US TAX COURT RECEIVED REDACTED US TAX COURT eFILED ALS MAY27 2016 MAY27 2016 5:43 PM AMAZON. COM INC. & SUBSIDIARIES , Petitioner(s) ELECTRONICALLY FILED v. Docket No. 31197-12 COMMISSIONER OF INTERNAL REVENUE, Respondent AMENDED SIMULTANEOUS OPENING BRIEF I I CERT F CATE OF SERVICE SERVED May 31 2016 Confidential - Lodged with Chambers Only UNITED STATES TAX COURT AMAZON.COM INC. and SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) l l ) ) l ) l Docket No. 31197-12 Judge Lauber ) RESPONDENT'S AMENDED SIMULTANEOUS OPENING BRIEF WILLIAM J, WILKINS Chief Counsel Internal Revenue Service OF COUNSEL: LINDA M. KROENING Division Counsel (Large Business & International) EWAN D. PURKISS Area Counsel (Communications, Technology & Media: Oakland) MARYE. WYNNE Senior Level Counsel (SL) JILL A. FRISCH Special Trial Attorney ANNE HINTERMEISTER Senior Counsel MELISSA D. LANG LLOYD T. SILBERZWEIG Special Trial Attorneys SHANNON L. COHEN JIMEEL R, HAMUD MELISSA L, HILTY DAVID A, LEE SCOTT W, MENTINK AARON T. VAUGHAN MY V. VO Attorneys CONTENTS PRELIMINARY STATEMENT ••...•..••.••.••.......••••...•....•..... 1 QUESTIONS PRESENTED•••••••••••.•...•.....••...•••..•...•....•. 3 RESPONDENT'S REQUEST FOR FINDINGS OF FACT••....•..••..•••.••.• 4 GLOSSARY OF TERMS •••.•••.•·, ••• . . . . . . . . • • • • • . • • • • . . . • • ..• . • • • 4 Preliminary and Jurisdictional Matters ••.•.•••..••••.•••••.• 7 ESTABLISHMENT OF AMAZON'S EUROPEAN BUSINESS ....•••.•.•.•...• 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 CATEGORY LAUNCHES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Fulfillment •.• . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Associates and 3PS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 AMAZON'S BUSINESS MODEL .. Sh�pping .................................................... 25 Amazon's Success . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 ........ European Structure Prior to the Business Transfer Date ....•. 29 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 AIM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 ASEU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Intercompany Royalty Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Amazon's QCSA .•.•...• . . . . . .. .. . . . . . . . . .. . . . . . . . . . . . .. . . . . . . . . . . . 34 Amazon's Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Patents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Economic Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 EU Service Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 52 License Agreements Post Restructuring . . . . . . . . . . . . . . . . . AIS " EU Affiliate Service Agreements Post PROJECT Goldcrest i 53 CONTENTS Reporting of Income and Deductions .•.••..••••••..•..•••.•••. 56 Project Goldcrest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 History of Project Goldcrest ••.•••...••••..•••...•.• , ..•.. 59 Deloitte . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 The Model . . . . . . . . . . . . . . . . . . . • . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Costs of Project Goldcrest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Luxembourg Tax Treatment of Project Goldcrest ••••••••.•..• 63 Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Tax Benefits of Goldcrest . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 69 Revised Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 IDCs in the Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 Projected and Actual Results •.•.•.••.•.....•...••.•.•.•.•. 79 Goodwill Impairment Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 The Social Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . . 82 The Deloitte Transfer Pricing Study ••..•.••••...••......•... 83 Amazon's US Tax Reporting ................................... 85 Dr. Frisch's Valuation of the IP Made Available to AEHT .••.. 88 Petitioner Abandoned Its Tax Return Valuation .....•....••.•• 90 Dr. Frisch' s DCF Methodology ...•.••....•..•..••....•.•..... , 91 Amazon's Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Bundle of Transferred Intangibles ......•........•...••.... 96 Dr. Frisch's Terminal Value Assumption .........•.........• 98 Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . . . . 102 Post-Tax Discount Rate . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . - ii - 106 CONTENTS Expected Return ........................................... 107 Best Method ....•.........•................................ 108 Applying a DCF Analysis to Transferred Intangibles ..•.•... 110 Innovation Assumptions .................................... 111 The Value of Transferred Assets Includes Benefits from Maintenance, Improvement, Extension, and Replacement •••.•. 112 Growth Options/New Businesses •••..•..•.••.••...••..•.•.•.• 115 Goodwill .................................................. 118 Opportunity Costs ......................................... 120 The DCF Takes into Account AEHT's Projected Spending on IDCs ...................................................... 121 Arm's Length Pricing ...................... -; ............... 122 IDCs ...............................................•...... 124 Market Capitalization Method •••...•......•••••.•.•.•.....•.. 125 Amazon's Brand, Trademark and Marketing Intangibles .•.•••.•• 128 Brand Defined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 How Brands Assist Consumers ............................... 130 Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 The Amazon Brand ......................................... . 133 Amazon Brand Reliability and Trust •..•....•••.....••...... 137 Amazon Brand Stickiness ................................... 138 Amazon's Strategic Long Term Thinking •.••...••..••..•..... 139 Amazon's Brand Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 Amazon's Pillars .......................................... 142 Price & Fulfillment in lieu of Marketing - iii - .................. 144 CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145 The Amazon Look and Feel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146 Amazon Marketing (Traffic) and Advertising . . . . . . . . . . . . . . . . 150 Sponsored Links . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 The Amazon Flywheel Amazon's Email Advertising . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . 154 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154 Free Shipping • . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154 Amazon's Brand in the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155 Leveraging the Amazon Brand, Know How and Experience . . . . . . 157 Retail Expansion in the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 Amazon's Customer Reviews . Single Detail Page (SOP) . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . 162 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163 Brand Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 Independent Brand Valuations . . . ' . . . . . . . . ·. . . . . . . . . . . . . . . . . . 171 Customer Information-Related Intangibles . . . . . . . . . . . . . . . . . . . . 172 Intellectual Property Management •••.••.. . . . . . . . . . . . . . . . . . . . . 175 Components of Brand Valuation Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 Respondent's Technology Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 Software Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 NPI Process ••.•• . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 Amazon's Website and Key Functions . . . . . . . . . . . . . . . . . . . . . . . . 186 . . . . . . . . . . . . . . . . . . . . . . . . 190 Innovation at . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196 R & D Budget Amazon Technology Leaders Ainazon ...•.•...•..•• iv CONTENTS "Reuse" in Software Engineering ................•.......... 197 Refactoring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 200 .............................. Scale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202 Personalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 A/B Testing .•.• . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 Single Global Platform Version Control and Software Deployment Apollo .. . . . . . . . . . . . . . . . . .. ... . .. . . . .... Brazil and ...... . ..... 209 . . . . . . . . . . . . . . 210 Kindle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211 Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 Amazon Web Services (AWS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 Buy v. Build ...... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216 Programming Languages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 Useful Life of Computer Software . . . . . . . . . . . . . . . . . . . . . . . . . . 219 Dr. Cohen's Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 Architecture .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 The Transition from Obidos to Gurupa . . . . . . . . . . . . . . . . . . . . . . 226 Ordering .•. . . . .. . . . . . . . . . . . . .. . . . . . . . . . 230 Amazon's Distinguishing Features: Payments; Fraud Prevention; Supply Chain; Prime; and 1-Click Algorithmic Knowledge and Know-How Embodied in the Code 231 . . . . . . . . . . . . 233 Technologies using customer and purchase data . . . . . . . . . . . . . 234 Data for Personalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 Wikis at Amazon .....•..• . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . 237 Patents and trade secrets embodied in the code - V - CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238 Sortation Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241 Fulfillment Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 242 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 Dr. Higinbotham's INCOME-BASED CUT METHOD . . . . . . . . . . . . . . . . . . . 245 Fulfillment Process EFN .••..••• Computing the Buy-In for Technology IP •••.•...•....•...... 247 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248 Useful Life ••• . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251 Projected IDCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253 Discount Rate • . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254 Amazon's M.com Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254 Negotiating and Pricing the M.com Arrangements . . . . . . . . . . . . 259 Projected Revenues The M.com Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . 261 Target Arrangement ........................................ 2 62 . . . . . . . . . . . . . . . . . . . . . . . . . . 265 Determining the Arm's Length Royalty Rate . . . . . . . . . . . . . . . . . 266 Amazon's Cost Pool •••.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268 Intangible Development Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269 Reported RAB and Cost Sharing Payments. . . . . . . . . . . . . . . . . . . . 272 Amazon Accounting •.•. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273 Employee Classification ••• . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276 PwC Section 41 Credit Work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277 Most Comparable Target Agreement Amazon IDC Identification . Flaws in Petitioner's Method vi . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . 279 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283 CONTENTS Dr. Higinbotham's Cost Pool Improvements . .•...•......•...• 287 Additional Omitted IDCs ................................... 290 Content ................................................... 291 Respondent's Adjustment and Petitioner's Failure to Substantiate ............................ , ................. 295 ULTIMATE FINDINGS OF FACT •...•...•...••...........•.....•...•. 298 POINTS RELIED UPON ...•..•.•.....•...........•................. 301 ARGUMENT ... • • .. . • • . • •.. • . . .. • . .. . • .. • . • . ... • • • • . . . ..... • • • • • . • 311 I. Petitioner Failed to Prove that Respondent Abused His Discretion in Increasing the Buy-in Payment for Amazon US's Pre-Existing Intangibles and that Petitioner's Buy-in Pricing was Arm's Length. ................................... 311 A. Arm's Length Pricing is Required in a Qualified Cost Sharing Arrangement. ..•.........•..•.•.••........•..• 313 B. Amazon US Made All of the Intangibles Used in its Website Business Available to AEHT and Must Receive an Arm's Length Payment for Them • .....•••.•.••..•...•••.••..• 318 1. All of the Intangible Property That Amazon US Made Available to AEHT is Included in Section 1.4824(b) and is Subject to the Buy-in Requirement••••••.•...• 318 2. Amazon US was the Tax owner of All of the Intangibles Transferred to AEHT in the Restructuring ..... 325 a. Tax Ownership of the "4-Way" Intangibles• ..••.•..• 325 The EU Affiliates Registered the Trademarks i. and Domain Names as Agents or Nominees of Amazon us. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327 11. Alternatively, Amazon US Owned the EURegistered IP under an Imputed Long-Term License. •... 331 3. The Website Intangibles Made Available for Use in Development Had Substantial Value and Must be Compensated in the Buy-in ...............•....•...•....• ,. 335 - vii - CONTENTS a. Section 1.482-7A Unambiguously Requires a Payment for Pre-Existing IP Used to Develop Covered Intangibles . . . . . . . . . . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337 b. The Purpose of Section 482 and the Section 482 Regulations, Including Section 1.482-7A, Supports Requiring an Arm's Length Charge for the Buy In .•••...• 340 i. There is no Buy-in "Safe Harbor." •..••....••...•• 345 11. Respondent's Buy-in Adjustment is Based on Concepts and Methods in the 1995 Cost Sharing Regulations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 9 The Unspecified DCF Method Used by Dr. Frisch is C. the Best Method to Determine the Arm's Length Charge for the Website Intangibles Made Available to AEHT • •••.••..•.• 353 The Discounted Cash Flow Valuation Method Used by 1. Dr. Frisch is the Most Reliable Method in this Case..•••. 355 2. An Aggregate Valuation is the Only (and, therefore, Most) Reliable Way to Value the Bundle of Website Intangibles ...................................... 357 3. The CUT and Profit Split Methods Are Less Reliable Than the Unspecified DCF Method in this Case •..•••••....• 362 4. Dr. Frisch's DCF Value Is the Amount That an Uncontrolled Party would pay for the Bundle of Intangibles that AC! Made Available to AEHT .•.••...••.... 366 a. Projected Cash Flow From EU Website Intangibles .•..• 367 b. Projected IDCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369 c. Arm's Length Return to EU Subsidiaries......••..... 371 d. Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . . . . . . . 372 Dr. Frisch's Valuation Provides an Arm's Length e. Return to AEHT on its Expected Cost Sharing Payments. .. 378 f. The IP Made Available to AEHT had an Indefinite Useful Life . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381 - viii - CONTENTS i. Amazon's eCommerce Platform Would be Expected to Last for a Long and Indefinite Period of Time . .••. 383 ii. Petitioner's Ramp Downs are Economically Incorrect and Unreliable . ............................ 389 g. Market Cap Valuations Corroborate the DCF Results .•. 392 5. ACI's Alternative Transactions Show that the Arm's Length Charge for the EU Website Intangibles is the Present Value of Their Expected Cash Flows •....•.•..••... 393 VERITAS Does Not Mandate Rejection of the DCF 6. Method to Value the Buy-in Intangibles in this Case •.•.•• 395 II. Harlow Higinbotham's Technology CUT Valuation, David Haigh's Brand Valuation and the Opinions of Brand Experts James Conley and Ronald Wilcox Corroborate Dr. Frisch's Buy-In . ..................................................... 404 A. Mr. Haigh's Brand Valuation Corroborates Dr. Frisch's DCF Valuation of the Entire Bundle of Intangibles Transferred to AEHT . •.••..•.•..•........•...•. 408 1. Brand Definition ..................................... 411 2. Trademarks Allow a Retailer to Reap Brand Value •..•.• 412 3. Amazon's Business Strategy and Investments Built the Leading On-line Retail Brand •••....•••••...••••....•. 414 4. A 2% Royalty is the Arm's Length Charge for the Brand Assets Made Available to AEHT•...•......•.•.•..•..• 416 5. A Declining "Waterfall" Royalty is Inappropriate ....• 418 6. Mr. Haigh Applied the 2% Royalty to the Proper EU Revenue Base. ..•.•.........................•....•........ 422 7. 13.13% is an Appropriate Discount Rate for the Relief From Royalty Analysis•.•.••...•••..••.•.......•••. 423 8. The Amazon Brand in Europe Had an Indefinite Useful Life.............................................. 423 - ix - CONTENTS a. Petitioner's Affirmative Reports Do Not Reliably Life Amazon's Marketing Intangibles ••.••.•••.•••..•••.• 426 b. Petitioner's Rebuttal Experts Relied on Untested and Unreliable "Lifing" Methods• ....•••...••..•..•.••.. 429 B. Dr. Wills' Separate CUT-based Valuation of Customer Information-Related Intangibles is Unreliable because it Fails to Properly Account for the Entire Value of Customer Information and it is Mathematically Incorrect . .. 432 C. Dr. Higinbotham's M.com CUT-Based Valuation is the Amount an Uncontrolled Party would Pay for the EU Website Technology Platform . ••...•••.•...•.•.••••...•..... 435 1. Amazon's Technology Intangibles Made Available to M.corn Third Parties ...................................... 436 2. Using the M.com Agreements as CUTs: Regulatory Requirements to Assess Reliability.•••••••..••••••.•.•.•• 438 3. Dr. Higinbotham's CUT.Analysis is Reliable and Supports a Price for the Technology Platform Transferred to AEHT of $3.3 Billion .....•.•........•...•. 439 a. The Target Agreement in Effect on the Valuation Date is the Best Available Comparable ...•...••.•..•.... 440 b. Four Percent is the Royalty Rate for the EU Website Intangibles that Corresponds to Dr. Higinbotham's $3.3 billion valuation••.•......•.......• 443 c. An Arm's Length Royalty Rate for the EU Website Platform Would not Decline Over Time.•..•.•..•••.••...• 443 d. Projected AEHT Revenues ............................. 444 e. Projected Cost Sharing Payments. , •.•.•••............ 4 4 5 f. Terminal Value. ..................................... 445 g. Discount Rate ....................................... 4. Dr. Wills' M.com Valuation of the Amazon eCommerce Technology Platform is Materially Less Reliable than Dr. Higinbotham's M.com Valuation because Dr. Wills - X - 44 6 CONTENTS used Wrong Comparables, Applied an Arbitrary Volume Adjustment, and Erroneously Ramped Down the Royalty Rate ..••••.•..••.••.....•••...•.••..••.•.•••.•....•...... 446 a. Dr. Wills Failed to Use the Best Available Comparable . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 4 7 b. Dr. Wills' "Volume Discount" is Unnecessary, Without Factual Support, and Arbitrarily Applied to Reduce the Royalty Rate. .•..••...•......•.••..•..•...•. 448 c. Dr. Wills' Royalty Ramp Down is Based on Unreasonable Assumptions and Ex Post Changes in Software Code . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451 i. The Transferred IP Made Available to AEHT. ..•..•• 454 11. The Methods Used by Petitioner's Technology Experts to Estimate Life and Decay Rates of Transferred Intangibles are Unreliable . .....•...•••.. 456 iii. iv. Petitioner's Ramp Down Techniques . .•.•..•...•.. 460 Dr. Unni's Ramp Down Curves are Unreliable. 461 v. Dr. MacCormack's Relative Contribution or Derivation Methodology Does Not Measure the Useful Life of Amazon's Source Code • ••....•......•.........• 462 vi. Derivation is an Inaccurate Measure of Useful Life . . . . . . . . . . . . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465 vii. Dr. Parkes' Opinion is Unreliable. ......•...•.. 467 viii. Petitioner's Birman/Alvisi Report• ....•....... 472 D. Arm's Length Parties would Expect the Present Value of the Transaction to be Zero. . .•..•...•..••.•...•.......• 4 7 5 III. Petitioner Failed to Prove that Respondent Abused his Discretion in Increasing Petitioner's Cost Sharing Payments and that its Reported Payments were Arm's Length. .. 477 A. Petitioner's QCSA Pricing is Not Arm's Length• •....... 479 - xi - CONTENTS 1. Petitioner's QCSA Does Not Meet the Arm's Length Standard Unless the Participants Share All Costs Related to the Intangible Development Area ••.•••••••••••. 479 2. By its Terms, Petitioner's QCSA Covers the Widest Possible Range of Intangible Property and Development Activities ............................................... 480 3. Section 1.482-7A(d) (1) Allows Allocation Only for Particular Costs that Benefit Intangible Development and other Activities and Requires Allocation based on the Costs' Relative Benefits •.••.••..•.••••....•.•.•.•••• 482 4. The Method Petitioner Used to Estimate IDCs in its Tax Reporting is Based on Unreasonable Assumptions and Produces Unreasonable Results ............................ 487 B. Petitioner Did Not Meet its Burden of Rebutting Respondent's Allocation and Substantiating the Amount of its T&C Costs that Relate to Intangible Development• ••.•.. 489 1. Petitioner Failed to Prove that its T&C Costs were Not Exclusively Related to Intangible Development ••••..•• 489 2. Petitioner Agreed that the Cost Sharing Payments Based on its Allocation Method were Materially Understated and did not Substantiate Any Different Amount .................................................... 492 3. Dr. Higinbotham's Identification of Additional IDCs does not Satisfy Petitioner's Burden; it Shows that Petitioner's Allocations were Unreasonable and Not Arm's Length Amounts ..•.............•............ - ... 4 95 C. Respondent's Cost Pool Income Determination is Not Arbitrary, Capricious, or Unreasonable and Should be Sustained. ................................................ 501 IV. Petitioner is Required to Include Stock-Based Compensation in its Cost Pools .••.•••••.•.•............••.•. 504 CONCLUSION . .................................................... - xii - 508 CITATIONS Cases Amazon.com, Inc. v. Commissioner, T.C. Memo. 2014-149 .•. 483, 489 Amazon.com, Inc. v. Commissioner, T.C. Memo. 2014-245 .••..... 410 Armco, Inc. v. Commissioner, 87 T.C. 865 (1986) .•••.•..•••... 351 Auer v. Robbins, 519 U.S. 452 (1997) •.•..•••••...•.•...••.••. 348 Barford v. Commissioner, 194 F.3d 782 (7th Cir. 1999)•••..••. 314 Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525, aff'd, 933 F.2d 1084 (2d Cir. 1991) ..•....••••.•.•.••••. 311, 314, 442 Boltar LLC v. Commissioner, 136 T.c. 326 (2011) ••..•••.•...•• 458 Callejas v. McMahon, 750 F.2d 729 (9th Cir. 1984) •.•.••••.••• 350 Caltex Oil Venture v. Commissioner, 138 T.C. 18 (2012).••.... 337 Carlos v. Commissioner, 123 T.C. 275 (2004) ••••••.••..•..•.•. 345 Chase Bank USA, N.A. v. McCoy, 562 U.S. 195 (2011) ........... 348 Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984) ................................... 506, 507 Commissioner v. First Security Bank, 405 U.S. 394 (1972) •.... 314 Compaq Computer Corp. v. Commissioner, T.C. Memo. 1999-220, 78 T.C.M. (CCH) 20 (1999) ......•..........•....•...•.•••.•. 312 CWT Farms, Inc. v. Commissioner, 79 T.C. 86 (1982), aff'd 755 F.2d 790 (11th Cir, 1985), ....................... , •.... 345 Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 458 DHL Corp. v. Commissioner, 285 F.3d 1210 (9th Cir. 2002), aff'g in part, rev'g in part, T.C. Memo. 1998-461, 76 T.C.M. (CCH) 1122 (1998) ........ , ................... , ••. passim Eli Lilly & Co. v. Commissioner, 856 F.2d 855 (7th Cir. 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313 - xiii - CITATIONS Exxon Corp. v. United States, 88 F.3d 968 (Fed. Cir. 1996) .•• 340 Grunenbaum v. Commissioner, 420 F.2d 332 (2d Cir. 1970) •••••• 350 H Group Holding, Inc and Subs. v. Commissioner, T.C. Memo. 1999-334, 78 T.C.M. (CCH) 533 (1999) ••••....••.••....•.•... 442 Hart v. McLucas, 535 F.2d 516 (9th Cir. 1976) .•••.••••.••.••• 338 Hospital Corp. of America v. Commissioner, 81 T.C. 520 (1983) . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . 323 Huffman v. Commissioner, 518 F.3d 357 (6th Cir. 2008) ... 345, 348 In re Lovin, 652 F.3d 1349 (Fed. Cir. 2011) ...•.......•.•.•.. 349 Jewett v. Commissioner, 455 U.S. 305 (1982) .••...••.••.. 338, 341 Kenco Restaurants, Inc. v. Commissioner, 206 F.3d 588 (6th Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312, 478 Levy v. Sterling Holding Co. LLC, 544 F.3d 493 (3d Cir. 2008) . . . . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348 Likins-Foster Honolulu Corp. v. Commissioner, 840 F.2d 642 (9th Cir. 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394 Lufkin Foundry v. Commissioner, 468 F.2d 805 (5th Cir. 1972) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 Mayo Foundation for Medical Education & Research v. United States, 562 U.S. 44 (2011) ................................. 506 Mitchell v. Commissioner, 775 F.3d 1243 (10th Cir. 2015) 337, 348 Montgomery Coca-Cola Bottling Co., Inc. v. United States, 615 F.2d 1318 (Cl. Ct. 1980) •.•...••...•.•..••....•.••..... 378 Nat'! Educ. Ass'n v. Commissioner, 137 T.C. 100 (2011) .••..•. 341 National Cable & Telecommunications Ass'n v. Brand X Internet Services, 545 U.S. 967 (2005) .•..•........... 348, 349 Nestle Holdings, Inc. v. Commissioner, T.C. Memo. 1995-441, 70 T.C.M. (CCH) 682, rev'd on other grounds, 152 F.3d 83 (2d Cir. 1998) . . . . . . . . . . , . , . . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . - xiv - 426 CITATIONS Park 'N Fly, Inc. v. Dollar Park and Fly, Inc., 469 U.S. 189 (1985) . . . . . . . . . , . . . . . . . . • . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 412 Peck v. Commissioner, 752 F.2d 469 (9th Cir. 1985) .•.••. 312, 315 Perkin-Elmer Corp. v. Commissioner, T.C. Memo. 1993-414, 66 T.C.M. (CCH) 634 (1993) .................... , ............... 312 R.T. French Co. v. Commissioner, 60 T.C. 836 (1973) ..•.•.•... 443 Rand v. Commissioner, 141 T.C. 376 (2013).•.•...•••••..•..••• 338 Schwab v. Commissioner, 715 F.3d 1169 (9th Cir. 2013) .••..... 338 Seagate Technology, Inc. v. Commissioner, 102 T.C. 149 (1994) . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314 Shea Homes, Inc. v. Commissioner, 142 T.C 60 (2014), appeal docketed, No. 14-72162 (9th Cir. July 16, 2014) ....•••..... 340 Stewart v. Commissioner, 714 F.2d 977 (9th Cir. 1983) •......• 314 Strom v. United States, 641 F.3d 1051 (9th Cir. 2011) .....•.• 340 Sundstrand Corp. & Subs. v. Commissioner, 96 T.C. 226 (1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311, 312, 314 U.S. v. Montgomery County, 761 F.2d 998 (4th Cir. 1985) .••••. 350 Union Carbide Corp. & Subs. v. Commissioner, 697 F.3d 104 (2d Cir. 2012) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344, 348 United States v. United States Gypsum Co., 333 U.S. 364 (1948) . . . . . . . . . . . . . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 378 VERITAS Software Corp. v. Commissioner, 133 T.C. 297 (2009), nonacq., 2010-49 I.R.B. (Dec. 6, 2010) .......... passim Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158 (1946), aff'd, 162 F.2d 513 (10th Cir. 1947) .......•.....•. 410 Xilinx, Inc. v. Commissioner, 598 F.3d 1191 (9th Cir. 2010) ..... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313, 315, 342, 349 - xv - CITATIONS Statutes I.R.C. section 41 (b) (2) (B) (ii) .....••..••..•.•••.••...•••••.• 497 I.R.C. section 41 (d) (1) ..................•................... 501 I.R.C. section 41 (d) (4) ....................................... 286 I.R.C. section 41 (d) (4) (B) •...•...•.•..•.•.•••••..•••... 498, 499 I.R.C. section 41 (d) (4) (D) .............•...........•......... 498 I.R.C. section 482 ........................................ passim I.R.C. section 6001........•................................. 485 I. R.C. section 6662... . . ... . .. . . . .. . .... . .... . ... . . . .. . . . . . .. 362 I.R.C. section 936 (h) (3) (B) .......................•.•........ 321 Other Authorities 57 Fed. Reg. 3571 (January 30, 1992) ••.••.•.•.•.••.....•..•.. 344 H.R. Conf. Rep. No. 99-841 at II-638 (1986), reprinted in 1986-3 C.B. (Vol. 4) 1, 638 •.•.•.•...•..•....••..•..•...... 343 H.R. Rep. No. 2, 70th Cong., 1st Sess. 16 (1927) •..••.•••.•.• 314 s. Rep. No. 960, 70th Cong., 1st Sess. 24 (1928) •...••.•...•• 314 Shannon P. Pratt and Roger J. Grabowski, Cost of Capital: Applications and Examples, 161 (4th ed. 2010) ••.•.•.••.•... 374 T.D. 8470, 1993-1 C.B. 90 .................................... 341 T.D. 8552, 1994-2 C.B. 93, 108 •..•.•••••••••.•....•.•.•. 331, 341 T.D. 8632, 1996-1 C.B. 85 ..•.•..••••.••.•.••.• 341, 344, 347, 348 T.D. 9441, 2009-7 I.R.B. 460 .•.•.••.•..•....•.•..••........•• 352 Rules Fed. R. Evid. 702 ....................................... 457, 458 Regulations Prop. Treas. Reg. §1.482 ...•.••.•...••.................•..... 344 - xvi - CITATIONS Prop. Treas. Reg. §1.482-7, 70 Fed. Reg. 51116-01, 2005-2 C.B. 625 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352, 353 Treas. Reg. §1.482-1 .................................... 339, 349 Treas. Reg. §1.482-l(a) •...•.......•...•...••••.....•.•. 313, 314 Treas. Reg. §1.482-1 (a) (1) ...............•.••.••.••..•....... 311 Treas. Reg. §1.482-l(b) ....•..•....•...•.•..••....• 314, 340, 341 Treas. Reg. §1.482-1 (bl (1) .•••••••.•••••...•.•.•••...•.• 314, 479 Treas. Reg. §1.482-l(b) (2) (i) ..••....•....•..•..........•...• 316 Treas. Reg. §1.482-l(c) •••••.•••.•..•...•....•.....•.... 340, 362 Treas. Reg. §1.482-l(c) (1) •...••........•...•.•.......•• 316, 354 Treas. Reg. §1.482-l(c) (2) ..••.....•..•....••• 354, 393, 438, 447 Treas. Reg. §L482-1 (cl (2) (ii) ••..•..•••.•....•.•.......•..••• 459 Treas. Reg. §1.482-1 (c) (2) (ii) (A) •........•..........•....... 367 Treas. Reg. §1.482-l(c) (2) (ii) (B) ............. 367, 431, 454, 459 Treas. Reg. §1. 482-1 (c) (2) (iii) ..•..•.•••..•••....•..•••..•.. 406 Treas. Reg. §1.482-l(d) (1) ..•••.•••..•.•..•••.....•...•...... 438 Treas. Reg. §1.482-l(d) (1) (iv) •.•...••.......•..••..•.••..... 375 Treas. Reg. §1.482-1 (di (2) .........•...........•....••.... passim Treas. Reg. §1.482-1 (d) (3) (ii) (A) ...•.•.......••..........•.. 441 Treas. Reg. §1. 482-1 (d) (3) (ii) (A) (2) •.......•.•...•.........• 448 Treas. Reg. §1.482-1 (d) (3) (ii) (BJ ..•.........•...•...•.. 331, 332 Treas. Reg. §1.482-1 (di (3) (ii) (Cl, Example 3•...•.•.......•.. 332 Treas. Reg. §1.482-l(d) (3) (iv) ....••....•.................••. 375 Treas. Reg. §1.482-l(d) (3) (iv) (G) ......•...•..•..........••.• 375 - xvii - CITATIONS Treas. Reg. §1, 482-1(f) (2) (i) ................................ 357 Treas. Reg. §1.482-l(f) (2)(ii) (A) ..••••••.•.••.•••••••••••••• 393 Treas. Reg. §l.482-4..••.••....•.•••.••••.•... 337, 338, 349, 354 Treas. Reg. §1.482-4(a)..•...••..•..•••••.•••.•.•..•••••..••• 353 Treas. Reg. §1. 482-4(b) ................................... passim Treas. Reg. §l.482-4(b)(6) ................................... 317 Treas. Reg. §1.482-4(c)(2) ........................... , ........ 441 Treas. Reg. §l.482-4(c) (2) (iii) (A) •••••.•.•••.•••..••.••.•.•• 438 Treas. Reg. §1.482-4(d) (2) ...... , ........................ ,... 394 Treas. Reg. §1, 482-4(f) (3) (i) ........................... 326, 331 Treas. Reg. §1.482-4(£) (3) (ii) ............................... 326 Treas. Reg. §1.482-4 {f) (3) (ii) (A) .