eBay’s Cost-Sharing Arrangement — Frankenstein’s Progeny

“Germany’s user information and live auctions were migrated . . . to . . . eBay’s platform and hosted by eBay’s servers in San Jose.”¹

“Rather than going to [eBay’s local foreign country affiliate], the money generated from customers continues to go to Berne-based eBay International AG, a spokeswoman said. . . . eBay declined to say why it channeled sales through Switzerland.”²

I. Introduction

In November 2012 the IRS was conducting continuous audit examinations of two of the internet’s largest online marketplace operators. The exams covered various tax years, including 2005-2009.³ Both competitors had cost-sharing arrangements (CSAs) affected by the revised cost-sharing regulations. Those regulations had been issued in temporary form (reg. section 1.482-7T) in late 2008 and made effective from January 5, 2009.⁴ They were promulgated in final form at the end of 2011.⁵

Figure 1, which was developed from screenshots of the competitors’ year-end Forms 10-K, shows pretax income and tangible assets in 2008, with percentages added by me.⁶ This was the last fiscal year before the January 2009 transition to the new cost-sharing regulations. Both competitors’ revenue at the time was split about evenly between U.S. and foreign territories. Importantly, as of year-end 2008, Company A operated its commercial internet platform exclusively from the United States, which was the location of almost all personnel and almost 90 percent of its long-lived tangible assets. Yet Company A reported only 13 percent of total pretax income in the United States.⁷ On the other hand, Company B, which employed much of its personnel offshore and located almost 40 percent of its commercial assets there, reported just under half its pretax income in the United States.

Table 1 expands that information to include additional key information from SEC filings that the IRS would have had access to at the time of its examinations. For this purpose, the estimated intellectual property investment is the foreign revenue proportion of total research and development expenses reported in SEC filings. This does not include platform contribution transactions (PCTs)⁸ and is expected to differ from the mechanisms used by each company to determine its cost-sharing payments under its CSA.

Table 1. Company A and Company B U.S. and Foreign Profit Information ($ millions)

Year	Company A				Company B
	Cum. U.S. Pretax Income	Cum. Foreign Pretax Income	Est. Cumulative Foreign RAB Share of IDCs	Foreign Cumulative Return on IDCs	Cum. U.S. Pretax Income	Cum. Foreign Pretax Income	Est. Cum. Foreign RAB Share of IDCs	Foreign Cum. Return on IDCs
2005	$944	$606	$150	404%	$601	$(173)	$226	-77%
2006	$1,720	$1,376	$387	356%	$997	$(192)	$557	-35%
2007	$2,438	$1,409	$705	200%	$1,357	$108	$966	11%
2008	$2,766	$3,265	$1,093	299%	$1,793	$573	$1,482	39%
2009	$2,914	$5,996	$1,493	402%	$2,322	$1,205	$2,102	57%
2010	$3,762	$7,246	$1,941	373%	$3,208	$1,816	$2,823	64%
2011	$5,509	$9,410	$2,537	371%	$3,866	$2,092	$3,655	57%
Total	$20,052	$29,308	$8,305		$14,144	$5,429	$11,809
Average foreign return on estimated IP investments				343%	Average foreign return on estimated IP investments			17%

These expanded results show that over this period, Company A earned an estimated foreign return of almost 350 percent on cost-sharing payments. Its cumulative U.S. pretax income was only around 68 percent of foreign income, meaning Company A’s foreign CSA participant (including any disregarded entity subsidiaries) was earning much larger profits and profit margins on these cost-sharing investments than its U.S. parent — even though the foreign CSA participant performed relatively minimal exploitation operations and owned only a small portion of the exploitation assets.⁹ Company B’s foreign CSA participant, on the other hand, earned only around 17 percent on these cost-sharing investments yet owned substantial exploitation assets, and its U.S. pretax income was almost triple the foreign pretax income.

A rational assumption would be that the IRS would not waste taxpayer money examining Company B’s transfer pricing or CSA, given the lopsided U.S. returns and substantial foreign assets and risks. And surely, the IRS would have challenged Company A’s results — either treating the CSA as invalid because of the foreign CSA participant’s lack of meaningful individual exploitation of the cost-shared intangibles or possibly labeling the entire arrangement a sham-like, tax-driven arrangement. However, the opposite occurred: The IRS challenged Company B’s CSA in November 2012 as noncompliant with U.S. regulations, and there is no evidence that the IRS at the time questioned or critically reviewed Company A’s cost-sharing results over the same period.¹⁰ So what companies are A and B?

• Company A is eBay Inc.

• Company B is Amazon.com Inc.

As many readers know, the IRS lost its challenge to Amazon’s CSA in March 2017.¹¹ The Tax Court found that the CSA was compliant with the regulations and that the IRS’s adjustment was arbitrary and capricious. This was yet another example of the IRS’s continuing difficulties with the diabolical “Frankenstein” cost-sharing regulations. Those regulations created a tax loophole that upended and even reversed the arm’s-length standard for IP transactions, making enforcement nearly impossible and spawning billions in questionable profit shifting and litigation, most of which the U.S. government has lost. Perhaps most unfortunate is that the IRS decided to take action against a compliant taxpayer under the relatively lax and largely unenforceable 1995 regulations, given the many other clearly invalid arrangements the agency should have been able to more easily challenge. This effort to go after Amazon while ignoring eBay and similar international arrangements suggests that the IRS has little ability to distinguish tax-compliant transactions from what sometimes amounts to tax evasion conducted through CSAs.

Lest there be any doubt, consider that in 2006 the IRS awarded an advance pricing agreement to Google Inc. for a cost-sharing transaction that (1) directly violated the first sentence in reg. section 1.482-7A, which required individual exploitation of the cost-shared intangibles; and (2) could have reasonably been labeled a sham transaction with a shell company when the CSA was executed in 2003.¹² In a 2016 academic paper, I documented how the IRS’s approach to transfer pricing exams in particular suffers from several deficiencies that produce high proportions of type I and II errors (Type I being erroneously determining a compliant taxpayer to be noncompliant, and Type II being a failure to identify a noncompliant taxpayer).¹³

Those reverse tax enforcement outcomes most often arise when taxpayers are preselected for mechanical transfer pricing compliance examinations either randomly or because of factors unrelated to transfer pricing risk. Further, widely divergent examiner capabilities are exacerbated by an absence of specialized forensic support. These examinations then suffer from various biases and deficiencies including:

• Acute information and resource asymmetry. The taxpayer has full knowledge of its operations and areas of potential or actual tax noncompliance, but the IRS has little to none of that knowledge and may be able to obtain only a small portion of it through resource-intensive efforts.

• Adverse selection. The IRS selects compliant taxpayers for examination and fails to select taxpayers that are violating tax laws or otherwise evading taxes.

• Confirmation bias. The IRS interprets information in a way that supports views the examiner already holds (such as the seemingly common belief that intangible assets are the most valuable contributor to profits in each and every case), thereby ignoring factors such as exploitation and supply chain services that will be significant in most cases and often a more valuable contributor to profits than relevant intangible assets.

• Bounded rationality. An IRS examiner, using limited information, makes decisions during an examination that are rational to him or her but are irrational based on full information. An example is the IRS’s challenge to Amazon’s cost-sharing buy-in payment based primarily or exclusively on perceived tax violations in the company’s transfer pricing documentation. Outside that context, Amazon reported only U.S. profits and extensive foreign losses in some years in the same period, possibly indicating “overcompliance” with U.S. transfer pricing laws.

The 2016 paper recommended that the IRS use centralized forensic risk detection technology to actively select transfer pricing examination candidates instead of just checking for transfer pricing issues once an examination target had been chosen based on other selection criteria. Advanced forensic and data analytics technology are widely used today by taxpayers but not by the IRS.

It also appears that the IRS never tried to enforce the 2008 temporary regulations in the context of preexisting CSAs affected by the significant cost-sharing transition rules, and in both preexisting and new CSAs subject to the periodic adjustment rules of reg. section 1.482-7(i)(6).¹⁴

This report, the fourth in a series on CSAs, examines eBay, whose analyzed arrangement is the smallest in terms of potential tax risk (hence the title). The previous three reports focused on Facebook Inc., Apple Inc., and Google Inc.¹⁵ This report compares the eBay and Amazon transfer pricing examinations and counterfactually selects eBay’s CSA instead of Amazon’s for a detailed forensic examination, beginning with its compliance with the 2008 transition rule. It finds that eBay appears to have not complied with that rule and could therefore be at risk of a tax adjustment exceeding $13 billion based on a periodic adjustment in 2017 and later tax years.

II. Regulatory Analysis

The facts in the public record and as presented in this report show that the IRS could issue eBay notices of proposed adjustment based on either or both of a commensurate with income analysis under the 2008 cost-sharing regulations (reg. section 1.482-7(i)(6)), and application of the effectively connected income rules (section 864(c) and other applicable provisions).¹⁶ The key aspects of these regulations in the context of eBay and its CSA are described below.

A. Commensurate With Income Test

Because eBay’s CSA predated the January 5, 2009, effective date of the 2008 temporary regulations, it was subject to a grandfathering clause in reg. section 1.482-7T(m)(1). If that preexisting CSA qualified for grandfathering, the IRS would be prevented from performing a periodic adjustment under reg. section 1.482-7(i)(6) against eBay’s foreign CSA participant. If the CSA failed to qualify for grandfathering, the foreign CSA participant would be subject to periodic adjustments if its actual results were outside a range defined in reg. section 1.482-7(i)(6).

Historically, the IRS has not enforced these regulations, and there is no evidence that it has ever investigated preexisting CSAs to apply the 2008 grandfathering rule. The IRS should examine eBay on this issue because the analysis of available public information in this report shows that eBay’s preexisting CSA did not qualify under reg. section 1.482-7T(m)(1) to be grandfathered. That analysis further shows that applying reg. section 1.482-7(i)(6) to eBay’s results produces a periodic trigger in one or more years after January 5, 2009, thus allowing the IRS to calculate a periodic adjustment for those years.

Even if the IRS has already examined the pricing of eBay’s PCTs in now-closed examination years and applied an adjustment to them, it could still apply a periodic adjustment.¹⁷ Importantly, taxpayers are required to maintain extensive documentation of PCTs under reg. section 1.482- 7(k)(2)(ii)(J).¹⁸ That and other PCT data post-January 5, 2009, would be a part of any periodic adjustment calculation under reg. section 1.482-7(i)(6).

The 2008 temporary regulations were released in T.D. 9441 on December 31, 2008, and published in the Federal Register January 5, 2009, as the “2008 temporary CSA regulations.” They contained the following transition rule at reg. section 1.482-7T(m), which remained unchanged in the final regulations, which were issued in 2011:

(1) In general. An arrangement in existence on January 5, 2009, will be considered a CSA, as described under paragraph (b) of this section, if, prior to such date, it was a qualified cost sharing arrangement under the provisions of section 1.482-7 (as contained in the 26 CFR part 1 edition revised as of January 1, 1996), hereafter referred to as “former section 1.482-7”), but only if . . . the activities of the controlled participants substantially comply with, the provisions of this section . . . by July 6, 2009.

(2) Transitional modification of applicable provisions. For purposes of this paragraph (m), conformity and substantial compliance with the provisions of this section shall be determined with the following modifications: (i) CSTs and PCTs occurring prior to January 5, 2009, shall be subject to the provisions of former section 1.482-7 rather than this section. [Emphasis added.]

The “former” CSA regulations (with which the transition rule mandated compliance) were originally issued in final form on December 20, 1995 (T.D. 8632), and were effective for tax years beginning on or after January 1, 1996 (the 1995 regulations).¹⁹ Taxpayers like eBay with preexisting CSAs could continue to have a valid, grandfathered CSA only if the arrangement met the requirements of the regulations in effect on January 1, 1996 — that is, they had to be qualified CSAs under those regulations. What exactly did those former regulations require of eBay?

For taxpayers with low- or no-substance, “lift and shift,” sham or sham-like preexisting CSAs, the 2008 temporary regulations presented some particularly troubling issues. First, by requiring compliance with the 1995 regulations, the transition rule mandated compliance with the individual exploitation requirement of paragraph (a)(1) of those regulations (which was inexplicably removed in the 2008 temporary regulations, together with the associated definitions). This provision — literally in the first sentence of the regulations — stated that a CSA is “an agreement under which the parties agree to share the costs of development of one or more intangibles in proportion to their shares of reasonably anticipated benefits from their individual exploitation of the interests in the intangibles assigned to them under the arrangement.” (Emphasis added.)

The regulations went on to define exploitation as the physical use of the IP in production of the commercial products or services (see below), and they provided examples of non-exploitation activities, such as distribution and reselling. Obviously, if there were no exploitation activities being performed (or managed and controlled) by the foreign CSA participant, no costs of development would be shared and no CSA could exist. Indeed, the preamble to these regulations (T.D. 8632) provided further guidance on this requirement:

Section 1.482-7(a)(1) defines a cost sharing arrangement as an agreement for sharing costs in proportion to reasonably anticipated benefits from the individual exploitation of interests in the intangibles that are developed. . . . It may be necessary to make adjustments to account for material differences in the activities that controlled participants perform in connection with exploitation of covered intangibles.

The second major issue was that the former regulations included an additional set of requirements that controlled foreign participants had to meet to continue as participants after January 5, 2009. Those regulations, found at reg. section 1.482-7A(c), read in part:

(1). . . . A controlled taxpayer may be a controlled participant only if it — (i) Uses or reasonably expects to use covered intangibles in the active conduct of a trade or business, under the rules of paragraphs (c)(2) . . . of this section. . . .

(2) Active conduct of a trade or business —. . . . (ii) Active conduct. In general, a controlled taxpayer actively conducts a trade or business only if it carries out substantial managerial and operational activities. For purposes only of this paragraph (c)(2), activities carried out on behalf of a controlled taxpayer by another person may be attributed to the controlled taxpayer, but only if the controlled taxpayer exercises substantial managerial and operational control over those activities. [Emphasis added.]

Notably, these participant requirements, which were effective for tax years beginning on or after January 1, 1996, were removed approximately five months later through a regulatory amendment issued in T.D. 8670 on May 13, 1996. However, that amendment is irrelevant to the 2008 transition rule because of reg. section 1.482-7T(m)(1), which refers to the earlier regulations as they existed on January 1, 1996, and thus ignores later amendments. The amendment in T.D. 8670, although applicable to tax years beginning on or after January 1, 1996, was effective only from May 13, 1996.

