Menu
Tax Notes logo

Partnership Petitions Tax Court to Adjust Partnership Items

DEC. 15, 2022

Desert Newco LLC et al. v. Commissioner

DATED DEC. 15, 2022
DOCUMENT ATTRIBUTES

Desert Newco LLC et al. v. Commissioner

DESERT NEWCO, LLC, GODADDY INC., Tax Matters Partner,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION FOR ADJUSTMENT OF PARTNERSHIP ITEMS UNDER CODE SECTION 6228

Petitioner hereby petitions for an adjustment of partnership items of partnership Desert NewCo, LLC for its taxable year ended December 31, 2017 (the “2017 Tax Year”) pursuant to former section 6228 of the Internal Revenue Code as in effect for partnership taxable years beginning prior to January 1, 2018.1 As the basis for this proceeding, Petitioner alleges the following:

1. Petitioner. GoDaddy Inc. (“GDI”) is a Delaware corporation with a principal place of business at 2155 E. GoDaddy Way, Tempe, AZ 85284.

2. Partnership. Desert NewCo, LLC (“DNC”) is a Delaware limited liability company that maintains its principal place of business at 2155 E. GoDaddy Way, Tempe, AZ 85284. DNC was classified as a partnership for U.S. federal income tax purposes during all relevant periods.

(a) DNC timely filed its Form 1065 for the 2017 Tax Year electronically with the Internal Revenue Service on September 10, 2018.

(b) During the taxable year at issue, GDI held an interest in the capital of DNC ranging from approximately 52.25% to 78.42%, and interest in the profit and loss of DNC ranging from approximately 52.25% to 78.42%.

3. Tax Matters Partner.

(a) Petitioner is the tax matters partner of DNC, as defined in former section 6231(a)(7), having been designated tax matters partner pursuant to former Treasury Regulations section 301.6231(a)(7)-1(c) on September 10, 2018.

(b) Petitioner was DNC's designated “member manager” (as defined in Treas. Reg. § 301.6231(a)(7)-2(b)(3)) during the 2017 Tax Year.

4. On December 16, 2020, Petitioner, on behalf of DNC, timely filed electronically with the Internal Revenue Service an Amended Return on Form 1065 for the 2017 Tax Year with an accompanying Form 8082, Administrative Adjustment Request (hereafter, the “AAR”). A copy of the AAR is attached hereto as Exhibit A.

5. No part of the AAR has been allowed or otherwise acted on by Respondent.

6. This Petition is filed after the expiration of six months from the date of filing of the AAR and before the date that is two years after the date of such AAR.

7. As of the date hereof, Respondent has not mailed to DNC any notice of the beginning of an administrative proceeding nor any notice of final partnership administrative adjustment for the 2017 Tax Year.

8. Requested Adjustments. The partnership items on DNC's return for the 2017 Tax Year that are sought to be changed, and the basis for such requested changes, are as follows:

(a) Research expenses incurred under section 174 in the amount of $174,780,505;

(b) Research credits under section 41 in the amount of $16,256,374;

(c) A net increase in other deductions attributable to depreciation, amortization, or other cost recovery as a result of increases or decreases to a transferee partner's proportionate share of DNC's adjusted basis under section 743(b) of $21,189 (for a total deduction of $111,854,510).

9. Supporting Facts. The facts on which Petitioner relies in support of the foregoing requested changes in treatment of partnership items are as follows:

(a) DNC, through its disregarded subsidiaries including GoDaddy.com, LLC and DNC's wholly owned indirect corporate subsidiary GoDaddy Media Temple, Inc. (collectively, “GoDaddy”) operates a worldwide internet domain registrar and web hosting business. GoDaddy is primarily involved in the software industry and supports millions of domains and websites.

(b) For the 2017 Tax Year, DNC was treated as part of the same controlled group under Treasury Regulation section 1.41-6(a)(3)(ii) with its wholly owned indirect subsidiary

(c) During the 2017 Tax Year and since, GoDaddy provided software-based services that allow customers to establish, maintain, and evolve their online presence, as well as a variety of domain name registration plans, website design services, hosting packages, and on-demand online services to customers. For the 2017 Tax Year, DNC's qualified research expenses (within the meaning of section 41(b), “QREs“) represented approximately 97% of GoDaddy's aggregate QREs, and GDMT's QREs represented the remaining approximate 3%.