•••••.•.••••••.••.•.•• 326, 327 Treas. Reg. §1.482-4(f) (3) (ii) (B) ..•.••..••••••••.•••• , •.••• , 326 Treas. Reg. §1.482-4(fl (3) (iv), Example 3.................... 332 Treas. Reg. §1.482-6 {C) (3) (i) (B) .......... ,,,.... ,, .. ,,,, .... 366 Treas. Reg. §l.482-7A(f) ........................... ,., ....... 316 Treas. Reg. Sl,482-7A ................. , ................... passim Treas. Reg. §l.482-7A(a)..................................... 339 Treas. Reg. §1.482-7A(a)(2)..................... , ......... passim Treas. Reg. §1.482-7A(a)(3) •••..•..•.••••.•••.••••• 316, 339, 479 Treas. Reg. §l.482-7A(b) (4) (iv) ......................... 317, 318 Treas. Reg. §l.482-7A(d)..................................... 316 Treas. Reg. §l.482-7A(d)(l) ............................... passim Treas. Reg. §l.482-7A(d) (2)........•....•..•..•.••. 505, 506, 507 - xviii - CITATIONS Treas. Reg. §l.482-7A(d) (3), Ex. 2••..•.•.....••.•.•..••.•••. 499 Treas. Reg. §1. 482-7A(e) ................................ 316, 479 Treas. Reg. §1.482-7A(g) ....••......•••.•••.•.•.... 324, 405, 452 Treas. Reg. §1.482-7A(g) (1) ••••.•••.•••••..•••.•.•• 316, 321, 339 Treas. Reg. §l.482-7A(g) (2) ............................... passim Treas. Reg. §1.482-7A(j) (2) (A) .•••.•.•.••••..••••..••.•.••••• 485 Treas. Reg. §1. 482-7A(j) (3) .................................. 318 Treas. Reg. §1.6001-1........................................ 485 Treas. Reg. 86, art. 45-1 (cl (1934) ........................... 341 Treas. Reg. §1.41-4 (a) (4) .................................... 498 Treas. Reg. §1.41-4 (a) (5) .................................... 498 Treas. Reg. §1.482-4 (d) ...................................... 476 Treas. Reg. §l.482-4(d)(l) .........•......................... 394 - xix - UNITED STATES TAX COURT AMAZON.COM INC. and SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) Docket No. 31197-12 ) l ) Judge Lauber l RESPONDENT'S AMENDED SIMULTANEOUS OPENING BRIEF PRELIMINARY STATEMENT This case involves income tax deficiencies determined by respondent of $8,380,790 and $225,653,149 for the 2005 and 2006 years, respectively. Trial was held before the Honorable Albert G, Lauber in two separate Special Sessions in Seattle, WA, from November 3, 2014 through November 26, 2014 and December 15, 2014 through December 23, 2014. The evidence consists of pleadings, fact and exhibit stipulations, testimony, and exhibits offered and demonstratives used at trial. The list of respondent's exhibits admitted during trial and demonstratives offered by the parties are attached to the January 30, 2015 letter from the parties to the Court. A list of petitioner's exhibits was admitted at trial. Exs. 1150-P, 1245-P. Docket No. 31197-12 The Court ordered the parties to file simultaneous opening briefs on or before April 22, 2015, and reply briefs on or before July 21, 2015. - 2 - Docket No. 31197-12 QUESTIONS PRESENTED 1. Whether the price Amazon Europe Holding Technologies SCS (AEHT) paid Amazon US for the initial buy-in of intangible property (IP) used to operate Amazon's European Websites Business was an arm's-length price under I.R.C. § 482. 2. Whether respondent's determination that petitioner omitted costs related to intangible development under its qualified cost sharing agreement (QCSA) in computing the cost sharing payments due from AEHT in the amounts of $23,032,018 and $109,889,346 in 2005 and 2006, respectively, is arbitrary and capricious and whether petitioner's claim to reduce the 2005 cost sharing payment by $59,752,000 should be denied. 3. Whether petitioner's claim to reduce its 2005 and 2006 cost sharing payments from AEHT in the amounts of $2,545,000 and $6,951,000, respectively, by excluding stock-based compensation (SBC) related to intangible development from the pool of intangible development costs (IDCs) should be denied. - 3 - �----------Docket No. 31197-12 RESPONDENT'S REQUEST FOR FINDINGS OF FACT GLOSSARY OF TERMS (a) "A9" refers to A9.com, Inc., a member of the Amazon US Group; (b) "ACI" refers to Amazon.com, Inc., a publicly traded corporation and common parent of the Amazon US Group; (c) "ADSI" refers to Amazon Data Services Ireland Ltd., an Irish company wholly owned by AEU; (d) "AEHT" refers to Amazon Europe Holding Technologies SCS, a Luxembourg limited partnership treated as a corporation for U.S. federal income tax purposes; (eY "AEU" refers to Amazon EU Sarl, a Luxembourg company wholly owned by AEHT; (f) "AIM" refers to Amazon.com Int'l M,;irketplace, Inc., a Delaware corporation and wholly owned direct subsidiary of ACI, formerly known as Amazon.com International Auctions, Inc. or "AIA;" (g) "AIS" refers to Amazon.com Int'l Sales, Inc., a Delaware corporation and wholly owned direct subsidiary of ACI; (h) "Amazon" refers to all or some members of the worldwide group of controlled corporations of which ACI is the common parent; - 4 - Docket No. 31197-12 (i) "Amazon.co.uk" refers to the website with the domain name "Amazon.co.uk;" (j) "Amazon.co.uk Ltd." refers to a company organized under the laws of England and Wales; (k) "Amazon.com" refers to the website with the domain name "Amazon.com;" (1) "Amazon.de" refers to the website with the domain name "Amazon.de;" (m ) "Amazon.de GmbH" refers to a company organized under the laws of Germany; (n) "Amazon.fr" refers to the website with the domain name "Amazon.fr;" (o) "Amazon.fr Holdings SAS" refers to a company organized under the laws of France; (p) "Amazon.fr Sar!" refers to a French company wholly owned by Amazon.fr Holdings SAS; (q) "Amazon CS Ireland" refers to Amazon cs Ireland Limited, a company organized under the laws of Ireland; (r) "Amazon (Jersey) Limited" refers to a company organized under the laws of Jersey, Channel Islands; (s) "Amazon (Jersey) Sales Limited" refers to a company organized under the laws of Jersey, Channel Islands; - 5 - Docket No. 31197-12 (t) "Amazon Logistik GmbH" refers to a German company wholly owned by Amazon.de GmbH; (u) "Amazon Logistique SAS" refers to a French company wholly owned by Amazon.fr Holdings SAS; (v) "Amazon US Group" or "Amazon US" refers to the affiliated group of corporations that join in filing a consolidated US federal income tax return with AC! as common parent; (w) "AMEU" refers to Amazon Media EU Sarl, a Luxembourg company wholly owned by AEU; (x) "ASE" refers to Amazon Services Europe Sarl, a Luxembourg company wholly owned by AEU; (y) "ASEU" refers to Amazon Sales EU, Inc., a Delaware corporation and wholly owned direct subsidiary of AC!; (z) "ATI" refers to Amazon Technologies, Inc., a Delaware corporation and wholly owned direct subsidiary of AC!; (aa) "Business Transfer Date" refers to May 1, 2006, the date upon which operation of the European Websites Business was commenced by the entities formed under the laws of Luxembourg that had elected to be disregarded as separate from AEHT for US federal income tax purposes; (bbl "EU Holdco" refers to Amazon Europe Holding, Inc., a Delaware corporation and wholly owned direct subsidiary of AC!; - 6 - Docket No. 31197-12 (cc) "European Retail Business" refers to Amazon's business of selling products online through the websites having European country-code top-level domain names, such as the websites Amazon.co.uk, Amazon.de or Amazon.fr; "European Websites Business" refers to the European (dd) Retail Business and the European 3PS Business; and "3PS Business" refers to Amazon's business of (ee) providing third parties with a set of eCommerce platforms, services, or tools for the sale of the third parties' goods and services. PRELIMINARY AND JURISDICTIONAL MATTERS 1. AC!, a publicly traded corporation and common parent of the Amazon us Group, is a Delaware corporation that maintained its principal place of business at the time of the filing of the Petition at 410 Terry Avenue North, Seattle, Washington, 981095210. Stip. 400. 2. ACI was incorporated on July 5, 1994 in the state of Washington. 1996. AC! was reincorporated in the state of Delaware in Stip. 142, 145. 3. Amazon was founded by Jeffrey P. Bezos. Mr. Bezos has served to date as Amazon's Chairman of the Board and Chief Executive Officer, except for a brief period of time in 19992000, as its President. Stip. 143. - 7 - ----------Docket No. 31197-12 4. In 1995, Amazon commenced operations as an online retailer of books through the domain name (also called web address or URL) "Amazon.com." 5. Stip. 144. On May 15, 1997, ACI completed an initial public offering (IPO) of 3,000,000 shares of its common stock. ACI's common stock was listed on the NASDAQ National Market under the symbol "AMZN." The IPO was successful and raised $54 million for Amazon, giving the company an implied market value of $438 million. Stip. 148; Tr. 7237:20-7239:14, 7241:10-22 (Blackburn). ESTABLISHMENT OF JIMAZON'S EUROPEAN BUSINESS 6. In April 1998, Amazon acquired three internet companies in the UK and Germany for an aggregate purchase price of $55 million: (a) Bookpages, Ltd. (www.bookpages.co.uk) (Bookpages), one of the UK's largest online bookstores, providing access to 1.2 million UK books in print; (b) Telebook (www.telebuch.de) (Telebook), with a catalog of nearly 400,000 German-language titles; (c) Internet Movie Database (www.imdb.com) (IMDB), a UK company originally launched in 1990 and a comprehensive repository for movie and television information on the Internet. Stip. 113-116, 175. - 8 - �-----------Docket No. 31197-12 7, In October 1998, Amazon re-launched the Bookpages and Telebook websites under the domain names "Amazon.co.uk" and "Amazon.de", respectively. 8. Stip. 176. In an April 1998 press release, Amazon announced that "[t]hese acquisitions [Bookpages, Telebook, and IMDBJ will enable Amazon.com to quickly offer European customers the same combination of selection, service, and value that we now provide our U.S. customers." 9. Stip. 116. Amazon entered the French market in August 2000, by launching an online retail business aimed at the French market through the French-language website "Amazon.fr." 10. Stip. 179. Beginning in 1998 and continuing through 2006, the European Retail Business was conducted through the websites Amazon.co.uk, Amazon.de and Amazon.fr. 11. Stip. 2. By 2000, Amazon.co.uk, Amazon.de and Amazon.com were the No. 1, No. 2 and No. 3 most popular online retail domains in Europe. Ex. 3-J at AMZCOM00041356. To its board of directors at that time, Amazon deemed its international expansion a success. 12. Ex. C-130-R at AMZCOM00015592. Starting with the 2003 Form 10-K, Amazon began breaking down its results into two segments, a North America segment and an international segment. Ex. 7-J at AMZCOM00041723. Tr. 2895:3-14 (Szkutak); Prior to that time, Amazon reported - 9 - Docket No. 31197-12 results from a product viewpoint. Tr. 2895:11-20 (Szkutak). Because of the growth of its international business, Amazon decided it was appropriate to change its reporting. Tr. 2895:5- 2896:12 (Szkutak). 13. By 2004 Amazon's European (EU) annual sales were $2.3 billion and accounted for one third of Amazon's worldwide revenues. Exs. C-4613-R Appendix A at 8 (Frisch), C-4638-R at 6 (Oswald), C-285-J at IRS_007847-053, 283-J, C-2380-P at Exhibit 2G (Wentland) • 14. For the years listed, Amazon had the following number of total employees in each country: OS A. 10,219 F. 11,213 K. 14,612 2003 2004 2005 Germany B. 1,611 G. 1,514 L. 1,658 OK C. 2,486 H. 2,260 M. 2,255 France D. 255 I. 183 N. 208 Lux E. 2 J. 2 o. 27 Stip. 934; Exs. C-2357-P, C-2220-P, C-2309-P. 15. For the years listed, Amazon had the following number of total employees in each country with the job title of either "Buyer", "Buying Assistant", "Manager, Buying", "Principal Buyer", "Director, Buying", "VP, Buying", "Purchasing Assistant", "Procurement Specialist", "Manager, Procurement", "Director, Procurement" or "VP, Procurement": - 10 - Docket No. 31197-12 us A. F. 2003 2004 2005 K. 148 179 198 UK Germany B. 43 G. 38 L. 34 C. 42 H. 70 M. 75 France D. 18 I. 6 9 N. Lux E. 0 J. 0 o. 1 Exs. C-2357-P, C-2220-P, C-2309-P. 16. For the years listed, Amazon had the following number of total employees in each country with the job title of either "Business Analyst", "Manager, Plan/Dev", "Financial Analyst", "Manager, Finance", "Director, Finance", or "VP Finance": us A. F. 2003 2004 2005 K. 183 181 231 UK Germany B. 15 G. 16 L. 18 c. H. M. 23 26 32 France 4 D. I. 5 N. 6 Lux E. J. o. 1 5 Exs. C-2357-P, C-2220-P, C-2309-P, 17. For the years listed, Amazon had the following number of total employees in each country with the job title of "FC (Fulfillment Center} Associate": us A. F. K. 2003 2004 2005 2,318 2,299 3,511 Germany B. 1,047 G. 1,055 L. 1,182 UK c. H. M. 549 984 989 France D, 127 I. 116 N. 132 Lux E, J. o. 0 Exs. c-2357-P, C-2220-P, C-2309-P. 18. For the years listed, Amazon had the following number of total employees in each country with the job title of either "Software Development Engineer", "Principal Software Development Engineer", "Manager, Software Development", "Director, Software Development", or "VP, Software Development": - 11 - Docket No. 31197-12 us 595 A. 995 F. K. 1,463 2003 2004 2005 Germany B. 3 G. 2 L. 1 UK c. 19 H. 34 M. 53 France 1 D. I. 0 N. 10 Lux E. 0 J. 0 o. 0 Exs. C-2357-P, C-2220-P, c-2309-P. AMAZON'S BUSINESS MODEL 19. In its early days, Amazon promoted itself as the "earth's biggest bookstore." 20. Tr. 4670:23-4671:1 (Kilar). As of December 31, 1998, Amazon's objective was to become the best place to buy, find and discover any product or service available online. Ex. 2-J at AMZCOM00041310. Amazon started with books and it was very clear from the beginning that the very long-term vision was to go beyond books and be earth's largest selection. Tr. 593:9-12 (Piacentini); Ex. C-130-R at AMZCOM00015591; Tr. 1039:21-1040:2 (Kleber). 21. In 2004, Amazon's vision was to provide the "Earth's Biggest Section" by building a place where people can find and discover anything they want to buy online. AMZCOM00144574. Ex. 1123-P at Amazon sought to be the Earth's Most Customer­ Centric Company by starting with the customer and working backwards. Ex. 1123-P at AMZCOM00144574; Tr. 4671:2-4 (Kilar); Tr. 175:4-11 (Valentine); Petition t 5.a.3. 22. At all times since 1997, Amazon.com used the internet to create real value for its customers and by doing so, sought - 12 - Docket No. 31197-12 to create an enduring franchise even in established and large markets. 23. Exs. 1-J at AMZCOM00041245; 2-J through 16-J. Through 1999, Amazon invested heavily, purposely losing money. (Kilar). line. Ex. C-130-R at AMZCOM00015590; Tr. 4623:2-16 Amazon was always extremely focused on the bottom Tr. 4665:1-7 (Kilar). 24. Amazon was focused on building a business that could last for generations. 25. Tr. 4670:9-20 (Kilar). Long-term thinking has been a key aspect of Amazon's business philosophy at all times. Ex. 1070-P at AMZCOM00115059- 060, AMZCOM00115072, AMZCOM00115081. Amazon invested for the long-term, sacrificing short-term profit to generate a long-term presence. Tr. 647:21-648:21, 739:12-22 (Piacentini); Ex. 8-J at AMZCOM00041785-787. 26. Free cash flow is the ultimate financial measure for Amazon and the one that it wants most to drive over the long term. Tr. 2908:9-20, 2909:18-24, 2944:14-10 (Szkutak); Tr. 175:12-18 (Valentine); Exs. 8-J at AMZCOM00041782, 1-J at AMZCOM00041245, 1123-P at AMZCOM00144610; Tr. 5859:2-16 (Frisch); Tr. 1040:3-6 (Kleber); Ex. C-4637-R at 14-15 (Oswald). Amazon differentiates itself by focusing on free cash flow more than GAAP income and noncash measures. (Szkutak); Ex. 1123-P at AMZCOM00144619. - 13 - Tr. 2944:24-10 .. Docket No. 31197-12 27. In its 1999 letter to shareholders, Mr. Bezos explained that the "Amazon.com platform is comprised of brand, customers, technology, distribution capability, deep eCommerce expertise, and a great team." 28. Ex. 3-J at AMZCOM00041357, By early 200 0, Amazon had reached "a 'tipping point,' where its platform allowed it to launch eCommerce business faster, with a higher quality of customer experience, a lower incremental cost,� h igher chance of success, and a faster path to scale and profitability than any other company." Ex. 3-J at AMZCOM00041357; Tr. 1008:7-10 (Kleber). 29. After September 11, 2001 and the dot-com bubble burst, Amazon focused more on profitability. Tr. 7259:20-25, 7261:12- 15, 7329:12-23 (Blackburn); Tr. 5451:5-16 (Dalzell); Tr. 1040:15-24, 1041:11-25, 1079:9-25 (Kleber). 30. In 2003, Amazon first showed a financial profit. Tr. 2898:9-12 (Szkutak). 31. company. Amazon was and is a very metric, input focused Tr. 2933:23-2942:5 (Szkutak); Tr. 4667:13-11 (Kilar); Tr. 114:13-16 (Valentine); Tr. 1059:1-3 (Kleber); Exs. C-4002-R, C-4074-R, 3051-R. Amazon uses customer-facing metrics to ensure it satisfies customers on every single transaction and earns their trust over the long term. Tr. 2946:4-2947:3 (Szkutak); Ex. C-4002-R; Tr. 1059:8-1061:25 (Kleber). - 14 - Metrics were -----------·· Docket No. 31197-12 produced by Finance. Tr. 1061:1-24 (Kleber); Tr. 7642:2-7643:15 (Olsavsky). 32. In March of 2005, Amazon's Chief Financial Officer, Tom Szkutak, presented management's proposed Health of the Franchise metrics to the board. 3051-R, C-4074-R. business teams. Tr. 2940:8-17 (Szkutak); Exs. Using metrics, Amazon set goals for the Tr. 2937:6-22 (Szkutak); Tr. 4669:5-4670:8 (Kilar); Tr. 7274:9-16 (Blackburn); Tr. 7641:19-7642:6 (Olsavsky). 33. In 2004, 87% of Amazon's international sales were media products. In North America, 70% of Amazon's net sales were media products. Ex. 1123-P at AMZCOM00144613. Amazon.de was seen as a relevant online bookstore known for selling other media products. 34. Tr. 963:2-10 (Kleber). In 2004, Amazon's operations in Europe had a 1111 market share of the online retail sales market, while Amazon's online retail sales market share in the US for the same period was approximately 1111, Tr. 7979:19-7980:15 discussing RD-569-C; Ex. C-4638-R at 11 (Oswald), 35. In 2004, Amazon's retail sales attributable to its operations in Germany, France, and the UK were - - 15 - 11111111 Docket No. 31197-12 11111111· 36. Tr. 7980:16-7981:18 discussing RD-570-C (Oswald). In 2005, Amazon's strategy for its existing retail business was to leverage disruptive trends, existing assets and competencies, and build new assets and competencies in order to build flywheels. As the flywheels spin around faster and faster, they generate increasing amounts of free cash flow and a business with an ever-improving customer experience. Ex. 3054-R at IRS_AMZ019199; Tr. 2656:6-2657:12 (Wilke); Tr. 421:20-25 (Greeley); RD-563; Tr. 7951:9-7952:17 (Oswald). CATEGORY LAUNCHES 37. As Amazon expanded, it launched additional product categories on its US and EU websites as detailed in the chart below. PRODUCT CATEGORIES Books Music Video Gift Center Electronics Toys Software Video Games Tools & Hardware E-Books for PCs and laptops and Amazon.com Website Launch 1995 1998 1998 1997 1999 1999 1999 1999 1999 Amazon.co.uk Website Launch 1998 1999 2000 2005 2001 2001 2000 2000 2004 Amazon.de Website Launch 1998 1999 2000 N/A 2001 2004 2000 2000 2004 Amazon.fr Website Launch 2000 2000 2000 N/A 2005 2007 2001 2001 2012 2000 N/A N/A N/A - 16 - Docket No. 31197-12 PRODUCT CATEGORIES wireless products Camera and Photo Kitchen Home& Garden Magazines Apparel and Accessories Sports & Outdoors Jewelry & Watches Gourmet Food Health & Personal Care Beauty Shoes & Accessories Baby Grocery Auto Parts & Accessories Office Supplies Amazon Basics, private-label line for quality consumer electronics Amazon.co111 Website Launch Alllazon,co.uk Website Launch Alllazon.de Website Launch Amazon.fr Website Launch 2000 2001 NIA NIA 2000 2000 2001 2002 2003 2003 2002 2008 2003 2004 2002 2008 2007 2007 2010 2003 2007 2006 2010 2003 2007 2007 2007 2003 2003 NIA 2008 NIA 2007 NIA 2009 2004 2005 2008 2007 2008 2007 2009 2009 2006 2006 2006 2007 2010 2009 2007 2010 2008 2007 2008 2009 2009 2009 2009 2009 2009 2009 NIA NIA 2013 Stip. 100; Ex. 1123-P at AMZCOM00144578-587. 38. In 2004, Amazon expected more category and country - 17 - Docket No. 31197-12 expansion over time. Ex. 1123-P at AMZCOM00144591. FULFILLMENT Fulfillment is the process where Amazon prepares an 39, order or item for shipment and ships it to the customer. 1061. Stip. Fulfillment includes activities related to buying, receiving, inspecting, and warehousing inventories; picking, packaging, and preparing customer orders for shipment; payment processing and related transactions such as guarantees for certain seller transactions and responding to inquiries from customers, 40, Stip. 913; Tr. 2660:10-14 (Wilke); PD-0450. In 1999, Amazon hired Jeff Wilke as Vice President of Operations to improve Amazon's' fulfillment process. Tr. 2645:13-2647:13, 2648:10-2650:6 (Wilke), 41. Amazon fulfills orders from its fulfillment centers. Tr. 2650:14-15 (Wilke), 42. Amazon's fulfillment centers are similar to large, complex assembly plants, or manufacturing facilities. Tr. 2650:21-25, 2673:6-7 (Wilke). 43. Unlike classic distribution centers, which move pallets of goods to stock a store, Amazon's fulfillment centers employ manufacturing processes to assemble customer orders. 2650:3-2651:9, 2673:1-4 (Wilke), 44. The fulfillment centers are a complex interaction - 18 - Tr. Docket No. 31197-12 between humans, machines and software. 45. Tr. 2679:22-24 (Wilke). By continually improving fulfillment software, the Tr. 2679:24-2680:2 fulfillment centers become more productive. (Wilke). 46. In 1999, Amazon invested approximately $300 million to build new fulfillment centers and to improve the fulfillment function process. Tr. 2648:5-8 (Wilke). Amazon opened fulfillment centers in the following locations on the following dates: UNITED STATES Year Opened Pre- • Seattle, WA 1998 •93,000 sq. ft. • New Castle, Delaware •202,046 sq. ft. 1998 1999 UNITED KINGDOM • Slough, England • 41,000 sq. ft. • Campbellsville, Kentucky •727,000 sq. ft. • Coffeyville, Kansas • 876,761 sq. ft. • Lexinaton, GERMANY • Regensburg • 32,000 sq. ft. • Bad Hersfeld 459,000 sq. ft. • - 19 - FRANCE Docket No. 31197-12 Year Opened UNITED STATES Kentucky •604,000 sq. ft. • Fernley, Nevada •588,560 sq. ft. 2000 UNITED KINGDOM • Martson Gate, England 503,000 sq. ft. • 2001 2003 2004 2005 • Reno, Nevada •336,000 sq. ft. • Chambersburg, Pennsylvania •420,000 sq. ft. • Lexington, Kentucky •380,000 sq. ft. • Gourock, Inverclyde, Scotland 294,000 sq. ft. • Hebron, Kentucky (two locations) •484,000 sq. ft. •542,960 sq. ft. • Louisville, Kentucky • 11,920 sq. ft. • Carlisle, • Glenrothes, Scotland • 270,000 sq. ft. • - 20 - GERMANY FRANCE • Orleans • 100,000 sq. ft. Docket No. 31197-12 UNITED S'l'A'l'ES Year Opened 2006 Pennsylvania • 558,700 sq. ft. • Lewisberry, Pennsylvania • 705,000 sq. ft. • Dallas, Texas •630,800 sq. ft. UNITED KINGDOM • Allentown, Pennsylvania •68,000 sq. ft. GERMANY FRANCE • Leipzig 832,000 sq. ft. • Stip. 106. ASSOCIATES AND 3PS 47, In July 1996, Amazon launched the Amazon.com Associates Program as part of its effort to increase customers. Stip. 146; Tr. 7250: 15-17 (Blackburn); Tr. 2983: 6-10 (Szkutak). Associates were paid a commission if an Amazon customer clicked through from an Associates website. Stip. 1034. The Associates Program was one of the first affiliate programs in eCornmerce. Tr. 2754:8-10 (Wilke). 48, Amazon. The method of implementing Associates was patented by Tr. 7250:8-14 (Blackburn). By December 1998, approximately 200,000 websites had enrolled in the Associates program. Stip. 151. - 21 - Docket No. 31197-12 49. In 1999, Amazon launched Auctions and then zShops. Stip. 154, 156. In November 2000, Amazon launched Amazon Marketplace which included Auctions and zShops. 3-J at AMZCOM00041365-66. Stip. 162; Ex. These programs permitted third parties to list and sell their selection on Amazon.corn's website. Tr. 7250:24-7252:23 (Blackburn); Ex. 3-J at AMZCOM00041366. zShops, offering fixed as opposed to auction pricing, was terminated in October 2006 and Amazon encouraged sellers to migrate all of their zShops listings to Amazon Marketplace for a better selling experience. 50. Stip, 154. In November 1999, Amazon launched Auctions and zShops on Amazon.co.uk and Amazon.de. Auctions and zShops were owned and operated by a US wholly owned Amazon subsidiary, Amazon.com International Auctions, Inc. 51. In March 2002, Amazon launched Amazon Marketplace on Amazon.co.Uk and Amazon.de. 52. Amazon.fr. 53. Stip. 177. Stip. 180. In November 2003, Amazon launched Marketplace on Stip. 181. By 2001, Amazon had begun marketing three programs for third-party sellers that were designed to provide catalog retailers, physical store retailers and manufacturers with cost­ effective eCornmerce solutions, and to expand selection on Amazon's websites for the benefit of its customers: - 22 - (a) the Docket No. 31197-12 Merchants@amazon.com Program, where the third-party seller offered products for sale on Amazon.com, either in the online retail stores or on a co-branded store on Amazon.com, or both; (b) the Merchant Program, where the third-party seller's eCommerce website operated at its own URL using Amazon.corn's features and technology; and (c) the Syndicated Stores Program, where the third-party seller's eCommerce website used Amazon.corn's eCommerce services and tools, and offered Amazon.corn's product selection. 54. Ex. 5-J at AMZCOM00041511. Under the Merchant Program, Amazon sometimes offered fulfillment services. Tr. 2919:20-2920:25 (Szkutak); Ex. 8-J at AMZCOM00041792. 55. Under the Syndicated Stores Program, Amazon was responsible for fulfillment and customer service and remitted a commission to the third party. 56. Ex. 5-J at AMZCOM00041511. As the Marketplace and Merchants@ programs evolved, they both came to be called Marketplace. Tr. 2992:18-2993:1 (Szkutak). 57. Amazon sought to leverage its platform by offering increased selection through its Marketplace, Merchants@, Merchants.com and Syndicated Stores programs. Ex. 1123-P at AMZCOM00144577, 4588, 4589; Tr. 2997:9-15 (Szkutak); Ex. 3054-R at IRS-AMZ019199; Tr. 7253:8-18 (Blackburn); Ex. 8-J at - 23 - Docket No. 31197-12 AMZCOM00041784; Tr. 1062:18-21 (Kleber); Exs. 1123-P at AMZCOM00144588-590, C-2197-P, C-425-J. 58. Amazon bet that its own business would benefit by increasing selection on its website. Tr. 7253:19-7254:2 (Blackburn); Tr. 424:1-3 (Greeley). Amazon's 3PS Business allowed Amazon's catalog to grow thereby providing more selection. 59. Tr. 425:1-426:1 (Greeley). Amazon wanted to enable other retailers to innovate on top of its eCommerce platform. 60. Ex. C-4622-R at i 37 (Felten). In 2003 to 2006, Amazon sought to develop the best third party selling platform in the market. (Kilar). Tr. 4641:2-18 Amazon sought to drive incremental selection, unit growth and new customers through the Amazon.com platform by adding hundreds of new partners. Exs. 3049-R at IRS_013315, C-475-R at AMZCOM00076263, C-4622-R at i 37 (Felten); Tr. 3568:6-9 (Moore). 61. ASIN is an inventory tag for each distinct item. 424:7-16 (Greeley). Tr. The number of distinct ASIN's in Europe grew from 244,488 in 1998 to 3.7 million by 2005. at Exhibit SD (Wentland). Ex. C-2380-P The number of distinct ASIN's in Europe grew to 38.3 million by 2013. Ex. C-2380-P at Exhibit SD (Wentland). 62. Amazon customers grew from 1.5 million in 1997 to - 24 - over Docket No. 31197-12 30 million in 2004. 63. Ex. C-4629-R at i 27 (Wilcox). At Amazon, the term "platform" was used to describe something upon which other people can build a business. Tr. 4646:6-11 (Kilar); Tr. 2027:16-25 (Porter); Tr. 233:22-235:8, 235:13-24 (Valentine); Ex. C-4000-R at AMZCOM00087184. 64. Amazon made a conscious decision in spring of 2004 to invest in Web Services as a business. Tr. 2972:15-21 (Szkutak). Amazon Web Services (AWS) was a way to leverage Amazon.corn's platform for developers. Ex. C-323-J; Tr. 2976:11-19 (Szkutak); 233:22-235:8 (Valentine); Ex. C-323-J at AMZCOM00010034. AWS offers developers high-usage services that are expensive, time­ consuming or distracting for developers to build themselves. Ex. C-323-J at AMZCOM00010030. SHIPPING 65. In November 2000, Amazon introduced its free Super Saver Shipping Offer on orders over $100 on the Amazon.com website. Stip. 163. Germany started free shipping in 2003. Tr. 1052:5-15 (Kleber). 66. By 2004, Amazon offered price guarantees, discounts, and free shipping in all countries. AMZCOM00144599-601. Ex. 1123-P at Amazon does not include the costs of free shipping or promotional offers in its marketing expenditures, but it views such offers as effective marketing tools. - 25 - Stip. Docket No. 31197-12 105; Ex. 8-J at AMZCOM00041792. 1\MAZON'S SUCCESS 67. A key to Amazon.corn's success is "creating a consistent, branded experience that is synonymous with shopping convenience." Ex. 163-R at AMZCOM00092317; RD-468; Tr. 6505:11- 21 (Conley). 68. In 2004, Amazon scored the highest ever score for customer satisfaction service in the industry online or offline. Ex. 1123-P at AMZCOM00144602. 69. Amazon was more capital efficient than bricks and mortar retailers because it did not invest in stores. Ex. 1123- Pat AMZCOM00144603. 70. The "long tail" refers to the additional selection that online retailers can offer because they are not constrained by the limited space of a traditional store. cater to the long tail customer. Amazon is able to Tr. 2977:20-2978:20 (Szkutak); Tr. 887:20-888:25 (Garambois). 71. capital. Inventory is a significant piece of Amazon's working Because Amazon sells the inventory before it has to pay its supplier , it has a negative operating cycle. 2967:3-24 (Szkutak); Tr. 5684:25-5686:2 (Frisch). Tr. Negative operating cycle is a source of cash and a margin benefit for Amazon. Tr. 2977:7-11 (Szkutak); Ex. 1123-P at AMZCOM00144605- 26 - Docket No. 31197-12 607, AMZCOM000144609; Tr. 5684:25-5686:2; Ex. C-4613-R at 33 (Frisch). 72. Amazon's negative operating cycle distinguishes it from a bricks and mortar retailer. Tr. 2968:3-6, 2977:14-17 (Szkutak); Ex. 3054-R; Tr. 5684:25-5686:2 (Frisch); 5431:55432:17 (Dalzell). 73. Amazon's revenues grew 31% in 2004. IRS-AMZ019346. Ex. 1018-P at International revenues grew 43% in 2004. 1018-P at IRS-AMZ019347. Ex. Amazon's free cash flow increased 38% to $477 million in 2004, a $131 million improvement over the prior year. Exs. 8-J at AMZCOM00041784; 1018-P at IRS­ AMZ019346. 74. In 2004, Amazon expected that its international business would generate greater than 50% of its revenue. Tr. 2979:17-2980:23 (Szkutak); Exs. 3054-R at IRS-AMZ019198, 1123-P at AMZCOM00144615. 75. In 2004, Amazon expected low double digit operating margins over the long term. Ex. 1123-P at AMZCOM00144617; Tr. 2981:1-8; Ex. 3054-R at IRS-AMZ019199; Tr. 5857:20-5858:9 (Frisch); Ex. 1018-P at IRS-AMZ019346. 76. Prior to 2004, Amazon implemented "two-pizza teams" as a way to improve Amazon's software development processes. 2773:2-2774:7, 2470:7-11 (Wilke). Tr. The two-pizza team concept - 27 - Docket No. 31197-12 stems from a book titled "Creation." Tr. 2773:2-2774:7 (Wilke). The idea was to organize Amazon's software development around teams that had fitness functions as the only definition of their success, and allow Amazon to scale more broadly than a classical hierarchical organization. 