A final issue was that the former regulations contained yet more guidance on what constituted exploitation activities for CSAs. Under former reg. section 1.482-7A(g)(5), exploitation activities include only activities that physically produce and sell the IP-based products or services to customers. Supporting activities such as marketing, promotion, customer support, and administrative activities that are ancillary to the exploitation activities are excluded. Former reg. section 1.482-7A(g)(8), Example 2, illustrates how that provision applies:

U.S. Subsidiary (USS) . . . and Foreign Parent (FP) enter into a cost sharing arrangement to develop new products within the Group X product line. . . . When the new Group X products are developed, however, USS ceases to manufacture Group X products, and FP sells its Group X products to USS for resale in USS’s market. USS earns a return on its resale activity that is appropriate given its function as a distributor, but does not earn a return attributable to exploiting covered intangibles. [Emphasis added.]

Now substitute eBay Switzerland for USS, and eBay US for FP:

eBay Switzerland and eBay US enter into a CSA to develop new products within the Group X product line. . . . When the Group X products are developed, however, eBay Switzerland ceases to manufacture Group X products, and eBay US sells its Group X products to eBay Switzerland for resale in eBay Switzerland’s market. eBay Switzerland earns a return on its resale activity that is appropriate given its function as a distributor, but it does not earn a return attributable to exploiting covered intangibles.

It is clear from this guidance that routine promotion, marketing, and customer support activities do not qualify as exploitation activities under the former regulations, with which eBay Switzerland was required to comply by January 5, 2009. Example 2 is not found in the 2008 temporary regulations, and the primary transaction it addressed (a transfer of interest in the covered IP) is now found in reg. section 1.482-7(f)(2).

That eBay Switzerland might not have met the individual exploitation requirements of the former regulations is fully consistent with the preamble to T.D. 8632 (the 1995 final regulations), which explained the purpose of the rule as originally proposed in 1992:

Under the proposed regulations [INTL-0372-88], only a controlled taxpayer that would use developed intangibles in the active conduct of its trade or business was eligible to participate in a cost sharing arrangement. This requirement was considered necessary to ensure that controlled foreign entities were not established simply to participate in cost sharing arrangements without performing any other meaningful function.

The preamble then explained why Treasury rejected commentators’ suggestions to loosen the eligible participant requirement:

Commenters argued that separate research entities (with no separate active trade or business) should be allowed to participate in cost sharing arrangements, as should marketing affiliates. . . . The requirements for being a controlled participant are basically the same as in the proposed regulations. In particular, a controlled participant must use or reasonably expect to use covered intangibles in the active conduct of a trade or business. Thus, an entity that chiefly provides services (e.g., as a contract researcher) may not be a controlled participant. These provisions are necessary for the reason that they are necessary to the proposed regulations: to prevent foreign controlled entities from being established simply to participate in cost sharing arrangements. [Emphasis added.]

According to reg. section 1.482-7T(m)(1), if eBay’s preexisting CSA did not meet the various provisions described above by January 5, 2009, eBay would no longer have a CSA as of that date, and its intercompany arrangements would therefore be subject to compliance with other transfer pricing code sections. Clearly, Treasury sought to make it difficult, if not impossible, for taxpayers with sham-type, low- or no-economic-substance CSAs to be allowed to meet the grandfathering rules in the 2008 regulations. However, it appears that the IRS never enforced those strict requirements.

The facts that follow show that neither eBay’s Swiss-incorporated CSA affiliate (eBay International AG) nor any related check-the-box affiliates used or otherwise exploited eBay’s cost-shared IP in their CSA territories or in any way managed or controlled eBay Inc.’s performance of those exploitation functions on their behalf exclusively in the United States. eBay Switzerland’s failure to meet the individual exploitation requirement of the former regulations illustrates the reason for Treasury’s concern in 1992, when it originally proposed the regulations, that it needed to strengthen the cost-sharing rules to prevent sham or sham-like CSA transactions.

Despite apparently not satisfying the requirements for the reg. section 1.482-7(m)(1) transition rule, eBay continued to maintain that its CSA was valid after January 5, 2009, and the IRS has not challenged the arrangement’s validity. That being the case, eBay’s failure to meet the transition rule can only mean that its CSA must be considered a “new” CSA covered by the 2008 temporary regulations, with effect from January 5, 2009. As a result, all of eBay’s PCTs from that date onward are subject to the periodic adjustment rules of reg. section 1.482-7(i)(6). As detailed later, performing a periodic trigger calculation under these regulations based on a 2017 adjustment year confirms that a substantial periodic adjustment is warranted.

Also, consider that even if eBay had complied with the transition rule by January 5, 2009, it may have waived its grandfathering two years later, in 2011, as the result of a material change in scope of a CSA. Such a change would include a “material expansion of the activities undertaken beyond the scope of the intangible development area” as described in reg. section 1.482-7T(m)(3) of the 2008 temporary regulations:

Special rule for certain periodic adjustments. The periodic adjustment rules in paragraph (i)(6) of this section (rather than the rules of section 1.482-4(f)(2)) shall apply to PCTs that occur on or after the date of a material change in the scope of the CSA from its scope as of January 5, 2009. A material change in scope would include a material expansion of the activities undertaken beyond the scope of the intangible development area, as described in former section 1.482-7(b)(4)(iv). . . . Whether a material change in scope has occurred is determined on a cumulative basis. Therefore, a series of expansions, any one of which is not a material expansion by itself, may collectively constitute a material expansion.

eBay’s acquisition of GSI Commerce in 2011 (later renamed eBay Enterprise Inc.) may have represented a material expansion in the scope of the CSA activity because it resulted in eBay’s entrance into an entirely new business line. Accompanying this entrance was a 36 percent increase in R&D expenses. There might not have been a material expansion if relevant portions of the acquisition were not folded into eBay’s existing CSA — that is, if they involved a continuation of the acquired target’s CSA or were otherwise used to create a new CSA separate from eBay’s existing CSA.

The calculations in this report assume that there was either (1) noncompliance with the transition rule or (2) a material expansion in the scope of the CSA activity, thereby causing a loss of grandfathering benefits. If neither of those occurred, the results described in this report would change.²⁰

B. ECI Taxation

ECI taxation is applied to foreign persons, including controlled foreign corporations such as eBay International AG.²¹ As a threshold, ECI taxation requires that the foreign person conduct a trade or business within the United States — either factually, through its own employees or agents, or by statute (section 875), by virtue of being a partner in a partnership that conducts a trade or business in the United States.

Later sections of this report document how eBay Switzerland has earned services income from platform users through the group’s integrated worldwide platform, which brings sellers and buyers together and is operated solely through the actions of U.S.-based personnel. eBay Switzerland’s business was conducted this way in 2009 and earlier years, and in most if not all later years. Under eBay’s chosen structure, a Swiss company (eBay Switzerland) earns income solely through eBay US’s decision-making on its behalf, and eBay US is the sole operator of the worldwide group platform that directly earns eBay Switzerland’s revenue. Therefore, eBay Switzerland has a de facto agent in the United States that is conducting its business on a continuous and regular basis. Those facts are far more than enough to cause eBay Switzerland to be engaged in a trade or business within the United States.

The application of ECI taxation is procedurally easier when there is a partnership. How eBay Inc. and eBay Switzerland have conducted eBay’s worldwide business must be examined in light of the entity classification rules of reg. section 301.7701-1 and -3. In short, with one central management, one operational structure that conducts the business of both eBay Inc. and eBay Switzerland, and one unified worldwide platform through which users from all parts of the world access the group’s services, there is clearly a joint business being conducted. That joint business constitutes an entity for federal tax purposes and, in the absence of an active election, will be treated as a partnership under the entity classification default rule.²² If eBay Switzerland is thus treated as a partner in a partnership that conducts the joint worldwide business of the eBay group,²³ it would be treated under section 875 as being engaged in a trade or business within the United States.

Once eBay Switzerland is found to be engaged in a trade or business in the United States (whether directly or through a partnership), each item of gross income must be considered under the applicable sourcing and ECI rules to determine the ECI that will be directly taxable in its hands.²⁴ Given that personnel in the United States actively participated in eBay Switzerland’s delivery of commercial services to customers, as well as in managing and operating the internet-based platforms through which cloud services income was earned, it seems certain that there will be significant U.S.-source income²⁵ treated as ECI under section 864(c)(3).²⁶

Note that ECI taxation may be applied in conjunction with transfer pricing adjustments. If the IRS chooses to apply and eventually sustains periodic adjustments under reg. section 1.482-7(i)(6) or other transfer pricing adjustments (such as intercompany service fee adjustments under reg. section 1.482-9 or the adjustments to the payments for PCTs under reg. section 1.482-7), eBay Switzerland’s profits would then be reduced under the correlative adjustment rules of reg. section 1.482-1(g)(2). And it is those post-correlative-adjustment profits to which ECI taxation would be applied.

For purposes of applying ECI taxation, the status of a CFC’s tax years as open or closed does not follow the status of the affiliated group’s tax years. This is because any CFC is a separate taxpayer with its own filing requirements on Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation.” If eBay Switzerland has never filed Form 1120-F for a prior year, under section 6501(c)(3), that year will still be open for adjustment. Further, the facts described in this report show how the eBay Inc. affiliated group has conducted major portions of its international business — most notably by providing its auction platform to foreign customers directly from the United States and by directly managing and making key operational decisions regarding eBay’s foreign businesses. Even if eBay Switzerland has filed protective Forms 1120-F for all prior years, claiming that it had no trade or business in the United States, many of those years should still be open under section 6501(c)(1) or (2), which suspends the statute of limitations if a false or fraudulent return has been filed or if there has been a willful attempt to evade tax, respectively.

eBay’s most recent Form 10-K, covering the year ended December 31, 2021, discloses that its 2010 through 2020 tax years are under examination by tax authorities. The form does not disclose the earliest year of eBay Inc. that is still open for U.S. tax assessments. In any case, many or all years of eBay Switzerland that precede that year will likely still be open for ECI taxation. ECI taxation includes not only the normal corporate tax at the rate applicable for the particular tax year but also the section 884 branch profits tax.²⁷ And if a tax return has not been timely filed,²⁸ the section 882(c)(2) denial of deductions and credits will increase the amount of taxable ECI.²⁹

III. Functional and Factual Analysis

The following bullet points summarize the more detailed research information that follows within this section. This information appears more than sufficient to establish that eBay violated the transition rule of reg. section 1.482-7T(m)(1) on January 5, 2009:

• eBay grew its foreign business primarily by acquiring foreign auction websites, typically at an early stage and often before profitability.³⁰ Shortly after each acquisition, the most important commercial operations — including the development, enhancement, and day-to-day operation of the auction website — were transferred to group personnel in the United States. This happened because after each acquisition, eBay jettisoned the existing software platform and transitioned all existing users to eBay’s centrally operated U.S.-based technology platform. Once foreign websites were migrated to the United States, the remaining foreign operations conducted only routine promotion, customer support, and administrative functions, such as reporting, collections, and billing. eBay US thereafter operated, managed, maintained, and hosted its many foreign websites from its offices and data centers on U.S. soil. These included the websites for France (eBay.fr), Germany (eBay.de), and the United Kingdom (eBay.co.uk). Despite these operations being conducted within the United States, revenue and profits were paid not to eBay group members in either the United States or the website’s country, but to eBay tax haven affiliates — primarily residing in Switzerland and Singapore — where eBay had negotiated tax rulings that provided for very low effective tax rates.³¹

• The activities of all foreign eBay affiliates were closely supervised and controlled by eBay US, such that those affiliates could not initiate any substantive changes to the U.S.-hosted foreign websites accessed by foreign customers without approval by eBay US executives and execution by other U.S. operational personnel. Nor could foreign affiliates make any substantive changes to their own local operations without approval from eBay US, which appointed, managed, and controlled local leadership as well as the leadership in the group’s tax haven principal companies. Indeed, eBay International is a U.S. operating division that was managed, controlled, and conducted within the United States by U.S. executives. eBay International AG appeared to be led by U.S. executives employed by eBay US up until immediately before the January 2009 CSA transition date.

• The value of eBay’s commercial operations in 2008 and 2009 was based almost exclusively on the company’s CSA-related technology platform, which was an automated internet auction, advertising, search, and payment platform that benefited from the economics of network effects, in which the value of the network to new users grows with the number of existing users of the network.³² At the time, that put eBay in a special class of companies whose businesses were based on network effects associated with automated technology platforms, such as Google and Amazon.

• Indeed, eBay’s automated auction trading, search, and advertising platform at the time was often compared with Google’s platform for search and advertising. By 2003, there were more automated transactions conducted on eBay’s electronic platform per day than there were trades on Nasdaq, and the number of searches conducted on the eBay site was second in number only to Google’s.³³ By the end of 2008, although Google and eBay had similar numbers of employees (20,222 versus 16,200, respectively), Google had around six times the fixed assets and 2.5 times the revenue and profits of eBay, although eBay’s revenue and pretax income per dollar of fixed assets were twice that of Google’s.³⁴ That indicated differences between their business models, with Google’s revenue attributable primarily to data-intensive search and advertising operations and eBay’s revenue based on the number and value of products sold on the platform.

• A fundamental goal of eBay was a centralized, unified, worldwide branded platform to be used in every market, allowing uniformity of user experience and allowing users in different countries to trade with each other internationally.

• All of eBay’s data centers in 2009 (and indeed, to the present) were located in the United States and customized to its operations, thereby allowing the hosting of all foreign auction services on one common platform with one operational group that was located exclusively in the United States. Foreign affiliates had no capability to independently exploit eBay’s IP in their territories or otherwise manage and control that exploitation — a key requirement of the former regulations cited by the reg. section 1.482-7(m)(1) transition rule.

• None of eBay’s foreign operations involved foreign personnel directly “using” eBay’s cost-shared IP (its auction, search, and advertising platform) to conduct exploitation activities as contemplated by the former cost-sharing regulations or managing and controlling those U.S.-based exploitation activities as required by the same regulations. Instead, according to available information, foreign affiliates provided only routine non-exploitation activities such as customer support, promotion, marketing, and administrative or contract operations of the sort that could be found in “service centers” that would qualify for only a routine return. Those local entities were often or exclusively limited to that routine return through intercompany contracts with the principal entity, such as eBay Switzerland.

