 

          2001                $40,526,234

 

      _____________________________________

 

 

Respondent's allocations arise from his attempt to increase VERITAS Ltd.'s reasonably anticipated benefit shares in 2000 and 2001 and his attempt to include unspecified costs in the research and development cost pool. See Exhibit A at Form 4549-B. VERITAS Ltd.'s 2000 and 2001 cost sharing payments were arm's length under section 482. Both Respondent's proposed increase of VERITAS Ltd.'s reasonably anticipated benefit shares and inclusion of unspecified costs in the research and development cost pool violate the arm's length standard and are arbitrary, capricious, and unreasonable.

4.d. Intercompany Allocation for Technical Support Services (the "Technical Support Services Issue"). Respondent erred in allocating income to VERITAS US from VERITAS US's foreign subsidiaries, treated as a group, under section 482 in the amount of $25,399,276 for 2001. Respondent erred in asserting section 162 as an alternative ground for his adjustment to VERITAS US's income in the . amount of $25,399,276 for 2001. See Exhibit A at Form 4549-B. VERITAS US correctly reported all income attributable under section 482 to the support services and assistance it provided to its foreign subsidiaries in 2001. VERITAS US correctly determined and deducted the service fees it owed for 2001 to foreign subsidiaries that performed support services conferring a benefit on VERITAS US. Respondent's allocations of income to VERITAS US under sections 482 and 162 violate the arm's length standard and are arbitrary, capricious, and unreasonable.

4.e. Gross Valuation Misstatement Penalty. Respondent erred in asserting the 40% gross valuation misstatement penalty under section 6662(h) for 2000 and 2001 in the amounts of $281,447,984 and $21,572,145, respectively. See Exhibit A at Form 4549-B. As set forth in 4.a, 4.c and 4.d, VERITAS US's return positions with respect to the Buy-in Issue, the Cost Sharing Allocation -- Other Costs Issue, and the Technical Support Services Issue are correct. Even if adjustments under section 482 are made by the Court, Respondent's attempt to impose penalties is not supported by the facts as VERITAS US relied in good faith on the advice of its outside advisors in determining the arm's length buy-in royalty payments owed by VERITAS Ireland with respect to the Buy-in Issue. Furthermore, Respondent's assertion of the gross valuation misstatement penalty ignores VERITAS US's compliance with the contemporaneous documentation requirements set forth in the Code and regulations as they relate to the Buy-in Issue, the Cost Sharing Allocation -- Other Costs Issue and the Technical Support Services Issue.

4.f. Substantial Valuation Misstatement Penalty. Respondent erred in asserting, in the alternative, the 20% substantial valuation misstatement penalty under section 6662(e) for 2000 and 2001. See Exhibit A at Form 886-A. As set forth in 4.a, 4.c and 4.d, VERITAS US's return positions with respect to the Buy-in Issue, the Cost Sharing Allocation -- Other Costs Issue, and the Technical Support Services Issue are correct. Even if adjustments under section 482 are made by the Court, Respondent's attempt to impose penalties is not supported by the facts as VERITAS US relied in good faith on the advice of its outside advisors in determining the arm's length buy-in royalty payments owed by VERITAS Ireland with respect to the Buy-in Issue. Furthermore, Respondent's assertion of the substantial valuation misstatement penalty ignores VERITAS US's compliance with the contemporaneous documentation requirements set forth in the Code and regulations as they relate to the Buy-in Issue, the Cost Sharing Allocation -- Other Costs Issue, and the Technical Support Services Issue.

4.g. Computational Adjustments. As a result of the errors set forth in paragraphs 4.a. through 4.d, which are incorporated here by reference, Respondent erroneously reduced the carryovers of tax attributes that are correctly available to Petitioner as of 2000, or 2001, including: (i) regular net operating loss carryovers and alternative minimum tax net operating loss carryovers; (ii) alternative minimum tax credit carryovers; (iii) foreign tax credit carryovers; (iv) alternative minimum tax foreign tax credit carryovers; (v) research credit carryovers; and (vi) charitable contribution carryovers.

5. Supporting Facts. The facts upon which VERITAS US relies are as follows:

5.a. The Buy-in Issue. VERITAS Ireland's royalty payments in 2000 and 2001 were arm's length and commensurate with the income attributable to the pre-existing intangibles licensed by VERITAS US.

5.a.1. VERITAS US developed, manufactured, and marketed data storage management software products for sale to end customers either directly or through Original Equipment Manufacturers ("OEMs") and distributors. Data storage management software products provide a variety of functions, including protection against data loss and file corruption, data backup, and system management and optimization.

5.a.2. VERITAS Operating Corporation, a Delaware Corporation, is a wholly owned subsidiary of VERITAS US.

5.a.3. During 2000 and 2001, VERITAS Ltd., formerly known as Heber Limited, an Irish corporation resident in Bermuda, was a wholly owned subsidiary of VERITAS Operating Corporation.

5.a.4. VERITAS Ireland, resident in Ireland, is a wholly owned subsidiary of VERITAS Ltd. that elected to be treated as a disregarded entity for United States federal income tax purposes pursuant to regulations promulgated under Treas. Reg. § 301.7701- 3.

5.a.5. Effective November 3, 1999, VERITAS US, VERITAS Operating Corporation, Seagate Software Network & Storage Management Group, Inc., and VERITAS Ltd. (singularly a "Party" or collectively the "Parties") entered into an Agreement for Sharing Research and Development Costs ("Cost Sharing Agreement").

5.a.6. Pursuant to the Cost Sharing Agreement, the Parties agreed to pool their respective resources from November 3, 1999, forward, for the purpose of sharing the costs and risks of research and development conducted by any Party (the "Research Program").

5.a.7. The Research Program included all research and development activities performed by the Parties, on or after November 3, 1999, in the field of computer software, including but not limited to: (i) the development of new intangible property; and (ii) the creation of improvements, updates, adaptations, or other modifications to existing intangible property.

5.a.8. Research and development costs included, inter alia, all direct costs related to research and development as determined under United States generally accepted accounting principles ("US GAAP").

5.a.9. VERITAS Ltd.'s territory under the Cost Sharing Agreement included Europe, the Middle East, Africa, Asia, and the Asia Pacific.

5.a.10. The Parties shared research and development costs on the basis of each Party's reasonably anticipated benefits to be derived from the intangibles developed during the R&D Fiscal Year ("Covered Intangibles"). The Parties measured the reasonably anticipated benefits by the relative gross revenue attributable to each Party's territory during the R&D Fiscal Year. In 2000 and 2001, the VERITAS Ltd. share of costs was calculated based on the relative gross revenue attributable to its territory even though VERITAS Ireland did not exploit the Asia Pacific Territory and the Japan Territory until January 1, 2001, and June 1, 2001, respectively. Under the Cost Sharing Agreement, "R&D Fiscal Year" was defined as each twelve-month period ending on December 31.