77. Tr. 2773:2-2774:7 (Wilke). Prior to 2005, the majority of Amazon's technology and content costs were incurred in the US and most of them were allocated to the North American segment. Exs. 1018-P at IRS­ AMZ00019346, 8-J at AMZCOM00041826, 9-J at AMZCOM00041927, 10-J at AMZCOM00042023, 11-J at AMZCOM00042117, 12-J at AMZCOM00042211, 13-J at AMZCOM00042301, 14-J at AMZCOM00042390391.· 78. Between 1995 and 2004, Amazon US spent approximately $1.487 billion on technology and content costs (including "Product Development" costs, as Amazon called the category before 1999). Exs. 1-J at AMZCOM00041277, 2-J at AMZCOM00041333, 3-J at AMZCOM00041397, 4-J at AMZCOM00041467, S­ J at AMZCOM00041553, 6-J at AMZCOM00041648, 7-J at AMZCOM00041742, 8-J at AMZCOM00041839, 3609-R at ii 37, 47 (Harden), C-2384-P at Table 1 (Mendelson). 79. Amazon is continuously innovating across all three dimensions -- price, convenience, and selection -- and leveraging technology and new business processes as part of that - 28 - Docket No. 31197-12 continuing innovation. 80. Tr. 436:15-437:6 (Greeley). Small incremental innovation is as important to Amazon as more disruptive innovation. 1038:1-16 (Kleber). Tr. 436:25-437:2 (Greeley); Tr. Innovation includes making a business process work for specific customer behavior, such as adapting Amazon's US technology to German behavior. (Kleber). Tr. 1038:1-16 Most of the time Amazon did not create technology; instead it incrementally improved its technology and processes. Tr. 7632:1-7634:6 (Olsavsky). 81. 2005. Amazon had a proven business model as of January 1, Tr. 6096:1-18 (Gompers). It had been operating incredibly successfully in the US. Tr. 6096:1-18 (Gompers). had billions of revenue in Europe and was not a start-up. It Tr. 6096:1-18 (Gompers). EUROPEAN STRUCTURE PRIOR TO THE BUSINESS TRANSFER DATE AIS 82. Effective December 1, 1999, Amazon.co.uk Ltd. sold its rights, title, and interest in certain assets, including the catalog, content, customer database, inventory and the lease to the UK distribution center, to AIS, then a newly formed, wholly owned US subsidiary of ACI. 83. Stip. 300; Ex. 164-J. Effective December 1, 1999, Amazon.de GmbH sold its customer database and inventory, and its rights to catalogs and - 29 - Docket No. 31197-12 content to AIS. Stip. 301; Tr, 2582:5-9 (Krabbenschmidt); Ex. 165-J. 84. Beginning in 1999 and continuing through April 30, 2006, AIS was the inventory owner and seller of record for the European Retail Business, other than with respect to CDs and DVDs sold to UK customers. 85. Stip, 22. From 1999 to 2001, Amazon.de GmbH, Amazon.co.uk and Amazon.fr Sarl (collectively the "EU Service Affiliates" or "EU Affiliates") were compensated by AIS on a cost plus basis. 2582:10-2583:9 (Krabbenschmidt); Stip. 23. Tr. Amazon.de GmbH was compensated at cost plus 5% for commissionaire services including procuring and purchasing products, arranging transportation and warehousing, dispatching products to customers and handling returns. Stip. 23(h). Ex. 31-J at AMZCOM00033821-822; Amazon.fr Sarl and Amazon Logistique SAS provided similar retail support, administrative, distribution, supply chain and warehousing services to AIS for cost plus 3% to 8%. Stip. 23(j), 23(m); Exs. 33-J, 38-J. 86. From the fourth quarter of 2001 (2003 for France) through December 31, 2003 (and through December 31, 2004 for France), Amazon's EU Service Affiliates were compensated by means of a referral bounty on new customers and a commission. Exs. 23-J at AMZCOM00033668, 28-J, 29-J at IRS_006796, 34-J at - 30 - Docket No. 31197-12 AMZCOM00004238, 40-J; Tr. 2582:2-9 (Krabbenschmidt). 87. It was projected that the new intercompany arrangements would cause the EU Service Affiliates to run at a Tr. 2583:11, 2583:25-2584:13 loss in the short term. (Krabbenschmidt). The EU tax authorities were not happy with the new customer bounty percentage of revenue approach. Tr. 2587:7-15 (Krabbenschmidt). 88. At the end of 2003, Amazon stopped using the advertising firm Widen (Krabbenschmidt). & Kennedy. At that point the EU Service Affiliates were put back on a cost-plus basis. 89. Tr. 2584:14-2585:2 Tr. 2586:3-9 (Krabbenschmidt). After December 31, 2003 (for the UK and Germany) and December 31, 2004 (for France), the EU Service Affiliates adopted a fee for services model similar to that in place before the commission arrangements. In addition, the EU Affiliates provided fulfillment services on behalf of AIS as well as purchasing and vendor relationship services. The relevant intercompany agreements provide for customer support and fulfillment at cost plus 3% and all other costs compensated with a 4.5% markup (8% in France). Exs. 23-J, 25-J, 35-J; Stip. 23. � 90. Beginning in 1999 and continuing through April 30, 2006, AIM recognized the gross income and deductions of the - 31 - Docket No. 31197-12 international 3PS Business. 91. Stip. 27. AIM was the sole shareholder in ASE, a Luxembourg company formed on or about July 1, 2003. 92. Stip. 303. ASE was formed for the purpose of functioning as a commissionaire in connection with the 3PS Business. ASE contracted with third-party sellers in its own name but for the benefit of the principal AIM. 93. Stip. 303. Starting in 2002, Amazon.co.Uk Limited and Amazon.de GmbH provided AIM with website development and design and marketing services for a 6% commission of revenue related to Marketplace. Stip. 28(a), 28(b); Ex. 40-J, Ex. 41-J, Sar! provided AIM with similar services. 94. Amazon.fr Stip. 28(c). Commencing on July 1, 2003 and continuing through April 30, 2006, Arnazon.co.uk Ltd., Amazon.de GmbH, and Amazon.fr Sar! provided services to AIM in relation to the European 3PS Business for 104.5% of total costs. Stip. 28; Ex. 42-J. ASEU 95. Beginning in 2004 and continuing through April 30, 2006, ASEU was the inventory owner and seller of record for the European Retail Business for CDs and DVDs to UK customers. · Stip, 31. 96. Beginning in 2004 and continuing through April 30, 2006, pursuant to a Commissionaire and Service Agreement, Amazon - 32 - Docket No. 31197-12 (Jersey) Limited agreed to act as a sales commissionaire on behalf of ASEU. Stip. 32. Amazon (Jersey) Limited agreed to provide ASEU order fulfillment services and sales commission services for cost plus 1%. Stip. 73; Ex. 44-J. INTERCOMPANY ROYALTY AGREEMENTS 97. Prior to the restructuring AIS and AIM licensed intangible property IP owned by Amazon US from ATI pursuant to license agreements with an effective date of October 31, 2003. Stip. 19, 21. 98. ATI served as the central repository for all Amazon's IP and valuable intangibles. Ex. 46-J at 7; Stip. 34; Ex. C-57- P at 16. 99. Pursuant to two October 31, 2003 license agreements, ATI licensed IP to AIM and AIS for a $100 annual royalty. 20-J at IRS_000477, 22-J at IRS 000411. AIS and AIM agreed to assign all derivative works from the property to ATI. at IRS_000476, 22-J at IRS_000410. Exs. Exs. 20-J AIM and AIS agreed that all goodwill arising from AIS's and AIM's use of trademarks, trade names, trade dress and service marks inured to the benefit of ATI. Exs. 20-J at IRS_000476, 22-J at IRS 000410. 100. By agreement dated January 1, 2005, but not executed until December 2006, ATI amended its license agreement with AIS to provide for a royalty equal to 10.5% of Net Revenue, defined - 33 - Docket No. 31197-12 as total gross third party revenue, exclusive of sales taxes and consumption type taxes, from all sources net of sales adjustments and bad debt. Ex. 21-J at IRS 000483. The amended license agreement stated that the royalty provisions in the original license were not intended to reflect an arm's-length royalty rate and that Amazon "completed a comprehensive economic analysis to determine the arm's length royalty rate and agreed to a royalty rate in accordance with the results of such analysis beginning in January 2005." Stip. 20; Ex. 21-J at IRS_000481; Tr. 2531:1-2532:19 (Krabbenschmidt). AMAZON'S OCSA 101. AEHT was formed on June 7, 2004 as a Luxembourg "societe en commandite simple" by EU Holdco, AIS and AIM. AEHT's Articles of Association describe the company's purpose: The Company's purpose is to take participations and interests in any Luxembourg or foreign companies that are part of the Amazon group of companies; to grant exclusively to one of its direct or indirect wholly owned subsidiaries, any loans, advances or guarantees; and to acquire through contributions, firm purchases or options, or in any other way any intellectual property rights, patents, and trade marks licenses and generally to hold, to license the right to use it solely to one of its direct or indirect wholly owned subsidiaries, sell or dispose of the same, in whole or in part, for such consideration as the Company may think fit, and to subcontract the management and development of those rights, trademarks, and licenses. Stip. 35; ,Ex. 50-J at AMZCOM00038921. - 34 - Docket No. 31197-12 102. AEHT had no employees at the time it was formed. 2589:16-24 (Krabbenschmidt). authority for AEHT. 103. Tr. Ms. Krabbenschmidt had signature Tr. 2590:1-4 (Krabbenschmidt). In December 2004, A9, a member of the Amazon US Group, and AEHT entered into an "Agreement to Share Costs and Risks of Intangible Development" with a stated effective date of June 7, 2004. 104. Stip. 36; Ex. 51-J. A9 is a subsidiary of Amazon, formed in October 2003, that runs the search engine for Amazon. Tr. 7281:23-12 (Blackburn); Ex. 1108-P at IRS-AMZ019292, 294. extremely important part of Amazon. Search is an Tr. 7282:6-7, 7285:1-10 (Blackburn); Stip. 173. 105. In December 2004, A9 and AEHT entered into an "A9 Intellectual Property Assignment Agreement" with a stated effective date of November 15, 2004. 106. Stip. 37; Ex. 52-J. On January 11, 2005, A9, AEHT, and ATI entered into an "Amended and Restated Agreement to Share Costs and Risks of Intangible Development" (collectively the 2004 and 2005 Cost Sharing Agreements are referred to as the "Cost Sharing Agreement"), with a stated effective date of January 1, 2005, (a) adding ATI as a party, (b) expanding the scope of development to include developing and otherwise enhancing the value of ATI's, A9's, and AEHT's intellectual property, and (c) - 35 - Docket No. 31197-12 adding additional terms and conditions. 107. Stip. 38; Ex. 53-J. On January 11, 2005, AEHT and ATI entered into a "License Agreement For Preexisting Intellectual Property with ATI" (the "License Agreement") with a stated effective date of January 1, 2005, in which ATI granted AEHT "certain intellectual property rights for the use of Amazon Intellectual Property," other than certain "Excluded Intellectual Property," Ex. 55-J. Stip. 40; The License Agreement included A9's intellectual property, which ATI had the right to transfer under a cross license agreement, effective October 31, 2003, between ATI and A9. Stip. 18; Ex. 19-J. 108. In July 2005, AEHT and ATI entered into an "Assignment Agreement for Preexisting Intellectual Property" with a stated effective date of January 1, 2005, in which ATI assigned AEHT "certain intellectual property rights for the use of Amazon Intellectual Property" (the "Assignment Agreement"). Stip. 42; Ex, 56-J. The intellectual property assigned in the Assignment Agreement was intended to comprise the "Excluded Intellectual Property" as defined in the License Agreement as of the Business Transfer Date. 109. Stip. 42. Amazon was unable to bifurcate the value of the A9 search technology from the value of the rest of the technology being transferred to AEHT. Amazon valued the pre-existing - 36 - Docket No. 31197-12 technology in its entirety for purposes of its tax reporting of the License Agreement between AEHT and ATI. Stip. 44; Ex. C-57-P. 110. Under the License Agreement entered into by AEHT and ATI, AEHT is granted rights to (1) copy, use, modify and create derivative works of the Amazon Intellectual Property; commercially or noncommercially exploit the Amazon Intellectual Property; and sublicense such rights. Ex. 55-J at AMZCOM00003050. AMAZON'S INTELLECTUAL PROPERTY 111. Because no statutory definition of intellectual property exists, contracting parties define it within their agreements. 112. Ex. 3634-R at 3 (Contreras). Lisa Norton, who held the title of Director, Global Direct Taxation at Amazon, was responsible for drafting the Project Goldcrest agreements with the advice of the law firm Preston, Gates. 113. Tr. 2505:19-25 (Krabbenschmidt); Stip. 406. Amazon defined the "Amazon Intellectual Property" to be transferred in the License Agreement to include: any and all intellectual property rights throughout the world, owned or otherwise held by Amazon Technologies prior to the Effective Date whether existing under intellectual property, unfair competition or trade secret laws, or under statute or at common law or equity, including but not limited to: (i) copyrights (including but not limited to reviews - 37 - Docket No. 31197-12 and editorial content), trade secrets, trademarks, rights of personality, publicity or privacy, rights in associate or vendor information, rights in customer information (including but not limited to customer lists and customer data) and any other intellectual property and proprietary rights (including but not limited to rights in databases, marketing strategies and marketing surveys); • . • but excluding all Excluded Intellectual Property. Excluded Intellectual Property is defined as the IP transferred under the Assignment Agreement. Exs. 55-J at AMZCOM00003047- 048, 56-J at AMZCOM00003091-105. 114. The Assignment Agreement entered into by AEHT and Amazon US, grants AEHT all right, title, and interest in current and past customer information and editorial content related to the amazon.co.uk, amazon.de, and amazon.fr websites; 382 domain name registrations and 154 trademark applications and registrations listed in the agreement; and any and all modification, extension, addition, improvement, transformation or new works created from such customer information, editorial content, domain names, or trademarks. Ex. 56-J at AMZCOM00003081, 3091-105. 115. The License and Assignment Agreements made available to AEHT the IP necessary to operate the EU Website Business to AEHT. Ex. C-4613-R, Appendix A at 1 (Frisch). The IP made available to AEHT included numerous website management, search, customer interaction, recommendation, transaction-processing and - 38 - Docket No. 31197-12 fulfillment services and systems, software, trademarks, service marks, copyrights, patents, domain names, trade dress, trade secrets, proprietary technologies, and similar intellectual property. 116. Ex. C-57-P at IRS 000114. Key business functions and value drivers for Amazon US as of the transfer date included platform technology, web design, catalog, search and browse features, personalization features, fulfillment process, order processing, customer service and brand. 117. Ex. C-57-P at IRS 000160-161. At all relevant times, Amazon regarded its patents, copyrights, service marks, trademarks, trade dress, trade secrets, proprietary technology and similar intellectual property as critical to its success, and it relied on trademark, copyright and patent law, trade secret protection and confidentiality and/or license agreements with its employees, customers, partners and others to protect its proprietary rights. Ex. 1-J at AMZCOM00041256 through Ex. 16-J at AMZCOM00042534. 118. The License Agreement, Assignment Agreement and Cost Sharing Agreement at issue in this case do not have a stated duration. 119. Tr. 4549:6-11, 4552:13-17, 4553:19-24 (Lasinski). The Assignment Agreement, Exhibit 56-J, is perpetual. Tr. 4549:6-11 (Lasinski). - 39 - Docket No. 31197-12 120. The License Agreement continues in effect for the life of all copyrights, patents, and other statutory protection related to the transferred IP and until all proprietary and confidential information and know-how related to the transferred IP enters the public domain. 121. Ex. 55-J at AMZCOM00003052. A trade secret is information that has commercial value and is not disclosed to the public. (Contreras). A trade secret is protected as long as the information is kept secret. 122. Tr. 7379:5-16 Tr. 7379:19-20 (Contreras). A trademark is a sign, symbol or word that is used to identify a good or service and its source. Tr. 7354:14-16 (Contreras); Ex. 3G34-R at 4 (Contreras); Tr. 6562:21-25; 6659:11-19 (Conley). 123. Goodwill is the positive associations the public makes with a trademark. Tr. 7367:12-22; Ex. 3634-R at 10 (Contreras). 124. In the US, goodwill is legally inseparable from the associated trademark and cannot be assigned separately from the associated trademark. Tr. 7367:22-24; Ex. 3634-R at 11 (Contreras). 125. Trademark protection is generally of unlimited duration, provided that the registrant continues to use the trademark in commerce and pay required renewal and maintenance - 40 - Docket No. 31197-12 fees. Ex. 3634-R at 9; Tr. 7355:8-16 (Contreras); Tr. 3152:20- 25, 3155:7-12 (Dolan); Tr. 4141:23-4142:1 (Golder). 126. A trade name is the name of a business. 22 (Contreras); 6665:2-12 (Conley). trademarked. 127. Tr. 7354:21- A trade name may also be Tr. 6665:19-6666:4 (Conley). A copyright protects works of authorship, including Ex. 3634-R at 16; Tr. 7377:9-10 (Contreras). source code. A copyright filed by a corporation has a duration of 95 years in the US and 70 years in Europe. Ex. 3634-R at 17-18; Tr. 7378:5- 7 (Contreras). 128. A patent legally protects a particular invention. Tr. 7368:12-13 (Contreras). 129. A patent provides legal exclusivity for 20 years. Tr. 7368:16-18 (Contreras); Ex. 3634-R at 19-F.4 (Contreras); Ex. C-4623-R at 1 34 (Conley). 130. A franchise is an intangible that gives the franchisee the right to operate a business. Tr. 3990:5-8 (Reilly). Patents 131. In May of 2006, Amazon was outsourcing its patent work to firms that prepared patent and trademark applications worldwide. 132. Tr. 4258:14-24, 4271:6-14 (Hayden). Since 2001, Amazon has asked its software developers - 41 - Docket No. 31197-12 to submit any ideas for consideration as patent applications that: (1) are not done by anyone else in a specific way; (2) are "new and cool"; (3) give Amazon.com a. competitive advantage; or (4) companies or people would pay for. Ex. C-2330-P at AMZCOM00076812. 133. An entity registering a trademark or patent wants the earliest priority date possible in order to enforce and protect the patent and trademark rights. 134. Tr. 7373:3-10 (Contreras). The US is a member of the Patent Cooperation Treaty, which permits an entity to get the same priority date for a patent filed on one country in any country that is a party to the treaty. By applying for a patent in the US, an applicant can file in the EU within one year and get the US application priority date. Tr. 7371:23-7373:10 (Contreras); 4264:16-4265:1 (Hayden). 135. Generally, it was more difficult to get ecommerce and software patents in the EU than in the US. Tr. 4245:12-4246:6 (Hayden). 136. Amazon's patent portfolio of pre-2005 priority date patents appreciated in value from 2000 to 2005. RD-470; Tr. 6510:15-25 (Conley). 137. Since at least 1999, Amazon's US homepage has included a link to a legal notice or "conditions of use" - 42 - Docket No. 31197-12 statement. Ex. C-4623-R at ii 82 and 83 (Conley). The notice lists patents covering website features to put users on notice of Amazon's right to recover damages from willful infringement claims. 138. Tr. 4267:19-4268:2 (Hayden). By 2003, 15 patents were listed in the Amazon website "conditions of use" notice including "all corresponding foreign counterparts." Additional US and international patents not listed in the notice also covered the website and its features. Ex. C-4623-R at 1 83 (Conley). 139. As early as 2003, Amazon's EU websites contained similar patent lists on their respective "conditions of use" notices; and by 2013, all of Amazon's EU websites listed all 87 US patents included on the US Website. Ex. C-4623-R at 1 83, 84, Appendix F.1-F.4 (Conley); Tr. 4257:3-9 (Hayden); Tr. 6511:5-20 (Conley). The 87 patents were part of 65 different patent families all of which claimed a priority date of 2004 or earlier. 140. Ex. C-4623-R at 1 85 (Conley). The 87 patents listed on the Amazon websites, including foreign websites, were all US patents. 6512:1 (Conley). Tr. 6511:21- All of the 87 patents listed on the Amazon.com website through 2013 had priority dates before 2005. Tr. 6511:5-20 (Conley). 141. A large multinational company like Amazon will accrue - 43 - Docket No. 31197-12 a large patent portfolio as a strategy to stop competitors from selling products in the same market, to defend against patent infringement suits, and for cross-licensing with other competitors. 142. Tr. 7374:19-7376:7 (Contreras). A patent may be used as a deterrent to infringement claims even where the patented invention is no longer being practiced by the patent holder. (Conley). Tr. 6508:24-6509:18, 6653:5-22 By listing US patents on its foreign websites, Amazon created a deterrent effect for EU competitors that also wanted to operate in the US market. 143. Tr. 6653:5-22 (Conley). Amazon's EU subsidiaries benefit from Amazon's large patent portfolio because in-country competitors are less likely to sue for patent infringement when facing a large patent portfolio. Tr. 7376:12-7377:1 (Contreras); Tr. 6653:5-22 (Conley). 144. It is important for Amazon to protect their inventions and to obtain and maintain patents. Tr. 4278:8-13 (Hayden). Economic ownership 145. Amazon.fr Sarl, Amazon.de GmbH, and Amazon.co.uk Ltd., agreed to transfer their respective interests in certain trademarks, domain names, and editorial content to AEHT pursuant to an assignment and license agreement (4-Way Agreement) with a - 44 - Docket No. 31197-12 stated effective date of April 30, 2006. 146. Stip. 353; Ex. 229-J. AEHT agreed to pay lump-sum amounts totaling €2,714,489, approximately $2,176,000 at the then-current exchange rate, for the domain names, trademarks, and other miscellaneous intangibles including "editorial content" as follows: Pavee Amazon.co.uk Description Editorial Content Total Amount £362,667 £362,667 Amazon.de Editorial Content Trademarks Domain Names Total €1,080,510 €146,860 €835,207 €2,062,577 Amazon.fr Editorial Content Domain Names Total €30,000 €259,245 €289,245 Ex. 229-J atAMZCOM00003385; Ex. C-4613-R at 46 n,42; Tr. 5618:18-5619:21 (Frisch); Ex. C-4625-R at 90-93 (Haigh). 147. To correct a clerical error, the agreement was amended in 2008 to increase the payment attributable to the German trademarks to €1,468,260 or $1,855,000. 148. Ex. 3001-R. Because Germany and France prohibited foreign companies from owning German and French domain names, domain names associated with Amazon's French and German businesses were registered in the name of the local subsidiaries. - 45 - Exs. C-146-R Docket No. 31197-12 at AMZCOM00009841, C-4061-R at IRS_002557. 149. AIS and AIM both entered into a Domain Name License Agreement with Amazon.de GmbH (the AIS-DE License Agreement and the AIM-DE License Agreement), with stated effective dates of January 1, 2000. Stip. 24, 30; Exs. 37-J, 43-J. Under the agreements, Amazon.de GmbH licensed the Amazon.de domain names for $100 per year, although payments were not made or recorded. Exs. 37-J, 43-J, 259-R at DT00706. 150. In connection with Project Goldcrest, Amazon sought to clean up the ownership issues with respect to the domain names and considered assigning or transferring them to ATI, AEHT or AEU. 151. Ex. 259-R at OT00707-708. The October 31, 2003 Parent Subsidiary Agreement between ACI and ATI, whereby ACI licensed IP to ATI, was amended retroactively in April 2006, to exclude the IP that was transferred in the 4-Party Agreement. Stip. 16, 17; Exs. 17-J, 18-J. 152. Trademarks can be registered in EU countries through national trademark offices, the Office of Harmonization in the Internal Market (CTM), and/or the Madrid Protocol. Ex. 3634-R at 7-9; Tr. 7355:21-7357:24 (Contreras). 153. A national trademark provides protection only in the country where the trademark was registered. - 46 - Tr. 7355:21-7356:5, Docket No. 31197-12 7356:18-19 (Contreras); Ex. 3634-R at 6 (Contreras). 154. EU. A CTM trademark provides protection throughout the Tr. 7356:6-17 (Contreras). 155. A trademark registered through the Madrid Protocol provides an entity the ability to request trademark protection for all countries who are parties to the treaty. Tr. 7356:21- 7357:8 (Contreras); Ex. 3634-R at 6 (Contreras), It is less time consuming and costly to register under the Protocol than register a national trademark. 156. 2003. Ex. C-146-R at AMZCOM00009841. The US was not a member of the Madrid Protocol until Tr. 7385:12-16 (Contreras); Exs. 3634-R at 6 (Contreras), C-146-R at AMZCOM00009841, 157. Jocelyn Krabbenschmidt, Amazon Tax Manager, drafted Exs. C-146-R and 259-R based on information from Amazon's legal department, including IP lawyers. Tr, 2444:5-9; 2578:21-15, 2580:7-2581:1 (Krabbenschmidt); Stip. 368, 406. The memo was provided to Deloitte for purposes of computing the buy-in. Tr. 2579:22-2580:5 (Krabbenschmidt); Ex, C-4061-R, 158. US. Amazon's entire IP group has always been based in the Tr. 4278:3-7 (Hayden). 159, Professor Franklyn failed to consider Amazon documents - Exs. C-4057-R, C-4058-R, and C-4061-R - that explain why the trademarks and domain names were registered by EU - 47 - Docket No. 31197-12 Service Affiliates. Exs. C-2394-P at 31-33 (Franklyn), C-4627-R at 6 (Haigh), 160. Amazon registered certain trademarks in the name of Amazon.de GmbH in order to gain trademark protection under the Madrid Protocol. Exs. C-146-R, 259-R, C-4061-R; Tr. 6728:22- 6729:3 (Haigh). 161. Amazon never intended to assign economic ownership to Amazon.de GmbH with respect to any mark. Exs. 259-R at DT00707- 0708, C-146-R at AMZCOM00009849, C-4061-R, · 162. Where a foreign country restricts registration to local entities, a foreign entity may engage a local agent or portfolio manager to register a domain name or trademark. At arm's length, the agent would agree to comply with the principal's instructions regarding any use of the domain name or trademark. The agent would agree not to engage in any business under the domain name or trademark without the principal's The agent would agree not to register any domain name, consent. trade name or trademark similar to the principal's marks or names. The agent would agree to transfer the registration to the principal or any third party specified by the principal upon the principal's request. 163. Ex. 3634-R at 21 (Contreras). In an open market situation, a brand of Amazon's stature would not permit third party licensees to take ownership - 48 - Docket No. 31197-12 of its brand. Tr. 6728:18-22; Ex. C-4627-R at 6-7 (Haigh). At arm's length, a global brand licensor would only 164. permit a third party licensor to register domain names and trademarks in a local territory under the terms of an explicit licensing agreement. Under such agreement, the domain names and trademarks would revert to the licensor at no additional cost in the event that the trademark and marketing IP license were terminated. 165. Tr. 6729:5-14; Ex. C-4627-R at 6 (Haigh). In its section 6662 documentation, Amazon's buy-in valuation included the value of the domain names and trademarks registered to Amazon.fr Sarl and Amazon.de GmbH. at 7-8 (Haigh) 166. Ex. C-4627-R '. Amazon US was the economic owner of domain names and trademarks. Tr. 2202:14-2203:3 (Comfort); Exs. C-299-J at AMZCOM00004146-151, 3078-R at AMZCOM00060889; Tr. 5618:185620:7; Ex. C-4613-R at 44-47 (Frisch). 167. Amazon US made all of the investments and took the risks involved in building the value of any items of IP that were registered in the EU affiliates' names. Ex. C-4613-R at 46 (Frisch). 168. At arm's length, Amazon US would not have been willing to make these investments and take the risks without arrangements in place to insure that it would derive the benefit - 49 - Docket No. 31197-12 from the IP. 169. Ex, C-4613-R at 46-47 (Frisch). The Amazon country manager in Germany, Ralf Kleber, played no role in managing intellectual property for Amazon. Tr. 1068:18-1069:3 (Kleber). He was unaware of whether Amazon.de owned any intellectual property. Tr. 1069:1-3 (Kleber) 170. A word mark is the most important and broadest type of a trademark. A word mark protects against the word without stylized script or design. Tr. 7384:1-14 (Contreras). A word mark prevents an entity outside the corporate family from using any variation of the protected word. Tr. 7387:6-7388:4 (Contreras). 171. Amazon US registered the CTM "Amazon" word mark trademark in 1996. Ex. 1241-P; Tr. 7383:16-23 (Contreras); RD- 531. 172. A design mark provides protection for a word of a certain length and size and any design associated with that word. Tr. 7387:17-24 (Contreras), 173. The description or category chosen on a trademark application is generally not disputed because companies know what their business is and pick a category to cover that field. Tr. 7453:17-25, 7454:1-6 (Contreras). 174, On the word mark CTM trademark application, Amazon - 50 - Docket No. 31197-12 selected Nice classifications 9, 37, and 42, and provided detailed descriptions of its business under each classification. Exs. 1241-P, 3637-R. 175. The way Amazon described its business on the Amazon word mark CTM trademark application would protect it against other third parties obtaining the same trademark. Tr. 7386:11- 21, 7391:6-25, 7392:1-25, 7393:1-25, 7394:1-25 (Contreras); Ex. 1241-P. 176. An Amazon trademark would be protected from infringement through the business description it provided on the trademark application even if it the corresponding Nice Class was not chosen. 177. Tr. 745·5:7-14 (Contreras). Because Amazon US owns the Amazon word mark, a third party purchaser of an Amazon EU owned trademark would need the consent of Amazon to enjoy the right to use the that trademark. Tr. 7455:20-25, 7456:1-25, 7457:1 (Contreras). 178. Amazon's later trademark applications in Europe, which included all Nice categories, was made possible by the original Amazon word mark trademark filed in 1996. Tr. 7454:7- 22 (Contreras); Ex. 1241-P. 179. EU trademark law is based on a Treuhand principle in which there is the formal holder of something, such as a trademark, and there is the real person, who is the relevant - 51 - Docket No. 31197-12 person for anything that has to do with liability. Tr. 7182:15- 7183:8, 7221:6-7222:15 (Heeren). EU SERVICE AFFILIATES 180. On May 1, 2006, AIS, as successor to ASEU, assigned to AMEU the sales commissionaire agreement between ASEU and Amazon (Jersey). 