• Based on an analysis of the foreign tax provision in relation to eBay’s foreign pretax income in 2008 and 2009, the group’s overall foreign tax rate was 2.86 percent. If eBay split that income between an IP-owning tax haven affiliate with a zero percent tax rate and other foreign affiliates with a combined 25 percent tax rate, 88.5 percent of that income would have been reported in the tax haven affiliate, and only 11.5 percent in the other affiliates where some physical activities took place. This would indicate that the foreign affiliates in places where its customers were located — such as Australia, Germany, and the United Kingdom — were earning extremely small levels of profit, levels that are commonly associated with only routine functions normally performed for a cost-plus service fee. Although it is doubtful that eBay would have structured operations this way in those early years, the low foreign tax rate could also mean that local affiliates paid substantial royalties to the tax haven IP owner.

A. Background

eBay International AG was registered in Switzerland on October 1, 1999, at which time (and for several years thereafter) it would have constituted a shell company.³⁵ eBay soon set up a CSA with this shell company and by 2000 the company began reporting substantial foreign profits. By 2006 eBay was reporting as much pretax profit in this and other foreign entities as it reported in the United States, despite the absence of any foreign exploitation or other nonroutine activities. By 2009 eBay was reporting foreign pretax income that exceeded its U.S. income by more than 1,700 percent and represented 95 percent of its worldwide pretax income — that is, reporting only around 5 percent of its income in the United States.

At the end of 2008 — around the time that eBay International AG was required to comply with the cost-sharing transition rule by performing its own IP exploitation activities or managing and controlling the U.S. group members that were actually conducting them — eBay had 6,250 non-U.S. employees (versus 9,950 in the United States). However, those employees were located almost exclusively in countries other than Switzerland and provided localization services, customer support, administration (such as accounting), procurement, fraud detection, promotion, and marketing, etc., none of which were considered exploitation activities under the former regulations.

eBay Switzerland, by contrast, appears to have had as few as 250 employees, and they were performing mostly individual back-office functions.³⁶ Moreover, the local-country services appear to have been paid for by eBay International AG and possibly eBay Luxembourg (both of which collected fees from customers in the foreign CSA territory) as contracted services. On the surface, it would appear that very little of the offshore revenue generated by eBay US’s commercial exploitation activities was remitted to the U.S. affiliate.

B. eBay’s Exclusively U.S.-Based IP Exploitation

Consider the following description of eBay’s operations from the time eBay International AG was created up to 2005, showing that eBay only ever had U.S.-based infrastructure and exploitation activities:

In 1999, eBay was one massive database server and a few separate systems running the search function. In 2005, eBay is about 200 database servers and 20 search servers. . . . Each server has between six and 12 microprocessors. . . . While the majority of the site can run on 50 servers, eBay has four times that. The 200 servers are housed in sets of 50 in four locations, all in the United States.³⁷ [Emphasis added.]

Two years later, beginning in 2007, eBay launched a plan to begin building out its own infrastructure with purpose-built, company-owned data centers. In that year, just before the issuance of the 2008 temporary cost-sharing regulations, the expense of leasing generic U.S. infrastructure from third parties at market rates was as much as 50 percent greater than operating owned infrastructure. This was disclosed as follows by a Stanford University research team that was granted insider access to eBay’s operations and finances in 2013:

By 2007, data center operating costs had grown large enough to raise interest by the CFO in developing new data center efficiencies, and momentum grew at the C-level for the company to figure out how to manage the cost moving forward (R. Jain, personal communication, May 21, 2013). The infrastructure team identified a need to get ahead of demand and determine how to keep costs under control. . . . The increase in business demand following this period put increasing pressure on the Global Services team to keep up with the accelerating speed and diversity of product deployments (and corresponding demand from eBay Inc.’s business units for infrastructure services). . . . As a cost center, the infrastructure operations team was challenged to meet increasing need for improved infrastructure performance despite budgetary pressures of growing data center expenditures.

In order to address the pressure of growing infrastructure cost and need for increased infrastructure reliability, eBay’s infrastructure team decided to diversify its data center portfolio by developing in-house data centers. In-house data centers are generally less expensive to operate than leased ones. For eBay, the difference accounted for approximately 50 percent of the total cost in 2004-2005 (R. Jain, personal communication, May 21, 2013). . . .

After eBay Inc. purchased two data centers in Denver in 2004 and in Phoenix in 2006, the group decided to build a new one in Salt Lake City, Utah. The construction of the Topaz data center started in 2007; it began operating in May 2010. [Footnote omitted.] The $287 million facility was eBay Inc.’s largest infrastructure investment to date and was expected to become a flagship data center. . . . “We have built a fault tolerant Tier IV level data center that is 50 percent less expensive to operate than the average of all other data centers we lease today,” said Dean Nelson, eBay’s Senior Director of Global Data Center Strategy. “It is also 30 percent more efficient than the most efficient data center in our portfolio. At a designed PUE2 of 1.4, it lowers both our economical and ecological costs” (Nelson, 2010).³⁸

The following third-party sources provide contemporary evidence of eBay’s wholly U.S.-based exploitation of its CSA-covered IP in 2009:

• “Substantially all of our system hardware [in 2004] is hosted at Cable & Wireless and Qwest facilities in San Jose, California, an eBay-owned data center in Denver, Colorado, and a Sprint Communications facility in Sacramento, California.”³⁹

• “eBay: The online retailer built its first data center in 2010 (it had previously leased data center space, which is what many in the industry do) in South Jordan, Utah.”⁴⁰

• “Online auction site eBay has chosen a suburb of Salt Lake City as the site for a $334 million data center project. . . . The facility, which could be as large as 250,000 square feet, would continue a regional expansion that has seen eBay acquire a large data center in Phoenix and expand its facility in Denver. The company is believed to have six data centers, including facilities in San Jose, Sacramento and Austin, Texas. . . . eBay last expanded its network in 2006, when it bought the former Switch-X data center in Phoenix for $16.3 million.”⁴¹

Note that, as shown in Figure 1, at year-end 2008 (only five days before the January 5, 2009, transition date), approximately 87 percent of eBay’s long-term assets were located in the United States, and those assets included its data centers used to deliver services to U.S. and international users. However, in 2009 — only one year later — these ratios became even more lopsided toward the United States when eBay’s U.S. pretax income dropped by two-thirds to only 5 percent of its total pretax income, while foreign income exploded by 50 percent to fully 95 percent of total income, as shown below. The foreign share of long-term tangible assets increased to a whopping 22 percent from 13 percent, but in dollar terms that increase was only $170 million, whereas the much larger U.S. asset position increased by an additional $118 million.

eBay, of course, has various explanations for these profit results, but none of them bear on the fact that these profits caused the company’s cost-sharing actually experienced return ratio (AERR) to exceed the threshold for a periodic adjustment (as shown later). CSAs are voluntary, and eBay basically signed up for these constraints when it entered the elective cost-sharing treatment for its controlled technology IP. However, because eBay in 2008 and 2009 owned, hosted, and operated its revenue-generating platform from data centers, and with related personnel and exploitation operations located exclusively in the United States, it did not meet the requirements for grandfathering under the 2008 transition rules.

C. Entry Into Foreign Markets

eBay first entered foreign markets in 1999, shortly after setting up the Swiss affiliate that would hold foreign rights to its U.S.-based technology platform. The following excerpt from eBay’s fiscal 1999 Form 10-K describes the company’s foray into foreign markets, stating essentially that it went from zero to 200 countries in only 12 months:

The Company has introduced country-specific services for Canada, the United Kingdom, Australia, Germany and as of February 2000, Japan. The Company believes that its user base already includes users located in over 200 countries. . . . eBay’s presence in the United Kingdom has been built with local management, grass roots and online marketing and local events; the market in Germany was built primarily through the June 1999 acquisition of alando.de.ag, an existing German trading service; the Company entered into a joint venture with a subsidiary of one of the largest media companies in Australia and New Zealand to penetrate that market; and the Company announced in February 2000 that it had entered into a relationship with NEC to jointly address the market in Japan.

eBay then purchased other foreign websites, including iBazar in France in 2001, which had operations in Belgium, Brazil, France, Italy, the Netherlands, Portugal, Spain, and Sweden. In 2001 eBay also acquired a controlling stake in Internet Auction Co. in Korea. That was followed by the acquisition of NeoCom in Taiwan in 2002 and EachNet in China in 2003. eBay also bought out its Australia and New Zealand joint venture partner, Ecorp Ltd., in 2002 for $65.5 million, apparently just after the venture attained profitability.⁴² These were the primary acquisitions that would become the flagship eBay-branded auction sites in Europe, the Americas, and Asia, though eBay would continue to make other synergistic acquisitions after this, such as mobile.de in 2004 (a German classified advertising site for vehicles) and Baazee.com Inc. (and its subsidiary Baazee.com India Pvt. Ltd., India’s largest online marketplace at the time, with around 1 million users), also in 2004.⁴³

When eBay acquired Alando.de in 1999, a company that began as a clone of eBay’s U.S. website, it had been in operation for only three months and had around 15 employees,⁴⁴ and, based on eBay’s financial reporting, was loss-making. The Internet Auction Co. in Korea had only 140 employees when eBay acquired it in 2001, and it was loss-making as well.⁴⁵ At the time of its acquisition in 2001, iBazar had fewer than 100 employees and reported a loss of $65 million on revenue of $3 million.⁴⁶ EachNet had around 200 employees and was loss-making when it was acquired by eBay in 2003.⁴⁷ In each case, as discussed below, the foreign websites were moved to the United States, rebranded, reprogrammed, and hosted on eBay’s centralized U.S.-based technology platform. Whatever local platform had been in use at the time of acquisition was typically jettisoned.

D. Migration of Foreign Ops to United States

In a series of Harvard Business School case studies prepared between 2002 and 2008, researchers were allowed inside access to eBay’s foreign operations and senior executives, who described eBay’s internal operations and provided facts that are important to establishing any transfer pricing and ECI violations. Indeed, one of these studies described eBay’s operations in August 2008 — only five months before the January 5, 2009, deadline for complying with the transition rules of the 2008 cost-sharing regulations.

The first case study, dated October 2001, described the planning for the migration of the Alando site to the United States and its rebranding under the eBay marks:

The integration plan called for an immediate rebranding of Alando’s site, while allowing the company’s management to largely maintain operational autonomy in the short-term. In a few months, the [U.S. management] planned to introduce listing fees to the German site, a vital ingredient to profitability. Finally, eBay planned to migrate the site to the eBay “template” [footnote omitted] and host it on eBay’s servers in San Jose. Such a move would eventually allow trading between the U.S. and German sites — a key aspect of [eBay US] international strategy.

From a technology and product perspective, we [eBay US] wanted to have one global trading platform. If we were to develop a cool, new feature for eBay, then we wouldn’t want to have to develop it again for a different platform. With this in mind, it was clear that we needed to transfer eBay Germany over to the eBay platform. Similarly, we were focused on building a global brand.⁴⁸

Another case study confirmed the following:

Fourteen months earlier, the German online trading company Alando.de had been acquired by eBay. From the beginning of the relationship, the company knew they would eventually need to convert their site to eBay’s online trading platform. . . . On July 16, 2000, Germany’s user information and live auctions were migrated from their old website to a new one based on eBay’s platform and hosted by eBay’s servers in San Jose. . . . eBay Germany owned several servers in Hamburg that would no longer be in use once the site was migrated. The company would use those servers to host the promotional section of the homepage. This would allow Germany to maintain control over their promotions.⁴⁹

The last sentence in this excerpt is illuminating, since it highlights that the foreign infrastructure was totally separated from eBay’s U.S. infrastructure, which performed the key exploitation activities that generated all commercial revenue from the foreign locations. The text also confirms how eBay US migrated and took over the former exploitation activities represented by the physical operation of the German auction website and hosted it from the United States. This left eBay’s new German affiliate with no control over any exploitation activities, and with management and control over only its promotional activities related to the site (and any local-country administration, such as billing and collection). Those activities are definitely important, but the 2008 CSA regulations were clear that promotional activities were ineligible for any nonroutine profits attributable to the CSA-covered IP. Indeed, as shown later, it appears that eBay Germany and other local affiliates never received any nonroutine profits for any of their local affiliate functions, and instead appeared to be remunerated mostly by eBay Switzerland with a risk-limited, single-digit markup in its costs.

The facts as described earlier appear to be a technical violation of the former 1996 cost-sharing regulations. Specifically, Example 2 of reg. section 1.482-7A(g)(8) made clear that routine activities, such as selling and distribution (and presumably promotion), that were not activities related to the exploitation of the covered CSA-related IP, did not constitute activities that would qualify for any of the nonroutine profits from the CSA. Nor would those promotion activities be considered a qualified use of the technology IP within the meaning of former reg. section 1.482-7A(a) or as a use of the IP in operations (within the meaning of former reg. section 1.482-7A(c) and (a)(1)).