5.a.11. Pursuant to the Cost Sharing Agreement, "Covered Intangibles" included any and all inventions, patents, copyrights, computer programs (in source code and object code form), flow charts, formulae, enhancements, updates, translations, adaptations, information, specifications, designs, process technology, manufacturing requirements, quality control standards, and other intangible property rights arising from or developed as a result of the Research Program.

5.a.12. In the event of a significant divergence between projected and actual benefit shares, the Parties agreed to make retrospective adjustments to the prior R&D Fiscal Year cost shares to reflect the actual benefit shares for the years in which the costs were incurred. Pursuant to the Cost Sharing Agreement, "significant divergence" was defined as a greater than 20% divergence between anticipated benefit shares and actual benefit shares.

5.a.13. In return for bearing its share of the costs and risks under the Cost Sharing Agreement, VERITAS US retained all rights, title and interests in and to all Covered Intangibles not granted to VERITAS Ltd., including the exclusive and perpetual right to manufacture the Products utilizing, embodying, or incorporating the Covered Intangibles outside of VERITAS Ltd.'s territory, and the nonexclusive and perpetual right to otherwise utilize all of the Covered Intangibles worldwide including in the marketing, sale, and licensing of Products utilizing, embodying or incorporating the Covered Intangibles and in further research into similar technology.

5.a.14. In return for bearing its share of costs and risks under the Cost Sharing Agreement, VERITAS Ltd. obtained the exclusive and perpetual right to manufacture Products utilizing, embodying, or incorporating the Covered Intangibles within VERITAS Ltd.'s territory, and the nonexclusive and perpetual right to otherwise utilize the Covered Intangibles worldwide including in the marketing, sale, and licensing of Products utilizing, embodying or incorporating the Covered Intangibles and in further research into similar technology.

5.a.15. The Cost Sharing Agreement constituted a qualified cost sharing arrangement under Treas. Reg. § 1.482-7(b).

5.a.16. Effective November 3, 1999, VERITAS US and VERITAS Ireland entered into a Technology License Agreement applicable to "Pre-existing Covered Intangibles" pursuant to which VERITAS US granted to VERITAS Ireland a limited, nonexclusive, and nontransferable license to utilize Covered Intangibles and confidential information within Europe, the Middle East, Africa, Asia, and the Asia Pacific: (i) to manufacture, market, distribute, sell, and license Products utilizing, embodying or incorporating the Pre-existing Covered Intangibles; (ii) to use the Pre-existing Covered Intangibles to provide technical support, training, consulting, or other services; and (iii) to sublicense the Pre- existing Covered Intangibles to third parties.

5.a.17. Pursuant to the Technology License Agreement, "Pre- existing Covered Intangibles" included any and all inventions, patents, copyrights, computer programs (in source code and object code form), flow charts, formulae, enhancements, updates, translations, adaptations, information, specifications, designs, process technology, manufacturing requirements, quality control standards, and other intangible property rights in existence as of November 3, 1999, relating to the design, development, manufacture, production, operation, maintenance, and/or repair of any or all of the Products.

5.a.18. Pursuant to the Technology License Agreement, "Products" include all products owned, licensed, or otherwise acquired by VERITAS US, which utilize, embody, or incorporate Pre-existing Covered Intangibles.

5.a.19. VERITAS Ireland also received a limited nonexclusive and nontransferable license to utilize VERITAS US Marks solely in conjunction with VERITAS Ireland's manufacturing, marketing, distribution, sale, lease, licensing and use of the Products in Europe, the Middle East, Africa, Asia, and the Asia Pacific.

5.a.20. Pursuant to the Technology License Agreement, "Marks" mean those trademarks, service marks and trade names used by VERITAS US in connection with any or all of the Products, as of November 3, 1999.

5.a.21. VERITAS US retained the unrestricted right to license rights in the Pre-existing Covered Intangibles and associated Marks to one or more additional persons, firms, or entities within Europe, the Middle East, Africa, Asia, and the Asia Pacific.

5.a.22. Consistent with the nonexclusive grant of rights to VERITAS Ireland, VERITAS US granted nonexclusive rights to certain OEMs related to, inter alia, the license and sale of Products embodying the Pre-existing Covered Intangibles within Europe, the Middle East, Africa, Asia, and the Asia Pacific.

5.a.23. VERITAS Ireland agreed to pay royalties for the sale/license of Products ("Product Royalties") and to pay royalties for the support of Products ("Support Royalties") in consideration for the rights and licenses granted to VERITAS Ireland by VERITAS US.

5.a.24. The Parties further agreed to review VERITAS Ireland's use of the rights granted by VERITAS US under the Technology License Agreement and the income attributable to VERITAS Ireland's use of the rights granted by VERITAS US under the Technology License Agreement and adjust the Product Royalties as necessary to ensure that VERITAS Ireland made an arm's length payment that was commensurate with the income attributable to the Pre-existing Covered Intangibles ("Periodic Review Requirement").

5.a.25. Subject to the Periodic Review Requirement, and in consideration for the rights and licenses granted to VERITAS Ireland by VERITAS US, VERITAS Ireland agreed to pay Product Royalties as follows:

 ___________________________________________________________________

 

 Period                                            Royalty Rate

 

 ___________________________________________________________________

 

 November 1, 1999 through December 31, 1999             34.7%

 

 January 1, 2000 through June 30, 2000                  34.7%

 

 July 1, 2000 through December 31, 2000                 26.5%

 

 January 1, 2001 through December 31, 2001              13.6%

 

 January 1, 2002 through December 31, 2002               6.0%

 

 January 1, 2003 through October 31, 2003                1.5%

 

 Post October 31, 2003                                   0.0%

 

 ___________________________________________________________________

 

 

5.a.26. VERITAS Ireland also agreed to pay to VERITAS US royalties for the maintenance and support of Products ("Support Royalties") for the period November 1, 1999, through October 31, 2000, at a rate of 25%. After October 31, 2000, VERITAS Ireland was no longer obligated to pay Support Royalties.

5.a.27. For the two-month period ending on December 31, 1999, VERITAS Ireland paid Product Royalties and Support Royalties totaling $6,300,000.

5.a.28. The Product Royalty rates set forth in paragraph 5.a.25 and the Support Royalty rate set forth in paragraph 5.a.26 for the Europe, Middle East and Africa territories ("EMEA Territory") were based on the following actual revenues for 1999 and projected revenues for 2000 through 2003:

 ________________________________________________________________________

 

 Period           License Revenues     Support Revenues        Total

 

 ________________________________________________________________________

 

 1999              $   28,732,000         $   907,000     $   29,639,000

 

 Jan-June 2000     $  148,101,000         $ 4,365,000     $  152,466,000

 

 July-Dec 2000     $  148,101,000         $ 4,365,000     $  152,466,000

 

 2001              $  509,263,000         $14,131,000     $  523,394,000

 

 2002              $  879,804,000         $22,877,000     $  902,681,000

 

 2003              $1,527,467,000         $37,036,000     $1,564,503,000

 

 ________________________________________________________________________

 

 

5.a.29. Effective June 28, 2000, VERITAS US assigned the Technology License Agreement to VERITAS Operating Corporation.