181. Stip. 51; Ex. 58-J Effective April 30, 2006 or May 1, 2006 (depending on the particular termination agreement), AIS terminated each of the AIS Retail Services Agreements, the AIS-AEU Services Agreement and the AIS-ADSI Services Agreement. Stip. 52; Exs. 59-J through 66-J, 182. Effective April' 30, 2006 or May 1, 2006 (depending on the particular termination agreement), AIM terminated each of its commission agreements with ASE, Amazon.co.uk Ltd., Amazon.de GmbH and Amazon.fr Sarl. 183. Stip, 53, 54; Exs. 67-J through 70-J, Effective April 30, 2006, Amazon.de GmbH terminated the AIS-DE Domain Name License Agreement and AIM-DE Domain Name License Agreement. Stip. 56, 57; Exs. 71-J, 72-J. LICENSE AGREEMENTS POST RESTRUCTURING 184. On April 30, 2006, AEHT licensed to AEU all of the intangible property AEHT acquired from Amazon US. 73-J. Stip. 58; Ex. AEU sublicensed such intangible property to ASE and AMEU. Stip. 59, 60; Exs. 74-J, 75-J. AEU agreed to pay AEHT a royalty - 52 - Docket No. 31197-12 that leaves the Luxembourg Operating Group a 4.5% return on total EU operating expenses with a minimum return to the Luxembourg Operating Group of 0.45% of EU revenue and a maximum return to AEU of 0.55% of EU revenue. Exs. 73-J at AMZCOM00002053-054, 74-J at AMZCOM00002065, 75-J at AMZCOM00002077. ASE, and AMEU. The Luxembourg Operating Group included AEU, Ex. 73-J at AMZCOM00002054. EU AFFILIATE SERVICE AGREEMENTS POST PROJECT GOLDCREST 185, AEU entered into service agreements with the EU Affiliates that had previously provided services to AIS and AIM. Stip. 61, 63, 65, 67, 69; Exs. 76-J, 78-J, 80-J, 82-J, 84-J. Under the agreements, Amazon Logistik GmbH, Amazon.de GmbH, Amazon Logistique SAS, Amazon.fr Sarl, and Amazon.co.Uk Ltd. provide fulfillment services, customer and merchant services, and support services to AEU. Stip. 61, 63, 65, 67, 69; Exs. 76-J, 78-J, 80-J, 82-J, 84-J. 186. The parties later amended such service agreements to add mark-up on costs for the services provided. The mark-up on costs generally ranged from 3% to 4.5% (except for 5% for fulfillment services in Germany and 8% for fulfillment and support services in France). Costs include all operating expenses directly and indirectly related to the services including general and administrative expenses. - 53 - Stip. 62, 64, Docket No. 31197-12 66, 68, 70; Exs. 77-J, 79-J, 81-J, 83-J, 85-J. 187. Starting on May 1, 2006, ADSI agreed to provide data storage and hosting services to AEU for cost plus 8%. 71; Ex. 86-J. Stip. Costs include all operating expenses directly and indirectly related to the services including general and administrative expenses. 188. Ex. 86-J at AMZCOM00002229. Starting on May 2, 2006, Amazon CS Ireland agreed to provide AEU with customer services for cost plus 3%. Ex. 87-J. Stip. 72; Costs include all operating expenses directly and indirectly related to the services including general and administrative expenses. 189. Ex. 87-J at AMZCOM00002219. In Deloitte's foreign transfer pricing reports for the fiscal year ending December 31, 2006, Amazon represented that the arm's length compensation, as a percentage of all costs, for the routine functions performed by its EU Service Affiliates was as follows: Functions Performed Marketinq Services Administrative Services Customer Support Services Fulfillment & Logistic Services Germany 4.5% 5.0% 3.0% 5.0% France 7.97% 4.97% 2.97% 8.03% UK 4.5% 4.5% 3.0% 3.0% Exs. C-404-P at AMZCOM00117076-104, C-2117-P at AMZCOM00117201228, and C-2208-P at AMZCOM00117326-351. 190. In a transfer pricing report for the fiscal year - 54 - Docket No. 31197-12 ending December 31, 2003, Amazon represented that an arm's length price for the services performed by Amazon.de GmbH was 3.0%, plus all costs, for functions performed with respect to customer referral, merchandising and marketing support services. Ex. C-2016-P at AMZCOM00116814-867. 191. After the Business Transfer Date, the EU Service Providers performed the same functions and received the same fees, but they performed the functions for AEHT and received the fees from AEHT. Tr. 2538:5-23 (Krabbenschmidt); Ex. C-145-R at AMZCOM00060699. 192. The EU Service Affiliates main goal was to add selection to the website both before and after the restructuring. Tr. 966:15-19, 1076:6-10, 1051:1-24 (Kleber); Ex. C-145-R at AMZCOM00060697, AMZCOM0060699. Functions performed included vendor management, in-stock management and editorial and product management. Tr. 1076:6-12 (Kleber). Vendor managers would try to acquire all the brands that Germans want to buy in specific categories by soliciting manufacturers and sellers. Tr. 966:23-967:22, 971:11-971:15 (Kleber). Product managers on the business intelligence side very much focused on metrics used to propose initiatives and expand service. Tr. 967:23-969:11 (Kleber). Product managers focused on units sold, revenues, gross margins and cost of goods sold. - 55 - Docket No. 31197-12 Tr. 4635:13-25, 4627:23-8 (Kilar). REPORTING OF INCOME AND DEDUCTIONS 193. Gross income and deductions of the European Websites Business accruing on or after the Business Transfer Date were not included as income and deductions of the Amazon US Group in petitioner's consolidated federal income tax return. 194. Stip. 57. On the day before the Business Transfer Date, AEHT had limited revenues, no costs of sales, and minimal expenses. Ex. C-4613-R at 25 (Frisch); Tr. 3806:2-24 (Wills); Ex. C-116-J at IRS 005864. On the day after the Business Transfer Date, AEHT had revenues of over $2 billion per annum. 25 (Frisch); Tr. 3806:2-24 (Wills). Ex. C-4613-R at Transferring intangibles to AEHT allowed AEHT to realize the cash flows from the European Websites Business. Ex. C-4613-R at 25; Tr. 5823:7-5837:4, 5849:12-5851:1 (Frisch). 195. From an economic point of view, the License Agreement and Assignment Agreement effectively transferred to AEHT and its subsidiaries the entire portfolio of intangible assets necessary to operate the European Websites Business as a going concern for the indefinite future. Exs. C-4616-R at 11 10, 11, C-4617-R at 1 11; Tr. 6047:22-6048:7, 6076:12-6077:1 (Gompers); Ex. C-57-P at 25. 196. The effect of the transfer to AEHT was that AEHT's - 56 - Docket No. 31197-12 revenue and profits went from nothing in 2006 to a very substantial number. Tr. 6094:8-18 (Gompers). PROJECT GOLDCREST 197. Beginning in 2004, Amazon undertook a series of transactions that restructured its EU business. Stip. 33, 304- 367; Ex. c-45-J. 198. The goal of Project Goldcrest was to reduce Amazon's financial statement tax rate and improve its cash tax position. Ex. 379-R; Tr. 2604:19-2606:19 (Krabbenschmidt). 199. Project Goldcrest did not impact any portion of Amazon's publicly reported financial position or operating results, except income tax. Ex. 3609-R'at 1 16 (Harden). The transfer of intangibles to AEHT did not result in any gain or loss on a financial acco�nting basis. Ex. 3609-R at 1 16, Exhibit D, 1-4 (Harden). 200. Amazon's management concluded that Project Goldcrest would not significantly impact Amazon's cash taxes paid in 2005 or 2006. 201. Ex. 3609-R at 11 26-29 (Harden). Differences between financial and tax accounting, such as timing differences and carryforwards, can lead to "deferred tax assets." GAAP treats these differences as assets because companies can use them to reduce income taxes on future income. Tr. 5307:13-18 (Harden). - 57 - Docket No. 31197-12 202. If company management believes a tax asset has a less than 50% chance of future use, GAAP requires the company to record a valuation allowance to offset the book value of that Ex. 3609-R at i 24; Tr. 5307:13-25 (Harden). asset. Because judgments about the likelihood of future use may change over time, the valuation allowance may also change, Ex. 3609-R at i 24 (Harden). 203. Amazon reported multiple types of deferred tax assets from 2004 through 2006, including NOLs, timing differences, and tax credits. Ex. 3609-R at i 23, Chart 1-E (Harden). Amazon reduced its valuation allowance for these assets by $240 million in 2004, $90 million in 2005, and $10 million in 2006. 3609-R at ii 25, 29 (Harden), Ex. Each reduction represents Amazon's judgment that it would, more likely than not, utilize those amounts in the future. 204. Tr. 5308:22-5309:6 (Harden). Project Goldcrest caused Amazon to have a higher effe ctive tax rate, on a GAAP basis, than the statutory tax rate in 2006. Ex. 3609-R at i 18; Tr. 5305:20-5307:3 (Harden). But the 2004-2006 decreases to Amazon's valuation allowance for deferred tax assets more th an offset that impact on a GAAP basis. Ex. 3609-R at ii 28-30 (Harden). Project Goldcrest did not reduce Amazon's GAAP net income over the period 2004 through 2006. Ex. 3609-R at i 29 (Harden). - 58 - Docket No. 31197-12 History of Project Goldcrest 205. In part because of permanent establishment issues in the EU, Amazon had been discussing establishing an EU HQ from the time Robert Comfort joined Amazon in April of 2000 as Amazon's vice president of tax and tax policy. Tr. 2183-84 (Comfort). 206. The decision to enter into cost sharing was made prior to the end of 2001. Tr. 2506:14-18 (Krabbenschmidt). timing was always a subject of discussion. The Tr. 2506:23-2597:11 (Krabbenschmidt). 207. Amazon's tax department was tasked with making sure it occurred in the most tax efficient way possible. Tr. 2196:8- 16 (Comfort). 208. Project Goldcrest was called Project New Haven before it was renamed Project Goldcrest. (Krabbenschmidt). Tr. 2623:11-2624:1 Earlier it was called IP Migration Project. Tr. 2633:14-2634:1 (Krabbenschmidt). Deloitte 209. Amazon understood it was required to pay for the intellectual property transferred and to pay for various other kinds of IP that would support the co-development going forward. Tr. 2198-99 (Comfort). 210. Prior to the end of 2001, Amazon hired a Deloitte - 59 - Docket No. 31197-12 economist to review the various valuation approaches that could Amazon decided on a valuation method which be selected. Deloitte then followed in petitioner's transfer pricing study provided to the IRS. Tr. 2199:5-15 (Comfort); Tr. 2446:13-24 (Krabbenschmidt). 211. Amazon wanted to be able to substantiate a shorter useful life for the transferred assets since 100% of the buy-in payments would be taxable in the US and would absorb a portion of Amazon's NOLs. Ex. 379-R; Tr. 2605:22-2606:10 (Krabbenschmidt). The Model 212. At the end of 2001, Jocelyn Krabbenschmidt, a CPA in the tax department of Amazon, was tasked with developing financial projections with Amazon's business and finance employees. Tr. 2200:2-25 (Comfort); Tr. 2444:23-2445:15, 2446:3-12, 2503:1-12 (Krabbenschmidt). Ms. Krabbenschmidt was responsible for estimating the cost and benefits of Project Goldcrest and gathering information Deloitte needed to do its valuation work. Tr. 2446:3-12, 2447:24-2448:3, 2449:3-9 (Krabbenschmidt). 213. The projections were not Ms. Krabbenschmidt's projections but the business' projections. 2506:6-12, 2546:22-2548:23 (Krabbenschmidt). - 60 - Tr. 2449:10-24, Ms. Krabbenschmidt Docket No. 31197-12 worked with Finance and the accounting teams to gather information to build out the projections in an excel model (the Model). 214. Tr. 2449:3-2450:5, 2451:5-2452:2 (Krabbenschmidt). Ms. Krabbenschmidt worked with Mr. Greeley, who was head of worldwide retail finance for part of 2004. the output of the forecast. He reviewed Tr. 2450:2-5, 2503:14-2504:1, 2546:22-2548:23 (Krabbenschmidt); Tr. 415:7-17 (Greeley). 215. In 2004, Mr. Greeley moved to oversee Amazon's worldwide media business. 216. Tr. 415:19-416:4 (Greeley). In August 2007, Mr. Greeley moved to Luxembourg to oversee all of the retail operations for Europe. Tr. 417:1-5 (Greeley); Ex. 1091-P. 217. The Finance teams at Amazon made sure that the financial implications of decisions were understood analytically; and that Amazon had performance metrics in place to focus the decision criteria. Tr. 413:15-414:17, 413:15- 414:17 (Greeley). 218. Finance and the business teams prepared bottoms up forecasts for the annual operating plans. would be forecasted based on trends. 219. Each subcategory Tr. 2866:14-23 (Szkutak). Mr. Greeley asked Shelley Salomon and Navid Veiseh, members of his financial planning and analysis team for the worldwide retail business, to take Amazon's existing 12-month - 61 - Docket No. 31197-12 forecast and extrapolate growth expectations of the business. Tr. 453:1-19 (Greeley). That projection was shared with each country's finance director for confirmation and then provided to Ms. Krabbenschmidt. 220. Tr. 453:25-454:19 (Greeley). Ms. Krabbenschmidt worked with various teams from the EU subsidiaries in determining information to include in the Model. Tr. 2504:3-16 (Krabbenschmidt); Tr. 1125:12-23 (Byrne). 221. Allister Byrne, a finance manager for Amazon.co.uk in 2004, provided Ms. Krabbenschmidt with forecasts for specific retail categories in 2004 in connection with Project Goldcrest. Tr. 1125:12-23 (Byrne). Those projections did not include projections with respect to the Kindle. (Byrne). Tr. 1128:25-1129:5 Those forecasts did not include projections with respect to Amazon's digital business. Tr. 1129:6-8 (Byrne). Those forecasts did not include projections with respect to AWS. Tr. 1129:9-11 (Byrne), 222. There were many iterations of the Model as Ms. Krabbenschmidt continually asked the finance and accounting teams for the best financial information available and updated the Model every time the company closed its books for a quarter or finalized an OPl or OP2. Tr. 2450:2-5, 2451:8-2452:2, 2503:14-2504:1, 2521:18-2522:25, 2523:1-18, 2533:13-19, 2546:222548:23 (Krabbenschmidt); Tr. 2249:1-16, 2251:10-2252:1 - 62 - Docket No. 31197-12 (Comfort); Tr. 2899:11-20 (Szkutak); Exs. C-4098-R at AMZCOM00058180, C-4096-R at AMZCOM00058170. 223. The valuation model prepared by Deloitte to value the buy-in was inser ted into Amazon's Model so it would update the buy-in value as Amazon updated financial informa tion. Tr. 2562:24-2563:15 (Krabbenschmidt). Costs of Project Goldcrest 224. There were incremental costs associated with Project Goldcrest because Amazon opened a new building and added employees. Tr. 725:7-726:9 (Piacentini); Exs. C-292-J at "S­ Team meeting" Tab page 4-5], C-292-J at "PowerPoint Summaries" Tab page 2, C-357-J, C-4100-R at 7-8; Tr. 2553:23-2554:25 (Krabbenschmidt). 225. The "Estimated Incremental Costs" of the EU servers in the Model came from IT finance. Tr. 2549:1-2550:1, 2552:18- 2553:21, 2570:7-14, 2572:22-2573:5 (Krabbenschmidt); Ex. 387-J. 226. The costs of establishing data centers in Ireland were higher than they would have been in the us. Tr. 2572:22- 2573:5 (Krabbenschmidt); Tr. 2999:1-11 (Szkutak); Ex. C-4094-R at AMZCOM00057346. Luxembourg Tax Treatment of Project Goldcrest 227. Amazon approached Luxembourg sometime in 2002 in connection with the establishment of a VAT office in Luxembourg - 63 - Docket No. 31197-12 for its Marketplace business. 228. Tr. 2217:18-2218:4 (Comfort). Amazon was attracted to Luxembourg as it offered the lowest VAT rate in the EU. Tr. 2189:19-2190:14, 2190:20-2191:6 (Comfort). 229. Amazon held meetings with Luxembourg representatives on January 9, 2003, and February 27, 2003. At the January 9 meeting, Amazon proposed forming a "legal entity in Luxembourg (LuxCo) to serve as a service commissionaire in connection with Amazon's European 'Marketplace' and Retail digital products businesses." At the February 27, 2003 meeting, Amazon intended to "explore, on a preliminary basis, the possibility of Amazon's establishing a principal in Luxembourg for its EU businesses." Stip. 403; Ex. C-299-J at AMZCOM00004134. 230. In or about September 2002, Amazon had discussed with Ireland creating a nonresident Irish IP Co to own the IP for the European Websites Business, which would be owned and operated by an Irish company. Ex. 3078-R at AMZCOM00060897; Tr. 2192:21- 2193:2 (Comfort); Tr. 2510:22-2513:6 (Krabbenschmidt). 231. As Amazon told the Luxembourg authorities, valuable intellectual property was owned by US entities. Tr. 2220:8-13 (Comfort); Exs. C-299-J at AMZCOM00004151, 3078-R at AMZCOM00060889; Stip. 404. A newly formed Luxembourg IP company, AEHT, would obtain exclusive rights to Amazon's - 64 - Docket No. 31197-12 intellectual property as a result of the proposed transfers. Tr. 2224:2-11 (Comfort); Ex. C-299-J at AMZCOM00004158. 232. Prior to engaging in the proposed restructuring of its European Websites Business, Amazon corresponded with the Luxembourg Ministry of Finance regarding an advance tax agreement, By letter dated July 30, 2003, PricewaterhouseCoopers (PwC), on behalf of Amazon, submitted to the Luxembourg authorities for review and approval an analysis of the structure proposed by Amazon, including the proposed Luxembourg tax treatment. Section 3 of the July 30, 2003 letter summarizes the proposed tax treatment outlined in the letter as follows: • The US/Luxembourg tax treaty will apply to payments made by Lux Opco to Lux SCS so long as Lux SCS continues to be held by qualifying US residents; • Dividends paid by Lux Opco to Lux SCS will qualify under the treaty and be subject to a dividend withholding tax rate of 0%, 5%, or 15%; • Royalties paid by Lux Opco to Lux SCS will qualify under the treaty and be subject to a 0% withholding tax; • A disposal of shares in Lux Opco by Lux SCS (in the future) would qualify for treaty benefits providing the various - 65 - Docket No. 31197-12 treaty conditions have been satisfied; • Lux SCS is tax transparent, for corporate tax, and net wealth tax purposes and is not subject to municipal business tax as it is not considered to be conducting commercial activity and as there is no Luxembourg permanent establishment (PE); and • The US non-resident partners of Lux SCS (based on the facts detailed in the July 30, 2003 letter) do not have a PE in Luxembourg, and are therefore not subject to corporate tax, municipal business tax, or net wealth tax on their share of the profits of Lux SCS or their individual interest in the assets of Lux scs. Stip. 405; Ex. C-300-J at AMZCOM00004175. 233. Amazon told the Luxembourg government that the royalty paid by operating company to the IP company would be based on an arm's length valuation of the IP. (Comfort); Ex. C-299-J at AMZCOM00004159. Tr. 2224:20-23 Amazon negotiated that royalty rate with the Luxembourg government. Tr. 2268:20- 25 (Comfort). 234. The royalty was a "soak up royalty" designed to capture most of the profits of AEU, the Luxembourg operating company. Tr. 2516:14-2517:7 (Krabbenschmidt). The soak up royalty was paid by AUE to AEHT pursuant to Ex. 73-J. - 66 - Tr. Docket No. 31197-12 2530:11-24 (Krabbenschmidt). 235. Luxembourg wanted to leave some return in the operating company so it could tax it. 236, Tr. 2269:1-10 (Comfort). The royalty that the operating company paid AEHT was for all of the intangibles that were transferred in Project Goldcrest. 237. Tr. 2269:6-10 (Comfort). Deloitte prepared a valuation that was given to the Luxembourg government to support a royalty of between 10.6% and 13.6% from the Lux OpCo to the IP holding company for the intangibles that were transferred in Project Goldcrest, Tr. 2224:24-2225:2, 2233:11-2234:21 (Comfort); Tr. 2524:24-2525:21 (Krabbenschmidt); Ex. C-133-R. 238. Mr. Comfort, Ms. Norton, Ms. Krabbenschmidt and Mr. Jeroen Pit of Amazon met with the Luxembourg authorities on September 9-12, 2003, Stip. 406; Ex. C-301-J. Amazon tax executives met with the Luxembourg prime minister. Tr. 2222:4- 12 (Comfort). 239. A presentation to the Audit Committee of the Board of Directors of ACI regarding Project Goldcrest was made on or about September 24, 2003. 240. Ex. 46-J; Stip. 34. By letter dated October 23, 2003, Amazon summarized its understanding of the conclusions reached during the meeting with the Luxembourg tax authorities and formally requested - 67 - Docket No. 31197-12 uacceptance of the terms and conditions under which [Lux OpCo] will operate with respect to the establishment of certain economic parameters for Luxembourg income tax purposes." 406. Stip. In the letter, Amazon proposed that Lux OpCo be permitted to retain a return of not less than .45% of EU revenue and not more than .55% of EU revenue, and that the remaining income from operating the European Websites Business be paid to Lux SCS as a royalty. Tr. 2516:14-2517:19, 2525:17-2529:3 (Krabbenschmidt); · Ex. C-302-J at AMZCOM00005060. 241. The final tax agreement between Amazon and Luxembourg provided for a royalty rate structured to leave between .45% and .55% total EU Revenue in the operating company. The rest of the income would be paid to IPCo and that income would not be taxed in Luxembourg or the US, unless repatriated. Tr. 2235:4-14 (Comfort); Tr. 2526:25-2529:3 (Krabbenschmidt); Ex. C-133-R at AMZCOM00060609, AMZCOM00060612. At the time, Amazon had no current plans to repatriate the income. Tr. 2235:20-25 (Comfort). 242. In a letter dated October 31, 2003, PwC outlined the facts, structure, legal agreements, and tax analysis, related to the proposed restructuring and requested that the Luxembourg authorities confirm the analysis presented in the letter. 407; Ex. C-303-J. - 68 - Stip. Docket No. 31197-12 243. On November 6, 2003, the Luxembourg authorities approved the contents of the October 23, 2003, and October 31, 2003, letters from Amazon and PwC. Stip. 408; Ex. C-304-J. '.Infrastructure 244. A data center is a building in which computer systems and associated networking racks for servers are stored. Tr. 1898:2-7 (Kufeld). 245. In the second half of 2003, Mr. Kufeld was asked to evaluate Ireland and Luxembourg as possible sites for Amazon's EU data centers. Tr. 1909:25-1910:4 (Kufeld). Mr. Kufeld recommended locating Amazon's EU data centers in Ireland. Tr. 1898:15-1899:11, 1900:15-1901:9, 1909:14-21 (Kufeld). 246. By memorandum dated December 9, 2003, Mr. Comfort advised Luxembourg tax authorities of infrastructure deficiencies in Luxembourg. 247. Stip. 409; Ex. C-306-J. The EU data centers were located in Ireland and the payment servers in Luxembourg. Tr. 1911:20-25 (Kufeld); Tr. 2190:17-2191:6 (Comfort). Tax Benefits of Goldcrest 248. The Model contained a tab entitled "S Team Meeting." That tab was not provided to the IRS during the audit. Exs. C- 292-J, C-156-R; Tr. 5697:10-12 (Frisch). 249. The Model computed the projected tax benefits from - 69 - Docket No. 31197-12 Project Goldcrest. Tr. 2236:19-2237:14 (Comfort). Mr. Szkutak and the S Team were briefed on the projected tax benefits as computed in the Model. Tr. 2225:11-2226:7 (Comfort); Tr. 2501:1-9, 2508:1-8 (Krabbenschmidt). Spreadsheets including projections and showing the cash and financial tax impact of Project Goldcrest were regularly reviewed with Mr. Szkutak. Tr. 2870:16-24, 2952:1-10, 2953:8-11, 2955:12-14 (Szkutak); Tr. 2201:10-23, 2215:15-22, 2225:19-2226:1 (Comfort); Tr. 2507:242508:1-3 (Krabbenschmidt). 250. Cash tax is the actual dollars a company pays when it files a tax return. Tr. 2247:22-25 (Comfort). Amazon focused on cash tax because free cash flow was an important metric at Amazon. 251. Tr. 2247:25-2248:3 (Comfort). In its tax planning, Amazon aimed to reduce cash outlays for income tax, regardless of the effect on the taxes reported in their financial statements. Ex. 3609-R at it 7, 31- 32; Tr. 5308:8-20 (Harden); Tr. 2247:25-2248:3 (Comfort). 252. The Model computed the net present value (NPV) of the estimated cash tax benefit from implementing Project Goldcrest. Exs. C-156-R, C-292-J "S-Team meeting" Tab, page 1, C-4100-R at 1. The cash tax benefit for Project Goldcrest was due to the tax savings on the royalty payments made by AEU to AEHT, estimated to be� of all EU sales, which would not be taxed - 70 - Docket No. 31197-12 in Luxembourg, less the NPV of the tax on the required buy-in payment. Exs. 379-R at AMZCOM00000015, C-156-R, C-292-J at "S­ Team meeting" Tab, pages 1-2, "Summary of Cash Taxes" Tab, "Powerpoint Summaries" Tab, page 2. 253. In computing the NPV of the cash benefit from Project Goldcrest, the Model used a discount rate of 13.5%. 2565:6 (Krabbenschmidt); Ex. C-156-R at 5, came from Treasury. 254. Tr. 2564:5- The discount rate Tr. 2565:16-18(Krabbenschmidt). Senior management at Amazon, i.e., Mr. Bezos and his direct reports, made the decision to enter into cost sharing. Tr. 2216:7-19, 2227:14-23, 2239:18-2240:6 (Comfort); Ex. C-301J, 255. Mr. Wilke and Mr. Piacentini were the two Amazon executives who were impacted the most by Project Goldcrest. Tr. 721:9-25 (Piacentini), 256. Mr. Piacentini was the head of EU retail before and after the Goldcrest restructuring. 257. Tr. 722:1-8 (Piacentini). Mr. Piacentini was not in favor of locating Amazon's EU headquarters in Luxembourg because it was necessary to recruit a lot of people to work there and Luxembourg was small. Tr. 723:18-724:11 (Piacentini). 258. Prior to the restructuring Amazon had Pan-Euro employees who would serve more than one country of destination. - 71 - Docket No. 31197-12 Tr. 1076:20-1077:25 (Kleber); Ex. 47-J at IRS_000677; Stip. 34. 259. The role of tax in the creation of the Luxembourg headquarters was to pay as little tax as possible in Europe. Tr. 644:18-22, 644:9-14 (Piacentini). 260. The benefits of Project Goldcrest for Mr. Piacentini were that a EU management team would allow him to dedicate more time to Asia. Tr. 642:16-643:3 (Piacentini). After the restructuring, more management resources were added to the European Websites Business, specifically a layer of management between Mr. Piacentini and the country managers. Tr. 722:18- 723:17 (Piacentini). 261. Mr. Piacentini understood that assets would be transferred from the US to Luxembourg as part of Project He was not involved in discussions about the asset Goldcrest. transfers and had only a high level understanding of what the assets were. 262. Tr. 724:12-20 (Piacentini). Mr. Piacentini was not concerned about the location of the transferred assets because it had nothing to do with his responsibilities which were to run the business, hire people and keep delivering on the three pillars. Tr. 724:21-725:6 (Piacentini). 263. Xavier Garambois was the Amazon France country manager at the time of Project Goldcrest and has been the vice- 72 - Docket No. 31197-12 president of Amazon's EU business in Luxembourg since 2012. 875:17-22, 877:17-18, 878:3-6 (Garambois). not involved in Project Goldcrest. (Garambois). Tr. Mr. Garambois was Tr. 934:21-24, 935:2-6 Mr. Garambois signed Amendment No. 1 to the 4-Way Agreement as a formality because he was the president of the company. Tr. 935:11-936:19 (Garambois); Ex. 3001-R. 264. The intercompany agreements had no impact on the Amazon.de website business. 265. Tr. 1063:1-1064:9 (Kleber). The cash tax and financial statement benefit of Project Goldcrest was continually discussed with Amazon Exhibit C-4098-R was a presentation made about management. Project Goldcrest to Amazon management and perhaps its full Board. Tr. 2242:10-25 (Comfort); Tr. 2533:2-5 (Krabbenschmidt). The computation of the benefits was based on the Model. Tr. 2533:7-19 (Krabbenschmidt) 266. Exhibit C-4097-R is a February 2004 presentation made after a Ministry of Finance meeting that was discussed with Messrs. Szkutak and Bezos. (Comfort). Tr. 2236:14-19, 2236:19-22 The estimates were based on the Model. 17 (Comfort). Tr. 2237:9- Amazon estimated a cash tax benefit from Project dollars. Goldcrest through 2010 of Ex. C- 4098-R at AMZCOM00058180; Tr. 2248:4-6 (Comfort); Tr. 2533:2-11 (Krabbenschmidt). Additional cash tax benefits would incur over - 73 - Docket No. 31197-12 time provided the EU business was profitable. Tr. 2248:12-25 (Comfort). 267. Amazon US's large NOL position was taken into account in discussing the impact of Goldcrest. Tr. 2243:1-ll(Comfort); Tr. 2507:13-22, 2534:18-2535:6 (Krabbenschmidt); Ex. 379-R. Spreadsheets estimated that the optimal timing for Project Goldcrest was when EU websites' operating margins reached� �- Exs. C-4098-R at AMZCOM00058188, C-292-J "NOL Utilization Analysis" Tab; Tr. 2243:12-2244:3 (Comfort); Tr. 2533:20-2534:17 (Krabbenschmidt). Optimal timing was dependent on the overall value of the EU business because the EU transferee was required to pay for intangibles and the more valuable they were the greater the payment and corresponding taxable income. Ex. C- 4098-R at AMZCOM00058188; Tr. 2244:9-21 (Comfort); Tr. 2533:202534:19 (Krabbenschmidt). 268. Amazon computed the cash tax benefits of Project Goldcrest based on different buy-in valuations and different transfer dates. Exs. C-156-R at 6, 10, 14-17, C-292-J, C-357-J, C-4100-R. 269. In May of 2004, the effective date of Project Goldcrest was estimated to be February 28, 2005. Ex. 47-J; Stip. 34. 270. Exhibits C-357-J and C-4100-R are presentations - 74 - Docket No. 31197-12 reviewed by the S Team. Tr. 2254:9-2555:4 (Comfort); Tr. 2524:6-25 (Krabbenschmidt). 271. The July 14, 2004 S Team presentation shows an NPV Tr. 2255:5- tax benefit from Project Goldcrest of 15 (Comfort); Ex, C-4100-R at 5. At that point, the Model generated a $400 million buy-in valuation. Tr. 2539:19-2540:5 (Krabbenschmidt); Ex. C-4100-R at 4. 272. The assumptions in the July 14, 2004 S Team presentation were compared with the Long Term Valuation Model prepared by the financial planning and analysis group (FP&A). Gross margins were the same and operating margins were lower in the Model. Tr. 2541:20-2542, 2544:12-2546:12 (Krabbenschmidt); Ex. C-4100-R at 1; Tr. 453:8-10 (Greeley). 273. A Valuation Model was provided to Ms. Krabbenschmidt by employees of Mr. Greeley. Ex. C-4107-R. worked on. 274. Tr. 2543:4-19 (Krabbenschmidt); It (Ex. C-4107-R) looks like a Model Mr, Veiseh Tr. 2423:1-18, 2427:19-2428:1 (Crow). The July 14, 2004 S Team presentation considered the impact of terminating Project Goldcrest. Ex. C-4100-R at 6; Tr. 2540:6-25 (Krabbenschmidt). 275. The October 2004 S Team presentation (Ex. C-357-J at 4) estimates a NPV tax benefit of Goldcrest. Tr. 2257:9-20 (Comfort). - 75 - from Project Docket No. 31197-12 Revised Pro;eotions 276. At the end of October 2004, Mr. Comfort told Ms. Krabbenschmidt that Mr. Szkutak said that Amazon's margins were going to dip and he wanted to evaluate delaying the project for a year. Tr. 2453:11-20, 2454:5-10, 2556:21-2557:7, 2559:4-7 (Krabbenschmidt). 277. Ms. Krabbenschmidt was told to work with Bill Crow, a member of Mr. Szkutak's corporate FP&A team, who would build out new forecasts for the Model. Tr. 2453:17-23, 2557:9-14, 2559:9- 13 (Krabbenschmidt); Tr. 2405:5-21, 2408:12-2409:3 (Crow). 278. Mr. Crow provided Ms. Krabbenschmidt with new financial projections (Ex. C-413-J) in about October of 2004. Tr. 2454:11-24, 2520:22-25, 2557:16-24 (Krabbenschmidt). Mr. Crow did not have substantive discussions regarding the projections with Ms. Krabbenschmidt. 279. Tr. 2426:18-24 (Crow). Mr. Crow's projections were the basis for the final Deloitte valuation. Tr. 2454:25-2455:15 (Krabbenschmidt). Those projections were not reviewed by Mr. Greeley. Tr. 2413:9- 18, 2426:25-2427:10 (Crow). 280, Mr. Crow's projections (Ex. C-413-J) used conservative growth rates. 281. Tr. 2435:14-21 (Crow); Ex. C-413-J. Ms. Krabbenschmidt prepared Ex. C-156-R, titled "Analysis of Cost of Delay and Cost of Valuation Change," after - 76 - Docket No. 31197-12 Project Goldcrest was delayed. (Krabbenschmidt). Tr. 2559:15-2560:9 The spreadsheet compares both gross margins and operating margins per the Goldcrest Model used for the October S Team Presentation and the margins computed using Mr. Crow's revised forecast. Ex. C-156-R at 5-6. Tr. 2559:15-2561:6 (Krabbenschmidt); There was a in the expected operating margins as a result in the forecast change directed by Mr. Szkutak. Tr. 2259:7-2260:22 (Comfort); Tr. 2561:25-2562:16 (Krabbenschmidt); Ex. C-156-R at 5. 