It is clear that eBay US took over and effectively replaced the brand, operating IP, assets, operations, and control of the acquired foreign websites, leaving behind control over only promotion and other routine business activities. eBay established that strategy in its first foreign acquisition, that of Alando — a strategy that eBay implemented over the objections of the local team:

Since September 1999, when the site [Alando.de] first began charging fees, its only source of revenue had been its final value fee — a small percentage of the final value of auctions ending in a sale. With this pricing structure, the company was willing to postpone profitability for an opportunity to earn increased market share. The founders informed Westly they did not believe it was yet time to introduce listing fees. However, eBay, which had been profitable from inception, considered listing fees to be a vital ingredient in “the secret sauce” that made eBay so successful. . . . Starting February 5, 2000 eBay Germany users were charged a fee to list items on the site. . . . In protest, users mail-bombed our mailboxes, and created sites on the Internet protesting the fees. . . . As listings dipped lower and lower, morale amongst the company’s sixty employees plummeted. . . . Finally, at the end of two weeks, the site bottomed out at approximately 250,000 listings, down one million listings from where they had been two weeks earlier.⁵⁰

The number of listings eventually recovered, and eBay Germany became successful, but eBay’s takeover of the site and introduction of user fees was a U.S. strategy the German staff strongly disagreed with. This situation clearly illustrates how the German website was firmly under U.S. management and control. U.S. control over the German operations was not a temporary phenomenon; it continued long after the initial migration, as was made clear in another case study by Harvard researchers:

The 2000 migration of the eBay Germany site to the eBay online trading platform hosted by eBay’s servers in San Jose had been an important milestone for all concerned. . . . If we had a great idea in Germany and wanted to bring it to life, we had to go through the central development pipeline 5,000 miles away [that is, eBay US]. . . . By 2004, the [U.S.] eBay system was far more sophisticated than anything we could have developed locally with the Germany team.⁵¹

eBay used the Alando strategy as the basis for virtually all its foreign expansion plans. The migration to — and then hosting and operation of — the acquired foreign auction websites on the eBay platform in the United States became a core competency and a primary growth strategy for eBay US. That is made clear by the following comments from yet another Harvard case study, this one discussing eBay’s acquisition of the Paris-based website iBazar SA⁵² in 2001:

Bannick explained that eBay [that is, the parent company in the United States] was paying close attention to the lessons learned from eBay Germany in managing the migration of the eight trading sites acquired with the purchase of iBazar. A full-time project manager was assigned to orchestrate the migration, supported by a fifty-member cross functional team, which met weekly. . . . The user interfaces on the international sites were changed before they actually migrated the site to San Jose. . . . With these changes, eBay now saw efficient, successful migrations as a core competency of eBay.⁵³ [Emphasis added.]

eBay’s migration of acquired foreign auction websites to its U.S.-based platform was not restricted to acquisitions in Europe and was not always successful. Its Chinese venture failed after the company acquired and then migrated China-based auction site EachNet to the United States, as it had done for its European acquisitions. English-language Chinese newspaper The Global Times published the following in 2009 based on comments by Bo Shao, the Harvard-educated founder of EachNet, who became a vice president at eBay after the acquisition but left within a year:

Many believe Taobao beat global online auction king eBay in China by being free, but not EachNet founder Bo Shao who sold the company to eBay in July 2003. A key catalyst was “migration,” the decision to terminate EachNet’s homegrown technology platform and move all EachNet users to the eBay US platform, said Shao. On the day of the migration, traffic to eBay China dropped by half. . . . “In order for the eBay US platform to catch up to EachNet’s China-specific features, development on the site was frozen for a year before the platform was moved,” said Shao. For an entire year beginning in October 2003, EachNet could not develop any new features or make significant changes to existing features. After the move, the local team lost most of its control on the site [to eBay US]. “It took nine months to implement any major changes and nine weeks to even change a word on the website as everything had to go through the headquarters technology development team,” said Shao. . . . “This is unthinkable,” said Shao. “Fast reaction to user demands is crucial in this market.”⁵⁴

The general manager from Germany appointed by eBay to lead the Chinese company was Stefan Gross-Selbeck. That appointment, made by the U.S. chief executive of eBay, Meg Whitman, was primarily to oversee and facilitate the migration of the Chinese website to the United States:

In August [2003] Meg Whitman asked Gross-Selbeck to serve as the Chief Operating Officer in China. He commented: “There wasn’t really a clear job description for when I arrived in China. Initially, my role was to manage EachNet’s integration into eBay, as well as the migration of the platform. . . . “It had been clear from the start that this was going to be a one-year assignment. The expectation was that the . . . migration would be done by then.”⁵⁵

This information on eBay’s strategy to migrate foreign websites to its U.S.-based infrastructure and host them from the United States helps explain why the company has only operated with U.S.-based data centers, operational personnel, and infrastructure. All of eBay’s exploitation functions (that is, delivery of its auction services through its U.S.-hosted and -operated technology platform) occurred in the United States both before and after January 2009, and that is the case even to this day — it was always eBay’s operating model.

E. Automated Internet Services

In 2008 eBay described the internet-based services provided on its U.S.-developed and -operated technology platform. These services represented all its revenues in three segments: marketplaces, payment, and communications. Communications, which was loss-making and represented only 3 percent of revenue, is not discussed in this report. The other two platforms each provided automated, software-driven, on-demand services worldwide. The following is an excerpt from eBay’s fiscal 2008 Form 10-K:

Our Marketplaces platforms seek to bring buyers and sellers together through fully automated . . . online websites that are generally available throughout the world at any time. The platforms include software tools and services, some available at no charge and others for a fee, that allow buyers and sellers to trade with one another more easily and efficiently. The Marketplaces platforms consist of our core online commerce platform, eBay.com and its localized counterparts, and adjacent platforms consisting of our classifieds websites, as well as StubHub, Shopping.com, Half.com, and Rent.com. . . . Our Marketplaces core platform, eBay.com, . . . has a global presence in 39 markets.

Our payments segment is comprised of online payment solutions — PayPal (which enables individuals and businesses to securely, easily and quickly send and receive payments online in approximately 190 markets worldwide) and Bill Me Later . . . enables online U.S. merchants to offer, and U.S. consumers to obtain, transactional credit at the point of sale. Our Payments network builds upon the existing financial infrastructure to create a global, real-time payment solution. . . .

PayPal earns revenues in several ways: . . . transaction fees when a Business or Premier account receives a payment; . . . a foreign exchange fee when an account holder converts a balance from one currency to another; . . . fees from merchants who utilize PayPal’s Pro direct payment card processing services or Payflow gateway processing services; . . . fees when a user receives payments from outside the user’s country of residence; . . . fees when a user withdraws money to certain bank accounts, depending on the amount of the withdrawal; . . . a return on certain customer balances; and [a]ncillary revenues are earned from a suite of financial products.

The fiscal 2008 Form 10-K said the following about the importance of the U.S.-based technology and infrastructure to eBay’s profitability:

Our technology infrastructure simplifies the storage and processing of large amounts of data, eases the deployment and operation of large-scale global products and services and automates much of the administration of large-scale clusters of computers. Our infrastructure has been designed around industry standard architectures to reduce downtime in the event of outages or catastrophic occurrences. We are continually improving our technology to enhance the customer experience and to increase efficiency, scalability and security.

These disclosures make clear that eBay’s revenue is generated almost exclusively from the company’s U.S.-based and -operated automated technology platform, and not from locally based personnel conducting mostly or wholly routine functions within a handful of the markets in which customers and users access eBay services. eBay operates much like Google, though the two companies provide different internet and cloud-based services. Importantly, for both, most personnel activities — with the exception of R&D (including software engineering) and the personnel who manage and operate the automated technology platforms day to day — are routine activities such as marketing, promotion, administration, customer support, and the like. The principal commercial business risks and the potential for both groups’ high level of nonroutine profits occur solely from activities that are managed, controlled, and conducted within the United States.

F. eBay’s Terms of Use for U.S.-Provided Services

The various agreements that eBay Inc. and eBay Switzerland and other affiliates have with the group’s customers and other users suggest that eBay US and eBay Switzerland report their territory revenue based on customer addresses. For example, the various eBay agreements with customers and advertisers are set out by the location of the customer or advertiser and indicate which eBay group member the customer is contracting with. Those contracts indicate generally that for countries within the Americas, the contracting eBay group member is eBay Inc. And it appears that in 2008 and 2009, all customers outside the Americas (including those in Germany and the United Kingdom, two of the group’s largest markets) contracted with eBay Switzerland. An excerpt from eBay’s terms of use in 2009 stated the following:

Welcome to ebayinc.com (the “Site”), owned and operated by eBay Inc. By accessing ebayinc.com you agree to the following Terms of Use. These Terms of Use are effective as of October 9, 2009. . . . By using ebayinc.com, you agree to the collection, transfer, storage and use of your personal information by eBay Inc. on servers located in the United States, as further described in our privacy policy.

General. . . . These terms and the other policies posted on ebayinc.com constitute the entire agreement between ebayinc.com and you, superseding any conflicting parts of any prior agreements. This agreement is governed by the laws of the State of California as they apply to agreements entered into and to be performed entirely within California between California residents, without regard to conflict of law provisions. You agree that any claim or dispute you may have against eBay must be resolved by a court located in Santa Clara County, California.

eBay’s agreement for non-U.S. users required payment to eBay’s Swiss affiliate and other foreign affiliates for services provided by eBay US. It also required that any complaints about services be sent to eBay US in San Jose, California. The following is an excerpt from eBay’s user agreement for its Hong Kong website in 2010. There are similar provisions in the user agreements on other eBay websites, such as the U.K. and Australian websites:

The following describes the terms on which eBay offers you access to our services. . . . Welcome to eBay. By using eBay . . . you agree to the following terms, including those available by hyperlink, with eBay International AG, and the general principles for the websites of our subsidiaries and international affiliates. . . . You shall make payment of these invoices in the name of eBay International AG, a company incorporated under Swiss laws and having its principal place of business at Helvetiastrasse 15/17, CH-3005 Bern, Switzerland. . . . Notices — Except as explicitly stated otherwise, any legal notices shall served on eBay International AG via registered mail, c/o eBay Inc, at the address: Legal Department, 2145 Hamilton Ave., San Jose, CA 95125 (Ref: eBay.com.hk). . . . General — If you reside within the European Union, your contract is with eBay Europe S.à r.l., located at 22-24 Boulevard Royal, L-2449 Luxembourg. The contracting entity for India domicile user is eBay India Private Limited, a company incorporated under Companies Act, 1956 (as applicable in India) and having its registered office at 101-B, Akruti Corporate Park, LBS Marg, Kanjurmarg (West), Mumbai 400079, Maharashtra (India). If you reside in the United States, your contract is with eBay Inc., 2145 Hamilton Ave., San Jose, CA 95125. In all other countries, services are offered by eBay International AG. eBay International AG is located at Helvetiastrasse 15/17, 3005, Bern, Switzerland.

By 2013 eBay’s user agreement stated the following, describing how payment continued to be made to eBay’s CSA participant and other foreign collectors for services provided by eBay US:

This User Agreement, the eBay Privacy Policy, and all policies posted on our sites set out the terms on which eBay offers you access to and use of our sites, services, applications and tools (collectively “Services”). . . . All policies and the eBay Privacy Policy here are incorporated into this User Agreement. You agree to comply with all the above when accessing and using our Services. The entity you are contracting with is eBay Inc., 2145 Hamilton Ave., San Jose, CA 95125 if you reside in the United States. It is eBay Europe S.à r.l., 22-24 Boulevard Royal, L-2449 Luxembourg if you reside in the European Union; eBay India Private Limited, 14th Floor, North Block, R-Tech Park, Western Express Highway, Goregaon (East), Mumbai 400063, Maharashtra if you reside in India; and eBay International AG, Helvetiastrasse 15/17, 3005, Bern, Switzerland if you reside in any other country.

eBay’s user agreement directed payment for eBay’s U.S. services to eBay International AG and controlled affiliates in Luxembourg and India, while its U.S. parent provided the marketplace services from the United States, where eBay’s foreign websites were operated and hosted. The user agreement also informs users that any legal notices should be sent to eBay US, further substantiating that eBay US manages and bears the risks of operating eBay’s platform for users worldwide.

G. Triple-Digit Swiss Margins

eBay has reported since 2008 that it benefited from tax rulings providing for low effective tax rates in its Swiss and Singaporean principal companies. Switzerland has a generous domicile company regime, under which some IP holding companies are exempt from taxation on up to 90 percent of their foreign-source and IP-based income, with expanded deductions for R&D expenses. This results in a tax rate of 10 percent or lower — often an effective tax rate of zero on applicable income of IP holding companies such as eBay Switzerland. eBay’s Swiss financial reports are not publicly disclosed, so I cannot determine its precise Swiss rate. What is clear is that eBay’s post-2009 foreign tax rates varied between 2 and 7 percent when its two largest foreign markets were Germany and the United Kingdom, both of which were high-tax countries in 2009 (29.4 percent and 28 percent statutory rates, respectively).⁵⁶ It seems likely that the effective Swiss and Singaporean tax rates were close to 0 percent.

Because knowledge about eBay’s exact internal legal and tax structure is limited, tables 2 and 3 were created using several hypotheses: (1) eBay Singapore is a branch of eBay Switzerland or otherwise pays its income to eBay Switzerland; (2) eBay’s CSA included all its operations, including its PayPal segment (which generated around 40 percent of eBay’s revenue and substantial Singapore income before its announced spinoff in 2014); (3) eBay’s tax rate in Switzerland and Singapore was effectively 0 percent; (4) eBay’s U.S. CSA territory reasonably anticipated benefit (RAB) share is 10 percent greater than the U.S. revenue share, to account for revenue from Canada and other non-U.S. Americas territories; (5) the costs of eBay’s Swiss and Singaporean affiliates consisted primarily of cost-sharing payments. Those assumptions, which may not be correct, are reflected in the hypothesized figures below, which show results for the seven years before and after January 2009. These tables support several important observations:

• A large percentage of foreign pretax income (possibly approaching 80 percent or more in some years) may have been reported in Switzerland and Singapore, leaving only small profits in eBay’s other foreign affiliates, where its active front-office business operations are located. Those single-digit profits reflect routine returns for support functions, thus making it difficult for eBay to claim that its foreign affiliates performed the individual exploitation activities necessary to qualify eBay’s preexisting CSA for grandfathering under the transition rules of the 2008 cost-sharing regulations.

• An inordinately high return appears to have been booked into the Swiss shell/holding company, a triple-digit return on total costs over the 14 years measured here. (This rate would decline if the Swiss and Singaporean tax rates were greater than zero; however, without knowledge of the Swiss and Singaporean pretax income and actual tax rates, this analysis can only show an imprecise estimate.)

• eBay’s U.S. returns declined precipitously in the first year after January 5, 2009, while its Swiss returns in this analysis more than doubled, indicating that eBay’s tax planning and U.S. profit shifting appeared to increase dramatically after the 2008 CSA regulations took effect.