5.a.30. Effective August 1, 2001, VERITAS Operating Corporation and VERITAS Ireland amended the Technology License Agreement (the "August 1, 2001, Amendment"). Pursuant to the August 1, 2001, Amendment and consistent with the Periodic Review Requirement, VERITAS Ireland agreed to make a prepayment for the EMEA Territory in the amount of $101,902,836.84. VERITAS Ireland's actual payment totaled $101,741,861 for the EMEA Territory.

5.a.31. The revised Product Royalty and Support Royalty prepayment of $101,741,861 for the EMEA Territory was based on the following actual revenues for 1999 and 2000, and revised projected revenues for 2001, 2002, and 2003:

 ________________________________________________________________________

 

 Period           License Revenues     Support Revenues        Total

 

 ________________________________________________________________________

 

 1999              $  28,732,000         $    907,000       $  29,639,000

 

 Jan-June 2000     $  86,412,000         $ 14,753,000       $ 101,165,000

 

 July-Dec 2000     $  86,412,000         $ 14,753,000       $ 101,165,000

 

 2001              $ 330,824,000         $ 56,074,000       $ 386,898,000

 

 2002              $ 443,304,000         $ 75,139,000       $ 518,443,000

 

 2003              $ 607,327,000         $102,941,000       $ 710,268,000

 

 ________________________________________________________________________

 

 

5.a.32. In the August 1, 2001, Amendment, VERITAS Ireland also agreed to pay Product Royalties to VERITAS Operating Corporation for the rights licensed in the Preexisting Covered Intangibles related to the Asia Pacific and Japan Territories (the "APJ Territory").

5.a.33. Prior to January 1, 2001, VERITAS US and VERITAS Operating Corporation, not VERITAS Ireland, exploited the rights in the Pre-existing Covered Intangibles in the Asia Pacific Territory.

5. a. 34. Prior to June 1, 2001, VERITAS US and VERITAS Operating Corporation, not VERITAS Ireland, exploited the rights in the Pre-existing Covered Intangibles in the Japan Territory.

5.a.35. Subject to the Periodic Review Requirement and pursuant to the August 1, 2001, Amendment, VERITAS Ireland agreed to pay Product Royalties related to the APJ Territory as follows:

 _____________________________________________________________________

 

 Period                                                 Royalty Rate

 

 _____________________________________________________________________

 

 November 1, 1999 through June 30, 2000                     50.4%

 

 July 1, 2000 through December 31, 2000                     38.5%

 

 January 1, 2001 through December 31, 2001                  19.8%

 

 January 1, 2002 through December 31, 2002                   8.7%

 

 January 1, 2003 through October 31, 2003                    2.2%

 

 Post October 31, 2003                                       0.0%

 

 _____________________________________________________________________

 

 

5.a.36. VERITAS Ireland agreed to pay Support Royalties at a rate of 25% for the APJ Territory. After October 31, 2000, VERITAS Ireland was no longer obligated to pay Support Royalties.

5.a.37. Subject to the Periodic Review Requirement, VERITAS Ireland agreed to make a payment of $25,108,454 for the APJ Territory, the amount equal to the net present value of the Product Royalties and Support Royalties and the parties' most recently available forecast of sales in the APJ Territory for the 2001, 2002, and 2003.

5.a.38. Effective July 1, 2002, and consistent with the Periodic Review Requirement VERITAS Ireland and VERITAS Operating Corporation entered into Amendment No. 3 to the Technology License Agreement ("Amendment No. 3"). Pursuant to Amendment No. 3, VERITAS Ireland agreed to pay Product Royalties for the APJ Territory as follows:

 ______________________________________________________________________

 

 Period                                                 Royalty Rate

 

 ______________________________________________________________________

 

 November 1, 1999 through June 30, 2000                     44.4%

 

 July 1, 2000 through December 31, 2000                     33.9%

 

 January 1, 2001 through December 31, 2001                  17.4%

 

 January 1, 2002 through December 31, 2002                   7.7%

 

 January 1, 2003 through October 31, 2003                    1.9%

 

 Post October 31, 2003                                       0.0%

 

 ______________________________________________________________________

 

 

5.a.39. Subject to the Periodic Review Requirement and pursuant to Amendment No. 3, VERITAS Ireland's payment was reduced to $15,832,000 for the APJ Territory. This amount was equal to the net present value of the Product Royalties and Support Royalties based on VERITAS Ireland's most recently available forecast of sales in the APJ Territory for 2001, 2002, and 2003.

5.a.40. The Product Royalty rates set forth in paragraph 5.a.38, and the payment amount set forth in paragraph 5.a.39 for the APJ Territory were based on the following actual and projected license and support revenues:

 ________________________________________________________________________

 

 Period           License Revenues     Support Revenues        Total

 

 ________________________________________________________________________

 

 2001               $  53,750,000         $ 5,509,000       $ 59,259,000

 

 2002               $  86,471,000         $ 7,856,000       $ 94,327,000

 

 2003               $ 120,739,000         $ 9,916,000       $130,655,000

 

 ________________________________________________________________________

 

 

5.a.41. The $9,276,454 reduction in the payment for the APJ Territory was reflected on Form 1120X (Amended U.S. Corporation Income Tax Return) for 2000, filed by VERITAS US on December 17, 2002.

5.a.42. Based on the original calculations detailed in the Technology License Agreement and the Periodic Adjustments, VERITAS Ireland made total royalty payments consisting of current royalties and prepaid royalties to VERITAS US of $123,873,861. VERITAS US included $6,300,000 in gross income for 1999 and the remaining $117,573,861 in gross income for 2000.

5.a.43. VERITAS Ireland made arm's length royalty payments in 2000 and 2001 for the non-exclusive rights in the Pre-existing Covered Intangibles licensed from VERITAS US under the Technology License Agreement. In addition, the royalty payments were commensurate with the income attributable to the Pre-existing Covered Intangibles licensed from VERITAS US under the Technology License Agreement.

5.a.44. On March 29, 2006, Respondent issued a Notice of Deficiency allocating income to VERITAS US in connection with the license rights covered under the Technology License Agreement in the amount of $2,376,126,139 for 2000. The Notice of Deficiency did not set forth the transfer pricing method relied upon by Respondent to support the proposed allocation of income to VERITAS US.

5.a.45. As of March 29, 2006, Respondent had not provided any analysis to VERITAS US setting forth the transfer pricing method upon which he relied to support the proposed income allocation of $2,376,126,139.