282. _The projected buy-in decreased from $400 million to $300 million as a result of the forecast change directed by Mr. Szkutak. Ex. C-156-R at 6; Tr. 2562:18-2563:15 (Krabbenschmidt). 283. Despite the delay, Amazon went ahead with the transfer of IP. Tr. 2208:22-2209:12 (Comfort); Tr. 2573:16- 2575:15 (Krabbenschmidt). 284. By letter dated December 5, 2004, Amazon informed Luxembourg authorities that the restructuring process would not be concluded by May 6, 2005, as contemplated in Amazon's October 23, 2003 and October 31, 2003 letters. Amazon requested that the Luxembourg authorities confirm that the agreement would remain in place so long as the restructuring was implemented by December 31, 2006. Stip. 410; Ex. C-305-J. - 77 - Docket No. 31197-12 285. By letter dated December 10, 2004, the Luxembourg authorities confirmed that the agreement would remain in place. Stip. 411; Exs. C-307-J, C-308-J. 286. Project Goldcrest did not solve issues with respect to creating a permanent establishment in UK, Germany and France. Tr. 2229:7-21 (Comfort). IDCs in the Model 287. The Model contains a tab entitled "Cost Sharing Payment Cale" which provides estimates of projected IDCs. Tr. 2468:9-16 (Krabbenschmidt); Exs. 283-J at "Cost Sharing Payment Cale" Tab, C-4635-R at 12-13 (Higinbotham). 288. The IDCs in the Model were used by Amazon to calculate the tax cash benefit for management. Tr. 2468:9-21 (Krabbenschmidt). 289. The Model included 2004 WW Total Tech costs of "from plan." The costs were sourced to the "2004 Data Table" Tab of Ex. 283-J, cells C57-70, which breaks down total into the cost center rollups of different the development groups at Amazon. Ex. 283-J at "Cost sharing payment calc" Tab, formula for cell E36. Tr. 2617:8-23, 2613:4- 2616-4 (Krabbenschmidt); Ex. C-4635-R at 12-13 (Higinbotham). 290. In the Model, WW Total Tech costs of for 2004 increases each year based on operating expense growth rates - 78 - Docket No. 31197-12 set forth in the "Model Variables" Tab, row 119, Ex. 283-J at "Cost sharing payment calc" Tab, formulas for cells F36, G36, H36; Ex. C-4635-R at 13 (Higinbotham). The cost share percentage in the Model, used to derive projected cost sharing payments, was calculated based on WW Tech costs allocable to the EU as percentage of revenue <1111111 for 2004). Ex. 283-J at "Cost sharing payment calc" Tab, formulas for cells F29, F39, F41. WW Tech costs as percentage of WW revenue decrease every year after 2004. 291. Ex. 283-J at "Cost sharing payment calc" Tab. Amazon's calculated 2005 IDCs in the Model is increased by over due to an unexplained "cushion" adjustment to the calculated roes. Tr. 5694:8-5696:19 (Frisch); Ex. 283-J at "Cost Sharing Payment Cale" Tab at cell F32. 292, The tab entitled "Cost Sharing Payment Cale" in the Model uses a 5% yearly growth rate for Amazon's cost sharing payment. Tr. 5696:22-5697:2 (Frisch); Ex. 283-J at "Cost Sharing Payment Cale" Tab at cells G33-K33. 293. In 2004, Amazon projected that operating expenses which includes roes, would decline as a percentage of sales. Tr. 5858:10-24 (Frisch); Exs. C-4107-R at 6, C-4108-R at 2. Projected and Actual Results 294. Amazon's Model projected that for 2005-2011, Amazon's Net revenue from EU operations would be $2.9 billion, $3.8 - 79 - Docket No. 31197-12 billion, $4.9 billion, $6.2 billion, $7.8 billion, $9.6 billion, and $11.9 billion, respectively. - 4613-R at 52 (Frisch). Exs. C-57-P at IRS_000121, c- - Petitioner's actual revenues from its European operations for this time period were for the respective years 2005-2011. - Exs. C-4613-R at 53 (Frisch), C-2380-P at Exs. 2d page 1, 2e page 1, and 2f page 1 (Wentland). 295. For the fiscal years 2006-2011, Amazon's Model projected year over year revenue growth for the EU business to be 30.6%, 27.2%, 27.3%, 25.3%, 23.4% and 23.4%, respectively. Exs. C-4613-R at 52 (Frisch), C-57-P at IRS 000121. - 296. Profit from European operations would be , respectively. 4613-R at 52 (Frisch). Exs. C-57-P at IRS_000121; c- - Petitioner's actual Gross Profit from its European operations for this time period were - - Amazon projected that for 2005-2011, Amazon's Gross for the respective years 2005-2011. Ex. C-2380-P at Exs. 2d page 1, 2e page 1, and 2f page 1. Goodwill Impairment Model 297. Amazon used a discounted cash flow (DCF) model to - 80 - , Docket No. 31197-12 test for goodwill impairment under GAAP for financial statement purposes. Tr. 5543:4-18 (Fildes); Ex. C-4108-R. The goodwill impairment model produced a NPV of projected free cash flow and that amount was compared to the book value of the assets to check for goodwill impairment. (Fildes); Ex. C-4108-R at 4. Tr. 5544:6-18, 5557:11-5558:14 The goodwill impairment model computed a fair value for Amazon and for individual countries' businesses. 298. Tr. 5545:4-18, 5557:1-10 (Fildes); Ex. C-4108-R. Amazon's goodwill impairment model used a terminal value assumption with an II growth rate after 2015. Ex. C-4108-R; Tr. 5553:4-11 (Fildes). 299. Amazon's goodwill impairment model used a 13% weighted average cost of capital (WACC) obtained from Amazon Treasury. 300. Tr. 5553:12-18 (Fildes); Ex. C-4108-R at 2. As of December 19, 2005, Amazon's goodwill impairment model determined that the NPV of free cash flow in the UK was , and in France was , in Germany was Ex. c-4108-R at 4-6. The total consolidated worldwide NPV of free cash flow was Tr. 5554:24-5555:17 (Fildes); Ex. C-4108-R at 2. 301. The accounting group at Amazon was responsible for the goodwill impairment model. 302. Tr. 5553:19-5554:3 (Fildes). Amazon's goodwill impairment model compared its - 81 - Docket No. 31197-12 results to that of the model used by Amazon's long term valuation team. 303. Ex. C-4108-R at 2. Amazon's 2005 goodwill impairment model computed growth rates from 2006-2010 for every individual product category Amazon sold in each country of operation. at 16-21. It used the same format that Amazon used to track to that level for OPl. 304, Ex. C-4108-R Tr. 2434:19-25 (Crow); Ex. C-4108-R at 22. Soon after joining Amazon, Mr. Fildes performed sensitivities to determine how adjusting growth rates would impact the net present value of free cash flow in the goodwill impairment model. Tr. 5546:1-3, 5546:24-5547:4, 5551:19- 5552:15, 5572:18-5573:10, 5540:12-13, 5548:4-5549:3 (Fildes). THE SOCIAL PLAN 305. In 2004, Amazon's French website business underwent a restructuring pursuant to a "social plan" that involved the French government. Pursuant to the social plan, Amazon let most of the employees of its French website business go, downsizing from 100 or 150 employees to 30 employees. Tr. 879:21-25 (Garambois). 306. The social plan was set forth in a detailed formal document prepared by Amazon France's legal department and outside counsel and shared with a number of French government authorities. Tr. 880:7-18, 922:15-24 (Garambois); Ex. C-2153-P. - 82 - Docket No. 31197-12 307. At the time of the French social plan, Amazon operated with a technology platform that allowed it to make changes centrally. Ex. C-2153-P at AMZCOM00116388. Throughout its history, both prior to 2004 and after, Amazon has been trying to improve its eCommerce platform. (Garambois). Tr. 928:23-924:11 The social plan identifies technology and processes that existed in 2004 and were available to Amazon France that allowed it to eliminate employees. Tr. 927:22- 928:22 (Garambois). THE DELOITTE TRANSFER PRICING STUDY 308. Pursuant to an engagement with Amazon, Deloitte prepared a transfer pricing study. Ex. C-57-P. The payments set forth in the License Agreement and Assignment Agreement are consistent with the Deloitte transfer pricing study, and are combined in the table below. Year 2005 2006 2007 2008 2009 2010 2011 Stip. 46. License Payments 73,220,000 66,170,000 47,330,000 25,460,000 10,220,000 3,090,000 1,030,000 Assignment Payments 0 16,514,000 7,619,000 2,803,000 818,000 187,000 50,000 Total 73,220,000 82,684,000 54,949,000 28,263,000 11,038,000 3,277,000 1,080,000 Total $226,520,000 $27,991,000 $254,511,000 309. Deloitte, in its valuation of the pre-existing - 83 - Docket No. 31197-12 intangible property made available to AEHT, relied on Amazon's projections in the Model, with updates for actual results for 2004 and minor modifications in the growth rate assumptions. Tr. 2452:11-19 (Krabbenschmidt); Exs. C-57-P at IRS_000121, 0182, C-4634-R at 11-12 (Higinbotham); Stip. 47. 310. The Deloitte Transfer Pricing Study concluded that the intangible property obtained by AEHT had an NPV of $216,711,000 as of January 1, 2005. 311. Stip. 48. Petitioner's federal income tax reporting for the years in issue was consistent with the Deloitte Transfer Pricing Study. Stip. 49. 312. Petitioner submitted the Deloitte Transfer Pricing Study to Respondent in response to Information Document Request (IDR) Number I-02 dated July 17, 2008, which requested "all buy­ in analysis documents and/or other buy-in valuation studies related to the valuation of any buy-in amounts for pre-existing intangibles as required by Treas. Reg. § l.482-7(g)," Petitioner did not submit any other valuation studies in its response to IDR Number I-02. 313. Stip. SO. Selected portions of the Model were provided to the IRS as IDR I-11, Tr. 2619:19-2620:4 (Krabbenschmidt); Tr. 5692:20-5693:19 (Frisch); Exs. 282-J, 283-J. 314. The Deloitte economist interviewed a few Amazon - 84 - Docket No. 31197-12 employees as part of the transfer pricing functional analysis related to Project Goldcrest, but Ms. Norton and Ms. Krabbenschmidt conducted the majority of the functional analysis interviews. 315. Stip. 1200. In connection with Project Goldcrest, Amazon also retained Deloitte to provide transfer pricing reports for foreign tax law purposes. Stip. 418. AMAZON'S US TAX REPORTXNG 316. At all relevant times, Amazon US annually filed a consolidated federal income tax return on a calendar year basis using the accrual method of accounting. 317. Stip. 401. Amazon US timely filed Form 1120, US Corporation Income Tax Returns, for tax years 2005 and 2006. Stip. 420; Exs. C-260-J, C-263-J. 318. On its 2004, 2005 and 2006 federal income tax returns, the Amazon US reported payments under the Assignment and License Agreements in the total amounts of $3,000,000, $70,220,000 and $82,684,000, respectively. J, Stip. 422; Ex, 371- The $3,000,000 reported in 2004 was accrued by A9 and deemed paid as part of the buy-in payment from AEHT in 2005. Stip. 422; Ex. 371-J. 319. On June 21, 2010, Amazon made an affirmative claim for refund for 2005 and 2006, requesting a reduction in its cost - 85 - Docket No. 31197-12 sharing payments of $2,545,000 and $6,951,000, respectively, with respect to stock based compensation. Ex. C-278-J; Stip. 425. 320. On its 2006 federal income tax return, the Amazon US reported that AIS transferred goodwill, going concern, notes receivable, third-party and intercompany contracts and cash totaling $207,812,605 (tax basis of $240,348,998), less liabilities of $7,413 to AEHT in exchange for stock of AEHT. Stip. 426; Ex. 319-J. 321. On its 2006 federal income tax return, Amazon US reported gain under section 356 of the Code as a result of the receipt of property in the reorganizations under section 368(a) (1) (D) in which the assets and liabilities of Amazon.co.uk Ltd., Amazon.de GmbH and Amazon.fr Holdings were transferred to AEHT. Stip. 427; Ex. 317-J, Amazon US computed the gain as follows: Amount Realized Basis Gain $195,690,000 $129,140,689 $ 66,549,311 Stip. 427; Ex. 386-J. 322. The amount realized was computed based on Deloitte's DCF valuations of the EU affiliates. (Krabbenschmidt); Ex. C-134-R. Tr. 2577:3-2578:1 Deloitte opined that the fair market value of the following Amazon European entities as of - 86 - Docket No. 31197-12 December 31, 2005 was as follows: Amazon.co.uk Amazon.de GmbH Amazon.fr Holdings SAS Total Fair Market Value $ 74,910,000 $ 96,560,000 $ 24,220,000 $195,690,000 Stip. 428; Ex. C-320-J. 323. Amazon did not file a Form 926 or a section 351 statement with any federal income tax return specifying that the license or assignment of IP from Amazon to AEHT was contributed to AEHT via a section 351 exchange. Exs. 249-J, 250-J, 251-J, 253-J, 254-J, 255-J, 256-J, C-257-J, 258-J, C-260-J and C-263-J. Amazon reported that AEHT and Amazon became cost sharing participants under section l.482-7(j) (3). Ex. C-117-J at IRS_005894; Stip. 326, 331. 324. For foreign tax law purposes, goodwill/going concern was transferred from AEHT to AEU in Project Goldcrest at fair market value which was deemed equal to book value because Amazon's goodwill/going concern has insignificant value when it is separated from the rest of the IP transferred in Project Goldcrest. Ex. C-45-J at IRS_005683; Tr. 2270:21-2272:8 (Comfort). 325. A statutory notice of deficiency was timely mailed to the Amazon US Group on November 9, 2012. - 87 - Stip. 402; Ex. 265-J. Docket No. 31197-12 DR. FRISCH'S VALUATION OF THE IP MADE AVAILABLE TO AEHT 326. Dr. Daniel J. Frisch, an expert in economics and transfer pricing, was retained by the IRS during the audit to perform an economic study of the buy-in. Tr. 5602:1-5; Ex. C- 4613-R at 2 (Frisch). 327. Dr. Frisch presented a close-to-final draft of his audit report to Amazon but received no comments or corrections from it. Tr. 5622 (Frisch). 328. Deloitte's selection of a seven year useful life for the IP and further ramp down of the amount of income attributable to the pre-existing intangibles were unreliable and led to an unreasonably low buy-in. Tr. 5605:21-5607:7; Ex. c­ .4613-R at 2, 10-11 (Frisch). 329. The implications of Deloitte's analysis were that over the first seven years of the agreement, Amazon US would give up more than $9 in expected profit for every $1 it collected from AEHT as a payment for the IP. would get all the profits for free. After that, AEHT Amazon's reported $216.7 million price for the transferred IP implies an internal rate of return (IRR) of 128% for AEHT over the first seven years of the investment. Exs. C-4613-R at 3, 9-10 (Frisch), C-4637-R at 18 (Oswald). 330. At arm's length, an uncontrolled party would not give - 88 - Docket No. 31197-12 up $9 for every $1 it expected in return because entering into a transaction at that price would decrease shareholder value and is contrary to how Amazon made decisions. Exs. C-4637-R at 15- 18 (Oswald), C-97-R; Tr. 7318:4-7319:21 (Blackburn). The implication of Deloitte's analysis is that by 2012, Amazon would be indifferent if an uncontrolled party were to use its IP without paying any royalty. 331. Ex. C-4613-R at 11 (Frisch). Deloitte constructed stocks of IDCs by accumulating IDC spending over time and applied the ratio of the stock of Amazon US's pre-Cost Sharing Agreement IDCs to the total of AEHT's accumulated IDCs under the Cost Sharing Agreement to ramp down the projected income arising from the intangibles over a seven year useful life. 35-39. Exs. C-4613-R at 15 (Frisch), C-57-P at Under Deloitte's ramp down, 69.9% of the income from the intangibles is used in computing the buy-in in 2005, 40% in 2006, 18.5% in 2007, 6.8% in 2008, 2.0% in 2009 and 0.5% in 2010. Exs. C-4613-R at 15-16 (Frisch), C-57-P at 38, Figure 11. 332. The Deloitte report made computational errors. Deloitte misapplied the half-year convention. WACC but claimed to apply a 13% WACC. 2402-P at 9 i 27 and n.42 (Cornell). It applied a 15% Tr. 5072:2-5073:1; Ex. CDeloitte stated it was assigning a 4.5% readily identifiable return to the Luxembourg operations for 2005-2011, but it actually applied a 3.9% return - 89 - Docket No. 31197-12 for 2011. Tr. 5073:6-25; Ex. C-2402-P at Exhibit 7A (Cornell). PETITIONER ABANDONED ITS TAX RETURN VALUATION 333. Deloitte used an unspecified income-based method in its transfer pricing report. Ex. C-57-P at 23 i 5.6; Tr. 4988:2-15; Ex. C-2402-P at 8 1 25 (Cornell). 334. Deloitte determined that cost plus 4.5% was an arm's length return to the EU Service Affiliates. Tr. 2627:25-2628:24 (Krabbenschmidt); Exs. C-4608-R, C-292-J; Tr. 5073:6-25; Ex. c- 2402-P at Exhibit 7A (Cornell). 335. Dr. Frisch agreed that Deloitte's arm's length service fees of cost plus 4.5% for the activities of the EU Service Affiliates were reasonable. Tr. 5615:17-5616:13, 5793:23-5794:7, 5865:23-5868:6 (Frisch). 336. Amazon abandoned its tax return methodology at trial. Compare Ex. C-57-P with Exs. C-2402-P (Cornell), C-2372-P (Iansiti), C-2390-P (Reilly), C-2396-P (Unni), C-2399-P (Willig), C-2388-P (Wills). 337. Petitioner's trial experts offered buy-ins resulting in the following IRRs to AEHT: Buy-In (Millions) $854.1 $525.1 $505.7 $420-560 IRR 40.6% 52.6% 53.7% Expert Cornell Cornell Unni Wills Method DCF DCF RPSM CUT Ex. C-4614-R at 12, 24-25; Tr. 5658:18-5662:6 (Frisch); Ex. - 90 - c- Docket No. 31197-12 2389-P at 7 (Wills). 338. Petitioner's lowest estimate of the buy-in price (without accounting for Prof. Franklyn's adjustments) is 193% of its return position. RF 329, 336, 337. 1 DR. FRISCH'S DCF METHODOLOGY 339. Dr. Frisch valued the transferred intangibles using a DCF methodology. Starting with the same Amazon projections used by Deloitte, Dr, Frisch converted them to valid measures of cash flows and discounted them using an 18% discount rate. Ex. c- 4613-R at 28-32 and Appendix A; Tr. 5608:8-12 (Frisch). 340. As determined by Dr. Frisch, the net present value of the arm's length price for the intangibles made available to AEHT in Project Goldcrest was $3.468 billion. (Frisch). Ex. C-4613-R at 3 Dr. Frisch's audit report, determining an arm's length buy-in of $3.6 billion, was used as the basis for respondent's statutory notice of deficiency. Pet. i 5.a.42-45. Respondent converted the present value of $3.6 billion into buy­ in payments by AEHT over a seven-year period and proposed income allocations under section 482 increasing Amazon OS's taxable income by $1,036,305,000 and $1,170,251,000 for 2005 and 2006, respectively. 341. 1 Pet. i 5.a.42. Dr. Frisch was given no instructions by the IRS other RF refers to Respondent's Request For Findings of Fact. - 91 - Docket No. 31197-12 than to determine the arm's length price for the IP. He independently determined that the DCF method was the best method for determining the buy-in in this case. Tr. 8060:23-8061:2 (Oswald); Tr. 5602:16-25 (Frisch). 342. In financial economics, the value of any set of assets at a given point in time is determined by the present value of the cash flows the assets are expected to generate in the future. 343. Ex. C-4616-R at ii 11, 15; Tr. 6033:6-21 (Gompers). The DCF theory made finance a quantitative field and is the cornerstone of finance. (Gompers). Using free cash flow is the textbook way of implementing a DCF. 344. Tr. 6033:12-21, 6036:8-13 Tr. 7324:17-7325:3 (Blackburn). The DCF valuation method used by Dr. Frisch is the most accepted and commonly used valuation approach in business and academia because of its intuitive appeal, its strong theoretical foundation, and direct link to the source of value (namely, future cash flows). Exs. C-4616-R at ii 8, 16, 17, 21, C-4617-R at ii 12, 44, 47 (Gompers). 345. The DCF approach begins with the fundamental items of revenues and costs, constructs detailed projections of the cash flows that the assets are expected to generate in the future, and makes explicit assumptions regarding growth rates in the future and the systematic risk to estimate value. - 92 - It provides Docket No. 31197-12 an accurate estimate of value when reliable projections of expected future cash flows and systematic risk associated with those cash flows are available. 346. Ex. C-4616-R at i 21 (Gompers). It is well-recognized in finance that the DCF valuation is the foundation on which all other valuation approaches are built. Every other valuation approach is derivative of the DCF and has embedded assumptions. Tr. 6033:22-6034:3; Ex. C-4617-R at i 48 (Gompers); Tr. 4754:164755:4 (Unni); Tr. 7502:6-17 (Timmins). 347. The DCF method of valuation builds up the value of a project or assets from its fundamentals, and in doing so, makes explicit the various assumptions that go into the valuation. The DCF method is more transparent than other valuation methods. Ex. C-4616-R at i 18; Tr. 6034:4-16 (Gompers). 348. The key value drivers in the DCF method are the cash flow forecasts, the long-term growth rate, and the discount rate specific to the assets being valued. Ex. C-4616-R at i 24 (Gompers). 349. One of the advantages of the DCF method is that it appropriately takes into account the systematic risk of the valued assets, as measured by the discount rate. Ex. C-4617-R at i 65 (Gompers). 350. The DCF method is used to value any kind of - 93 - Docket No. 31197-12 intangible asset, as well as portfolios or bundles of intangible assets. Tr. 6036:1-6037:4 (Gompers). The DCF method is often used in the valuation of intangible assets. A DCF analysis is the most common method used by senior executives and private equity practitioners to value IP assets. In literature and practice, there is a distinct preference for the DCF approach to determine the value of intangible assets. Ex. C-4616-R at 1 19 (Gompers). 351. Amazon tries to perform a DCF analysis in connection with every potential acquisition. Tr. 7294:13-17 (Blackburn). Tr. 546:6-547:1 (Greeley); Amazon's DCFs often employ a terminal value assumption, using a growth rate based on gross domestic product. Tr. 2918:15-2919:7 (Szkutak); Tr. 7296:23-25 (Blackburn); Exs. C-134-R, C-4088-R at "Financial Justification" row 149, C-92-R at 16-18, 21, C-93-R at "StandAlone Summary" row 57. Amazon's Acquisitions 352. From its formation through December 31, 2004, Amazon acquired 17 companies. The total purchase price of 14 of those acquisitions was more than $1.2 billion. 353. Stip. 112. On July 6, 2005, Amazon acquired CustomFlix Labs, Inc. (CustomFlix), a provider of music and video burn on demand - 94 - Docket No. 31197-12 services. 2 Stip. 133-34, Prior to acquiring CustomFlix, Amazon prepared a standalone DCF, Stip. 135; Exs. C-92-R at AMZCOM00000346, AMZCOM00000362, C-93-R at AMZCOM00060166 (Tab 1 - StandAlone Summary; Tab 2 - StandAlone DCF-Details). also prepared build versus buy analyses. Amazon Ex. C-92-R at 16-18; Tr. 7310:6-7311:4 (Blackburn). CustomFlix provided Amazon with a head start on the 354. development effort and in recruiting content providers. 7312:11-22 (Blackburn). Tr. CustomFlix had "special sauce" in the form of intellectual property that would be hard to replicate. Ex. C-92-R at 5-6; Tr. 7312:23-7313:3, 7315:23-7316:12 (Blackburn) 355. On March 18, 2005, Amazon acquired the assets of Pulver Technologies, Inc. (PulverTech), a systems integrator focused on providing e-solutions for retailers. Stip. 136. Amazon analyzed the acquisition price under three alternatives: 1) partnering with PulverTech and building the functionality in­ house; 2) acquiring PulverTech outright; and 3) tightening the partnership but remaining independent (status quo). Stip. 137; Exs. C-96-R at 7-9, C-97-R; Tr. 7318:22-7319:21 (Blackburn). 356. As Amazon told its Board of Directors, it relied most Project SunDance was a code name for the CustomFlix acquisition. Tr. 546:2-5 (Greeley). 2 - 95 - Docket No. 31197-12 heavily on its 10-year standalone DCF model to value Shopbop. It also reviewed comparable company revenue multiples to benchmark a fair price. Ex. C-298-J at IRS_Oll377, IRS_011382; Tr. 7289:24-7291:25 (Blackburn). Bundle of Transferred Intangibles 357. The transfer of all cash flows relating to the European operations is, as an economic matter, a transfer of the European business. Exs. C-4613-R at 27 (Frisch), C-4616-R at 1 22 (Gompers); Tr. 5033:21-5034:9 (Cornell). 358. The most reliable way to value all of Amazon's intangibles is to value the entire business, and then subtract the value of the tangible assets. Ex. C-4613-R (Frisch); Tr. 5079:14-5080:1 (Cornell). 359. A DCF valuation will undervalue the total business and the underlying intangibles to the extent it relies on cash flow projections that are too low. 360. Tr. 5078:7-5079:3 (Cornell). A bundle of IP was transferred to AEHT including business systems, trademarks, domain names, software code, patents, copyrights, systems, procedures, know-how, trade secrets, and look and feel of the website. Tr. 5634:21-56:7, 5771:11-17; Exs. C-4614-R at 3-4 (Frisch), C-57-P at IRS_000115, 229-J; Stip. 353. 361. Business systems include the look and feel of the - 96 - Docket No. 31197-12 website, the way the website operates, the way the website connects to the fulfillment system, the reliability and accuracy of that interconnection, the systems, and all the things that make Amazon a convenient and powerful website to use for Internet shopping. 362. Tr. 5804:23-5805:11 (Frisch). The transferred IP consists of all the IP utilized and necessary to operate Amazon's website, third party services business, and other businesses in Europe. Exs. C-57-P at IRS_000114, c-4637-R at 7 (Oswald). 363. The income attributable to all of the intangibles that were transferred is included in the DCF. In the situation of Amazon, the use of the DCF is a reliable method of getting around the problem of finding CUTs for every item of IP transferred. 364. Tr. 5873:21-5883:7 (Frisch), From an economic point of view, valuation of assets that are highly complementary to each other requires valuing these assets as one combined unit. It would be unreasonable to value each asset individually because such analysis would not take into account the overlapping costs and revenues across the assets. The analysis also would not take into account the benefits arising from the combination of these assets. Ex. c- 4617-R at t 75 (Gompers). 365. The Amazon IP is more valuable used as a bundle or - 97 - Docket No. 31197-12 portfolio. The ability to use those assets in conjunction with each other as a business is far more valuable than selling off the individual pieces. 366. Tr. 6057:9-17, 6128:22-25 (Gompers). A sum of the parts valuation is also called a liquidation value where a company is chopped-up and its individual pieces are valued. (Gompers). Tr. 6056:6-11, 6151:3-6 For almost every firm, the value of the business is greater than the sum of the parts. Tr. 6056:18-21 (Gompers). An improvement to Amazon's technology that increased customer purchases would be more valuable the larger its customer list. Ex. C-4637-R at 21; Tr. 7949:11-7951:8 (Oswald); Ex. C-4629-R at 1 20 (Wilcox); Tr. 5042:10-15 (Cornell). 367. The inclusion of trademarks in the bundle implies longer lives for the intangibles as a whole. Exs. C-4614-R at 13 (Frisch), c-2402-P at 40 n.174. Dr. Frisch's Terminal Value Assumption 368. Because the useful life of the intangibles was indeterminate, Dr. Frisch used a terminal value assumption. 5607:11-12; Ex. C-4613-R at 12-14 (Frisch). Tr. The use of a terminal value is a common and well-accepted approach to valuing intangibles that can be expected to last an indefinite period of time. Ex. C-4613-R at 12-14, Appendix C (Frisch); Tr. 3996:22- 25, 3979:5-13 (Reilly), Tr. 6080:17-6081:5 (Gompers). - 98 - Docket No. 31197-12 369. Economists routinely use terminal value assumptions when valuing businesses. 370. Tr. 5037:3-11 (Cornell). A terminal value assumption does not assume that the Instead, it recognizes intangibles will literally last forever. that it is impossible to know how long the intangibles will be valuable. Discounting future cash Ex. C-4613-R at 13 (Frisch). flows acknowledges the inherent risk that the expected cash flows may not materialize. Ex. C-4637-R at 17 (Oswald); Tr. 5607:11-5608:7, 5613:25-5614:24 (Frisch). 371. Amazon's cash flow projections used by Deloitte, and corroborated by Forrester Research reports, assume rapid strong growth. Amazon expected rapid growth. Tr. 5611:18-5612:19; Exs. C-4613-R at Table 2, Appendix E; C-4614-R at 4 (Frisch); c- 57-P at Appendix 4; Tr. 171:2-9 (Valentine). 372. Increased internet penetration explains why it was reasonable to project that Amazon's European Websites Business would grow rapidly. 373. Tr. 5859:17-23 (Frisch); Ex. 1123-P at 38. Increased internet penetration enabled growth of eCommerce, including Amazon. Tr. 2331:13-19, 2333:1-9 (Roper); Tr. 952:1-13 (Garambois); Tr. 5067:3-11 (Cornell). At the end of 2004, it was expected that internet penetration and eCommerce would grow in Europe. Tr. 952:23-953:3 (Garambois); Tr. 3513:10-17 (Mendelson). - 99 - Docket No. 31197-12 374. The lack of flat-rate pricing for internet access hindered Amazon's development in Germany for a time because German consumers limited their web browsing. introduced flat-rate pricing in 2004. Deutsche Telekom Tr. 1008:15-1009:6 (Kleber), 375. Moore's Law is a rule of thumb in the software engineering field that dates back to the 1960s. (Felten). Tr. 6398:9-10 Moore's Law says that any measure of performance or capacity (e.g., the speed of a computer, the amount of storage, or the bandwidth of a wire or cable) will tend to double every 18 months, or equivalently, increase by 10 times every five years. Tr. 6398:12-17 (Felten). Moore's Law has been remarkably accurate over the decades. 376. Tr. 6398:17-18 (Felten). One effect of Moore's Law is to reduce the cost or the technical difficulty of operating large scale systems over time because those systems tend to become more capable. 6400:7-11, 6400:11-14 (Felten). company can leverage Moore's Law. 377. Through routine maintenance, a Tr. 6404:22-6406:6 (Felten). As of the Business Transfer Date, Amazon expected to benefit from Moore's Law. 378. Tr. Ex. 1123-P at 38. Dr. Frisch assumed a 3.8% growth rate after 2011 for Amazon's business in Europe. Tr. 5612:20-5613:24 (Frisch). projected long-term growth rate for the EU economy was 3.8%. - 100 - The Docket No. 31197-12 Ex. C-4613-R at 30-32 (Frisch). 379. Amazon's growth rate projections lined up with projections of overall ecornmerce growth. Tr. 5680:23-5681:9, 5724:5-25 (Frisch); Tr. 6038:22-6039:6; Ex. C-4616-R at ii 30, 33 (Gompers). Dr. Frisch's use of a terminal value after 2011 that 380. assumes growth at the 3.8% GDP rate is a conservative assumption. Exs. C-4613-R at 31 (Frisch); C-4616-R at ii 37, 39; Tr. 6080:13-6081:25 (Gompers). 381. Dr. Frisch's projections assume, conservatively, that Amazon's business would completely mature by 2011. Tr. 5068:4-20 (Cornell). 382. One would expect it to take another five, or even ten years, for the EU website to converge from the 2011 growth rate of 111111 to 3.8%. Ex. C-4616-R at ii 37, 39; Tr. 6080:13- 6081:25 (Gompers). 383. A company is considered to have matured once its growth rate slows to rates similar to the rate of nominal GDP growth. 384. Tr. 5067:17-5068:3 (Cornell). If Dr. Frisch had assumed that the growth rate of revenues, costs and expenses other than IDCs were to decline in a straight line fashion for 10 years after 2011 to 3.8%, his estimate of the buy-in would have been $5.698 billion. - 101 - Ex. C- Docket No. 31197-12 4613-R at 32 (Frisch). 