Table 2. Illustrative eBay Intercompany CSA-Related Profit Segmentation 2002-2008 if Swiss and Singaporean Tax Rates Were 0%

Inputs and Assumptions ($ millions)	2002	2003	2004	2005	2006	2007	2008
eBay U.S. revenue	$898	$1,407	$1,890	$2,471	$3,109	$3,743	$3,969
eBay foreign revenue	$316	$759	$1,381	$2,081	$42,861	$3,930	$4,572
eBay U.S. pretax income	$266	$449	$821	$944	$777	$718	$328
eBay foreign pretax income	$132	$212	$307	$606	$771	$33	$1,856
Total development costs	$105	$159	$241	$328	$495	$620	$726
Foreign current tax provision	$10	$10	$28	$80	$67	$86	$102
Foreign current tax rate	8%	5%	9%	13%	9%	258%	5%
eBay Swiss RAB share (est. non-Americas)	19%	29%	36%	40%	93%	46%	49%
Assumed average foreign tax rate (ex-Switzerland)	25%	25%	25%	25%	25%	25%	25%
Assumed Swiss tax rate	0%	0%	0%	0%	0%	0%	0%
Outputs (Pretax)
eBay U.S. return on total costs	42%	47%	77%	62%	33%	24%	9%
Est. eBay Switzerland return on total costs (CSA pmts)	470%	376%	223%	217%	110%	0%	409%
Rest-of-world return on total costs	15%	6%	9%	18%	1%	1%	10%
Est. Swiss % foreign profit	70%	80%	64%	47%	65%	0%	78%

Table 3. Illustrative eBay Intercompany CSA-Related Profit Segmentation 2009-2015 if Swiss and Singaporean Tax Rates Were 0%

Inputs and Assumptions ($ millions)	2009	2010	2011	2012	2013	2014	2015
eBay U.S. revenue	$3,985	$4,214	$5,484	$6,778	$7,712	$8,495	$3,624
eBay foreign revenue	$4,742	$4,942	$6,168	$7,294	$8,335	$9,407	$4,968
eBay U.S. pretax income	$149	$848	$1,746	$605	$594	$173	$396
eBay foreign pretax income	$2,730	$1,250	$2,164	$2,479	$2,872	$3,358	$2,010
Total development costs	$803	$908	$1,235	$1,573	$1,768	$2,000	$923
Foreign current tax provision	$65	$92	$65	$120	$190	$165	$106
Foreign current tax rate	2%	7%	3%	5%	7%	5%	5%
eBay Swiss RAB share (est. non-Americas)	50%	49%	48%	47%	47%	48%	54%
Assumed average foreign tax rate (ex-Switzerland)	25%	25%	25%	25%	25%	25%	25%
Assumed Swiss tax rate	0%	0%	0%	0%	0%	0%	0%
Outputs (Pretax)								Average
eBay U.S. return on total costs	4%	25%	47%	10%	8%	2%	12%	15%
Est. eBay Switzerland return on total costs (CSA pmts)	618%	197%	320%	270%	253%	282%	321%	323%
Est. rest-of-world return on total costs	6%	8%	4%	7%	10%	8%	9%	7%
Est. Swiss % foreign profit	90%	71%	88%	81%	74%	80%	79%	80%

H. Foreign Routine Functions, Profits

Sometime around 2000-2001 eBay made comments to researchers at Harvard University that indicated that its foreign employees would perform what might be interpreted as nonroutine activities after the website had been migrated to eBay US:

In October 1999, the company launched eBay U.K. and eBay Australia, a joint venture, and in February 2000, it launched eBay Japan, also a joint venture. . . . The local team in each country was not simply a marketing arm of the U.S. operation, as was often the case in other internet companies. Rather, they had profit and loss responsibility, and were expected to drive for the bottom-line through business development, marketing, community support, and product management. However, responsibility for operating and maintaining the sites resided in San Jose.⁵⁷ [Emphasis added.]

These comments are a misnomer, made by an operational leader who may not have been aware of eBay’s tax positions (which is what matters in this analysis). Based on the facts of eBay’s dealings with its other affiliates and the guaranteed limited-risk cost plus markup arrangements, the local promotion, and administrative activities (delineated in intercompany contracts), the local affiliates’ profits were guaranteed and pertained only to their local promotional activities — not the operation of the website itself. In reality these foreign affiliates in Germany, Australia, the United Kingdom, and elsewhere appeared to earn only single-digit returns for their activities and operated under restrictive services agreements (see below). Customer payments for using the eBay platform, which was and is hosted in the United States, were paid to eBay Switzerland in most cases (or other principal entities such as eBay Luxembourg or PayPal Singapore), and only small profits were left in those local higher-tax rate countries. eBay’s claims don’t pass the proverbial duck test: If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. eBay’s comments to the Harvard researchers don’t stand up to its tax arrangements. Facts matter. Indeed, a different university researcher, also investigating eBay’s Australian operations, said the following about the same operations described above — but based on the Australian tax structure (versus operational comments from personnel in the United States):

eBay is still blithely pretending it doesn’t have an Australian business and that the billion dollars a year it makes from operating its online auction house in this country . . . is really the business of an entity residing at 15 Helvetiastrasse, Bern, Switzerland. According to its accounts, the latest for the year to December 2016, eBay Australia is still masquerading as being in the business of “the recommendation of market penetration strategies” on behalf of eBay International AG. . . . So eBay is the quintessence of the undisclosed agency, a puppet regime designed to whisk Australian profits offshore to a tax haven.⁵⁸

Further, eBay recently sued an employee in Australia, in a case in which some confidential financial documents were disclosed. The same researcher (an adjunct associate professor at the University of Sydney School of Social and Political Sciences) stated the following after reviewing those documents:

eBay on the other hand, claims its businesses in Australia — both the online auction business and its advertising business — are not Australian businesses at all. Their revenues with Australian customers are therefore booked directly to an entity in Zurich, Switzerland, eBay International AG. . . . Whereas Google claims the billions in revenues it makes in Australia in its advertising operations actually constitute a Singaporean business, eBay also denies it has a transactions or advertising business here. The financial statements for eBay Australia and New Zealand for the last 14 years reveal a company that has paid total income tax of $6.2 million at an average $446,000 per year. This equates to 2 per cent of the $317.8 million in revenues. . . . eBay now generates close to $1 billion of revenues in Australia in just a year . . . Like Google, eBay [Australia] recognises revenue for providing support to eBay related entities overseas but not from its Australian customers. The fraction of revenues it actually recognises in Australia is then soaked up by salary and other costs so a bare smidgeon is left over in profits to be taxed. . . . This ploy of providing “services” to a related offshore entity is also used by eBay’s former associate, PayPal. Over the nine years to 2014, the electronic payments firm has paid more than $1 billion of its $1.2 billion in revenues to its parent and associates in Singapore leaving very little to be taxed in this country. PayPal claims that these payments, the bulk of which are made to PayPal Private Limited, its immediate parent company, are for “services provided in accordance with Service Provider Agreements for the processing of, and supporting the online payments business.”⁵⁹

This financial information strongly implies that local-country foreign affiliates are effectively risk-limited providers of routine services to eBay’s holding or shell companies in tax havens, and that they earn only a sliver of profits by design. However, we do not have to infer this; it is demonstrated by an eBay intercompany services contract that was made public in litigation before the Mumbai Income Tax Appellate Tribunal.⁶⁰ eBay International AG had appealed a tax assessment for the 2006-2007 tax year in which the Swiss company was deemed to have a permanent establishment in India. The court ruled against the Indian tax authority. However, in the course of this proceeding, eBay’s intercompany services agreements between eBay Switzerland and eBay India were disclosed. The following excerpts were taken from the trial transcript:

Further referring to clause 4.2 of the agreement, . . . the Service Provider [eBay India] shall be compensated by the assessee [eBay Switzerland] for the performance of the services set forth in clause 3.1 of this agreement by an amount equal to 108 percent of actual cost of operations.

On the successful completion of the sale, the assessee raises periodic invoice on the seller for the “user fee.” The sellers are required to make payment of the user fee to eBay India/eBay Motors for the transactions undertaken on the websites of the assessee. After making collection from the sellers, eBay India/eBay Motors remit the user fee, so collected, to the assessee. . . . The assessee, in turn, reimburses the costs incurred by them with 8 percent mark-up.⁶¹

Having established that eBay India was a limited-risk, non-entrepreneurial, services provider to eBay Switzerland, the court in India went on to disclose the particulars of the services contract between the related affiliates. The following terms were in the contract, illustrating that it was eBay International AG (itself controlled by eBay US executives, according to research in this report) that managed and controlled the activities of eBay India:

Service Provider shall at all times during the Term of this agreement: (a) Suggest to eBay International, all pertinent legal requirements relating to the business for the Service Provider Territory. (b) Provide market data relating to industry (c) Provide marketing and promotional services within the Service Provider territory as directed by eBay International. (d) Perform payment processing and collection activities related to eBay International’s business in the Service Provider Territory, including look box service. (e) On directions from eBay International, prepare and discuss budgets or other similar matters relation to the Service Provider Territory and provide market data, as may from time to time be requested by eBay International. (f) Perform local customer support activities as specified by eBay International from time to time. (g) Furnish such reports and information relating to its activities as may be requested from time to time by eBay International during the Term of this Agreement; and (h) Such other administrative and support activities as eBay International shall request.

It was also found that the entire income of eBay India and eBay Motors was derived from such services rendered to the assessee, eBay AG.

The litigation in India and Australia appears to show that eBay, much like Google, set up its international tax structure to treat its local-country affiliates as routine, limited-risk service providers, contracted by eBay Switzerland or eBay Singapore, which booked most of the revenue and profits generated by the exploitation of eBay’s IP through its online platform hosted and managed in the United States. Those arrangements also masked the ultimate management and control eBay US exercised over these limited foreign activities, including management and control of the holding and shell company principals in these arrangements. This runs afoul of the 2008 CSA transition rules, which required that eBay’s foreign CSA participants (or presumably entities under their management and control) individually exploit the cost-shared intangibles by performing, managing, or controlling the CSA-related exploitation activities that generated their territorial profits. It is clear from the facts that this was not the case. Judging by the overall foreign profits and current tax rates shown earlier, it would appear that eBay’s Australian and Indian businesses were not outliers, and that the same approach would undoubtedly have applied to affiliates in other jurisdictions, such as Germany and the United Kingdom.

I. eBay U.S.-Controlled Swiss Affiliate

eBay’s foreign operations were being started and expanded by U.S. executives directly from the United States since before the 1999 creation of eBay International AG. Indeed, the activities of this and other foreign eBay affiliates in different countries were all performed by suborganizations within eBay’s U.S.-based international division, which had ultimate responsibility for all non-U.S. operations. During the relevant period up to and after the January 5, 2009, effective date for grandfathering under reg. section 1.481-7T(m)(1), eBay made no apparent changes to how the group exploited the cost-shared intangibles. Recall that the regulation required that a foreign group member conduct, manage, and/or control individual exploitation (that is, the use of the IP in revenue-generating operations) to qualify as a CSA participant.

As explained earlier, the cost-shared intangibles are actually exploited solely within the United States through the development, enhancement, and day-to-day operation of the internet-based platforms through which services are provided to customers and other users worldwide. Personnel outside the United States conduct only limited-risk, routine functions, which eBay implicitly admitted through its apparent use of cost-plus pricing mechanisms for reporting income in countries where it maintains those personnel.

Bill Cobb’s job duties were consistent with this description. Cobb was a senior vice president and general manager in the United States responsible for eBay’s international operations between June 2002 and December 2004. From the United States he directed eBay’s foreign business support functions conducted by group personnel in a limited number of foreign countries, making day-to-day decisions on all important business matters. According to his LinkedIn page (November 2021), Cobb built the management team in Europe; “professionalized” eBay’s foreign management and financial reporting systems; and led eBay’s international acquisitions in China, Germany, India, and Korea. He was replaced by Andre Haddad, another U.S. executive, who was replaced by Wendy Jones, another U.S. executive. During this time, there were no foreign-based executives who had seniority over the U.S. executives in charge of international operations. This fact is relevant for the 2008 CSA transition rule.

As the information about the group’s operations makes clear, eBay’s foreign operations represent only limited-risk support functions for the U.S.-located exploitation of the group’s cost-shared intangibles. Further, those foreign operations were developed, managed, and controlled by U.S. executives, who determined foreign acquisitions, hired and trained foreign personnel, and managed the migration of acquired foreign businesses and websites to the U.S.-based eBay platform.

eBay has thousands of personnel in foreign locations who play important roles. The point here is that under U.S. transfer pricing regulations, those important — but non-exploitation — functions do not qualify eBay for the 2008 CSA transition grandfathering that would make it exempt from the periodic adjustment rules of reg. section 1.482-7(i)(6).

J. U.S.-Hosted Foreign Websites

The information in Figure 3 was retrieved from Host.io, a domain data provider. Host.io provides multiple application programming interfaces that help users access the details on any web domain. These screenshots (with highlighting by the author) show how eBay’s foreign websites are hosted in the United States, and they link eBay webpages such as those on Facebook, Instagram, and Twitter. eBay’s French, German, and U.K. site information is shown, and Host.io shows that all of eBay’s foreign websites are hosted in the United States.

Also, because eBay’s platform resides in the United States, and buyer and seller information is processed in the United States and other locations, eBay must abide by data privacy laws in each country. In section 5 of its user privacy notice, eBay informs users that it “may share your personal data among eBay group companies in order to fulfil our contract with you under the User Agreement and, if applicable, the Payments Terms of Use.” eBay provides the following to users regarding inquiries for the user privacy notice:

We have appointed data protection officers in several countries to oversee the protection of your personal data. If you have any questions about this User Privacy Notice or about data protection at eBay in general, you can contact the data protection officer responsible for your country at any time. You will find the contact details of your data protection officer in the list of our data protection officers in our eBay Privacy Center.

The list of data protection officer contacts to which this site refers is found on another eBay website, a screenshot of which is shown in Figure 4. The list for each country provides only one contact — at a U.S.-based email address. In other words, all data privacy inquiries are transmitted to eBay US, which appears to manage and control the controller operations in each country.

K. Swiss Activities Are Non-Exploitation

eBay International AG was created in 1999 as a shell company. By 2004 it had only approximately 50 personnel, and possibly around 200 by 2009, according to LinkedIn information and sources mentioned earlier. The company appears to have had fairly high turnover rates. According to public information found on LinkedIn as well as in Harvard Business School case studies and other sources noted herein, eBay’s Swiss cost-sharing partner largely carried out routine coordination, customer support, billing, and back-office activities, and for most of the period leading up to the January 2009 transition date it was led directly by U.S. executives. According to LinkedIn information, eBay International AG made extensive use of contractors, trainees, interns, freelancers, and short-term employees rotating in and out. This is important because eBay’s use of a CSA to shift multiples of its U.S. profits — and in some years almost all its U.S. profits — offshore into tax havens depended on the Swiss entity meeting the requirements of the CSA regulations’ transition rules on January 5, 2009. Those high turnover rates and high proportions of low-level and contract employees appear inconsistent with the level of operational management capability, and the ability to manage and control the risks associated with its profit generation, required under reg. section 1.482-1.⁶² Further, if that entity (and any check-the-box subsidiaries) did not meet the requirements of the 2008 CSA transition rules — for example, if it lacked the ability to manage and control the exploitation of the CSA-controlled IP related to its territory profits — eBay’s CSA would have ceased to exist on January 5, 2009.