5.a.46. On May 15, 2006, forty-seven days after Respondent issued the Notice of Deficiency, Respondent delivered to VERITAS US a Form 5701, Notice of Proposed Adjustment for Issue No. 1 (SAIN No. 408), dated May 15, 2006, signed by Nanette Hamilton, International Team Manager.

5.a.47. On May 15, 2006, forty-seven days after Respondent issued the Notice of Deficiency, Respondent delivered to VERITAS US an undated and unsigned report entitled "VERITAS Cost Sharing Arrangement -- A technical analysis of the CUTs and Useful Life estimation."

5.a.48. On May 15, 2006, forty-seven days after Respondent issued the Notice of Deficiency, Respondent delivered to VERITAS US an undated report entitled "An Analysis of VERITAS Software Corporation's Transfer Pricing Methodology For Years Ending December 31, 2000 and December 31, 2001", authored by G.L. Bennett, Economist.

5.a.49. On May 15, 2006, forty-seven days after Respondent issued the Notice of Deficiency, Respondent delivered to VERITAS US a report entitled "VERITAS Software Corporation Cost Sharing Arrangement with VERITAS Holdings Ltd: Economic Analysis as of November 3, 1999," authored by Brian C. Becker of Precision Economics, LLC, and dated March 8, 2006.

5.a.50. On information and belief, the reports referenced in paragraphs 5.a.46, 5.a.47, 5.a.48, and 5.a.49, which purport to form the basis for Respondent's $2,376,126,139 income allocation were not complete on March 29, 2006, the date Respondent issued the Notice of Deficiency.

5.a.51. VERITAS US's worldwide consolidated pre-tax profit before accounting for acquisition and restructuring costs was:

           __________________________________

 

           Year                WW Profits

 

           __________________________________

 

           1999              $  193,901,000

 

           2000              $  379,860,000

 

           2001              $  410,055,000

 

           2002              $  370,780,000

 

           2003              $  476,901,000

 

           Total             $1,831,497,000

 

           __________________________________

 

 

5.a.52. Respondent's proposed adjustment related to VERITAS US's license of Pre-existing Covered Intangibles to VERITAS Ireland for use in the EMEA and APJ Territories exceeds VERITAS US's consolidated worldwide profits for 1999 through 2003, before reductions for acquisition and restructuring costs, by approximately $545 million.

5.a.53. VERITAS Ireland's actual license and support revenues in the EMEA Territory through 2003 were as follows:

 ________________________________________________________________________

 

 Period           License Revenues     Support Revenues        Total

 

 ________________________________________________________________________

 

 1999               $  24,286,224        $  1,373,158       $ 25,659,382

 

 2000               $ 167,767,492        $ 14,916,235       $182,683,727

 

 2001               $ 260,361,658        $ 36,786,956       $297,148,614

 

 2002               $ 267,525,889        $ 65,041,020       $332,566,909

 

 2003               $ 315,354,940        $109,209,076       $424,564,016

 

 ________________________________________________________________________

 

 

5.a.54. VERITAS Ireland's actual license and support revenues in the APJ Territory through 2003 were:

 ________________________________________________________________________

 

 Period           License Revenues     Support Revenues        Total

 

 ________________________________________________________________________

 

 2001                $24,506,427          $ 2,414,851       $26,921,278

 

 2002                $41,666,600          $ 9,483,404       $51,150,004

 

 2003                $56,078,607          $16,535,096       $72,613,703

 

 ________________________________________________________________________

 

 

5.a.55. Respondent's proposed adjustment related to VERITAS US's license of Pre-existing Covered Intangibles to VERITAS Ireland for use in the EMEA and APJ Territories exceeds VERITAS Ireland's Product Revenue and Support Revenue through 2003 as set forth in paragraph 5. a. 53 and paragraph 5. a. 54 by approximately $1 billion.

5.a.56. Respondent's $2,376,126,139 lump sum buy-in income allocation is contrary to the arm's length standard under section 482.

5.a.57. Respondent's $2,376,126,139 lump sum buy-in income allocation is contrary to the commensurate with income standard under section 482.

5.a.58. Respondent's $2,376,126,139 lump sum buy-in income allocation is arbitrary, capricious, and unreasonable.

5.b. Cost Sharing Allocation -- Stock Based Compensation. VERITAS US and VERITAS Ltd. properly excluded stock options from the Cost Sharing Pool under section 482.

5.b.1. The allegations set forth in paragraphs 5.a.1 thru 5.a.15, supra, are incorporated by reference.

5.b.2. In 1993, VERITAS US established an Equity Incentive Plan, as amended (the "Stock Option Plan").

5.b.3. The stock options granted under the Stock Option Plan included both Incentive Stock Options ("ISOs") and Nonqualified Stock Options ("NQSOs").

5.b.4. Upon VERITAS US's granting of an option or other stock right under the Stock Option Plan, the person to whom the option was granted, once vested, was entitled to exercise that option or right for a period determinable under the Stock Option Plan.

5.b.5. The options granted under the Stock Option Plan typically vested over a four year period.

5.b.6. The term of the option issued under the Stock Option Plan varied based upon numerous factors, including, among other things, the employee's total stock holdings in VERITAS US, termination of employment, disability and death. An employee's right to exercise an option lapsed the earlier of ninety days after termination of employment or the date of expiry. In certain circumstances, the term of the option was as long as ten years from the grant date.

5.b.7. Typically, VERITAS US issued stock options to employees that were "at the money" options. That is, the option entitled the employee, after vesting occurred, to buy VERITAS US stock at a price that was equal to the price of VERITAS US stock as of the date of the grant of the option. Thus, unless the price of VERITAS US stock increased to a level greater than the exercise price of the option by the date of expiry, the options were worthless.

5.b.8. Upon exercise of an option, the employees typically paid cash to VERITAS US for the exercise price, either by check, through a same day sale commitment, through a margin commitment, or combination thereof.

5.b.9. In 1993, VERITAS US established an Employee Stock Purchase Plan ("ESPP") under section 423 to provide employees of VERITAS US and certain designated subsidiaries with a convenient means of acquiring an equity interest in VERITAS US through payroll deductions to enhance such employees' sense of participation in the affairs of VERITAS US and subsidiaries and to provide an incentive for continued employment.

5.b.10. Pursuant to the ESPP, VERITAS US's and certain designated subsidiaries' employees were given the right to purchase the stock at 85% of its fair market value.

5.b.11. Under the Stock Option Plan and ESPP, options were not specifically earmarked for R&D employees. VERITAS US granted options to employees working in R&D and non-R&D departments.

5.b.12. On various dates in 2000 and 2001, certain VERITAS US employees exercised their stock options or stock rights.

5.b.13. Parties dealing at arm's length do not include the spread between the fair market value of the stock on the date of exercise and the exercise price on the date of grant as a cost or expense in the pool of costs that parties share in a joint development or similar arrangement.

5.b.14. Respondent's calculation of the amounts to be allocated to the cost sharing pool is erroneous both in theory and in fact. There was no cost or expense incurred by VERITAS US when employees exercised stock options.