(d) GoDaddy's software and product development model can be organized by internal “pillars” representing unique roles and workstreams in relation to its products and online services. During the 2017 Tax Year, GoDaddy's software and product development efforts can be grouped into six core pillars: Care, Domains, Independent, International, Partners, and Platform.

(1) The Platform pillar was focused on technology platforms. GoDaddy's investments in platform capabilities included platforms for e-commerce and application services, data, content and marketing, and enterprise operations.

(2) The Independence pillar was focused on supporting small business with website development and management. Projects related to this pillar included online editing and publishing tools that help small businesses create websites regardless of skill level as well as a website builder for creating a business's virtual storefront.

(3) The Partners pillar was focused on experienced web developers and other web professionals. Products from the Partners pillar included client management applications to enable web professionals to manage clients' websites, administrative access and shopping features to make it easier to buy and manage multiple products for web professionals' clients, and control panels and content management tools.

(4) The Domains pillar was focused on solutions for management of customers' business operations. Primary products of the Domain pillar included primary domain registrations, an aftermarket which processes secondary domain name sales, and domain name add-ons.

(5) The International pillar was focused on international customers and markets.

(6) The Care pillar was focused on customer service, providing technical assistance to customers located throughout the world.

(e) Petitioner, with assistance from outside advisors, reviewed GoDaddy's expenses in relation to each pillar and determined whether they qualified for research credits under section 41 and whether GoDaddy was entitled to claim them for the 2017 Tax Year.

(f) To identify qualified research expenses, Petitioner reviewed documentation related to GoDaddy's development efforts, conducted interviews with GoDaddy financial, technical, and project management personnel familiar with the nature and purpose of each group's activities and expenses, and received detailed information regarding the information of research activities performed during the 2017 Tax Year.

(g) Based on this detailed investigation, GoDaddy identified the following amounts of “qualified research expenses” (within the meaning of section 41(b)(1)) under each pillar in 2017:

(1) $76,865,331 in connection with the Platforms pillar, accounting for roughly 42.6% of GoDaddy's QREs, of which

$75,788,824 was attributable to wage expenses, $123,132 was attributable to contract expenses, and $953,375 was attributable to computer rental or lease costs.

(2) $49,971,410 in connection with the Independence pillar, accounting for roughly 27.7% of GoDaddy's QREs, of which $49,914,849 was attributable to wage expenses and $56,561 was attributable to contract expenses.

(3) $27,263,829 in connection with the Partners pillar, accounting for roughly 15.1% of GoDaddy's QREs, of which $27,057,823 was attributable to wage expenses and $206,006 was attributable to contract expenses.

(4) $12,943,070 in connection with the Domains pillar, accounting for roughly 7.2% of GoDaddy's QREs, of which $12,759,602 was attributable to wage expenses and $183,468 was related to contract expenses.

(5) $11,410,264 in connection with the International pillar, accounting for roughly 6.3% of GoDaddy's QREs, of which $11,364,967 was attributable to wage expenses and $45,297 was attributable to contract expenses.

(6) $1,831,465 in connection with the Care pillar, accounting for roughly 1.0% of GoDaddy's QREs. All of the QREs incurred in connection with the Care pillar were attributable to wages.

(h) GoDaddy incurred QREs of $98,738,167, $108,033,467, and $154,932,600 for the tax years ending December 31, 2014, December 31, 2015, and December 31, 2016, respectively, determined on a basis consistent with the determination of QREs reflected in paragraph 9(g). In such years DNC incurred $96,227,941, $105,286,927, and $150,993,741 of such QREs, respectively.

(i) The expenses described above were undertaken for the purpose of discovering information which was technological in nature and the application of which was intended to be useful in the development of new or improved computer software, processes or techniques to be used in connection with the pillars.

(j) The expenses described above were incurred to eliminate uncertainty concerning the development or improvement of the computer software, processes or techniques used in connection with the pillars or the capability or method for developing or improving such desired computer software, processes or techniques.

(k) Substantially all of the expenses described above were incurred in activities constituting elements of a process of experimentation for a purpose related to a new or improved function, performance, reliability or quality of the computer software, processes, or techniques used in connection with the pillars.

(l) The expenses described above were incurred for research involving a process of experimentation that fundamentally relied upon the principles of engineering and computer science.