According to all available evidence, it appears that no meaningful exploitation activities, or indeed any nonroutine activities as defined by the 2008 cost-sharing regulations, are found offshore, and that the substantial nonroutine profits booked offshore (which were multiples of the U.S. profits) were booked mostly into foreign tax haven affiliates. In 2009 eBay’s CSA apparently lacked substance and was noncompliant with U.S. CSA laws and possibly other regulations and statutes (such as the economic substance doctrine, the sham transaction doctrine, and ECI regulations). It seemed to resemble a sham-type arrangement, or at a minimum one exhibiting less economic substance (for example, the existence of independent exploitation) than was required by the 2008 regulations. As noted earlier, these regulations were in fact designed to eliminate such dubious structures.

L. eBay’s CSA Compliance

The sections above appear to support the following conclusions:

• eBay grew its foreign operations initially through foreign customers and other users throughout the world accessing the U.S. auction platform. Later, eBay acquired existing auction websites along with the personnel operating and supporting those websites, as well as their existing foreign users. After those acquisitions, all foreign exploitation operations were eliminated and migrated to the U.S. auction platform. These acquisition targets were mostly unprofitable, and in most cases were made profitable by the continued investments of eBay US and the use of the U.S.-based auction platform.

• Migrating foreign websites to the United States became a core competency of eBay US that was important to its success and profitability.

• eBay US closely managed all foreign operations, including those of its foreign CSA participants. eBay US hosted and operated the websites directed at foreign customers and users; hired foreign staff for non-exploitation, routine activities related to customer support, marketing, and local functions; and worked directly with eBay’s foreign country affiliates, bypassing eBay International AG (and/or PayPal Private Ltd).

• eBay US controlled all senior foreign leadership positions and business activities. And above a particular level, all senior leadership positions of international operations were located in the United States. The group also moved some foreign personnel to the United States to run foreign multicountry operations from the United States as U.S. executives.

• Foreign business units had no operational control over any exploitation activities in their countries and had to submit any requests for changes to eBay US for approval and implementation by eBay US personnel.

• Foreign local-country operations outside Switzerland and Singapore were routine contract services entities that performed routine back-office, customer support, promotion, billing, and other administrative functions. For those services, they earned low routine profits, which should not be treated as individual exploitation activities for purposes of the reg. section 1.482-7T(m)(1) transition rules.

• eBay never operationally transitioned its U.S.-based internet-based platforms, nor the operation or control of those platforms (which represent the group’s worldwide exploitation of cost-shared intangibles) to any foreign affiliates, especially its controlled foreign CSA participant, eBay International AG, before January 5, 2009.

• No foreign affiliate had sufficient personnel or infrastructure to conduct any of the exploitation functions performed by eBay US in its U.S.-based data centers and related infrastructure by or after January 5, 2009.⁶³

It seems clear that eBay has always maintained, operated, and hosted its commercial revenue-generating internet platform from the United States, under U.S. management and control, as part of its centralized one-worldwide-platform strategy. No foreign affiliate has ever possessed or exploited eBay’s CSA-controlled IP offshore, nor has any foreign affiliate managed and controlled the U.S. operations that conduct those activities. On January 5, 2009, foreign affiliates performed only non-exploitation-type routine activities, as defined by the former cost-sharing regulations.

As a result, eBay conducted its global/international operations from the United States, and eBay US used and exploited its CSA-related IP exclusively from the United States for the benefit of eBay Switzerland and related foreign affiliates. Those exploitation activities, or management and control over those activities, were required to be present within eBay International AG or related CSA participants and check-the-box affiliates by January 5, 2009, but they never were. It seems apparent that eBay did not qualify under reg. section 1.482-7T(m)(1) to be grandfathered and therefore could not be exempt from a periodic adjustment under reg. section 1.482-7(i)(6). Indeed, eBay technically did not have a CSA after January 5, 2009.

A periodic adjustment is the regulatory treatment for eBay’s “new” CSA, which began January 5, 2009, and was subsequently respected by the IRS. That new CSA is subject to all the provisions of the 2008 CSA regulations, with no exceptions or exemptions from a periodic adjustment.

IV. Periodic Trigger Calculation

The preceding analysis concludes that eBay did not comply with the 2008 cost-sharing transition rules because it failed to comply with the former regulations’ participation requirements, which stated that the performance of, or management and control over, the key exploitation activities that generate the foreign CSA-related income must be present within any foreign CSA participant. Given that eBay was noncompliant on January 5, 2009, the analysis concludes that eBay had a new CSA on that date, subject to the full provisions of the 2008 CSA regulations, including the periodic adjustment provision. Therefore, eBay’s profit results since 2009 would be subject to a periodic trigger analysis.

One of the most important inputs to the periodic trigger calculation involves the PCT value of acquisitions, which for this analysis would be those occurring after January 5, 2009.⁶⁴ These acquisitions can include intangible assets or personnel and facilities that will contribute to the cost-shared intangibles. This is a difficult exercise using only public information because not all e-Bay acquisitions have been publicly announced. It is unknown whether or to what extent any of the acquisitions include intangibles that would be within the scope of the eBay CSA and thus would represent PCTs to cost-shared intangibles. Moreover, although some book accounting figures may be published for particular acquisitions, those figures may not comport with tax accounting or CSA PCT contribution values, the latter involving complex rules that can produce PCT values in the amount of the entire acquisition price, even when the book accounting figure may attribute only part of the acquisition price to technology intangibles.

Generally, an acquisition or portions thereof would give rise to a PCT only if the acquisition involved capabilities, resources, or rights that were “reasonably anticipated to contribute to developing cost shared intangibles.”⁶⁵ The value of the platform contribution would be estimated according to methods in reg. section 1.482-7(g)(1)(i) through (vi) (which include unspecified methods). However, under appropriate circumstances, the foreign share of the entire adjusted acquisition value would be the PCT value under reg. section 1.482-7(g)(5)(iii). Under this method, the adjusted acquisition value would be the full acquisition price plus any assumed liabilities and minus the value of any tangible assets. Although this acquisition price method is normally rare, it may be useful for many eBay acquisitions because of the understanding that eBay often acquires small independent enterprises for their intangible properties and knowledgeable employees.

The approach taken here is to account for all publicly known acquisitions since January 5, 2009, at their reported or estimated full acquisition prices (because the amounts of liabilities, tangible assets, or portions of acquisition value constituting a PCT value are unknown). When an acquisition is disclosed but not its value, the value to be substituted in this computation is the average of all the disclosed acquisition values for acquisitions from January 5, 2009. The average was determined after removing the two highest-value acquisitions from the calculation to reduce bias.

This approach may conservatively overvalue the PCTs to some extent because (1) it is almost certain that not all acquisitions will include intangibles that will contribute to CSA cost-shared intangibles to such an extent that the full acquisition price method would prevail as the best method; and (2) most, if not all, of the publicly announced acquisitions are expected to be among the largest ones, so that use of the average of these larger acquisition values is expected to capture or exceed the value of any omitted acquisition values.

The calculations herein assume that all acquisitions were made by eBay Inc. and contributed to the CSA cost pool as PCTs, requiring payment by eBay Switzerland. This method for estimating eBay Switzerland’s PCT payments is conservative. This is because the periodic adjustment calculations treat PCT payments as investments on which eBay Switzerland would be entitled to earn an appropriate return. By assuming that eBay Switzerland actually made required PCT payments and by using an estimation method that likely overvalues the amount of the PCT payments, the total investment amount is increased. If PCT payments were not made or were smaller in amount, the size of the periodic adjustments calculated here would be larger.

This last point is important when one looks at the how these acquisitions are actually accounted for. For instance, according to eBay’s SEC filings, of the total cash consideration paid for the acquisition of GSI Commerce on June 17, 2011, for $2.377 billion, $1.484 billion was attributed to goodwill and $819 million was attributed to intangible assets. It may well be the case that eBay contributed only $819 million to the CSA as a PCT, but because eBay’s internal PCT tax accounting is unknown, the PCT is conservatively valued at the full acquisition price of $2.377 billion. This book accounting information is not available for most of the known acquisitions. The PCT value for undisclosed acquisitions is therefore based on the average of all the disclosed acquisitions for all years since 2008, excluding the two highest values over the period.

Table 3 compares the acquisition information reported on eBay’s fiscal 2011 Form 10-K with the PCT values computed for this report. The model predicts PCT values for 2011 that are close to and slightly above eBay’s total payments for acquisitions. Note that eBay discloses this information in its SEC filings for only some years. Also, the acquisition values disclosed in the notes to this report do not match the total value reported in eBay’s statement of cash flows, so it is difficult to true up these figures, and the tax and CSA accounting information is not public.

These calculations therefore err on the side of overvaluation of the acquisition-related PCTs in aggregate. Despite this, the results indicate substantial underpayment for eBay’s IP by eBay Switzerland and excessive profits booked into eBay Switzerland and other foreign affiliates that is far above what should be allowed under the statutorily required commensurate with income standard.

All the periodic adjustment calculations and computations of the acquisition-related platform contribution transactions discussed in this report can be obtained from the author. Those materials include a summary of eBay’s acquisitions, together with references for these acquisitions and their values (if disclosed). The PCT payments for these acquisitions were combined with the totals for estimated cost-sharing payments as the basis for the periodic adjustment calculations. The results under the acquisition price method are generally expected to provide a reasonable, and likely substantially overstated, value of identified PCTs in each year on average.

A. Periodic Adjustment Exceptions

Reg. section 1.482-7(i)(6)(vi)(A)(1) through (4) identifies four exceptions that could prevent a periodic adjustment. In eBay’s case, the applicable period when these exceptions could apply would start on January 5, 2009. That is a result of eBay’s earlier-described noncompliance with the transition rules of the 2008 regulations under reg. section 1.482-7(m)(1), which caused a new CSA as of January 5, 2009, given that the IRS did not challenge the validity of eBay’s CSA after that date.

The first exception concerns when a taxpayer has transferred the cost-shared IP to an unrelated party under conditions that are similar to the contribution to the controlled CSA participant and the unrelated transfer price was used as the basis for pricing the PCT. By all indications, this has never occurred at eBay.

The second exception occurs when the indicated periodic trigger was the result of extraordinary events, beyond the control of the controlled participants, that could not reasonably have been anticipated at the time of the trigger PCT. Note that this exception assumes that the taxpayer otherwise complied with the CSA regulations in every other way. By the time the eBay CSA was entered into, the success of its platform was well established, and no facts appear to support this exception. Indeed, before eBay launched any international businesses, when its revenue was exclusively domestic, its revenue growth rate was between 50 and 100 percent per quarter, as shown below, or as much as 1,000 percent per year, as shown in its Form 10-K405⁶⁶ for the year ending 1998. Its foreign growth rates never approached those levels, and eBay grew its foreign operations through acquisitions. After each acquisition, it transferred the established foreign sites and infrastructure to the United States and imposed the U.S.-operated standard platform on each newly acquired foreign market. As seen with the closure of eBay’s China and Japan businesses, this strategy was not always successful.

The third exception is difficult to understand, even after reviewing the IRS’s discussion of it in the preambles to the regulations. It appears to apply when the periodic trigger occurs as the result of contributions other than platform contributions. Because it is quite clear that platform contributions contribute significantly to eBay Switzerland’s extremely high profits, this exception would not apply.

The fourth exception would apply if a periodic trigger would not have occurred if anticipated profit and losses in future years were taken into account in the current year. eBay’s foreign profits continue to increase year after year, which indicates that the periodic trigger would occur no matter how many future years were considered.

There are also five- and 10-year safe harbors. The five-year safe harbor states that if eBay’s foreign participant CSA-related results are so low that they fall below the periodic trigger range, no periodic trigger will be allowed to exist for the first five years of the CSA (which, in my analysis, is from January 5, 2009). In the 10-year safe harbor, if the taxpayer has no periodic trigger in the first 10 years of its CSA under the 2008 regulations, the taxpayer will be exempt from a periodic adjustment for the remaining life of the CSA. eBay qualifies for neither of these safe harbors because it appears to have triggered a periodic adjustment in every year since 2009.

In summary, eBay does not appear to qualify for any of the exceptions or safe harbors that would prevent a periodic adjustment under reg. section 1.482-7(i)(6).

B. Periodic Trigger Calculation

Having concluded that eBay did not meet the transition rules and grandfathering requirements to be exempt from a periodic adjustment under reg. section 1.482-7(i)(6) and would not meet any of the exceptions or safe harbors, the next step in this analysis is to perform a periodic trigger calculation. If the calculation shows that a periodic adjustment is triggered, the adjustment will be calculated.

The periodic trigger calculation, which is described in reg. section 1.482-7(i)(6)(i) through (iv), triggers a periodic adjustment if the foreign participant’s AERR is above the periodic return ratio range (PRRR). The AERR is the present value of the total profits of the foreign CSA participants (PVTP) divided by the present value of the CSA-related investments (the sum of PCTs and cost-sharing payments) known as PVI. The upper bound of the PRRR limitation is 1.5. However, if the taxpayer has not substantially complied with the documentation requirements referenced in reg. section 1.482-7(k), the PRRR threshold is reduced to 1.25. It is assumed that eBay has met the requisite documentation requirements and that the 1.5 AERR threshold applies. Because eBay is publicly traded, the applicable discount rate (ADR) is eBay’s weighted average cost of capital (WACC) in the year in which the trigger PCT occurs under reg. section 1.482-7(i)(6)(iv)(B), which is 2009 in this analysis.

The calculations that follow use eBay’s 2017 fiscal year as the adjustment year. According to eBay’s fiscal 2021 SEC filings, the IRS was in the process of examining its tax years from 2010 onward as of February 24, 2022. The trigger PCT occurred in 2009, and eBay’s ADR in 2009 is reported on a financial website to have been 14.08 percent.⁶⁷ All the following tables use that ADR.