5.b.15. At arm's length, unrelated parties would not and did not pay for the spread relating to stock options or stock rights in joint development or similar arrangements.

5.b.16. Respondent's attempt to increase VERITAS Ltd.'s reasonably anticipated benefits share as it relates to the inclusion of the stock option spread at exercise in the cost pool is arbitrary, capricious, and unreasonable under section 482.

5.b.17. Respondent's allocation of the spread on exercise of stock options is arbitrary, capricious, and unreasonable under section 482.

5.b.18. Respondent's proposed adjustment is directly contrary to the Court's decision in Xilinx v. Commissioner, 125 T.C. 37 (2005).

5.c. Cost Sharing Allocation -- Other Costs. VERITAS Ltd.'s Cost Sharing Payments made pursuant to the Cost Sharing Agreement were arm's length and reflected VERITAS Ltd.'s share of reasonably anticipated benefits.

5.c.1. The allegations set forth in paragraphs 5.a.1 through 5.a.15, and 5.a.33 through 5.a.35, supra, are incorporated by reference.

5.c.2. VERITAS US and VERITAS Ltd. calculated the sum of the research and development costs incurred by VERITAS US and VERITAS Ltd. for the Covered Intangibles for each fiscal year, less the territory specific research and development costs incurred by each Party, to determine the "Allocable R&D Costs" to be shared by VERITAS US and VERITAS Ltd.

5.c.3. VERITAS US and VERITAS Ltd. determined that the most reliable estimate of reasonably anticipated benefits to be derived from the Covered Intangibles by the Parties during each R&D Fiscal Year was each Party's actual relative gross revenue in its territory as defined in the Cost Sharing Agreement. In 2000 and 2001, VERITAS Ltd.'s share of costs was calculated based on the relative gross revenue in its territory even though VERITAS Ireland did not exploit the Asia Pacific Territory and the Japan Territory until January 1, 2001, and June 1, 2001, respectively. The gross revenues used to calculate each Party's reasonably anticipated benefits were:

 ______________________________________________________________________

 

                                                             Rest of

 

                        Americas % of        Rest of       World % of

 

           Americas       Worldwide           World        Worldwide

 

 Year      Revenues        Revenue           Revenues        Revenue

 

 ______________________________________________________________________

 

 2000  $  881,286,000      76.96%         $263,859,000       23.04%

 

 2001  $1,052,361,000      74.85%         $353,543,000       25.15%

 

 ______________________________________________________________________

 

 

5.c.4. VERITAS Ltd. paid its share of the Allocable R&D Costs based on the percentage of gross revenues from its territory for each R&D Fiscal Year as follows:

      ______________________________________________________________

 

                Share of Allocable R&D        Amount of Allocable

 

                     Costs Paid by             R&D Costs Paid by

 

      Year           VERITAS Ltd.                  VERITAS Ltd.

 

      ______________________________________________________________

 

      2000              23.04%                     $40,273,000

 

      2001              25.15%                     $60,358,000

 

      ______________________________________________________________

 

 

5.c.5. The shares of the Allocable R&D Costs paid by VERITAS Ltd. during 2000 and 2001, which were based on the percentage of gross revenues derived from the VERITAS Ltd. territory in each year, were amounts that would have been paid by parties at arm's length.

5.c.6. On March 29, 2006, Respondent issued a Notice of Deficiency allocating income from VERITAS Ltd. to VERITAS US in connection with the Cost Sharing Agreement. The Notice of Deficiency did not specify the increases to VERITAS Ltd.'s reasonably anticipated benefit share or the additional costs added to the Allocable R&D Costs by Respondent.

5.c.7. On information and belief, as of March 29, 2006, Respondent had not completed any calculations supporting the increases to the reasonably anticipated benefits share for 2000 and 2001, as asserted by Respondent in the Notice of Deficiency.

5.c.8. On information and belief, as of March 29, 2006, Respondent had not done any analysis to support the inclusion of additional costs in the Allocable R&D Costs for 2000 and 2001, as asserted by Respondent in the Notice of Deficiency.

5.c.9. On May 15, 2006, forty-seven days after Respondent issued the Notice of Deficiency, Respondent delivered to VERITAS US a Form 5701, Notice of Proposed Adjustment for Issue No. 2 (SAIN No. 526- 11.), dated May 15, 2006, signed by Nanette Hamilton, International Team Manager. The Form 5701 stated that additional marketing and product management costs should have been included in the pool of Allocable R&D Costs, and that VERITAS Ltd.'s reasonably anticipated share of benefits from the Covered Intangibles "were 30% and 35% for the years 2000 and 2001 respectively."

5.c.10. On information and belief, as of May 15, 2006, Respondent had not completed any calculations supporting the 30% and 35% anticipated benefit shares for VERITAS Ltd. that Respondent applied in the Form 5701.

5.c.11. Respondent's allocations relating to increasing VERITAS Ltd.'s anticipated benefits from the cost sharing arrangement and including certain unspecified costs in the pool of Allocable R&D Costs are arbitrary, capricious, and unreasonable.

5.d. The Technical Support Services Issue. VERITAS US correctly reported under section 482 all income from technical support services it rendered in 2001 and correctly deducted under section 162 service fees it owed to related entities for technical support services.

5.d.1. In 2001 VERITAS US, VERITAS Ireland and certain other foreign affiliates offered their customers the opportunity to enter contracts for technical support and maintenance of VERITAS software, in return for a fee. In 2001, the levels of support available to customers consisted primarily of the "Basic" and the "Extended Business" levels of support.

5.d.2. Customers who purchased the "Basic" level of support had access to VERITAS call centers in the United States, the United Kingdom, Australia, and Japan during normal business hours. Customers who purchased the "Extended Business" or higher levels of support had access to VERITAS call centers 24 hours a day, 7 days a week, 365 days a year and, under certain limited circumstances, could meet with support personnel.

5.d.3. VERITAS US and VERITAS Ireland contracted with customers to provide technical support services and earned support revenue from customers in 2001. Certain other foreign affiliates earned support revenue in lesser amounts.

5.d.4. Members of the VERITAS worldwide group provided support and maintenance services to customers on a "follow-the-sun" basis. Various members operated call centers around the world so that at least one call center was always open. A customer call placed to a closed call center was routed to an open call center and handled by technical support personnel there.

5.d.5. Under the "follow the sun" model, the member of the VERITAS group providing support to a customer was often not the same as the member earning support revenue from that customer.