(m) The expenses described above were for research to develop software to be commercially licensed or otherwise marketed to third parties or to enable the GoDaddy business to interact with third parties or to allow third parties to initiate functions or review data on the systems of the GoDaddy business.

(n) None of the expenses described in paragraph 9(g) above were with respect to software developed by the GoDaddy business primarily for its (or a related party's) internal use within the meaning of the governing Treasury Regulations.

(o) GoDaddy retained substantial rights in the research developed in connection with the expenses described above. Where persons other than GoDaddy employees performed such research, such research was performed on behalf of GoDaddy pursuant to agreements that were (i) entered into prior to the performance of the qualified research, (ii) provided that the research was to be performed on behalf of GoDaddy, and (iii) required that GoDaddy bear the expense even if the research was not successful.

(p) GoDaddy's expenses described above were not funded by any grant, contract, or otherwise by another person (or governmental entity).

(q) The $953,375 of expenses described in paragraph 9(g)(1) above were incurred by DNC for the right to use computers in the conduct of qualified research (within the meaning of the governing Treasury Regulations) that were not (i) owned or operated by GoDaddy, (ii) located on GoDaddy's premises, or (iii) primarily used by GoDaddy.

(r) In identifying the QREs described in paragraphs 9(g)(1) through 9(g)(5)9(g)(6), 65% of the contract expenses incurred by GoDaddy were claimed. DNC incurred a total of $945,329 in contract research expenses for the 2017 Tax Year.

(s) At the time of the filing of the AAR, neither DNC nor GDMT had (i) made any claims for research credits under section 41 on any original or amended return for the 2017 Tax Year using a method other than the alternative simplified credit method of section 41(c)(5) or (ii) made any claims for research credits under section 41 for any tax year using the alternative incremental credit method of section 41(c)(4).

(t) In connection with the filing of the AAR, DNC filed a Form 6765 and made a valid election to determine its research credit under the alternative simplified credit method of section 41(c)(5).

(u) The amount of DNC's claimed research credits in paragraph 8(b) above equals its share of the research credit for the GoDaddy controlled group determined using the alternative simplified credit method under section 41(c)(5), i.e. 14% of the excess of GoDaddy's QREs for the 2017 Tax Year over 50% of GoDaddy's average QREs for the prior three tax years.

(v) Due to the unrealized gain in DNC's property at the time of various transfers of interest in DNC to GDI resulting in basis adjustments under section 743(b) and section 755, DNC should have reported additional depreciation, amortization, or other cost recovery deductions allocable to GDI in the amount of $36,762 as compared to DNC's originally filed Form 1065 for the 2017 Tax Year.

(w) After properly taking into account reductions of interests in DNC by a partner of DNC during the 2017 Tax Year, DNC should have reported lesser depreciation, amortization, or other cost recovery deductions allocable to such partner under section 743(b) and section 755 in the amount of $15,533 as compared to DNC's originally filed Form 1065 for the 2017 Tax Year.

(x) DNC had a valid election under section 754 in effect for the 2017 Tax Year.

(y) The adjustments described in paragraphs 9(v) and 9(w) were the result of the transfer of an interest in DNC by sale or exchange or on the death of a partner.

(z) The amount of DNC's claimed deduction in paragraph 8(c) is the result of netting the adjustments described in paragraphs 9(v) and 9(w), for a total adjustment of $21,189 to the deduction originally reported on DNC's Form 1065 for the 2017 Tax Year, which yields a total deduction of $111,854,510.

* * * *

WHEREFORE, Petitioner prays that this Court determine that the foregoing adjustments to partnership items for the partnership taxable year ending December 31, 2017 should be allowed, and grant Petitioner such other and further relief to which it may be entitled.

Dated: December 15, 2022

Mario J. Verdolini, Jr.
Tax Court Bar No. VM0077
(212) 450-4969
mario.verdolini@davispolk.com

Christopher A. Baratta
Tax Court Bar No. BC0755
(212) 450-3115
christopher.baratta@davispolk.com

Counsel for Petitioner

Davis Polk & Wardwell LLP
450 Lexington Avenue
New York, NY 10017
(212) 450-4000

FOOTNOTES

1Section references herein are to the Internal Revenue Code or the Treasury Regulations promulgated thereunder, as the context requires, in each case as in effect for the 2017 Tax Year.

END FOOTNOTES

DOCUMENT ATTRIBUTES
Copy RID