Veritas Software Corp. v. Commissioner

Veritas Software Corp. (Veritas US) (plaintiff) made, developed, marketed, and sold computer-storage-management software. This software was sold directly to customers and through original equipment manufacturers (OEMs) like Dell, Microsoft, and HP. OEMs sometimes sold the Veritas products bundled with the OEM’s operating systems or unbundled as a separate product. Veritas operated in a deeply competitive market, and its products had an average useful life of four years. Veritas began expanding to other nations. A collection of Veritas subsidiaries known as Veritas Ireland was assigned all of Veritas US’s existing sales agreements with European-based subsidiaries. Veritas US and Veritas Ireland entered an Agreement for Sharing Research and Development Costs (RDA) and a Technology License Agreement (TLA). The agreements gave Veritas Ireland the right to manufacture Veritas products within Veritas Ireland’s territory as well as the right to use Veritas US’s trademarks, trade names, and service marks. As consideration, Veritas Ireland agreed to pay royalties to Veritas US—$6.3 million was paid in 1999, and a remaining $166 million lump-sum buy-in was paid in 2000. In 2002, Veritas US adjusted that payment down to $118 million. Although Veritas US filed its federal income tax returns on time in 2000 and 2001, the Commissioner of Internal Revenue (the commissioner) (defendant) determined that the returns did not accurately reflect Veritas US’s income. In March 2006, the commissioner issued a notice of deficiency based on a report from Brian Becker in which Becker found that an arm’s-length value for the lump-sum buy-in payment would be between $1.9 million and $4 billion, with an ultimate figure of $2.5 billion assessed. This led to findings of deficiencies of $758 million and penalties of $303 million. Veritas US filed suit, seeking redetermination of the matter. Before trial, the commissioner employed an expert named John Hatch, who applied a buy-in value of $1.675 billion. Hatch’s testimony applied an “aggregate” valuation rather than valuing individual items obtained by Veritas Ireland. Hatch also treated the buy-in as equivalent to a sale of Veritas US and failed to provide underlying support for his testimony. Meanwhile, Veritas US supported its calculation by using the amount of comparable uncontrolled transactions. Veritas’s expert, William Baumol, found that agreements between Veritas and the OEMs were comparable and that the valuation submitted by Veritas had been accurate.