5.d.6. To facilitate the centralized collection of the costs of providing technical support services, VERITAS Software Global Corporation ("VERITAS Software Global"), a member of the VERITAS US consolidated return group, entered into separate Technical Support Services Agreements (the "Technical Support Agreements") effective January 1, 2001, with VERITAS Ireland, VERITAS Software UK Limited ("VERITAS U.K."), VERITAS Software Australia Pty Ltd. ("VERITAS Australia"), VERITAS Software Japan K.K. ("VERITAS Japan"), VERITAS Software Argentina SA ("VERITAS Argentina"), VERITAS Software (Canada) Inc. ("VERITAS Canada"), VERITAS Software Brazil, Ltda. ("VERITAS Brazil"), VERITAS Software Mexico SA de CV ("VERITAS Mexico"), VERITAS Software France SA ("VERITAS France"), VERITAS Software Hong Kong Limited ("VERITAS Hong Kong"), VERITAS Software India Private, Ltd. ("VERITAS India"), and VERITAS Software GmbH ("VERITAS Germany") (collectively, the "Foreign Support Service Providers").

5.d.7. VERITAS U.K. was a wholly owned subsidiary of VERITAS Ltd. that elected to be treated as a disregarded entity for United States federal income tax purposes pursuant to regulations promulgated under Treas. Reg. § 301.7701-3.

5.d.8. Pursuant to the Technical Support Agreements, VERITAS Software Global engaged the Foreign Support Service Providers to furnish the following services: (i) responding to technical inquiries placed through the call centers; and (ii) providing other technical support services requested by VERITAS Software Global ("support services").

5.d.9. Each Foreign Support Service Provider had the expertise and knowledge, as of 2001, to deliver high quality support services to customers.

5.d.10. During 2001, VERITAS U.K., VERITAS Australia, and VERITAS Japan each employed large numbers of highly skilled and knowledgeable technical support employees, including engineers, technicians, managers, and staff. VERITAS U.K., VERITAS Australia, and VERITAS Japan each operated call centers used by customers worldwide. VERITAS Ireland, VERITAS Argentina, VERITAS Canada, VERITAS Brazil, VERITAS Mexico, VERITAS France, VERITAS Hong Kong, VERITAS India, and VERITAS Germany each employed a lesser number of technical support employees.

5.d.11. Under the Technical Support Agreements, VERITAS Software Global was required to pay service fees to each Foreign Support Service Provider, in 2001, equal to: (i) the direct and indirect costs that it incurred to provide support services; and (ii) an 8% markup on those costs (the "2001 service fees").

5.d.12. To assure that the costs of providing support services were properly allocated among all members of the VERITAS group, VERITAS Software Global functioned as a centralized clearing house for intercompany technical support charges by: (i) collecting all costs of providing support incurred by VERITAS Software Global and the Foreign Support Service Providers; and (ii) allocating those costs among the members of the group that earned support revenue from customers.

5.d.13. For the purpose of collecting shared costs, VERITAS Software Global pooled the total costs incurred in 2001 by VERITAS Software Global and the Foreign Support Service Providers to provide support. These costs (the "2001 pooled support costs") consisted of: (i) the direct technical support costs booked in Departments 1600- 1680 and 4300-4380 by each entity; (ii) indirect technical support costs; (iii) an 8% markup on those direct and indirect costs; and (iv) operating expenses incurred at the foreign call centers, which were not marked up (the "call center costs"). VERITAS Software Global determined costs, expenses, and revenues under US GAAP on an annualized basis.

5.d.14. VERITAS Software Global determined that the 2001 pooled support costs incurred worldwide to deliver support services to VERITAS customers were $114,466,353 (including the 8% markup), consisting of: (i) its own direct and indirect support costs plus an 8% markup, a total of $71,575,465; (ii) the 2001 service fees of $32,800,851 it owed to Foreign Support Service providers; and (iii) call center costs of $10,090,037.

5.d.15. For the purpose of allocating the pooled support costs among members, VERITAS Software Global and VERITAS Operating Corporation entered into a Global Technical Services Cost Allocation Agreement ("GTSCA") effective on January 1, 2001, with VERITAS Ireland, VERITAS U.K., VERITAS Australia, VERITAS Japan, VERITAS Argentina, VERITAS Canada, VERITAS Brazil, VERITAS Mexico, VERITAS France, VERITAS Hong Kong, VERITAS India, and VERITAS Germany (each singularly a "GTSCA Party," and collectively "GTSCA Parties").

5.d.16. The GTSCA Parties reported the following annualized support revenues for 2001:

 _____________________________________________________________________

 

                                                       Share of

 

                                   Support              Support

 

 Party                             Revenues            Revenues

 

 _____________________________________________________________________

 

 VERITAS Software Global and

 

   VERITAS Operating

 

   Corporation (VERITAS US)     $ 254,261,375           87.53%

 

 VERITAS Ireland                   32,866,267           11.31%

 

 VERITAS Argentina                    294,430             .10%

 

 VERITAS Brazil                       124,753             .04%

 

 VERITAS Mexico                       239,757             .08%

 

 VERITAS France                        17,556             .01%

 

 VERITAS Germany                       44,294             .02%

 

 VERITAS U.K.                          88,189             .03%

 

 VERITAS Australia                  1,875,797             .65%

 

 VERITAS Japan                        684,807             .24%

 

 VERITAS Canada

 

 VERITAS India                           -0-                0%

 

 VERITAS Hong Kong                       -0-                0%

 

 _____________________________________________________________________

 

 Total                           $290,497,225             100%

 

 _____________________________________________________________________

 

 

5.d.17. Pursuant to the GTSCA, VERITAS Software Global allocated a share of the total 2001 pooled support costs of $114,466,353 to the GTSCA Parties that earned and reported support revenues from customers, based on the ratio of each Party's net support revenue to the aggregate net support revenue of all GTSCA Parties. Each GTSCA Party was allocated a share of the total 2001 pooled support costs equal to the percentages shown in the schedules set forth in paragraph 5.d.16.

5.d.18. VERITAS Software Global correctly allocated the following dollar costs to each GTSCA Party as that Party's share of the total 2001 pooled support costs:

 _____________________________________________________________________

 

                                        Allocated          Share of

 

                                      Pooled Support    Pooled Support

 

 Party                                    Costs              Costs

 

 _____________________________________________________________________

 

 VERITAS Software Global and

 

   VERITAS Operating Corporation

 

   (VERITAS US)                        $100,188,125         87.53%

 

 VERITAS Ireland                         12,950,491         11.31%

 

 VERITAS Argentina                          116,016           .10%

 

 VERITAS Brazil                              49,157           .04%

 

 VERITAS Mexico                              94,473           .08%

 

 VERITAS France                               6,918           .01%

 

 VERITAS GmbH                                17,453           .02%

 

 VERITAS U.K.                                34,750           .03%

 

 VERITAS Australia                          739,131           .65%

 

 VERITAS Japan                              269,839           .24%

 

 VERITAS Canada                                -0-            None

 

 VERITAS India                                 -0-            None

 

 VERITAS Hong Kong                             -0-            None

 

 Total                                 $114,466,353           100%

 

 ____________________________________________________________________

 

 

5.d.19. For 2001 VERITAS Software Global incurred $71,575,465 of its own annualized 2001 support costs (including the 8% markup). Under the GTSCA, VERITAS US owed $100,188,125 as its 87.53% share of 2001 pooled support costs. VERITAS US netted the $100,188,125 it owed under the GTSCA against VERITAS Software Global's own annualized support costs of $71,575,465. Therefore, VERITAS US had a liability of $28,612,660 for 2001 under the GTSCA for support services that benefited VERITAS US.