385. The terminal value in Dr. Frisch's valuation is equal to 3.9% of the undiscounted cash flow amount of $10.164 billion or $399 million. Ex. C-4613-R at 37; Tr. 5623:4-5624:5, 5687:24-5690:2 (Frisch); Tr. 5039:2-10 (Cornell), 386. out years. The terminal value assumption heavily discounts the Tr. 5649:10-5650:18; Ex. C-4613-R at 37 (Frisch). For example, only $54.5 million of the projected cash flows of $953 million for 2024 are reflected in Dr. Frisch's buy-in valuation. Tr. 5687:19-5690:2; Ex. C-4613-R, Table 3 (Frisch), Discount Rate 387. Because future cash flows are subject to risk, estimated future cash flows must be discounted to the present using a discount rate that reflects the riskiness of the assets. The appropriate discount rate is the rate of return that market participants would require to participate in alternative investments with equivalent types and levels of risk. Exs. C- 4616-R at i 40, C-4617-R at i 32 (Gompers), C-4637-R at 18 (Oswald). A "normal return" is equal to the cost of capital. Tr. 5025:19-5026:3 (Cornell). 388. In financial economics, investment projects that are expected to generate the "cost of capital" are considered viable investment opportunities, since they allow the investor to earn - 102 - Docket No. 31197-12 the normal rate of return commensurate with the risk of the investment. 389. Ex. C-4617-R at 1 32 (Gompers). In finance, an investor only requires compensation for nondiversifiable or systematic risk, which is risk they cannot avoid. Tr. 6042:18-6043:17; Ex. C-4617-R at 21 1 40 (Gompers); Tr. 5069:4-8 (Cornell). Idiosyncratic or firm­ specific risk is irrelevant for the discount rate. Tr. 6043:2- 17 (Gompers). 390. The capital asset pricing model (CAPM) is the method most taught in business schools, and most used by CFOs, analysts and investment banks, to estimate systematic risk. Tr. 6042:3- 15 (Gompers). 391. Amazon's beta indicates how much Amazon's stock price goes up and down compared to the market, which is the amount of risk that cannot be hedged. Tr. 6041:4-22 (Gompers); Exs. C- 4638-R at 7 (Oswald), C-4613-R at 68 n.110 (Frisch). 392. Amazon uses a WACC computed by Amazon Treasury in its DCFs for acquisitions, speculative and operational investments. Tr. 2882:11-2883:21, 2912:20-2913:1, 2914:21-2915:13 (Szkutak); Tr. 7294:18-7295:18 (Blackburn). Amazon uses a WACC computed by Amazon Treasury in any sort of NPV analysis that Amazon would do. Tr. 2431:4-16 (Crow). 393. Using the CAPM, Dr. Frisch computed a WACC of 18% to - 103 - Docket No • .31197-12 discount the cash flows in his DCF analysis. Eighteen percent is the expected rate of return that an uncontrolled party in AEHT's situation would require, in light of the risks of operating the European Websites Business. Tr. 5614:2-24 (Frisch); Exs. C-4613-R at 34, C-4617-R at i 32 (Gompers), c- 4637-R at 18 (Oswald). 394. An appropriately risky discount rate provides an arm's-length return. 395. Tr. 5029:23-5030:1 (Cornell). The definition of value is that one earns a fair rate of return for the riskiness of the assets purchased. Tr. 6144:12-17 (Gompers). 396. Due to similarities in business operations, assets, and systematic risks between Amazon's US and European Websites Business, the rate of return that market participants require on an investment in Amazon's publicly-traded stock provides a reasonable estimate of the systematic risk for Amazon's European Websites Business. 397. Ex. C-4616-R at i 41 (Gompers). The discount rate used by Dr. Frisch is conservative. Using a less conservative discount rate would result in a higher value of Amazon's European Websites Business and the transferred intangible assets. Exs. C-4616-R at 1 43, C-4617-R at t 38; Tr. 6043:21-6044:9 (Gompers). 398. The boom and bust of Internet stocks during late - 104 - Docket No. 31197-12 1999-2001 led to high beta estimations for Internet stocks due to their high volatility compared to the overall market. Ex. C- 4638-R at 7-8 (Oswald). 399. When the distortive effects of the "dot-com" period are excluded from the analysis of Amazon's expected beta as of January 1, 2005, the WACC for Amazon as of January 1, 2005 is 12.46%. 400. Ex. C-4638-R at 8-9 (Oswald). By using a discount rate of 18%, Dr. Frisch deducts from his valuation of Amazon's European Websites Business an annual cash flow return of 18% on AEHT's investments, including investments in Amazon's IDCs under the Cost Sharing Agreement, going forward. The value estimated using the DCF method represents the present value of cash flows in excess of this annual cash flow return of 18%. Ex. C-4616-R at 11 41, 42 (Gompers) 401. In competitive markets, investors seeking returns greater than their cost of capital would drive up prices until the expected return on the investment equaled the cost of capital. 402. Tr. 5026:10-23 (Cornell); Ex. C-4637-R at 19 (Oswald). The fact that an investment has a net present value of zero does not indicate an investment failure. Rather, it means that wealth will grow at the rate the investor requires, given his appetite for risk. Ex. C-4616-R at 1 32 (Gompers). - 105 - Docket No. 31197-12 403. If investments are expected to generate the cost of capital, the investor gets just what it requires. Ex. C-4616-R at i 32 (Gompers). 404. Eighteen percent is a high rate of return; NPV equals zero does not mean you are not making money. Tr. 5638:17- 5641:6; Ex. C-4613-R (Frisch). 405. At the time of the transaction corporate bond rates were 7% and Treasury bond rates were 4.5%. Tr. 5614:9-17 (Frisch). 406. Amazon Treasury updated the company's WACC periodically, usually once or twice a year. Tr. 2882:1123, 2907:24-2908:4 (Szkutak); Exs. 289-J, C-4107-R at "Assumptions" Tab; C-57-P at Appendix 9. 407. If Dr. Frisch had used the 13% discount rate Amazon used, the estimate of the buy-in would be $6.004 billion. Ex. C-4613-R at 34-35 (Frisch). Post-Tax Discount Rate 408. Typically, fair market valuations are post-tax cash flows discounted at a post-tax interest rate. (Frisch); Ex. C-4626-R at 16-18 (Haigh). Tr. 5615:2-4 Because the buy-in amount will be included in Amazon's taxable income, for purposes of section 482 it is computed as pre-tax cash flow discounted by - 106 - Docket No. 31197-12 an after-tax discount rate. Tr. 5615:2-16; Ex. C-4613-R (Frisch); Tr. 3950:6-15, 3990:12-18 (Reilly); Ex. C-2391-P at 15 (Reilly); C-2396-P i 91 (Unni); Ex. C-2388-P at 51, 52 (Wills). 409. From AEHT's point of view, there is little or no difference between pre-tax cash flows and after-tax cash flows, since it is reasonable to project that AEHT will pay little or no income taxes to Luxembourg. Ex. C-4613-R at 35; Tr. 5615:2- 16 (Frisch). Expected Return 410. A third party investor will expect to earn only its cost of capital if it brings nothing to the table except its willingness to take on risk. 411. Tr. 5026:24-5027:21 (Cornell). The expected rate of return assigned to AEHT in calculating the buy-in does not limit its actual return. Tr. 5744:9-5748:16 (Frisch); Tr. 7883 (Higinbotham). 412. On an expected basis Amazon US would expect to make a lot of money because it owns the preexisting intangibles prior to the transfer. If the EU projections turn out better than expected, AEHT would receive all that return (excess). 4981:16-4984:8 (Cornell). Tr. If things turn out worse than expected, AEHT bears that risk. Tr. 5641-46:6; Exs. C-4613-R at 19-22; C-4614-R at 5-7 (Frisch). If a transferee pays a buy-in that is equal to the discounted present value of the income - 107 - Docket No. 31197-12 earned by the intangibles and things work out as expected, the transferee will earn a rate of return on his investment equal to the discount rate. 413. Ex. C-4613-R at 21 (Frisch). If there is unexpected/uncontemplated income from the intangibles, then such income cannot be in the projections and AEHT appropriately gets the benefit of that income without having to pay for it. Tr. 5722:11-5723:7 (Frisch); Tr. 4981:16- 4984:8, 5024:17-5025:1 (Cornell); Tr. 7883:9�19 (Higinbotham). 414, To the extent the European Websites Business's actual growth exceeded the growth rates used for the buy-in projections, AEHT would realize returns in excess of its cost of capital. 415. Tr. 4982:17-4984:8 (Cornell). If it is reasonable to project that a bundle of intangible assets will produce income of $3.468 billion in present value, then an arm's length party would be willing to pay approximately $3.468 billion for those intangibles. 4613-R at 23 (Frisch). intangibles. Ex. c- That income arises from pre-existing Ex. C-4613-R at 23 (Frisch); Tr. 5036:18-24 (Cornell). Best Method 416. In performing his best method analysis, Dr. Frisch considered using comparable uncontrolled transactions (CUTs). Using the top three merchants participating in the UK, Germany - 108 - Docket No. 31197-12 and France Merchants@ programs during each of the years from 2005-2007, Dr. Frisch derived a 12.5% commission rate that confirmed his primary DCF method. Tr. 5608:16-5609:1, 5753:2- 25; Ex. C-4613-R at 39-40 and Appendix A at 73-76 (Frisch). 417. The rights acquired by the participating Marketplace merchants are different than the rights acquired by AEHT as part of the restructuring. Under Marketplace, a participating (1) modify, copy, republish or merchant is not permitted to: make any derivate of the websites; (2) use any customer information (email, addresses, etc.); or (3) perform other data mining activities related to the websites. Ex. C-4637-R at 8 n.10; Tr. 7946:15-22 (Oswald). 418. It is extremely difficult to find external CUTs for marketing intangibles. 5758:3 (Frisch). Tr. 5609:24-5611:2, 5881:9-21, 5756:21- There were no internet retailers in the data bases Mr. Reilly used to find his proposed CUTs for Amazon's trademarks. Tr. 3996:16-19 (Reilly). There were no internal CUTS for Amazon's trademarks and trade names. Tr. 4006:23- 4007:1 (Reilly). 419. A profit split method was not an appropriate method for valuing the intangibles because AEHT, being a brand-new entity, had no pre-existing intangibles. (Frisch). - 109 - Tr. 5635:8-5636:3 Docket No. 31197-12 Applying a DCF Analysis to Transferred Intangibles 420. The DCF approach is appropriate to use in this case because reliable projections of expected future cash flows and a reliable estimate of systematic risk associated with those cash flows at the time of the transaction are available. Exs. c- 4616-R at ii 22, 30 & n.31, C-4617-R at ii 12, 65, C-4618-R at 7-8; Tr. 6037:5-6038:6, 6040:19-22 (Gompers). 421. In projecting revenues for analysts, Amazon takes the risks of the business into account. 422. Tr. 2897:15-21 (Szkutak). From a financial economics perspective, Dr. Frisch's approach of estimating the value of the transferred intangible assets by calculating the total value of Amazon's European Websites Business, deducting from it the value of the tangible assets involved in the EU website operations, measured as of the valuation date, and providing AEHT an 18% return on IDCs, is an appropriate way of estimating the value that would be paid for the pre-existing intangible assets in an arm's length transaction. Exs. C-4616-R at i 25, C-4617-R at i 10; Tr. 6045:18-6047-2 (Gompers), 423. Given the nature of Amazon's business generally, the value of its tangible assets is relatively easy to calculate. Tr. 6045:24-6046:12; Ex. C-4616-R at i 23 (Gompers). 424. Dr. Frisch takes asset depreciation into account in - 110 - Docket No. 31197-12 his DCF valuation analysis. (Gompers). Ex. C-4617-R at 1 5; Tr. 6054:9-12 Dr. Frisch applies conservative estimates of depreciation and amortization, capital expenditures (CAPEX), and changes in net working capital to adjust Amazon management's operating profit forecasts to estimate the expected free cash flows. Exs. C-4616-R at i 31, C-4617-R at 1 34 (Gompers). Dr. Frisch also deducts payments associated with maintaining, enhancing and extending the intangibles. Tr. 6054:13-21 (Gompers). Innovation Assumptions 425. Dr. Frisch's valuation takes into account the significant technology challenges referenced in Amazon's Form 10-Ks and market analyst reports. 426. Tr. 5846:24-5847:9 (Frisch). Dr. Frisch assumed that Amazon would continue to innovate its websites, fulfillment systems and business systems as its EU websites grew. Tr. 5868:2-5869:1; Ex. C-4613-R at Appendix A at 5 (Frisch). 427. Dr. Frisch assumed that an independent party in AEHT's situation would expect that technology require a lot of care and feeding and maintenance over time, and that innovation is foreseeable subject to some risk that challenges may not be met. Tr. 5807:12-21 (Frisch). - 111 - Docket No. 31197-12 The Value of Transferred Assets Includes Benefits from Maintenance, Improvement, Extension, and Replacement 428. A purchaser of assets assumes it must invest in capital expenditures, R&D, and maintenance in order to maintain the assets going forward. An uncontrolled purchaser would project out the revenues but subtract out the costs associated with maintenance and extension in valuing assets. No one would value assets over their life assuming no maintenance or extension. 429. Tr. 6052:16-6053:2 (Gompers). Dr. Frisch's valuation provides AEHT an expected return of 18% on its IDCs. (Cornell). Tr. 4985:21-4986:4, 5038:11-22 Subtracting IDCs and providing that return to AEHT decreased the present value of Dr. Frisch's DCF calculation. Tr. 5038:11-5039:1 (Cornell). 430. Discontinuing further development of the transferred IP is not consistent with Amazon's management approach and longterm thinking. 431. Ex. C-4637-R at 20 (Oswald). The Cost Sharing Agreement involved investments in development activities related to: (a) maintaining, improving, and enhancing pre-existing assets (asset maintenance); (b) extending the pre-existing intangible assets by replacing them with new assets (asset extension); and (c) exploring future growth options, to the extent that activities related to - 112 - Docket No. 31197-12 extending the pre-existing intangible assets also result in development of new intangible assets. Ex. C-4617-R at i 17; Tr. 6048:12-6049:1 (Gompers); Ex. 53-J at AMZCOM00003022, 432. From an economic point of view, the Cost Sharing Agreement enabled AEHT to share with Amazon US, the cost of the investments necessary for its continued asset maintenance and extension. 433. Ex. C-4617-R at i 15 (Gompers). In applying the DCF method, Dr. Frisch made the reasonable assumptions that AEHT would make ongoing investments related to maintaining, improving, enhancing, and extending the transferred pre-existing intangible assets jointly with Amazon US under the Cost Sharing Agreement, which would ensure continuation of Amazon's European Websites Business operations going forward. 434. Ex. C-4617-R at 1 13 (Gompers). Or. Frisch takes into account expenses expected to be incurred on activities related to maintaining, improving, enhancing, or extending the transferred pre-existing intangible assets in his DCF valuation analysis. Since these expenses ensure that the transferred pre-existing intangible assets will be renewed and replenished, Dr. Frisch's assumption that Amazon's European Websites Business will continue its main operations going forward is reasonable. 34; Tr. 6050:12-17 (Gompers). - 113 - Ex. C-4617-R at ii 5, Docket No. 31197-12 435. The expected expenses deducted by Dr. Frisch include the expected cost sharing payments. 436. The expected cost sharing payments include R&D costs associated with new technologies. 437. Tr. 6050:24-6051:7. Tr. 6051:8-25 (Gompers). Or. Frisch's valuation does not embed any benefits of the Cost Sharing Agreement. Tr. 6052:1-8, 6050:18-6051:7 (Gompers). 438. The expected investments related to maintaining, improving, and enhancing pre-existing intangible assets prolong the useful life of those assets. Ex. C-4617-R at i 18; Tr. 6053:9-6054:8 (Gompers). 439. The expected benefits from investments in asset maintenance should be attributed to the pre-existing assets and, therefore, included in determining the value that an independent third party would be willing to pay for the pre-existing assets in an arm's-length transaction. 440. Ex. C-4617-R at 1 18 (Gompers). The pre-existing intangible assets provide a platform for building new assets that will replace the pre-existing assets when they became obsolete. Ex. C-4617-R at i 19 (Gompers). 441. The expected benefits from investments in extending the pre-existing assets are in the form of extending continued business operations into the indefinite future. - 114 - Ex. C-4617-R at Docket No. 31197-12 i 19 (Gompers). 442. The expected benefits from asset extension should also be attributed to the pre-existing assets and included in determining the value that an independent third party would be willing to pay for the pre-existing assets in an arm's-length transaction. Ex. C-4617-R at i 19 (Gompers). Growth Options/New Businesses 443. From an economic perspective, growth options represent new types of business or opportunities (distinct from the existing business) that AEHT could enter because of its existing assets lboth tangible and intangible assets). Ex. C- 4617-R at i 20; Tr. 6159:5-10 (Gompers). 444. Growth options are attributable to pre-existing intangibles. Ex. C-4614-R at 4 (Frisch); Tr. 4989:4-24 (Cornell); Ex. C-4617-R at i 20; Tr. 6083:22-6084:4 (Gompers). 445. options. Investors and arm's length parties pay for growth Tr, 4991:19-23 (Cornell). Growth options are not solely attributable to the services of an individual. 4991:24-4993:6 (Cornell). Tr. Growth options are attributable to all of a firm's pre-existing intangible assets, including systems, business processes and human capital. Tr. 4989:25- 4991:18 (Cornell). 446. It would have been appropriate for Dr. Frisch to - 115 - Docket No. 31197-12 include in the value of the pre-existing assets the value of any identifiable growth options that were closely related to the pre-existing assets. 447. Ex. C-4617-R at i 25 (Gompers). The Frisch valuation does not include the value associated with such growth options and is therefore conservative. Ex. C-4617-R at i 25; Tr. 6077:2-4, 6079:1-21, 6088:19-6090:17 (Gompers). 448. Growth options were available to AEHT but were not embedded in the forecast that Dr. Frisch used. Tr. 6079:1-21, 6088:19-6090:17 (Gompers). 449. Spain. Amazon's Model includes no line items for Italy or Tr. 6090:1-8 (Gompers); Ex. 283-J at "2004 YTD Consol External IS" Tab. 450. The projections that Dr. Frisch utilized are right in line with projected ecommerce growth in Europe and within UK, Germany and France. The projections do not include additional income attributable to growth options. Tr. 6077:6-6078:3, 6079:22-12 (Gompers). 451. Dr. Frisch's use of a terminal value that assumes growth at the 3.8% GDP rate to calculate the value of the cash flows in years after 2011 shows that he is not including growth options. 452. Tr. 6081:15-6082:1 (Gompers). The transferred pre-existing intangible assets - 116 - Docket No. 31197-12 provided AEHT with the access to the benefits expected from investments in activities related to maintaining, improving, enhancing, and extending pre-existing assets, as well as to exploring future growth options. Ex. C-4617-R at� 26 (Gompers). 453. Merely innovating or investing in the development of new assets does not ensure success. The likelihood of success for such investments is largely affected by the systems, processes, culture and environment of the organization in which they take place. 454. Tr. 5062:19-5064:2 (Cornell). An innovative idea, such as Amazon Prime, is unlikely to lead to the creation of value without access to the pre­ existing assets and resources that are required to bring the idea to fruition. 455. Tr. 5042:10-19 (Cornell). If a company planned to sell �re-existing assets to a third party in an arm's-length transaction, it would not forgo the value of expected benefits from investments in asset maintenance, asset extension, and growth options. Ex. C-4617-R at�� 26, 33 (Gompers). 456. When selling a valuable asset, an uncontrolled seller would require full compensation for giving up the value associated with owning the asset going forward. The empirical evidence shows that an uncontrolled buyer typically pays a total - 117 - Docket No. 31197-12 price which includes the value attributable to growth options. Ex. C-4617-R at i 28; Tr. 6084:5-18 (Gompers). 457. AEHT could not have earned the projected returns from Amazon's cash flow projections if it had not received buy-in intangibles from Amazon. 458. Tr. 5029:16-22 (Cornell). Dr. Frisch's valuation was based on reasonable methods which were applied in a reasonable manner. Ex. C-4616-R at t 9 (Gompers). Goodwill 459. "Goodwill" has no consistent definition in economics. Economists, including Dr. Cornell, tend not to use the term "goodwill" outside of the accounting context because it is a confusing and loaded term. 460. Tr. 5000:13-25 (Cornell). The accounting definition of "goodwill" is the difference between what a buyer pays for an asset and the amount refl ected on the books of the seller. Tr, 4999:13-22 (Cornell); Tr. 5662:15-25 (Frisch); Tr. 6976:6-6977:6 (Haigh). 461. Under US GAAP, an intangible asset is not included in goodwill if it: (a) arises from contractual or other legal rights; or (b) it is capable of being separated or divided from the acquired entity, and of being sold, transferred, licensed rented or exchanged (either on its own or in combination with a related contract, asset or liability). - 118 - Ex. C-4625-R at 107-112 Docket No. 31197-12 (Haigh) 462. Investors do not care about the difference between identifiable intangible assets, unidentified intangible assets or goodwill. They simply want to know what is being purchased and what the assets' prospects for the future are. Tr. 7555:11- 19 (Timmins). 463. Growth options are not the same thing as goodwill or going concern, 464. Tr. 5001:1-14 (Cornell). In his reports, Dr. Cornell relied on petitioner's counsel's definition of "pre-existing intangibles." That definition excludes items that financial economists consider to be intangibles, and permits certain intangibles to be transferred without compensation. Tr. 4994:3-4995:24, 5000:11- 25, 4994:3-4995:10 (Cornell). 465. As a matter of economic principles, when the intangibles are identifiable and valued correctly there is no material amount of goodwill, 466. Tr. 5771:6-5775:6 (Frisch). Amazon paid its developers and other employees fair, competitive compensation. Tr. 5056:11-15 (Cornell); Tr. 7313:7- 17, 7320:4-6 (Blackburn). 467. Amazon lost engineers at approximately the same rate as Microsoft, which had a reputation for great pay and a great work environment. Tr. 203:17-204:9 (Valentine). - 119 - Docket No. 31197-12 468. Employees are arm's length parties and what they are paid is an arm's length price. Tr. 5722:1-5770:13 (Frisch). Opportunity Costs 469. The opportunity cost principle is a fundamental principle of economics: uncontrolled parties acting rationally in their own self-interest consider all the choices available to them and only enter into transactions that are preferable to the alternatives. Ex. C-4637-R at 9-10; Tr. 7954:03-7955:12 (Oswald). 470. Calculating the NPV of an investment is a common tool used to assess the opportunity cost of an investment. Ex. C- 4637-R at 12; Tr. 7955:13-7957:15 (Oswald). 471, The opportunity cost of the transaction at issue can be analyzed by looking at the alternatives available to Amazon US at the time. Ex. C-4637-R at 15 (Oswald). One alternative was to keep the IP and continue to operate the EU business as it had previously. A second alternative was to transfer the IP to an uncontrolled party instead of to AEHT. 16; Tr. 7958:14-24 (Oswald). Ex. C-4637-R at 15- A third alternative transaction Amazon could have pursued would have been for its Luxembourg operating subsidiary, AEU, to pay the royalty directly to Amazon US. Tr. 8067:8-16 (Oswald). 472, Amazon US gave up the cash flows related to the EU - 120 - Docket No. 31197-12 business by transferring the IP to AEHT. Amazon's opportunity cost of transferring the IP to AEHT is measured by the long-term expected cash flows related to the EU business it gave up. Ex. C-4637-R at 16 (Oswald). 473. If Amazon US were acting rationally it would consider alternatives to transferring the IP, including continuing to develop and exploit the IP in the EU market itself, Ex, C-4637- R at 17 (Oswald), 474. Where both the transferor and transferee have the same expectations, the transferee receives the assets and the associated benefits whereas the transferor receives the payment; the result is a zero sum game (both parties receive zero NPV from the transaction). Tr. 7957:16-7958:11, 7961:9- 7962:9 (Oswald). 475. Amazon could have kept the intangibles and expected to make $3,5 billion net of IDCs. Tr, 5650:19-5652:9; Ex. c- 4613-R at 17-18 (Frisch), The DCF Takes into Account AEHT's Projected Spending on IDCs 476. At arm's length, Amazon US would not have transferred its intangibles for a price that would give a party such as AEHT, which did not bring any intangibles of its own to the table, an above-normal rate of return merely because AEHT was - 121 - Docket No. 31197-12 going to reimburse Amazon US for future IDC expenses. Exs. C- 4613-R at 17-18, C-4614-R at 18; Tr. 5636:6-5637:5, 5650:195652:9 (Frisch); Ex. C-4637-R at 22-23 (Oswald). 477. Companies seek to maximize their profits. It is economically irrational to assume that the transferee would stop paying for IDCs. Exs. C-4613-R at 18-19 (Frisch), C-4637-R (Oswald). 478. Because profits in the DCF are computed net of IDCs, the transferee's projected future spending on IDCs is taken into account. 479. Exs. C-4613-R at 18-19 (Frisch), C-4637-R (Oswald). An arm's length seller would expect to be able to earn approximately $3.067 billion during 2005-2024 from the intangible assets transferred in the restructuring. It would have been reasonable for an arm's length transferor to expect to give up this amount by transferring the intangibles. Ex. c- 4613-R at 36 (Frisch). 480. It makes no economic sense to conclude that the greater the amount of R&D that the transferee is expected to do post-transfer, the lower the value of the pre-existing intangibles at the time of transfer. Ex. C-4614-R at 24 (Frisch). Arm's Length Pricing 481. The value a company places on its future cash flow - 122 - Docket No. 31197-12 streams is equal to the results of a DCF that utilizes reliable projections and discount rates. A company would generally accept nothing less than the DCF value for the sale of its business, and would keep running the business itself if it could not find a buyer who would pay the full DCF value. Tr. 5036:17- 5037:2 (Cornell). 482. Amazon would require payment for the full value of its growth options when transferring its pre-existing intangibles to AEHT, if AEHT were a newly formed entity that brought nothing but cash to the table in exchange for those intangibles. 483. Tr. 5029:5-15 (Cornell). No rational company would give something of value to an unrelated party without compensation. A company with IP that enables it to make future intangible development investments that are expected to generate returns greater than the cost of capital generally would not transfer that IP to another without compensation. 484. Tr. 5033:11-20 (Cornell). In an uncontrolled transaction, a company would require compensation with respect to all of the intangible property that it was allowing an unrelated party to benefit from. Tr. 5031:19-5032:5, 5032:21-5033:3 (Cornell). 485. Uncontrolled third parties can structure the compensation for the sale of intangibles in many ways, including - 123 - Docket No. 31197-12 up-front fees, earn-outs or the sharing of future profits. Tr. 5032:11-20, 5033:1-10 (Cornell). 486. Amazon would not have sold all its intangibles necessary for the European Websites Business for only $500-$854 million to an uncontrolled party at the end of 2004. Tr. 5030:9-17 (Cornell). roes 487. In his audit report, Dr. Frisch used the IDCs set forth in IDR I-11, grown at the same 5% rate as in Amazon's Valuation Model. 5697:2. After 2011, the IDCs grow at a 3.8% rate, as do revenues. 3, 4 & Ex. C-4614-R at 8-9 (Frisch); Tr. 5692:10- Tr. 5692:2-8 (Frisch); Ex. C-4613-R at 31-32, Tables 5 (Frisch). 488. Amazon's projected IDCs declined as a percentage of revenue over time, which is a good thing for a company. Tr. 5810:9-5811:15 (Frisch). 489. Amazon's valuation model assumed a 5% increase in operating costs, including technology, per annum. Ex. C-4107-R at 2 and 13; Tr. 5998:2-25 (Veiseh). 490. Assuming an arm's length purchaser would accurately estimate its IDCs necessary to carry on the business, the correct measure of IDCs should be used to compute the buy-in. Tr. 5617-5618:2, 5628:2-22; Exs. C-4613-R at 41, C-4615-R - 124 - Docket No. 31197-12 (Frisch). 491. AEHT's projected roes are an outlay of cash for AEHT. If they are increased, AEHT's projected cash flows from the European Websites Business decrease and the arm's length buy-in will also decrease as quantified below: With IDR I-11 Model !Des With "alternative" roes Higinbotham roes grown at 5% With Hiqinbotham roes With Notice roes $3.468 billion $3.154 billion $2.946 billion $2.482 billion Exs. e-4613-R at 41-43, Tables 3, 4 and 5, e-4615-R (Frisch); RD-405. 492. If Amazon were conducting blue sky R&D that did not relate to the pre-existing intangibles, then that portion of the roes should not have been subtracted from the cash flows, thereby increasing the buy-in. 493. Tr. 5625:17-5627:11 (Frisch). As long as significant important pieces of the bundle were exclusive, AEHT would be the only party pursuing the European Websites Business. Tr. 5819:14-25, 5819:14-5822:2 (Frisch). MARKET CAPITALIZATION METHOD 494. Dr. Frisch considered a market approach as a sanity check for the value of Amazon's IP. 5611:4-17 (Frisch). Ex. e-4613-R at 76; Tr. Using revenues to allocate Amazon's market value capitalization resulted in a value of $5.4 billion for the - 125 - Docket No. 31197-12 transferred IP. Tr. 5789:23-5790:14; Ex. C-4613-R at 40-41 (Frisch), 495. Jim Timmins is an expert in investment banking and venture capital investments, with over 30 years of experience in evaluating and valuing companies, particularly technology-driven companies. Ex. 3607-R at Appendix B at 2-4; Tr. 5257:8-5259:23 (Timmins), 496. Mr. Timmins is the founder and the managing director of Teknos Associates, a Silicon Valley-based business valuation services firm that provides valuation and fairness opinions on behalf of technology-driven companies. Ex. 3607-R at Appendix B at 1, 3; Tr. 5259:5-11; 7494:1-13 (Timmins). 497. The market value of Amazon is set in large part by the value of its intangible assets. Ex. 3607-R at ii 45-56 (Timmins); Ex. C-4613-R at 37-38, Appendix A at 77-78 (Frisch); Stip. 111. 498. As of January 1, 2005: value (TEV) was $18.7 billion; (b) 1111111 (a) Amazon's total enterprise Ill or approximately 1111 of the $18.7 billion TEV was allocable to Amazon's European operations; (c) the value of the tangible assets for Amazon's European operations was ; and (d) the value of the intangible assets underlying Amazon's European operations was $4.8 billion. Ex. C-4611-R at ii 106, 116; Tr. 5266:11- 126 - Docket No. 31197-12 5267:14, 7496:21-24, 7499:17-7500:4 (Timmins). 