The calculations of the periodic trigger for eBay Inc. are based on book information shown in SEC filings and other information and may differ to some extent from tax information. First, the information used as inputs to the periodic trigger calculation is shown in Table 4.

Note: U.S. territory revenue for purposes of computing the RAB share was estimated as 110 percent * U.S. revenue, to account for estimated revenue from Canada and other Americas territories, on the assumption that eBay’s CSA reflected a conventional Americas/Non-Americas RAB share distribution. If that was not the case, or if eBay had more than one CSA, this analysis may not be accurate (though one would still expect eBay’s results to bring about a periodic trigger in one or more disaggregated CSAs).

The periodic trigger calculation is shown in Table 5 and follows the process and formatting shown in reg. section 1.482-7(i)(6)(vii), Example 1.

As can be seen, a periodic trigger is indicated by this calculation beginning in year 1 of the January 5, 2009, CSA and in every year thereafter — by a substantial amount. This would indicate that a periodic adjustment calculation according to reg. section 1.482-7(i)(6) is warranted. Importantly, a periodic trigger in only one year would trigger a periodic adjustment in that year and every following year for the life of the CSA.

V. Periodic Adjustment Calculations

The five steps laid out below are formulaic. The background to them, though, is the commensurate with income concept that was inserted into section 482 (as well as section 367(d)) in the Tax Reform Act of 1986. In short, the concept behind these formulaic steps is to allow a CSA participant to earn a return only to the extent of two factors:

• The first factor is the routine exploitation functions performed. Normal transfer pricing concepts and applicable regulations under section 482 will determine the return for these functions. For eBay Switzerland, including its disregarded entity subsidiaries, these functions include the sales and marketing, customer support, contract services, and any other routine activities performed by those affiliates. Because eBay US performed most if not all of the primary and high-value exploitation functions over the relevant period, these routine returns to the foreign CSA participants would exclude any return for those functions.

• The second factor is the platform contribution that each CSA participant has made to the arrangement. The residual profit split method is used by applying the relative value of each participant’s PCTs to determine that participant’s share of actual profits exceeding the calculated routine returns. According to the facts presented in this report, eBay’s CSA was noncompliant from the start because eBay Switzerland (including its disregarded entity subsidiaries) never would have met the individual exploitation requirement of the pre-2009 regulations. The position taken here is that even if eBay has been successful in hiding its noncompliance and convincing the IRS that its CSA was legitimate from the beginning, the factual noncompliance would not support ownership of legacy IP beginning in 2009, when a new CSA would have been initiated. Therefore, the application of the residual profit-split method imbedded in the periodic trigger calculations leaves eBay US with 100 percent of any residual profits.

Table 4. Key Inputs to eBay Inc. Periodic Trigger and Periodic Adjustment Calculations

Year	Year No.	Discount Rate	Discount Factors	U.S. Revenue Per SEC Filings	Foreign Revenue Per SEC Filings	Est. Foreign CSA Territory Revenue	Est. Foreign RAB % [(Total Revenue - 110% * U.S. Revenue)/Total Rev]	Total R&D Costs Per SEC Filings	Est. Foreign RAB Share Of R&D Expense	Total Pretax Profit Per SEC Filings	Foreign Pretax Profits Per SEC Filings	Estimated PCT Pmts. For Acquisitions
FY2009	1	14.08%	0.88	$3,985	$4,742	$4,344	50%	$803	$400	$2,879	$2,730	$646
FY2010	2	14.08%	0.77	$4,214	$4,942	$4,521	49%	$908	$449	$2,098	$1,250	$42
FY2011	3	14.08%	0.67	$5,484	$6,168	$5,620	48%	$1,235	$596	$3,910	$2,164	$1,597
FY2012	4	14.08%	0.59	$6,778	$7,294	$6,616	47%	$1,573	$740	$3,084	$2,479	$33
FY2013	5	14.08%	0.52	$7,712	$8,335	$7,564	47%	$1,768	$833	$3,466	$2,872	$469
FY2014	6	14.08%	0.45	$8,495	$9,407	$8,558	48%	$2,000	$956	$3,531	$3,358	$34
FY2015	7	14.08%	0.40	$3,624	$4,968	$4,606	54%	$923	$495	$2,406	$2,010	$75
FY2016	8	14.08%	0.35	$3,866	$5,113	$4,726	53%	$1,114	$586	$3,651	$2,122	$185
FY2017	9	14.08%	0.31	$4,091	$5,476	$5,067	53%	$1,224	$648	$2,276	$1,858	$37
FY2018	10	14.08%	0.27	$3,382	$5,268	$4,930	57%	$1,051	$599	$2,249	$2,105	$367
FY2019	11	14.08%	0.23	$3,303	$5,333	$5,003	58%	$976	$565	$1,749	$1,572	$
FY2020	12	14.08%	0.21	$4,151	$6,120	$5,705	56%	$1,087	$604	$3,420	$2,257	$39
FY2021	13	14.08%	0.18	$5,048	$5,372	$4,867	47%	$1,325	$619	$398	$(1,210)	$33

Table 5. Estimated eBay Inc. Periodic Trigger Calculation

	(a)	(b)	(c)	(d)	(e)	(f) = d + e	(g) = b - c	(h) = g/f	(i)	(j)
Year	Year No.	eBay Foreign Territory CSA-Related Sales	Non-CC/Non-IDC Costs (Est.)	CC/IDCs (Est.)	PCTs	PVI = Est. Total Investment Costs	PVTP = Est. Divisional Profit (Loss)	AERR = PVTP/PVI	AERR > 1.5	‘Excess’ AERR vs. 1.5 Limitation
FY2009	1	$4,344	$568	$400	$646	$1,045	$3,776
FY2010	2	$4,521	$2,780	$449	$42	$491	$1,741
FY2011	3	$5,620	$1,263	$596	$1,597	$2,192	$4,356
FY2012	4	$6,616	$3,365	$740	$33	$773	$3,252
FY2013	5	$7,564	$3,390	$833	$469	$1,302	$4,174
FY2014	6	$8,558	$4,210	$956	$34	$990	$4,348
FY2015	7	$4,606	$2,026	$495	$75	$570	$2,580
FY2016	8	$4,726	$1,833	$586	$185	$771	$2,893
FY2017	9	$5,067	$2,523	$648	$37	$685	$2,543
FY2018	10	$4,930	$1,859	$599	$367	$966	$3,071
FY2019	11	$5,003	$2,865	$565	$—	$565	$2,137
FY2020	12	$5,705	$2,805	$604	$39	$643	$2,900
FY2021	13	$4,867	$5,425	$619	$33	$652	$(558)
Yr 0 PV Thru Yr 1		$3,808	$498	$350	$566	$916	$3,310	3.6	Yes	141%
Yr 0 PV Thru Yr 2		$7,281	$2,634	$695	$598	$1,293	$4,648	3.6	Yes	140%
Yr 0 PV Thru Yr 3		$11,066	$3,485	$1,096	$1,674	$2,770	$7,582	2.7	Yes	82%
Yr 0 PV Thru Yr 4		$14,973	$5,471	$1,533	$1,693	$3,226	$9,502	2.9	Yes	96%
Yr 0 PV Thru Yr 5		$18,887	$7,226	$1,964	$1,936	$3,900	$11,662	3	Yes	99%
Yr 0 PV Thru Yr 6		$22,770	$9,135	$2,398	$1,951	$4,349	$13,634	3.1	Yes	109%
Yr 0 PV Thru Yr 7		$24,601	$9,941	$2,595	$1,981	$4,576	$14,660	3.2	Yes	114%
Yr 0 PV Thru Yr 8		$26,249	$10,580	$2,799	$2,045	$4,845	$15,669	3.2	Yes	116%
Yr 0 PV Thru Yr 9		$27,797	$11,351	$2,997	$2,057	$5,054	$16,446	3.3	Yes	117%
Yr 0 PV Thru Yr 10		$29,118	$11,849	$3,158	$2,155	$5,313	$17,269	3.3	Yes	117%
Yr 0 PV Thru Yr 11		$30,292	$12,522	$3,290	$2,155	$5,445	$17,770	3.3	Yes	118%
Yr 0 PV Thru Yr 12		$31,466	$13,099	$3,415	$2,163	$5,578	$18,367	3.3	Yes	120%
Yr 0 PV Thru Yr 13		$32,345	$14,078	$3,526	$2,169	$5,695	$18,267	3.2	Yes	114%

The five formulaic steps to calculate the periodic adjustment are set out in reg. section 1.482-7(i)(6)(v) as follows:

1. As of the date of the trigger PCT, determine the present value of the PCT payments using the adjusted residual profit-split method as described in reg. section 1.482-7(i)(6)(v)(B). (Note that for this purpose, these PCT payments are primarily those related to the eBay Inc. acquisitions, which are assumed to represent all of eBay’s acquisitions since 2008.)

2. Convert the present value of the PCT payments determined in step 1 into a level royalty rate as a percentage of the reasonably anticipated divisional profits or losses over the entire duration of the CSA activity.

3. Multiply the step 2 royalty rate by the actual divisional profit or loss for tax years preceding and including the adjustment year to yield a stream of contingent payments in each year, and convert those payments to a present value as of the CSA start date. In the event of a loss in any particular year, the result will be a negative contingent payment for that year.

4. Convert any actual PCT payments through the adjustment year to a present value as of the CSA start date (January 5, 2009) and subtract that present value from the present value result determined in step 3. This difference is the amount in present value terms of the participant’s deficiency in PCT payments. Then convert this present value payment to a nominal amount in the adjustment year. This nominal amount is the periodic adjustment to be recognized by the U.S. taxpayer as additional taxable income in the adjustment year. (Note that step 4 actually includes three substeps. After a periodic adjustment has been calculated for a particular adjustment year, every subsequent year will automatically be subject to a periodic adjustment in accordance with step 5.)

5. Apply the step 2 royalty rate to the actual divisional profit or loss for each tax year after the adjustment year to calculate amounts for each year. Then subtract from each year’s amount any actual PCT payment made for the same year. The differences are the periodic adjustment for each respective post-adjustment tax year.

Reg. section 1.482-7(i)(6)(v)(B)(2) contains the following guidance regarding the determination of the applicable royalty:

Projected results for the balance of the CSA Activity after the Determination Date, as reasonably anticipated as of the Determination Date, shall be substituted for what otherwise were the projected results over such period, as reasonably anticipated as of the date of the Trigger PCT.

The detailed guidance, as reflected in reg. section 1.482-7(i)(6)(vii), Example 1, paragraphs (v) through (vii), requires that the entire projected life of a CSA be included in the calculation of the level royalty rate.

The following tables show the step 4 and 5 results, representing the periodic adjustment calculations through the fiscal 2017 adjustment year. Steps 1-3 are available from the author.

Once the adjustment year result is obtained, step 5 computes the periodic adjustment due for the remaining years for which information is available (the last year representing the determination date), using the adjustment-year royalty rate. Because eBay has reported book financial results through 2021, Table 7 shows results for fiscal 2018, 2019, 2020, and 2021, with the 2021 tax year being the last result included as of the determination date.

Table 6. Estimated eBay Inc. Periodic Adjustment Calculations in Adjustment Year 2017

Periodic Adjustment Per Reg. Section 1.482-7(i)(6) ($ millions)
Year	(a)	(b)	(c)	(d) = b * c	(e)	(f) = d - e	(g) = f/(Det. Year ADR)
	Year No.	Est. Divisional Profit and Loss	Royalty Rate In Determination Year	Nominal Royalty Due Under Adjusted RPSM	Nominal Payments Made (PCTs)	Additional PCT Owed	Present Value Of the Owed PCT in Adjustment Year (2017)
FY2009	1	$3,776	78%	$2,938	$646	$2,292	Convert year 0 amounts to PV in 2017 adjustment year.
FY2010	2	$1,741	78%	$1,355	$42	$1,313
FY2011	3	$4,356	78%	$3,389	$1,597	$1,793
FY2012	4	$3,252	78%	$2,530	$33	$2,497
FY2013	5	$4,174	78%	$3,247	$469	$2,779
FY2014	6	$4,348	78%	$3,383	$34	$3,349
FY2015	7	$2,580	78%	$2,007	$75	$1,932
FY2016	8	$2,893	78%	$2,251	$185	$2,066
FY2017	9	$2,543	78%	$1,979	$37	$1,942
Yr 0 PV Thru Yr 9		$16,446		$12,795	$2,057	$10,739	$35,142

Table 7. Estimated eBay Inc. Periodic Adjustment Calculations for Years Between Adjustment Year and Determination Date

Periodic Adjustment Per Reg. Section 1.482-7(i)(6) ($ millions)
Year	(a)	(b)	(c)	(d) = b * c	(e)	(f) = d - e
	Year No.	Divisional Profit and Loss	Royalty Rate in Adjustment Year	Nominal Royalty Due Under Adjusted RPSM	Nominal Payments Made (PCTs)	Additional Periodic Adjustment to Be Made
FY2018	n/a	$3,071	78%	$2,389	$367	$2,022
FY2019	n/a	$2,137	78%	$1,663	$—	$1,663
FY2020	n/a	$2,900	78%	$2,256	$39	$2,217
FY2021	n/a	$3,310	78%	$2,575	$33	$2,542

Table 8 shows the total estimated taxes that the IRS could impose on an audit cycle covering the years through the determination date based on this analysis. Importantly, as disclosed in eBay’s 2019 Form 10-K, the company was required to pay the Tax Cuts and Jobs Act transition tax, beginning with its 2017 tax return, on all accumulated unrepatriated foreign income because of the U.S. implementation of a territorial tax system in 2017. These taxes could be paid in installments, which eBay elected to do.⁶⁸

Note that in 2014 eBay changed its capital allocation strategy and treated its accumulated foreign earnings as of fiscal year-end 2013 as no longer being permanently reinvested outside the United States. This change resulted in an increased deferred tax liability of approximately $3 billion, which was later reduced to $2.1 billion after the spinoff of PayPal. To the extent that eBay did repatriate in pre-TCJA years any earnings and paid a 35 percent tax thereon, there would be a reduction in the amount shown as additional total taxes in Table 8.