5.d.20. After the allocation of costs through the GTSCA, VERITAS US was allocated $100,188,125, or 87.53% of the total 2001 pooled support costs, and reported 87.53% of total 2001 support revenue recognized worldwide.

5.d.21. VERITAS US deducted $95,124,012 in its 2001 US consolidated return, comprised of two elements: (i) VERITAS Software Global's actual 2001 support costs of $67,329,310 (excluding the 8% markup), and (ii) the $27,794,702 that VERITAS Software Global paid for 2001 service fees. The deduction of $95,124,012 represents VERITAS US' share of 2001 pooled support costs net of the 8% markup on its annualized support costs, which VERITAS US included in income.

5.d.22. For 2001, VERITAS Ireland incurred $765,635 of annualized 2001 support costs (including the 8% markup). After the allocation of costs through the GTSCA, VERITAS Ireland bore $12,950,491, or 11.31% of the total 2001 pooled support costs of $114,466,353, and reported 11.31% of total 2001 worldwide support revenue.

5.d.23. The allocations of the 2001 pooled support costs among VERITAS US, VERITAS Ireland and the other beneficiaries of intercompany services represent the fees that an uncontrolled party would pay at arm's length for similar technical support services provided under similar circumstances.

5.d.24. VERITAS US earned the appropriate arm's length service fees for the support services VERITAS Software Global performed, and paid the appropriate share of the 2001 pooled support costs, as determined under sections 162 and 482, Treasury Regulations thereunder, and consistently applied sound accounting practices. No further service income is due to VERITAS Software Global, VERITAS Operating Corporation, or VERITAS US.

5.d.25. On March 29, 2006, Respondent issued a Notice of Deficiency allocating income of $25,399,276 "in accordance with sections 162 (sic) and 482" to VERITAS US from its foreign subsidiaries, based on Respondent's undisclosed determination of the benefit share for 2001 to which VERITAS US was allegedly entitled. See Exhibit A at Form 886-A, Explanation of Items-Intercompany Allocations for Technical Support Services.

5.d.26. The Notice of Deficiency did not identify those foreign subsidiaries whose income was being allocated to VERITAS US, and did not identify or explain the methodology used by Respondent to allocate income. See Exhibit A at Form 886-A, Explanation of Items-Intercompany Allocations for Technical Support Services.

5.d.27. On information and belief, as of March 29, 2006, Respondent had not completed his analysis of the relative benefits derived by the foreign subsidiaries from the technical support services performed by VERITAS US, as asserted by Respondent in the Notice of Deficiency.

5.d.28. On information and belief, as of March 29, 2006, Respondent had not determined the methodology to compute the appropriate arm's length charge for intercompany support services.

5.d.29. On May 15, 2006, forty-seven days after Respondent issued the Notice of Deficiency, Respondent delivered to VERITAS US a Form 5701, Notice of Proposed Adjustment, No. 4 (SAIN 526-22), dated May 15, 2006, signed by Nanette Hamilton, International Team Manager. The Form 5701 stated that "Exam has used the 2001 current year revenue split [of VERITAS US] to estimate the intended benefit shares for technical support services in 2001."

5.d.30. Respondent's allocation of technical support service income under section 482 to VERITAS US for 2001, and his alternative disallowance of the deductions under section 162 claimed by VERITAS US for service fees owed to Foreign Technical Support Service Providers under the GTSCA, are arbitrary, capricious, and unreasonable.

5.e. Gross Valuation Misstatement Penalty. VERITAS US is not subject to the 40% gross valuation misstatement penalty for 2000 and 2001.

5.e.1. The allegations set forth in paragraphs 5.a.1 thru 5.a.58 and 5.c.1 thru 5.d.30, supra, are incorporated by reference.

5.e.2. In connection with entering into the Technology License Agreement and the Cost Sharing Agreement, VERITAS US engaged Ernst & Young LLP to assist in the determination of the value of VERITAS US's intangibles in existence as of November 3, 1999.

5.e.3. Ernst & Young prepared a report entitled "VERITAS Software Corporation § 6662 Contemporaneous Documentation for FYE December 31, 1999" (the "1999 Transfer Pricing Report"). The 1999 Transfer Pricing Report was completed and delivered to VERITAS US in August 2000.

5.e.4. The 1999 Transfer Pricing Report determined the arm's length payment owed by VERITAS Ireland to VERITAS US for the rights granted pursuant to the Technology License Agreement and Cost Sharing Agreement to exploit intangibles in existence as of November 3, 1999, in the EMEA Territory.

5.e.5. VERITAS US later engaged Ernst & Young to assist in the determination of the arm's length royalty payments owed by VERITAS Ireland to VERITAS US for the rights to exploit intangibles in existence as of November 3, 1999, in the APJ Territory. VERITAS Ltd. began serving the Asia Pacific region on January 1, 2001, and Japan on June 1, 2001.

5.e.6. Ernst & Young prepared a report entitled "VERITAS Software Corp. Section 6662 Contemporaneous Documentation for APAC Region and Japan" (the "2001 Transfer Pricing Report"). The 2001 Transfer Pricing Report was delivered to VERITAS US in September 2001.

5.e.7. On May 25, 2004, VERITAS US filed a request for a unilateral Advance Pricing Agreement ("APA Request") with Respondent's Advance Pricing Agreement Program.

5.e.8. As of the date VERITAS US filed the APA Request, Respondent had not sent VERITAS US a notice of examination for 2000.

5.e.9. As of the date VERITAS US filed the APA Request, Respondent had not sent VERITAS US a notice of examination for 2001.

5.e.10. As a prerequisite demanded by Respondent to his consideration of the APA Request, VERITAS US executed a Form 872, Agreement to Extend the Statute of Limitation, for 2000 (the "First Statute Extension").

5.e.11. VERITAS US executed the First Statute Extension on September 17, 2004, seven days prior to the expiration of the 2000 statute of limitations, extending the statute of limitations to March 31, 2005. Respondent failed to return a countersigned copy of the First Statute Extension to VERITAS US.

5.e.12. At the time that VERITAS US executed the First Statute Extension, Respondent had not notified VERITAS US of his intent to examine 2000.

5.e.13. At the time VERITAS US executed the First Statute Extension, Respondent had not notified VERITAS US of his intent to examine 2001.

5.e.14. In early 2005, following an initial meeting with members of the Advance Pricing Agreement Program and Respondent's Examination Representatives, Respondent rejected VERITAS US's APA request and notified VERITAS US of its intent to examine 2000.