499. As of January 1, 2005, of Amazon's $18.7 billion TEV was allocable to Amazon's European operations based on the ratio of the revenues of Amazon's European operations to Amazon's total revenues ($6.9 billion) for the year ended December 31, 2004. Ex. C- 4611-R at �1 105, 106; Tr. 5267:15-5269:21 (Timmins). 500. The ratio of the revenue of Amazon's European operations in 2004 to Amazon's total revenue in 2004 should be used to determine the portion of Amazon's TEV attributable to Amazon's European operations because: (a) Amazon did not have positive operating income during part of the period from 1999 to 2004; and (bl investors valued Amazon for its revenue growth potential. Ex. 3607-R at 11 102, 103; Tr. 7497:4-11, 7557:7-19 (Timmins). 501, Using revenue for a series of years to determine the portion of Amazon's TEV attributable to Amazon's European operations would have underweighted the TEV of the European operations because revenue from international operations increased as a percentage of Amazon's worldwide revenue before January 1, 2005, and Amazon's management expected that revenue from international operations would continue to increase as a percentage of Amazon's worldwide revenue after January 1, 2005. - 127 - Docket No. 31197-12 Ex. C-4611-R at 1 81; Tr. 7505:20-7506:10, 7510:1-11, 7551:57552:16 (Timmins). 502. Gross profit is not used to compute reasonably anticipated benefit (RAB) shares. Tr, 5862:12-5863:3 (Frisch); PD-1459. AMAZON'S BRAND, TRADEMARK AND MARKETING INTANGIBLES 503. Diego Piacentini was the most senior Amazon executive responsible for international retail since joining the company in 2002. Mr. Piacentini has been a member of Amazon's S-Team since its inception and has reported directly to Jeff Bezos except for a few months. 504. Tr. 578:2-579:10 (Piacentini). Mr, Piacentini has always been responsible for Amazon's international marketing activities. Tr. 650:4-7 (Piacentini), 505. Mr. Piacentini was responsible for developing Amazon's global marketing plan for both the US and international markets from 2002-2004. Tr. 650:8-16, 652:16-18 (Piacentini); Ex. C-114-J. 506. Amazon's global marketing plan was presented to and approved by the S-Team. 507. Tr. 652:19-23 (Piacentini). Jason Kilar joined Amazon's marketing group in 1997, He engaged in promotional activity for Amazon for about a year. Tr. 4579:22-4580:2, 22-24 (Kilar). - 128 - In 1998-2000, Mr. Kilar Docket No. 31197-12 managed Amazon's entry into the video business. 4581:16 (Kilar). Tr. 4580:25- After video, Mr. Kilar ran Amazon's books, music, video and DVD business (BMVD) in North America for two years with responsibility for managing pricing strategy and vendor relationships and accountable for revenue, costs, and margin, Tr.4580:15-24, 4581:25-4582:16 (Kilar). BMVD, Mr. Kilar became VP of Marketplace. (Kilar). After managing Tr, 4582:17-4582:21 Next, Mr. Kilar became VP (and eventually SVP) of Worldwide Application Software. Amazon in January 2006. Tr. 4583:12-25, Mr. Kilar left Tr. 4578:14-20 (Kilar). Brand Defined 508. A brand is a relationship that exists between a company that provides goods or services and the customers in the marketplace. Ex. 128-J at AMZCOM00092229; Tr. 6484:24-6485:2, 6667:21-6668:8 (Conley). A brand is a feature that serves to distinguish a seller's goods or services from other sellers. Ex. C-2386-P at 7 (Dolan). Brand becomes a label for the feature set that encourages a customer to make purchases. brand is the label on a business. The Tr. 3244:6-17, 3245:22-3246:4 (Dolan). 509. A brand is defined as "trademarks and associated goodwill together with related marketing intangible assets and intellectual property rights that help produce the associated - 129 - �----------Docket No. 31197-12 goodwill." The term brand often includes a bundle of intangible property rights and other intangible assets such as domain names, design rights, trade dress, packaging, advertising visuals, and written copy. The list reflects the bundle of rights that would normally be included in a brand licensing agreement. 510. Ex. C-4625-R at 20 (Haigh). While a brand may include all sorts of intangibles, the asset that secures the brand and gives it strength is the trademark. 511. Tr. 6667:8-20 (Conley). Strong brands can help a company to differentiate itself from competitors, attract new customers, build a loyal customer base, and enter new markets. These brand benefits can thus create immense, long-lived value for companies. Strong brands often comprise a significant portion of a company's value. Ex. C-4629-R at 11 8, 34 (Wilcox), How Brands Assist Consumers 512. Companies attempt to differentiate their products by offering features and benefits so consumers will choose their products over competitors' products. As a company consistently delivers distinguishing features and benefits, consumers come to associate those features with that company's products. These associations among customers and potential customers are the company's "brand." Ex. C-4629-R at 1 13 (Wilcox). - 130 - -----------·Docket No. 31197-12 513. Brand value creates brand loyalty which occurs when consumers continually choose the same brand. Tr. 7001:13-21 {Wilcox). 514. Brand loyalty has short-term and long-term financial value to the brand owner because a consumer's brand loyalty may lead them to purchase that brand over long periods of time. Tr. 7001:22-7002:4; Ex. C-4629-R at 1 16 {Wilcox). 515. Customers may also actively identify with a brand community, which increases their loyalty and commitment to the brand. Ex. C-4629-R at 1 17; Tr. 7025:12-19 {Wilcox). 516. Brands create value for customers by reducing search costs associated with purchasing decisions. Ex. C-4630-R at 1 17 {Wilcox) . 517. Another way brands create value is through time savings because customers know what to expect and how to operate a familiar brand. 518. Ex. C-4630-R at i 19 {Wilcox). Kleenex facial tissue is low cost, purchased in small quantities and the quality is not difficult to discern, yet the brand value is over $4 billion. Ex. C-4630-R at i 14 (Wilcox). Trademarks 519. Trademarks have increased in general importance because, in contrast to other registered IP, trademarks can be perpetuated permanently, so long as legal requirements are -. 131 - .. Docket No, 31197-12 satisfied, and thereby accumulate value if managed properly. Tr. 6656:17-6657:10 (Conley). 520. brand. A trademark provides the legal protection for a Tr. 3150:15-19, 3151:1-5, 3276:14-15 (Dolan); Tr. 4141:20-22 (Golder); Tr. 6484:20-23 (Conley). The rights to exploit a brand accrue to the holder of a trademark. Tr. 3230:11-20, 3282:18-3283:8 (Dolan). 521. The holder of a trademark gets to exploit all subsequent activities that enhance the brand related to that trademark. 522. Tr. 3282:18-3283:6 (Dolan). Amazon's business people see no difference between a trademark and a brand. 523. Tr. 1069:4-14 (Kleber). Amazon's trademarked symbol (arrow under the name) is both a word mark and a figurative (design) mark. Ex. 1234-P; Tr. 7387:17-7388:4 (Contreras). 524. Amazon's trademarked symbol (arrow under the name) means that Amazon carries a wide range of selection from A to Z. Tr. 2943:2-18 (Szkutak); Ex. 8-J. 525. Amazon's trademark is on all of its boxes, identifying that the box is from Amazon. Tr. 2943:19-2944:2 (Szkutak). 526. The trademark provides exclusivity over the brand representing Amazon's feature set so Amazon can distinguish - 132 - Docket No. 31197-12 itself from competitors. 527. Tr. 3246:20-3247:2 (Dolan). The Amazon trademarks and brand increased in value from its inception until January 1, 2005, and continuing through the time of trial. Tr. 3228:24-3229:17 (Dolan); Tr. 4144:2-11 (Golder). 528. It was expected that Amazon would continue to develop the trademarks transferred to AEHT on January 1, 2005, and those trademarks would increase in value. Tr. 3236:21-3237:2, 3241:19-3242:l (Dolan). The Amazon Brand 529. Amazon undertook strategies to strengthen and broaden the Amazon brand name. 530. Ex. 8-J at AMZCOM00041785. Amazon sales increased from $148 million in 1997 to $5.26 billion in 2003. Customers grew from 1,5 million in 1997 to over 30 million in 2004. Exs. C-4629-R at� 27 (Wilcox), 1-J. 531. As of December 31, 1999, Amazon had built the leading global eCommerce brand and platform. 532. Ex. 3-J at AMZCOM00041356. As early as 2000, Amazon was an exemplar of the financial commitment necessary to maintain market leadership. By January 1, 2005, it increased its ability to leverage assets to maintain market leadership. Tr. 4184:22-4185:8, 4186:18 (Golder). - 133 - �-----------· Docket No. 31197-12 533. As of December 31, 2000, Amazon was a unique asset with the brand, customer relationships, technology, fulfillment infrastructure, the financial strength, the people, and the determination to extend its leadership in an infant industry and build an important and lasting company. so by keeping the customer first. 534. Amazon's plan was to do Ex. 4-J at AMZCOM00041427. The value proposition Amazon used to build its brand helped Amazon survive the dot-corn bust of 2000. Tr. 3256:11- 3257:2 (Dolan). 535. By the early 2000s Amazon had created strong global brand recognition through its relentless focus on the customer experience. 536. Ex. C-4629-R at i 41; Tr. 7018:16-21 (Wilcox). A goal of Amazon in 2003 was to drive unaided awareness of Amazon as a price and selection leader among relevant competitors as measured by a Brand Health or equivalent study approved by the S-Tearn. Ex. C-4122-R; Tr. 730:1-731:11 (Piacentini); Tr. 4640:1-24 (Kilar). 537. Amazon prepared a Health of the Franchise study for consideration by the S-Tearn that consisted of internal metrics that Amazon used to measure itself, most of which involved the three pillars. 538. 2000s. Ex. C-4074-R; Tr. 752:3-25 (Piacentini). Amazon had built a very strong brand by the rnid- Ex. C-4629-R at i 9 (Wilcox). - 134 - �-----------Docket No. 31197-12 539. By 2004, Amazon had over 30 .million customers. Amazon achieved this success by offering customers an easy, hassle-free, reliable, and personalized shopping platform where they could buy a wide variety of products at low prices. Ex. c- 4629-R at 1 9 (Wilcox). 540. Amazon worked very hard to associate positive attributes to the Amazon brand. It was obsessed with customer experience, innovation, and continuous improvement in understanding its competitors to avoid letting customers down. Tr. 625:4-15 (Piacentini). 541. Brands are developed by managing customer relationships and offering value propositions that interest the customer. Tr. 6485:4-7 (Conley). 542. Amazon built its trademarks and brand by regularly executing on its value proposition. 543. Tr. 3254:10-21 (Dolan). The Amazon trademark and brand assets transferred on January 1, 2005, would be expected to contribute to future brand development after the transfer. 544. Tr. 3243:4-8. (Dolan) It is easier, taking fewer resources and less time, to build on an existing brand than to create a brand from scratch. 545. Tr. 3242:22-3243:3 (Dolan), The Amazon brand symbolizes its promise to the customer of a wide choice of products, attractive prices, speedy - 135 - 11111111111 Docket No. 31197-12 and reliable delivery, good quality service, and ease of use. Ex. C-4625-R at 12 (Haigh). 546. Awareness of the Amazon brand name was important to Building a strong level of service helps build Amazon. awareness of the brand; then you keep working on it to keep that high. Tr. 668:7-17 (Piacentini). 547. As Mr. Szkutak told investors and analysts at Goldman Sachs and Bank of America conferences in 2004, Amazon had a very· recognizable brand that was a key advantage. Mr. Szkutak discussed Amazon's ranking of 74 in the top 100 Interbrand ranking. Tr. 2981:20-2982:10 (Szkutak); Ex. 1123-P at AMZCOM000144592. 548. Amazon's brand name and technology are related in that technology and continuous innovation are the base of Amazon's three pillars that allows it to improve. As long as that happens, customer connection with the brand and innovation is high. 549. Tr. 638:9-15 (Piacentini); Ex. 1123-P at 6. In 2005, Amazon anticipated that it would continue to innovate around the three pillars because that was part of its core values. 550. Tr. 648:10-15 (Piacentini). Through the use of online community features such as product reviews, retailers encourage customers to become "brand ambassadors" who promote the brand through word-of-mouth. - 136 - This �------------·· Docket No. 31197-12 serves as marketing for the brand, which helps acquire new customers. 551. Ex. C-4629-R at 1 18 (Wilcox). Amazon's focus on the customer experience led to highly satisfied and loyal customers that felt so strongly about the Amazon brand that their word of mouth was known as one of Amazon's most powerful customer acquisition tools. household name by 2005. Amazon was a Ex. C-4629-R at 11 9, 39 (Wilcox); Tr. 6947:7-11 (Haigh). 552. Customers love Amazon. Tr. 1082:4-19 (Kleber). J\mazon Brand Reliability and Trust Tr. 534:16-21 (Greeley). 553. Customers trust Amazon. 554. Consumer trust accretes to the Amazon brand name as consumers have reliable experiences with Amazon. Tr. 3251:4- 3252:22 (Dolan). 555. Customer trust is vital to Amazon. Amazon creates customer trust by delivering constantly against the three pillars. 556. Tr. 630:24-631:4, 653:18-24 (Piacentini). Amazon had been extremely successful in creating very high levels of customer bonding. In 2005, 54% of US buyers were committed customers to Amazon compared with an industry average of well under 10%. 557. Ex. C-4625-R at 38 (Haigh). The Amazon brand was well positioned relative to its competitors regarding reliability and trust at the time of the - 137 - ..... Docket No. 31197-12 transfer. Exs. C-113-J at AMZCOM00015861, C-4629-R at i 36 (Wilcox). 558. Reliability and trust are brand attributes that are harder to compete for than other brand attributes. Exs. C-113-J at AMZCOM00015861, C-114-J at AMZCOM00016068. 559. Consistent, positive experiences on Amazon websites strengthened customer loyalty to its brand. Ex. C-4629-R at i 37· (Wilcox). 560. The Amazon brand is distinguished from Walmart based on quality and trust perceptions. Tr. 7022:15-7023:12 (Wilcox). Amazon Brand Stickiness 561. Switching costs are the costs to the consumer to change brands, and are made up of financial, hassle, and time costs to the consumer. 562. Tr. 7005:19-7006:1, 7007:8-11 (Wilcox). In 2004, an Amazon customer would incur switching costs in changing websites. 563. Tr. 7007:8-7008:18 (Wilcox). The switching costs of using a different website are significant hassle costs because you have to re-enter your shipping, billing, and credit card information. Tr. 7009:9- 7010:15 (Wilcox). 564. Stickiness occurs when switching costs are sufficient that a consumer will continually go back to the same vendor. Tr. 7009:1-8 (Wilcox). - 138 - Docket No. 31197-12 565. perception. Customer stickiness informs service quality Tr. 7012:21-7013:13 (Wilcox). Consumers base their service quality perception on prior positive experiences and discount negative experiences. 566. Tr. 7015:5- 7017:11 (Wilcox). Amazon's stickiness was significantly increased by being an early entrant into the online retail business. Ex. c- 4629-R at i 38 (Wilcox). 567, The Amazon brand name is hugely important in the online world because it simplifies decision making. Tr. 7002:5- 7005:18, 7029:10-15 (Wilcox); RD-512. 568. Amazon's success can be attributed to the fact that people are willing to spend money to save time. Tr. 7030:18-23 (Wilcox). Amazon's Strategic Long Term Thinking 569. Amazon's marketing strategy required the sacrifice of short-term profits to develop a loyal customer base and strong brand. Ex. C-4629-R at i 35 (Wilcox). 570. Willingness to fail and to learn from mistakes has been a key aspect of Amazon's business philosophy at all times, resulting in innovation. Ex. 1070-P at AMZCOM00115063; Tr. 604:13-605:14 (Piacentini). 571. As of December 31, 1998, Amazon planned to continue to enhance and broaden its brand, customer base and eCommerce - 139 - Docket No. 31197-12 expertise with the goal of creating customers' preferred online shopping destination, in the US and around the world. Ex. 2-J at AMZCOM00041310. Amazon's Brand Strategy 572. From the beginning, Amazon's marketing strategy was designed to strengthen the brand name, increase customer traffic to the Amazon website, build strong customer loyalty, maximize repeat purchases and develop incremental revenue opportunities. Exs. 1-J at AMZCOM00041255, 2-J at AMZCOM00041312. 573. From the beginning, Amazon intended to expand its presence in foreign markets and it expected to incur significant costs in establishing international facilities and operations, in promoting its brand internationally, in developing localized versions of its website and other �ystems and in sourcing, marketing and distributing products in foreign markets. Ex. 8-J at AMZCOM00041796. 574. As of December 31, 1997, Amazon sought to build customer loyalty by creatively applying technology to deliver personalized programs and service, as well as creative and flexible merchandising. 575. Ex. 1-J at AMZCOM00041255. As of December 31, 1998, Amazon's websites promoted brand loyalty and repeat purchases by providing an inviting experience that encouraged customers to return frequently and �o - 140 - Docket No. 31197-12 interact with other customers. 576. Ex. 2-J at AMZCOM00041310. According to a Court declaration filed by Mr. Bezos, a key to Amazon's success is "creating a consistent, branded experience that is synonymous with shopping convenience." The uniqueness and consistency of that experience is particularly crucial to Amazon's ability to expand its business successfully. Ex. 163-R at AMZCOM00092317. 577. According to Mr. Bezos, the steep increase in the value of Amazon's brand from its inception was due to a continued focus on the fundamentals - selection, lower product prices, better availability, better discovery tools, and better information about products. 578. Ex. C-4629-R at S 34 (Wilcox). The quality of service provided by Amazon is very important to the company. Tr. 7271:24-7272:1 (Blackburn); Tr. 202:17-24 (Valentine). 579. In 2004, Amazon's goal remained to solidify and extend its brand and customer base. Ex. 8-J at AMZCOM00041785; Tr. 2983:21-2984:25 (Szkutak). 580. Amazon considered brand risk. By brand risk, it meant poor execution of the three pillars and failure to continuously innovate. Ex. C-422-J at AMZCOM00073139; Tr. 683:20-684:11 (Piacentini). 581. Amazon's strategy was to expand its franchise by - 141 - Docket No. 31197-12 expanding beyond books and media. Ex. C-441-J at AMZCOM00075880; Tr. 682:5-683:1 (Piacentini). Amazon's Pillars 582. The three pillars of selection, price and convenience have been Amazon's mantra since the beginning. Tr. 588:25-589:4 (Piacentini). 583. Amazon consistently messaged its brand promise - the promise to deliver the three pillars to customers. Delivery of the three pillars was Amazon's core message and what it wanted its customers to know it for. Tr. 653:10-17, 654:7-20 (Piacentini). 584. Amazon's business strategy of focusing on price, selection, and convenience has been the same since 1997. Tr. 420:8-19, 422:11-21 (Greeley); Exs. 1-J at AMZCOM00041247, 1123P at AMZCOM00144576. 585. Amazon wanted to make sure that the three pillars were understood across the company. Tr. 614:14-615:1 (Piacentini). 586. The value of the Amazon brand depended on continuous innovation and execution of the three pillars, and at the end of 2004 Amazon planned to continue to innovate and execute on them. The name Amazon will have value for customers if Amazon keeps investing in the three pillars and innovates. - 142 - Tr. 727:23-729:4 Docket No. 31197-12 ( Piacentini) 587. Mr. Piacentini's role was to make sure that the three pillar innovation piece was well understood by the Amazon employees in UK, Germany and France and that the countries were executing against these strategies. Tr. 589:5-590:9 (Piacentini). 588. Amazon had processes to review country performance in executing on the pillars, including weekly, monthly, and quarterly reviews. It reviewed input metrics to measure progress in delivering against agreed strategies. Tr. 590:10- 591:10 (Piacentini). 589. Amazon's success can be largely attributed to its focus on a customer-centric business. Ex. C-4629-R at i 28 (Wilcox). 590. Amazon used different techniques to enhance the customer experience. Specifically, Amazon "personalized" customer experience, used technologies to remember past purchases and make recommendations based on past purchases, and invented the 1-Click ordering software to speed up the order process for customers. 591. Ex. C-4629-R at i 29 (Wilcox). Data mining and add-on services like "Wish Lists," "Amazon Anywhere," and "All Product Search" were used to more effectively market the Amazon website to customers. - 143 - Ex. C-4629- Docket No. 31197-12 Rat� 29 (Wilcox). Price & Fulfillment in lieu of Marketing 592. Amazon is very tactical in brand building; the contribution to development of the brand is in areas like fulfillment and price instead of conventional advertising and marketing. 593. Tr. 6885:9:16 (Haigh); Tr. 3254:10-3255:20 (Dolan). As early as December 31, 1997, Amazon offered attractive pricing programs that reduced its gross margins. Ex. 1-J at AMZCOM00041257, 268. 594. Amazon filled its brand name with life by maximizing selection, low price, and convenience. Tr. 975:18-977:12 (Kleber). 595. By 2003, Amazon chose to provide its customers free shipping and lower product prices in lieu of spending money on traditional advertising. Ex. C-4625-R at 36 (Haigh). The free shipping and lower product prices led to "word of mouth" that is powerful and equally if not more effective in building and enhancing the brand than traditional advertising. Ex. C-4625-R at 37 (Haigh); Tr. 3254:22-3255:20 (Dolan). 596. The expectation when Amazon Prime was launched was that it would earn more of the business from current customers. Ex. 1018-P at IRS-AMZ019350; Tr. 3001:10-3002:19 (Szkutak), Tr. 1130:18-25 (Byrne); Tr. 6832:19-6833:11, 6835:24-6836:7 - 144 - �---------·-Docket No. 31197-12 (Holden). The Amazon Flywheel 597. Amazon's strategy of focusing on price, selection, and convenience is sometimes referred to as the "virtuous cycle" or "growth flywheel." Tr. 418:21-420:25 (Greeley); Ex. 1123-P at AMZCOM00144575. 598. Jeff Bezos, Amazon's founder and Chief Executive Officer, drew a diagram of a "flywheel" on a napkin depicting the virtuous cycle before a meeting of Amazon's board of directors in the fall of 2001. Tr. 418:21-419:7; 434:2-12 (Greeley); Tr. 236:13-16 (Valentine); Ex. 1123-P at AMZCOM00144575. 599. Amazon believes that price, selection, and convenience drive the customer experience. Tr. 421:10-12 (Greeley) 600. The goal was to get that flywheel spinning off those three things and they will feed one another and create a flywheel that accelerates over time and grows the business. 5432:18-5433:18 (Dalzell); Tr. 236:13-237:9 (Valentine); Tr 420:3-7 (Greeley). 601. By the end of 2004, Amazon had created a positive customer experience which in turn created a brand with significant financial value that would be expected to outlive - 145 - Tr. -----------Docket No. 31197-12 its website technology. Ex. C-4629-R at ii 25, 33 (Wilcox). The Amazon Look and Feel 602. In 1999, Mr. Bezos signed a legal declaration stating that creating a consistent branded experience that is synonymous with shopping convenience would be a key to Amazon's success, then and in the future. The uniqueness and consistency of that branded experience is particularly crucial to Amazon's ability to expand its business successfully. Ex. 163-R at AMZCOM00092317. 603. Amazon had a brand marketing group prior to the restructuring. Ex. C-135-R at AMZCOM00000113; Tr. 2595:1- 2596:4, 2596:20-2597:7 (Krabbenschmidt);· Tr. 7489:14-19, 7491:11-18 (Krock). 604. The brand marketing group included designers who created graphics to support the Amazon brand. Tr. 7491:1-10 (Krock). 605. Content, including product copy, book copy and product management for the website, is important to the customer experience because it allows customers to discover products faster, better, and easier. Tr. 5434:12-5435:23 (Dalzell); Tr. 2011:16-25 (Porter). 606. Amazon's website content is a very valuable asset to its customers. Tr. 2011:16-25 (Porter) - 146 - �----------Docket No. 31197-12 607. By 2002, Amazon had a goal to harmonize design on its three EU websites. 608. Tr. 1080:20-1081:13 (Kleber). Anne Krook worked for Amazon from 1997 to 2010. 7471:19, 7474:1-7475:2 (Krook). Tr. Ms. Krook was responsible for the launch of Amazon.co.uk. and Amazon.de. Tr. 7476:1-4 {Krook) 609. Prior to the restructuring, editors created new features and content for the Amazon website. Tr. 7474:3-4, 7475:3-21 (Krook). 610, Product category managers created content for product lines on the website. Product line content included both the review of an individual product and the description of entire product lines. 611. Tr. 7484:6-16 (Krook). A designer created individual graphics, solved website navigations problems, and created user interfaces for new features. 612. Tr. 7485:1-15 (Krock). A web developer takes the output of software developers and translates that output into something visible for the customer. 613. Tr. 7486:18-24 (Krock). Web developers created templates and coding for new product lines on the Amazon US and EU websites. Tr. 7485:16- 7486:10 (Krock). 614. Amazon wants all of its websites to look alike so - 147 - Docket No. 31197-12 customers recognize them. 615. Tr. 1050:9-19 (Kleber). The employees responsible for the customer experience side of the web page were the "painters• and the software engineers were the "plumbers." Amazon. Both were equally important at Tr. 145:18-146:12 (Valentine); Tr. 1034:11-15 (Kleber). Most of the painters were in the retail organization that developed and owned the layout of the page. Tr. 165:13-22 (Valentine). 616. Amazon employees trained in design and in Amazon practices for design are called "customer experience bar raisers." Tr. 1995:5-18 (Porter). Widget owners or component owners work with customer experience bar raisers to design the look and feel for their services. 617. 2003. Tr. 1995:5-1996:6 (Porter). Exhibit 128-J, the Amazon Brand Book, was produced in Ex. 128-J; RD-453; Tr. 6486:21-6487:20 (Conley). 618. Amazon used "The Amazon Brand Book" as a guideline for typefaces, colors, and graphics for the website. Tr. 7489:23-7490:19 (Krock). Ex. 128-J; A version of the Amazon Brand Book existed as far back as 1998 or 1999. Tr. 7476:1-7477:7, 7490:8- 13 (Krock) . 619. In 2003, Amazon's brand objective was to make purchasing from Amazon a routine way to buy and thereby drive customers to make more purchases from Amazon. - 148 - Ex. 128-J at �-----------Docket No. 31197-12 AMZCOM00092231. Amazon delivered, in part, on its brand promise using patented technology including 1-Click, customer reviews, and personalized recommendations. Tr. 6488:14-6489:20 (Conley). Ex. 128-J at AMZCOM00092232; Amazon used customer information to market its products to its large customer base, providing the customer with a personalized shopping experience. Ex. C-4629-R at ii 38, 42 (Wilcox). 620. In 2003, Amazon scored the highest customer satisfaction rating in the US for online and offline companies by the American Customer Satisfaction Index. Ex. C-4630-R at i 28 (Wilcox) • 621. Amazon's community of consumers provide a continuous stream of feedback improving the shopping experience for future customers and assisting Amazon in further improving services. Exs. C-4630-R at i 28; C-4629 at i 33 (Wilcox). 622. A strong unified brand was vital as it entered more categories and partnerships. Amazon believed that a strong brand would help it dominate the online shopping market. Ex. 128-J at AMZCOM00092230; Tr. 6489:21-6490:9 (Conley). 623. In 2003, Amazon believed that its brand was bigger than just the Amazon website and online retail. AMZCOM00092237; Tr. 6490:10-6491:10 (Conley). - 149 - Ex. 128-J at Docket No. 31197-12 Amazon Marketing (Traffic) and Advertising 624. Amazon's marketing department is called the "traffic department." Tr. 621:6-9 (Piacentini). generates visits to the Amazon websites. The tra ffic department Tr. 621:10-13 (Piacentini). 625. Amazon had one of the largest marketing budgets among online retailers and aggressively engaged in a wide variety of marketing activities, including online advertising, offline advertising, email marketing, public relations, referrals and co­ branded credit cards. 626. Ex. C-4629-R at 1 35 (Wilcox). Although Amazon spends hundreds of millions of dollars on advertising, it refers to it as "traffic generation" rather than advertising. 627. Tr. 443:10-444:12 (Greeley). Amazon's marketing strategy is designed to drive customer transactions to Amazon's detail pages. Amazon increases customer traffic to the website through its associates program and online marketing. 628. Tr. 2983:1-18 (Szkutak}. To determine what the customer wanted, Amazon continuously performed market research, evaluated customer focus groups, reviewed complaint emails, and got feedback from its customer service function. 629. Tr. 4623:9-4625:15 (Kilar). II of at 1111111 In 1998, Amazon's marketing spend accounted for Amazon's indirect and G&A costs, compared to technology - 150 - Docket No. 31197-12 site development at 1111, and G&A at was due to the Associates program. 11111· The high percentage Tr. 4630:10-4631:17 (Kilar); Ex. C-130-R at AMZCOM00015594, 630, Amazon used press releases and interviews by Mr. Bezos to encourage word of mouth traffic to the website. Tr. 7246:6-7248:7 (Blackburn). 631. Amazon promoted its business by working with cartoonist Garry Trudeau to publish a collaborative comic strip on the internet. Amazon also engaged in a collaborative effort with John Steinbeck, Tr. 4613:19-4615:2 (Kilar). Sponsored Links 632. Amazon generates traffic by buying key words on Google or "sponsored links" so that a customer sees a paid advertisement for Amazon when he types a search term. Amazon had technology to bid on sponsor links and key words and to optimize its presence in free search results. Tr. 621:14- 622:12, 655:6-12 (Piacentini), 633. In Amazon's sponsored links technology, algorithms determine the key words associated with its products and places bids on those words, mainly on Google. most visible placement. The highest bid wins the Amazon's technology bid a massive amount of key words because it wanted to get beyond books in an efficient manner. Tr. 743:12-744:9 (Piacentini). - 151 - Docket No. 31197-12 634. As early as 1998, Amazon entered into contracts with other Internet companies such as Yahoo, MSN and AOL (a paid channel), to drive traffic and customers to the Amazon website. Tr. 7242:1-7244:14, 7248:23-7249:9 (Blackburn); Tr. 905:22-906:9 (Garambois). 