Table 8. Estimated Federal Taxes for a Periodic Adjustment Covering the Adjustment Year and Through the Determination Date ($ millions)

	Applicable Year	Periodic Adjustment	Statutory Federal Rate	Estimated Federal Taxes
Initial periodic adjustment	2017	$35,142	35%	$12,300
Subsequent periodic adjustment	2018	$2,022	21%	$425
Subsequent periodic adjustment	2019	$1,663	21%	$349
Subsequent periodic adjustment	2020	$2,217	21%	$466
Subsequent periodic adjustment	2021	$2,542	21%	$534
Tax Cuts and Jobs Act repatriation taxes paid in 2018, 2019, 2020, and 2021				$(844)
Total				$13,229

VI. Alternative Approaches

A. Other Transfer Pricing Issues

If the IRS chose to apply neither a periodic adjustment under reg. section 1.482-7(i)(6) nor ECI taxation, it could pursue transfer pricing adjustments on other bases given eBay’s highly skewed foreign profitability in some years, as shown by the forensic analysis conducted for this report. The IRS’s options include the following.

1. Application of periodic adjustment under reg. section 1.482-4(f)(2).

The periodic adjustment rules under reg. section 1.482-4(f)(2) predate the 2008 CSA regulations but have always been extremely difficult if not impossible to apply. In my experience and research, there are no known situations in which the IRS has tried to apply this regulation. Indeed, the problematic characteristics of the regulation and the lack of detailed guidance were almost certainly a reason for the new periodic adjustment regulation under the 2008 CSA regulations. However, there are instances in which reg. section 1.482-4(f)(2) is applicable and could still be applied by the IRS.

eBay’s skewed results showing proportionately far more foreign profits than domestic profits is such an instance. If a taxpayer’s preexisting CSA qualified for the grandfathering provisions of reg. section 1.482-7T(m)(1) and (2) of the 2008 regulations, the taxpayer would be subject to the periodic adjustment regulations of reg. section 1.482-4(f)(2) for all its PCTs both before and after January 5, 2009; reg. section 1.482-7(i)(6) would not apply at all, subject to any post-January 5, 2009, “material change in the scope of the CSA from its scope as of January 5, 2009” (which is left undefined but restricted only to expansions and not contractions in the CSA’s scope). Therefore, successfully transitioning a preexisting CSA to the 2008 regulations would make it much more difficult to apply a periodic adjustment. If a taxpayer’s preexisting CSA did not qualify for transition under the 2008 CSA transition rules, only the pre-January 5, 2009, PCTs would be subject to the more-difficult-to-apply reg. section 1.482-4(f)(2) rules.

In cases in which reg. section 1.482-4(f)(2) applies to any open tax year, it can apply to any applicable period PCT regardless of the statute of limitations or whether the PCT had already been examined:

The consideration charged in each taxable year may be adjusted to ensure that it is commensurate with the income attributable to the intangible. . . . A periodic adjustment under the commensurate with income requirement of section 482 may be made in a subsequent taxable year without regard to whether the taxable year of the original transfer remains open for statute of limitation purposes.

Although reg. section 1.482-4(f)(2) adjustments may be difficult to apply, the IRS could still undertake to apply this provision, especially in egregious cases such as appears to be the situation for eBay.

2. Application of transfer pricing adjustments to PCTs under reg. section 1.482-7(g).

Instead of applying a periodic adjustment under reg. section 1.482-7(i)(6) or -4(f)(2), as applicable, on an aggregate basis to all relevant PCTs, the IRS could apply the 2008 reg. section 1.482-7(g) provisions to seek to adjust particular PCTs only in open tax years after January 5, 2009. This would theoretically include omitted PCTs as well as underpriced PCTs. This approach applies various methods described in reg. section 1.482-7(g) and requires substantial case development, fact finding, and often highly subjective analyses. As a result, this approach comes with substantial litigation risk. The IRS lost one case in which it tried this approach (Amazon),⁶⁹ and it is involved in an ongoing second case related to this approach (Facebook).⁷⁰ The reg. section 1.482-7(g) approach is often difficult to apply because of taxpayer information asymmetry, especially in cases in which the taxpayer has substantial documentation purporting compliance under applicable regulations, often prepared with information the IRS may not have access to.

3. Application of transfer pricing adjustments to PCTs under reg. section 1.482-9.

The reg. section 1.482-9 regulations are generally relevant for intercompany services for tax years beginning after July 31, 2009.⁷¹ There are two general instances in which this would be highly relevant in the context of a CSA: (1) omitted or underpriced services transactions that affect the profits earned by the foreign CSA participant (such as allocation of head office services that benefit the foreign CSA participant, allocation or charging for exploitation services — possibly embedded within a cost of goods sold or cost of services charge — or services that are deemed to be overhead for intangible development expenses; and (2) services that are interrelated with a transfer of IP, or that themselves result in a transfer of IP or otherwise constitute a high-value or nonroutine service. Notably, for most multinationals, the expenses associated with selling general and administrative services often exceed the amounts for R&D expenses, and therefore these expenses can be substantial and can result in high-value intangible assets apart from technology IP covered by a CSA. The analysis of services fees can involve substantial case development and complex calculations involving, for instance, the computation of allocation drivers; profit elements based on comparables searches and possibly adjustments to same; the determination of non-allocable expenses such as shareholder and duplicative activities and activities providing only a remote benefit to foreign affiliates; a benefits analysis; and analyses regarding whether specific services should alternatively be priced as an IP transfer or as an aggregated transaction with a non-services element.⁷² Regarding this last transaction, reg. section 1.482-9(m)(1) states:

A transaction structured as a controlled services transaction may include other elements for which a separate category or categories of methods are provided, such as . . . a transfer of tangible or intangible property. . . . Ordinarily, an integrated transaction of this type may be evaluated under this section and its separate elements need not be evaluated separately, provided that each component of the transaction may be adequately accounted for in evaluating the comparability of the controlled transaction to the uncontrolled comparables and, accordingly, in determining the arm’s length result in the controlled transaction. See section 1.482-1(d)(3).

Further, reg. section 1.482-9(m)(2) addresses services transactions that themselves result in a transfer of IP and must then be analyzed under reg. section 1.482-4:

A transaction structured as a controlled services transaction may in certain cases include an element that constitutes the transfer of intangible property or may result in a transfer, in whole or in part, of intangible property. Notwithstanding paragraph (m)(1) of this section, if such element relating to intangible property is material to the evaluation, the arm’s length result for the element of the transaction that involves intangible property must be corroborated or determined by an analysis under section 1.482-4.

Finally, reg. section 1.482-9(m)(4) provides more generalized guidance on the application of the services regs to almost any transaction that involves a services component:

A transaction structured other than as a controlled services transaction may include one or more elements for which separate pricing methods are provided in this section. . . . Ordinarily, a single method may be applied to such an integrated transaction, and the separate services component of the transaction need not be separately analyzed under this section, provided that the controlled services may be adequately accounted for in evaluating the comparability of the controlled transaction to the uncontrolled comparables and, accordingly, in determining the arm’s length results in the controlled transaction.

Services transactions can often be material and indeed could be more important to profitability than the CSA-related IP transactions. While the analyses of intercompany services can be more complex and labor intensive than the application of a periodic adjustment, those analyses may be required when the taxpayer has substantially underpriced its intercompany services apart from any IP transactions, or when the services and IP transactions are otherwise interrelated.

If the IRS chose to not propose periodic adjustments to eBay under either reg. section 1.482-7(i)(6) or -4(f)(2), the performance by eBay US of all exploitation activities on behalf of its various foreign subsidiaries would be a logical target for the IRS to apply reg. section 1.482-9 adjustments in all open years.

B. Recharacterization

Although the author believes that periodic adjustments and ECI taxation are the better approaches, the publicly available facts also strongly support recharacterization. Unlike the periodic adjustment and ECI approaches, which can be applied in conjunction with each other or individually, recharacterization would be appropriate only if the IRS declined to initiate periodic adjustments and ECI taxation.

The background facts of how eBay Inc. manages the entire business of eBay Switzerland and other foreign affiliates, and how it conducts major portions of the foreign group members’ business on their behalf (for example, full conduct of eBay’s foreign revenue-generating activities and operation of the internet-based platforms through which eBay Switzerland and other affiliates earn cloud services revenue), strongly support a position that eBay Switzerland is nothing more than an agent of eBay Inc.

Note that a recharacterization approach could be applied only to eBay Inc.’s open years. As indicated earlier, it is unknown what the earliest open year is, but according to Form 10-K disclosures, it is no earlier than 2010. In contrast, both periodic adjustments and ECI taxation should allow some taxation of eBay’s foreign income earned in earlier years.

VII. Key Methodological Assumptions

In preparing this analysis, the following assumptions underlie the calculations presented earlier.

1. eBay US made all U.S. and foreign acquisitions that constitute platform contributions.

All available public information suggests that all acquisitions made by eBay Inc. were accomplished as purchases by the U.S. company. For any of these acquisitions that contributed to the CSA-covered IP development activities, eBay’s foreign CSA participant (eBay Switzerland) is required to make PCT payments for their RAB share of the value of those CSA contributions. Those PCT payments have been assumed in this model to be the maximum value possible by applying the acquisition price method. This is expected to provide the most conservative estimates possible.

2. There are undisclosed and underpriced PCTs and other uncompensated transactions.

This periodic adjustment analysis explicitly assumes that eBay Switzerland paid an arm’s-length price under applicable regulations (in fact, the maximum value in the case of acquisitions of intangible assets and personnel that would contribute to the development of cost-shared intangibles) for all identified PCTs. Therefore, to the extent that a periodic adjustment exists, it would be the result of unidentified PCTs or PCTs contributed by eBay US that were not paid for by eBay Switzerland and/or other foreign CSA participants, and other non-CSA-related controlled transactions that could inflate the divisional profits of eBay Switzerland. Those other non-CSA-related transactions could include underpayments for U.S. services such as commercialization services, executive management, head office services, administrative services, etc. Importantly, these underpaid services could include charges for eBay US’s day-to-day operation and maintenance of the eBay marketplace platform, which generates the bulk of eBay Switzerland’s CSA territory revenue. Note that these payments for operation of the platform are different from payments made by eBay Switzerland under the CSA that represent its share of developing and enhancing cost-shared intangibles.

One reason the commensurate with income standard is necessary is that it is often impossible for the IRS to sufficiently identify all current and future PCTs, operating contributions, and non-CSA-related intercompany transactions, to adequately explain all future CSA outcomes in a way that can reliably value platform contributions made at the outset of the CSA or later, throughout the CSA’s existence. Only through a periodic adjustment analysis in future years can the IRS be confident that the CSA has properly accounted for the value of all PCTs and that other intercompany transactions have been properly priced. The periodic adjustment calculations do not attempt to identify these missing transactions but to merely confirm that they exist. Taxpayers can, of course, avoid a periodic adjustment by performing the periodic trigger calculations themselves and revising their transfer pricing on an ongoing basis to ensure that the periodic trigger limitations are not breached for any applicable period.

3. Reg. section 1.482-7(i)(6) applies to eBay’s CSA beginning in 2009.

The transition rules of the 2008 cost-sharing regulations at reg. section 1.482-7(m)(1) required that before January 5, 2009, eBay’s preexisting CSA meet the conditions of the former CSA regulations that were effective as of, and as existing on, January 1, 1996. The calculations assume that eBay’s CSA was noncompliant before January 5, 2009, so that the relevant transition rules in reg. section 1.482-7(m) (the grandfathering provisions) would not apply, meaning that eBay is assumed to have a new CSA beginning on January 5, 2009. As such, the periodic adjustment rules under reg. section 1.482-7(i)(6) apply for any PCTs that occurred after January 5, 2009.

4. Alternative methodological assumptions that could change these results.

If eBay Switzerland (and/or other foreign principal CSA participants assumed in this report to be disregarded entity subsidiaries of eBay Switzerland) made its own acquisitions, there could be some amount of PCT payments due by eBay Inc. to eBay Switzerland. Further, if eBay Switzerland were treated as having made any PCTs at the January 5, 2009, initiation of the new CSA, eBay Switzerland would be due some portion of the nonroutine returns under the residual profit split method mandated by reg. section 1.482-7(i)(6).

VIII. Conclusion

According to the facts and analysis documented in this report, it is clear that eBay Inc. did not comply with the transition rules in the 2008 temporary cost-sharing regulations (reg. section 1.482-7(m)(1)), primarily because eBay Switzerland failed to meet the requirements of the former (January 1, 1996) cost-sharing regulations as of January 5, 2009. Although this would expressly disqualify eBay’s CSA from being a valid CSA from January 5, 2009, the IRS’s apparent acceptance of the arrangement in one or more now-closed tax years, as well as in other still-open years, means that eBay Inc.’s CSA with its Swiss affiliate must be considered a new CSA effective from January 5, 2009, with no benefit of any of the grandfathering provisions provided in reg. section 1.482-7(m)(1) and (2). As a result, eBay would not qualify for exemption from compliance with the 2008 periodic adjustment regulations in reg. section 1.482-7(i)(6). An indicative calculation of that periodic adjustment according to these regulations and based on conservative assumptions shows that eBay Inc. appears to be subject to a substantial periodic adjustment whose tax payments would exceed the amounts of tax underpayments reserved in eBay’s uncertain tax positions combined with its deferred tax liabilities for the TCJA deemed repatriation taxes.

In conjunction with, or as an alternative to, making periodic adjustments or other transfer pricing corrections, the IRS has a particularly strong basis for assessing ECI taxation directly on eBay Switzerland. Further, as an alternative to making periodic adjustments, the IRS could consider recharacterizing the eBay Inc./eBay Switzerland relationship to treat the foreign CSA participant as nothing more than an agent of eBay Inc.

Importantly, the apparent recognition within eBay Switzerland and other offshore affiliates of significant profits that should have been reflected within the United States potentially affects state taxes, especially for any states that apply their state income tax on a water’s-edge or other approach that excludes eBay’s foreign profits from the allocable tax base. These findings should provide a basis for state tax audits to recoup significant amounts of underpaid taxes to the extent they enforce transfer pricing laws in the state. That so many code sections appear to have been violated by eBay Inc.’s potentially sham and almost certainly nonqualifying CSA without IRS detection or enforcement — despite a plethora of publicly available evidence and information — raises the possibility that this could be yet another in a long line of spectacular enforcement failures produced by the Frankenstein cost-sharing regulations.