5.e.15. On February 17, 2005, VERITAS US executed a second statute extension for the 2000 year, extending the 2000 statute of limitations to March 31, 2006 (the "Second Statute Extension").

5.e.16. On March 8, 2005, Respondent mailed to VERITAS US a notice informing Petitioner of his intent to audit the 2000 year.

5.e.17. On March 17, 2005, Respondent held its initial conference with VERITAS US regarding the audit of VERITAS US's 2000 year.

5.e.18. Between March 8, 2005, and October 25, 2005, Respondent's examination representatives issued a total of twenty-six Information Document Requests ("IDRs"). VERITAS US responded to the twenty-six IDRs in a timely manner, and in most cases provided the requested information prior to the agreed date for responding to the individual IDRs.

5.e.19. Between March 8, 2005, and December 28, 2005, Respondent's examination representatives did not identify, or request VERITAS US to identify, individuals for interviews with Respondent's Examination Representatives.

5.e.20. Between March 8, 2005, and December 28, 2005, Respondent's examination representatives did not issue an IDR seeking to interview individuals regarding the Buy-in Issue.

5.e.21. On March 24, 2005, Respondent requested VERITAS US's section 6662(e) transfer pricing documentation for the tax year ending December 31, 2 000. VERITAS US produced the 1999 Transfer Pricing Report within the thirty days required by section 6662(e).

5.e.22. The 1999 Transfer Pricing Report fulfills the statutory and regulatory requirements to avoid any valuation misstatement penalty on section 482 adjustments.

5.e.23. On March 24, 2005, Respondent also requested from VERITAS US the cost sharing documents required under Treas. Reg. § 1.482-7(j)(2) for 2000. VERITAS US responded to the request within the thirty days required by Treas. Reg. § 1.482-7(j)(2) and the documentation provided fulfills the regulatory requirements to avoid any valuation misstatement penalty on section 482 adjustments.

5.e.24. In June 2005, Respondent notified VERITAS US that it intended to open an audit of 2001.

5.e.25. On June 21, 2005, VERITAS US executed a Form 872, Agreement to Extend the Statute of Limitation for 2001.

5.e.26. In connection with opening the 2001 audit, Respondent requested VERITAS US's transfer pricing documentation under section 6662(e) and VERITAS US's cost sharing documentation under Treas. Reg. § 1.482-7(j)(2). VERITAS US produced the 2001 Transfer Pricing Report and cost sharing documentation within the thirty day period set forth in the Code and regulations. The documentation provided fulfills the statutory and regulatory requirements for the avoidance of any valuation misstatement penalty on section 482 adjustments.

5.e.27. In December 2005, Respondent's Examination Representatives demanded that VERITAS US execute a third unrestricted extension of the 2000 statute.

5.e.28. In response, VERITAS US offered to enter into a "restricted" extension of the 2000 statute of limitations which would have extended the statute with respect to each issue identified by Respondent's examination representatives as of December 2005.

5.e.29. Respondent's examination representatives rejected VERITAS US's offer of a restricted extension.

5.e.30. VERITAS US correctly reported the intercompany transactions on an arm's length basis under section 482 in its returns. No penalty under section 6662(h) is appropriate.

5.e.31. VERITAS US reasonably relied on the documentation prepared by its outside adviser, Ernst & Young, to justify the amounts VERITAS Ireland paid to VERITAS US pursuant to the Technology License Agreement for intangibles in existence as of November 3, 1999.

5.e.32. VERITAS US maintained documentation sufficient to support the allocation of costs between VERITAS US and VERITAS Ireland.

5.e.33. VERITAS US maintained documentation sufficient to support the amounts allocated for Technical Support Services.

5.e.34. Respondent is erroneously imposing section 6662(h) penalties on VERITAS US for the years in issue.

5.f. Substantial Valuation Misstatement Penalty.

VERITAS US is not subject to the 20% substantial valuation misstatement penalty for 2000 and 2001.

5.f.1. The allegations set forth in paragraph 5.a.1 thru 5.a.58 and 5.c.1 thru 5.e.34, supra, are incorporated by reference.

5.f.2. VERITAS US correctly reported the intercompany transactions on an arm's length basis under section 482 in its returns. No penalty under section 6662(e) is appropriate.

5.f.3. VERITAS US reasonably relied on the documentation prepared by its outside adviser, Ernst & Young, to justify the amounts VERITAS Ireland paid to VERITAS US pursuant to the Technology License Agreement for intangibles in existence as of November 3, 1999.

5.f.4. VERITAS US maintained documentation sufficient to support the allocation of costs between VERITAS US and VERITAS Ireland.

5.f.5. VERITAS US maintained documentation sufficient to support the amounts allocated for Technical Support Services.

5.f.6. Respondent is erroneously imposing section 6662(e) penalties on VERITAS US for the years in issue.

5.g. Computational Adjustments. Petitioner correctly reported carryovers of the following tax attributes as of 2000, or 2001: (i) regular net operating loss carryovers and alternative minimum tax net operating loss carryovers; (ii) alternative minimum tax credit carryovers; (iii) foreign tax credit carryovers; (iv) alternative minimum tax foreign tax credit carryovers; (v) research credit carryovers; and (vi) charitable contribution carryovers.

WHEREFORE, VERITAS US requests that this Court try this case, determine that no deficiencies and no penalties are due from the Petitioner, and grant Petitioner such other and further relief as this Court deems just and proper.

Dated: June 26, 2006

Respectfully submitted,

 

 

Andrew P. Crousore

 

T.C. No. CA0420

 

 

Beth L. Williams

 

T.C. No. WB0109

 

 

Scott H. Frewing

 

T.C. No. FS0327

 

Baker & McKenzie

 

660 Hansen Way

 

Palo Alto, California 94034

 

(650) 856-2400

 

 

James M. O'Brien

 

T.C. No. OJ0027

 

 

Mark A. Oates

 

T.C. No. OM0113

 

Baker & McKenzie

 

130 East Randolph Drive

 

Chicago, Illinois 60601

 

(312) 861-8000

 

 

Attorneys for Petitioners

 

FOOTNOTE

 

 

1 All section references are to the Internal Revenue Code of 1986, as in effect for the taxable years at issue.

 

END OF FOOTNOTE
DOCUMENT ATTRIBUTES
  • Case Name
    VERITAS SOFTWARE CORPORATION & SUBSIDIARIES, SYMANTEC CORPORATION (SUCCESSOR IN INTEREST TO VERITAS SOFTWARE CORPORATION & SUBSIDIARIES), Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
  • Court
    United States Tax Court
  • Docket
    No. 12075-06
  • Authors
    Crousore, Andrew P.
    Williams, Beth L.
    Frewing, Scott H.
    O'Brien, James M.
    Oates, Mark A.
  • Institutional Authors
    Baker & McKenzie
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2007-1327
  • Tax Analysts Electronic Citation
    2007 TNT 14-27
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