635, Sponsored links are a paid channel as is the Associates program. Tr. 906:10-23 (Garambois). Amazon wanted customers to come back directly to the website and not through a paid channel. 636. Tr. 7249:20-25 (Blackburn). Amazon measured how many visitors made a purchase. Ex. C-4122-R; Tr. 4638:16-4639:1 (Kilar). Amazon sought worldwide sessions growth (visits to its website) of 50% in 2003. Beginning by 2002 and continuing after, Amazon structured the content of its website to optimize its placement in search results using algorithms. Tr. 6849:16-6850:17, 6852:2-10 (Holden). 637. Amazon did search engine marketing to drive traffic to its websites. Tr. 6847:6-17 (Holden). In 2002 or 2003, it built an automated system called Urumbamba to drive traffic to Amazon by placing millions of ads based on their downstream contribution profit to optimize the ad placements, the content of the ads, and the bids for placing those ads. Urumbamba bought sponsored links. Essentially, Tr. 6847:3-22, 6850:22- - 152 - Docket No. 31197-12 6851:23 (Holden); Tr. 7249:1-4 (Blackburn). Tr. 6849:2-13 (Holden). The team that built Urumbamba still existed as of 2014 and is called Hydra. 638. Tr. 6851:20-6852:1 (Holden). The French website business purchased sponsored links from search engines like Google to attract traffic to its website. Tr. 905:12-25 (Garambois). 639. Amazon France moved to Urumbamba in October 2004. Urumbamba was the first version of a tool/algorithm that allowed Amazon France to bid on sponsored links. developed in the US. Urumbamba was Earlier tools available to Amazon France identified some key words and were used in addition to manual bidding. 640. Tr. 938:7-939:22 (Garambois). Amazon's online search results marketing technology was created by a team in the US. first in the US. It was implemented and tested By 2005, Amazon Europe was using the same underlying technology for online traffic, Tr. 656:6-21 (Piacentini). 641. Amazon also paid associates or affiliates program a referral fee to generate traffic to Amazon website. 623:21 (Piacentini). Amazon. Tr. 622:12- The Associates program was invented by Tr. 657:20-658:2 (Piacentini). The Associates program used a global technology platform that was first created and - 15 3 - Docket No. 31197-12 launched in the US. Tr. 656:24-25, 658:3-18 (Piacentini). The US built a self-service platform for the Associates program; Europe was trying to use the same platform. Tr. 660:13-18 (Piacentini). Amazon's Email Advertising 642. Amazon engaged in email marketing. charge of email marketing in 1997. Mr. Jassy was in Tr. 4616:14-4617:15, 4578:14-17 (Kilar). 643. Amazon chose email advertising as a more cost effective way to advertise than traditional advertising. It leveraged its customer database to make email advertising more effective. Ex. C-114-J at AMZCOM00016122, 124-5; Tr. 3305:5- 3306:18 (Dolan). Amazon's Customer Reviews 644. Amazon used customer reviews and personalization recommendations in Europe by 2005. Customer reviews attracted customers and made Amazon an authority in that area. Customer reviews and personalized recommendations were enabled by technology and algorithms developed in the US. Tr. 685:17-689:7 (Piacentini). Free Shipping 645. In 2000, Amazon used TV advertising as part of its marketing strategy. - 154 - 1111111111 Docket No. 31197-12 646. Amazon's marketing strategy at the time of the 2002 operating plan was to obtain new customers and lower the cost of new customers. Amazon decided to drop off-line brand advertising and give the money back to customers in terms of free shipping. Ex. C-422-J at AMZCOM00073173; Tr. 678:12-680:12 (Piacentini). 647. In July of 2003, Amazon announced that it was shifting resources from TV and more traditional advertising to free shipping. (Szkutak). Ex. 391-J at 83721-22; Tr. 2985:18-2986:25 Amazon stopped broad scale advertising. Tr. 2987:1- 4 (Szkutak); Tr. 620:10-621:5 (Piacentini). 648. " By 2003, Amazon's free super saver shipping initiative was offered on all websites, including the EU websites. 649. Ex. 391-J; Tr. 2987:19-2988:2 (Szkutak). Free shipping was a marketing strategy. Tr. 694:20- 695:9 (Piacentini); Exs. 1018-P at IRS-AMZ019345, 391-J; Tr. 2986 (Szkutak). 650. Amazon was able to calculate the number of new customers it gained by free shipping and the cost of those customers. Tr. 680:9-12, 693:25-694:1 (Piacentini). lunazon's Brand in the EU 651. The Amazon brand in the EU consists of the Amazon name, domain names, trademarks, logos, trade dress, tag lines, - 155 - Docket No. 31197-12 design and advertising copy (including jingles, if any), web design (which create the "look and feel" of the Amazon web screen), market research materials, and brand manual. Ex. c- 4625-R at 12 (Haigh). 652. In 2002, Amazon's goals in Germany included addressing brand risk - making sure it delivered the right message consistently. Ex. C-422-J at AMZCOM00073139; Tr. 1070:3-9, 1073:5-25 (Kleber). 653. As of Sept. 9, 2002, Amazon was the clear leader in customer awareness among internet users relative to its competition in the UK and Germany. Tr. 3300:18-3302:4 (Dolan); Exs. C-113-J at AMZCOM00015851, C-114-J at AMZCOM00016064. 654. In connection with Amazon's 2002 operating plan, the s-team considered measurements of Amazon's brand reach and awareness of the Amazon name in 2001. At the time, in Germany and the UK, more customers than in the US mentioned Amazon when asked about places to shop on the internet. Ex. c-422-J at AMZCOM00073171; Tr. 662:11-665:17 (Piacentini). Amazon, both in the US and Europe, was the website that most frequently came to the internet users' minds when asked about places to shop on the internet. Exs. C-4629-R at 1 36 (Wilcox), Ex. C-114-J at AMZCOM00016064. 655. The Amazon brand was very strong in Amazon Germany --------- - 156 - Docket No. 31197-12 and Amazon UK. 656. Tr. 6954:14-24 (Haigh). As of Sept. 9, 2002, Amazon had been successful in building strong perceptions of convenience and reliability in the UK, Germany and France. Exs. C-113-J at AMZCOM00015859, c- 114-J at AMZCOM00016066; Tr. 665:23-666:5 (Piacentini); Tr. 3303:10-3304:5 (Dolan). 657. Between 1998 and 2005, the number of new customers for Amazon's UK, German, and French websites increased annually from 0.2 million to 7.4 million. 658. Ex. C-4629-R at i 36 (Wilcox). Petitioner quickly changed the names and website addresses to include the Amazon name of the UK and German booksellers that it acquired. 659. Tr. 720:15-721:8 (Piacentini). Amazon's customers in Europe associate its brand name with a positive customer experience today. That perception can be expected to last as long as Amazon continues to innovate, expand selection and offer low prices. Tr. 634:2-16 (Piacentini). Leveraging the Amazon Brand, Know How and Experience 660. Leveraging a brand from one product category to another is a well understood marketing concept. Tr. 3265:20- 3266:2 (Dolan); Ex. C-4629-R at i 19 (Wilcox). 661. Retailers also derive value from a strong brand through brand extension opportunities. - 157 - • A strong brand becomes a Docket No. 31197-12 tremendous source of long-term value for the company. Ex. c- 4629-R at i 19 (Wilcox). 662. Companies that have strong brands are able to reap greater rewards from innovation. 663, Amazon has leveraged its brand name to move into new and different markets. 664. Ex. C-4629-R at i 20 (Wilcox). Tr. 7029:21-25 (Wilcox). By 1997, Amazon had invested and intended to continue to invest aggressively to expand and leverage its customer base, brand, and infrastructure as it moved to establish an enduring franchise. 665. Ex. 1-J at AMZCOM00041245. Amazon's strategy was to reposition its brand globally, evolving from an online bookstore to a seller of everything. Ex. C-422-J at AMZCOM00073183; Tr. 680:23-681:3 (Piacentini). 666. Amazon used its name in many products and services that it launched after 2005. Ex. 1070-P at AMZCOM00115081; Tr, 715:15-716:24 (Piacentini). 667. As early as 2001, there was an expectation that Amazon would leverage its brand well beyond books and into other retail areas. 668. Tr. 4183:8-17 (Golder). No Amazon brand extensions had failed prior to January 1, 2005 other than perhaps Auctions. (Golder). - 158 - Tr. 4144:16-25 Docket No. 31197-12 669. Cross-selling is the activity of educating customers that Amazon sells products other than books and media products. Tr. 672:6-10 {Piacentini), Buying key words relating to other products is cross-selling. Tr. 674:1-10 (Piacentini). 670. With respect to cross-selling and in general, Amazon's practice was to see what was done in the US, determining whether the learnings also applied in Europe. Tr. 674:11-16 (Piacentini). 671. Before and after 2005, product categories were generally launched in the US and then internationally. Tr. 668:18-24 (Piacentini). 672. When Amazon enters new product categories, margins are lower because it does not know how to sell those categories. It takes time to develop vendor relationships. Tr. 646:24-647:7 (Piacentini). 673. In 1997, there were a series of meetings about launching new categories, particularly music, video, and software. Stip. 100; Tr. 4617:16-4618:10 (Kilar). Music, launched in the fall of 1998, was the first new category of products after books sold by Amazon. (Kilar). The next category launched, videos, was launched in early November 1998. 674. Stip. 100; Tr. 4615:13-16 Stip. 100; Tr. 4619:11-16 (Kilar). During the 2004 Holiday season, electronics surpassed - 159 - _________..... Docket No, 31197-12 Amazon's book business in North America and Germany. Ex. 1018-P at IRS-AMZ019347, 52; Tr. 3003:8-3004:1 (Szkutak). 675. Launching a new category required a functional specification that set forth what was required for the website, how to source and store the product, a pricing plan and an explanation of what Amazon wanted customers to experience. Tr. 4619:25-4620:17 (Kilar); Tr. 7260:12-7261:8 (Blackburn). Members of Amazon's product groups, design groups and technical groups would contribute to the functional specification, including the look and feel of the website. 4621:22-24, 4622:3-20 (Kilar). Tr. 4621:3-18, The technical employees would use the functional specification to create the technology necessary to implement the new category. Tr. 4620:23-4621:1 (Kilar) 676. The job of the technical program managers was to translate a functional spec, which was a very business and product focused document, into technical terms that a software developer could code against. Tr, 4633:4-17 (Kilar); Tr. 7258:15-7259:13 (Blackburn). 677. Product managers, like Mr. Kilar, develop ways to serve customers better. 678. improving. Tr. 4633:20-4634:1 (Kilar). Amazon's online marketing technology was continuously Europe always had a lag of a few months or a few - 160 - Docket No. 31197-12 quarters and received the technology after it was tested and perfected in the US. Seattle. 679. All technology started in the US in Tr. 656:19-658:17 (Piacentini). Whenever Amazon launched a new product category, the EU businesses would reuse as many assets as possible. It was not smart to start from scratch with something Amazon already had in its hands. An example of something that would be reused in other countries is a product detail page. (Piacentini). Tr. 615:1-18 Amazon did not want to reinvent the wheel. Tr. 669:6-21 (Piacentini). 680. Experience in the US in a product category would be a data point that would it launch the category in another country, such as France. 681. Tr. 907:20-908:4 (Garambois). When Mr. Greeley moved to Luxembourg in 2007 as Amazon's Vice President, EU Retail and Marketing, one of his responsibilities was driving best pan-European practices, ensuring that Amazon's business processes from the US were applied across all of Europe. Ex. 1091-P; Tr. 463:12-464:15 (Greeley). Retail Expansion in the EU 682. In the UK, Amazon had around 50% of the online.book market in 2005. No company had a greater share of online book sales in the UK or Germany in 2005. - 161 - Tr. 713:15-714:19 Docket No. 31197-12 (Piacentini). 683. At the end of 2004, online penetration, the percentage of people using the internet, and broadband penetration was expected to grow. 684. Tr. 952:23-953:3 (Garambois). As of 2004, Amazon France used Amazon tools that had been implemented on a worldwide basis allowing local customer preferences to be taken into account. AMZCOM00116390. Ex. C-2153-P at An example is Amabot, a technology that decides what content to show customers on the website. Amabot was developed in the US and made available to France. Another example is Correios, a targeted e-mail program based on prior book purchases. 685. France. Tr. 930:15-931:11 (Garambois). In 2004, Amazon had 40% of the online book market in Ex. C-2093-P at AMZCOM00099308. Share of the online market is one of the metrics that Amazon looks at to ensure that it is making progress. Tr. 942:10-13 (Garambois). Single Detail Page (SDP) 686. Amazon began its third party seller business with Auctions and ZShops. They did not work well because it was hard to find the products offered by the third party sellers on the Amazon website. Amazon subsequently launched single detail page (SDP) which listed the third parties' products along with the same products offered by Amazon. Tr. 689:11-690:14 - 162 - �--------....... Docket No. 31197-12 (Piacentini). 687. Single Detail page was a fantastic tool to add selection outside the US. 688. Tr. 691:15-692:3 (Piacentini), Single Detail Page was developed and launched first in the US and was launched later in Europe. technology component. SDP had a big The SOP technology platform was built in the US and had to be rebuilt to be used in Europe and Japan. Tr. 690:15-692:21 (Piacentini). 689. When evaluating the Shopbop acquisition for Amazon's Board of Directors, Amazon evaluated the Shopbop brand. Ex. c- 298-J at IRS_Oll373,376; Tr. 7299:20-7301:15, 7292:11-7293:21 (Blackburn). At the time of the acquisition, Amazon determined that Shopbop had a well-regarded, differentiated brand that would help maximize and expedite Amazon's success in apparel. The Shopbop acquisition would leverage Amazon's expertise in online marketing, logistics, and technology to drive growth in sales and improvements through Shopbop's business and operations. Ex. C-298-J at IRS_Oll373,376; Tr. 7302:18-7303:4 (Blackburn) Components of Brand Valuation 690. David Haigh is respondent's expert in brand valuation, with experience in business valuation. 16 (Haigh). - 163 - Tr. 6678:11- Docket No. 31197-12 691. Mr. Haigh has extensive experience valuing brands as a joint head of Interbrand UK Limited's global brand valuation practice and currently as founder and CEO of Brand Finance. Ex. C-4625-R at 7 (Haigh). 692. billion. 693. The Amazon brand in Europe had a value of $2.040 Ex. C-4626-R at 17 (Haigh). Fair market value is defined as the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in a transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion. Ex. C-4625-R at 20 (Haigh). 694. Fair market value presupposes that the asset is valued on the basis of highest and best use which is defined as the most probable use of a property which is physically possible, appropriately justified, legally permissible, financially feasible, and which results in the highest value of the property being valued. 695. Ex. C-4625-R at 20 (Haigh), The business pursued by the Amazon group in Europe is the highest and best use of the Amazon brand in Europe. Ex. C- 4625-R at 21 (Haigh). 696. For the Amazon brand, Mr. Haigh would advise a client to pay the net present value of the expected future royalties - 164 - �---------Docket No. 31197-12 equal to a 2% royalty rate renewed into perpetuity. Tr. 6962:8- 19 {Haigh). 697. When IP works together it should be valued together. In Amazon's case, the brand and domain names are integral to one another. One would have to pay for both the brand and domain names because they cannot exist without each other. Tr. 6952:12-6953:23 {Haigh). 698. A licensee's alternative to licensing the Amazon brand in Europe is creating a new brand. (Haigh). Tr. 6962:20-6963:4 Creating a new brand is highly risky and expensive with a strong probability of failure. Tr. 6963:7-10 {Haigh). The costs to build a new brand to be equivalent to Amazon in Europe could exceed Mr. Haigh's valuation of the Amazon brand in Europe. Tr. 6964:3-6 {Haigh). Costs of building a new brand include losing current customer base and competing with Amazon US or a party that licenses the Amazon brand in Europe. Tr. 6963:15-6964:3 (Haigh). 699. Amazon would be unlikely to engage in a rebranding exercise in Europe. Tr. 6964:7-11 (Haigh). Amazon's brand has attributes that are hard to establish - convenience, reliability, and trust. 700. Ex. C-114-J at AMZCOM00016068. The licensor can choose to use the intangible itself or license to another party if the licensor is unhappy with the - 165 - �---------....... Docket No. 31197-12 licensee. 701. Tr. 6936:16-22 (Haigh). Mr. Haigh conducted a search for trademark license agreements related to online retail and eCommerce services. Ex. c-4625-R at 25-26 (Haigh). 702. In searching for comparable license agreements, Mr. Haigh eliminated agreements that were not primarily for trademarks and: 1) did not relate to online retail; 2) were between related parties; 3) were not standard license agreements; and 4) where the royalty was not based on net sales. Ex. C-4625-R at 26-29 (Haigh). 703. The remaining agreements were the license agreement between TSA Stores, Inc. and Mega Sports Co., the license agreement between RadioShack Corporation and InterTAN Australia, the agreement between MacMark Corporation and Equilink Licensing Corporation, and the agreement between SNAP! LLC and ValueVision International, Inc. 704. Exs. 1101-P, 1063-P, 1015-P, 1053-P. The four comparable trademark agreements provided a royalty rate range from .5% to 2%. 705. Ex. C-4625-R at 29 (Haigh). The assignment agreement assigned to AEHT "all right, title, and interest" and did not limit the use of the Amazon brand to manufactured goods. 706. Ex. 56-J at AMZCOM000003083. The royalty rate range for brands in the online/internet retail sector is 0.5% to 2.0%. - 166 - Ex. C-4625-R at Docket No. 31197-12 29 (Haigh). 707. Based o n the strength of the Amazon brand, the Amazon brand in Europe should command the top rate in the royalty rate range. Ex. C-4625-R at 29 (Haigh). 708. There is typically not a negative correlation between volume and royalty rate in the trademark license area. 5758:4-10 (Frisch). Presuming that royalty rates will always decline as volume increases is wrong. 709. Tr. Tr. 6732:2-14 (Haigh). The vast majority of license agreements had flat royalty rates. Tr. 6732:9-10 (Haigh). thumb is that royalty rates are flat. The general rule of Parties will often enter into trademark license agreements with flat royalty rates with terms that average between 10-15 years. 710. Tr. 4022:8-22 (Reilly). An investor considers expected margins, not necessarily the current margins. Tr. 6956:10-15 (Haigh). investor also considers alternatives. An Tr. 6957:9-13 (Haigh). A bricks and mortar retailer with 4.5% margins would find a model providing a 7 to 8% return extremely attractive and would be willing to pay a high royalty rate. A licensee entering a deal that it believes will secure the future of its business may forgo a significant proportion of the margins. Tr. 6958:1-20 (Haigh). 711. .... The owner of a brand as strong as Amazon's would not - 167 - Docket No. 31197-12 agree to cap the royalties. 712. Tr. 6965:11-17 (Haigh). License agreements generally are renewed on the same terms as the prior agreement including the royalty rate. Tr. 6934:18-23 (Haigh). 713. Amazon's Model projections included commissions for the marketplace which needed to be grossed up to get to revenues. 714. Tr. 6684:24-6685:7; Ex. C-4626-R at 3-4 (Haigh). Revenues defined as shipping, giftwrap, and service revenue need to be accounted for. These revenues are directly linked to the contribution of the brand, since these cash flows would not arise unless the customer gravitates towards the website because of the brand. 715. Ex. C-4626-R at 4 (Haigh). Assuming a gradual decline in the growth of revenues is more reliable than an immediate decline to a terminal growth rate, Ex. C-4626-R at 4-5 (Haigh); Tr. 6685:8-6686:6, 6733:8- 6734:11, (Haigh). 716. Amazon's weighted average cost of capital (WACC) provides the appropriate discount rate for valuing the Amazon brand in Europe. 717. Ex. C-4625-R at 44-45 (Haigh). The correct discount rate for valuing the Amazon brand in Europe is 13.13%. The 13.13% discount rate consists of an after tax cost of debt in Europe of 3.68%; a cost of equity in Europe of 13.39% and a country risk premium of 4.84%. --------- - 168 - Ex. c- Docket No. 31197-12 4625-R at 45 (Haigh). 718. By 2005, the EU was economically confident and optimistic. Perceived economic and investment risk were low and expected WACC rates were equally low. In 2004 and 2005, the EU economy was doing well with stable growth, modest inflation, low unemployment and low interest rates. Euro denominated interest rates were particularly low, supported by the strong German economy, which propagated the belief that Germany would support the Euro and local economies across the whole of the Euro-zone. Economic turmoil caused by the dot-com burst and subsequent market correction had run its course between 2000 and 2002. Ex. C-4628-R at 10-11 (Haigh). 719. In 2005, systemic risks were not higher in eCorrunerce than bricks-and-mortar retailing. Bricks-and-mortar retailers were more at risk from the new generation of e-retailers, who could afford to compete on price because of their relatively lower fixed cost base. Ex. C-4628-R at 11-12 (Haigh), Brand Life 720. The expectation is that a brand will last for an extended period of time. Amazon was trying to position its brand for the long term. Tr. 3244:6-3245:15 (Dolan). The life of a brand name can extend beyond the life of the firm using it. Tr. 4079:13-4080:1, 4152:18-4155:24 (Golder). - 169 - • Docket No. 31197-12 721. It is implausible that a brand as strong as Amazon would lose all its value in seven years. Ex. C-4629-R at 1 11 (Wilcox) 722. The Amazon brand in Europe has an indefinite useful economic life. Ex. C-4625-R at 13 (Haigh). have an indeterminate useful life. 723. Amazon's trademarks Tr. 3995:19-21 (Reilly). Third party license agreements usually contain, either explicitly or implicitly, conditions that the licensee will invest in marketing and advertising activities to maintain and develop the brand in the licensee's territory. Licensors that create a brand are prepared to license it only on the understanding that the licensee will maintain the value of the brand. Ex. C-4625-R at 42 (Haigh). 724. A licensee's general obligation to protect and maintain the assets under license mitigate the likelihood of the brand diminishing. The licensee is driven by its own profit motives and requirements under the agreements. Ex. C-4628-R at 6 (Haigh), 725. If Amazon US had entered a fixed term license instead of assigning its brand in perpetuity to AEHT, it would have been reasonable to expect the license to be renewed. Tr. 6969:7-16 (Haigh), 726. The Amazon brand in Europe has an indefinite useful --------- - 170 - Docket No. 31197-12 economic life because there is no foreseeable limit to the period over which the brand is expected to generate net cash flows for its businesses. 727. Ex. C-4625-R at 13 (Haigh). For an active growing brand such as Amazon, one would expect continued investment. 728. Tr. 6953:10-6954:2 (Haigh). The total IP portfolio transferred by Amazon US to AEHT, including the brand and the patent portfolio, would have been expected to appreciate in value as of January 1, 2005. Ex. C-4623-R 11 12, 63, 41, 119-120 (Conley); Tr. 6495:9-14 (Conley); RD-460. Independent Brand Valuations 729. Interbrand publishes an annual report providing valuations on the strongest brands in the world. Ex. C-4629-R at i 21 (Wilcox). 730. According to Interbrand's ranking of the top 100 brands in the world, Amazon was ranked 66 in 2004, ahead of brands such as Adidas, Rolex, and Cartier. Amazon's estimated brand value in that year was $4.2 billion, which was approximately 23% of its market capitalization of $18.1 billion. According to a branding ranking report by Millward Brown, Amazon's brand value in 2006 was approximately $6.0 billion. Ex. C-4629-R at i 34 (Wilcox). 731. The publicized Interbrand, Millward Brown, and Brand --------- - 171 - Docket No. 31197-12 Finance valuations for the Amazon global brand all converge, within 10%, around $3 billion for 2005. Amazon's valuation method diverges from those of Interbrand, Millward Brown and Brand Finance by an order of magnitude. Ex. C-2386-P Table IV-1 at 53-54 (Dolan). CUSTOMER INFORMATION-RELATED INTANGIBLES 732. Amazon had a large base of customers loyal to the Amazon brand that were a continued source of financial value to the company. 733. Ex. C-4629-R at 1 42 (Wilcox). Amazon was always trying to learn from customer data that it collected and, by 2005, it had software that helped it analyze data from customers that was used in Europe. Tr. 660:21-662:4 (Piacentini), 734. Amazon collects and retains information associated with each customer account, such as: email addresses, shipping addresses, method(s) of payment and payment information (e.g., credit card number), purchase history, timeliness of delivery, return history, clicks or pages viewed, and customer wish lists. Tr. 535:1-537:13, 538:24-539:15 (Greeley). from a marketing perspective. That data was useful Ex. C-4623-R at 11 110-111 (Conley); Tr. 3245:16-21 (Dolan). 735. Prior to 2005, Amazon collected customer data for every European customer and it retains such data indefinitely. - 172 - Docket No. 31197-12 Tr. 541:8-16 (Greeley). Amazon keeps customer order and credit card information indefinitely. 736. Tr. 204:11-19 (Valentine). The Amazon customer database is a trade secret. Ex. C-4623-R at ii 110-111; Tr. 6495:4-9 (Conley); Tr. 6842:18-20 (Holden). 737. Amazon's patented technologies attract customer transactions which increase the value of the customer database. The Amazon customer database allows Amazon to enhance its brand by providing better customer experiences. Ex. C-4623-R at i 112 (Conley). 738. Amazon generally keeps reviews and anything relevant to its customers indefinitely. 739. Tr. 205:9-206:15 (Valentine). The value of customer information in conjunction with the Amazon brand will always be higher than the value of only customer information. 740. Ex. C-4630-R at i 49 (Wilcox). Petitioner did not value Amazon customer data set's purchase history and buying patterns for transfer pricing purposes. Exs. C-4630-R at ii 49-53 (Wilcox), C-4638-R at 13- 14 (Oswald) • 741. Amazon keeps product information indefinitely as part of its catalog. 742. Tr. 204:19-205:2 (Valentine). AEHT benefitted, as of May 1, 2006, from a list of customer who had previously purchased from Amazon US that Amazon - 173 - • 1111111111 Docket No. 31197-12 US transferred to AEHT. Ex. C-2388-P at 53 (Wills). Dr. Wills attempted to value this by assuming that a customer being transferred from Amazon US to Amazon EU is equivalent to a new customer that is referred to Amazon from an Associate or Syndicated Stores site. 743. Ex. C-2388-P at 53 (Wills). Dr. Wills' valuation is mathematically incorrect. Tr. 7065:9-7066:2; Ex. C-4630-R at 11 54-61 (Wilcox). It is a simple mathematical fact that the total customer spend is equal to the product of the number of customers and the mean customer spend, not the median. 54-61 (Wilcox). Tr. 7065:9-7066:2; Ex. C-4630-R at ii Using·the mean, customer information-related intangibles have a value between $101.8 million and $129.2 million. 744. Ex. C-4630-R at 1 61 (Wilcox). By using separate CUTs for technology, trademarks and customer information, Dr. Wills ignores the positive impact of Amazon's strong brand of the value of customer information. 7048:25-7050:19; Ex. C-4630-R at 11 48-53 (Wilcox). Tr. The value of customer information in conjunction with brand will always be higher than the value of only customer information. Ex. C-4630- R at i 49 (Wilcox). 745. Dr. Wills' valuation does not include any value associated with the historical personal information of customers. Tr. 7967:13-7968:8, 7977:4-7978:7; RD-568-C; Ex. - 174 - c- �--------·....... Docket No. 31197-12 4638-R at 13-14 (Oswald}. Customers' historical data is valuable because it allows Amazon to provide a customized shopping experience. Tr. 7967:13-7968:B, 7977:4-7978:7; Ex. c- 4638-R at 13-14 (Oswald}. 746. Dr. Wills also undervalues the Amazon customer information transferred to AEHT by relying on referral fees from third party websites. A customer being transferred from Amazon US to Amazon EU will not change their shopping behavior because they may not even know the transfer has occurred. A new customer, referred from a third party site does not have the same brand loyalty or shopping experience as customers who have used Amazon previously. Tr. 7048:25-7050:19; Ex. C-4630-R at 11 4 9-50, (Wilcox) . INTELLECTUAL PROPERTY MANAGEMENT 747. Intellectual property management is the stewardship and control of intellectual property assets to realize competitive advantage. (Conley}. Ex. C-4623-R at i 42; Tr. 6479:4-8 The intellectual property management discipline has a history of more than thirty years. Ex. C-4623-R at 11 42-62; Tr. 6491:18-6493:13 (Conley}. 748. The strategic management of corporate IP to transfer value from short- to longer-lived corporate IP assets has been occurring both intentionally and inadvertently for decades. - 175 - Ex. �--------11111111 Docket No. 31197-12 C-4623-R at 'll'l! 42, 45, 49, 57-61; Tr. 6646:19-6647:4, 6660:166661:7 (Conley). 749. Amazon used patent protected claims to help deliver on its brand promise of convenience, selection, and price and information. Ex. 128-J at AMZCOM00092232; RD-455; Tr. 6488:14- 6489:20 (Conley). Amazon.corn's patented 1-Click purchasing is a key feature that is identified with and distinguishes the Amazon.com site and brand. Exs. 163-R at AMZCOM00092317, 3026-R at AMZCOM00092337-38; RD-468; Tr. 6505:24-6506:4, 6506:15-6507:1 (Conley). The I-Click patent claims contributed ease of use to the brand promise of convenience. Ex. 128-J at AMZCOM00092232; RD-455; Tr. 6488:14-6489:5 (Conley). 750. Companies plan for patent expiration by leveraging a company's brand, (Conley). Tr. 3264:21-3265:19 (Dolan); Tr. 6658:13-19 Leveraging the brand to survive patent expiration is part of "value transference". Tr. 6656:17-6657:13 (Conley). There are many examples of Amazon undertaking value transference to use patents to build trademark value. Tr. 6660:24-6661:7; Ex. C-4623-R at ii 64-69, 90-94, 113-118 (Conley). 751. There are many examples of companies undertaking value transference to use patents to build trademark value. 6660:24-6661:7 (Conley). 752. Brands help maintain the value of patents after - 176 - Tr. ..... Docket No. 31197-12 patent expiration. expiration. Companies typically plan for patent Leveraging trademarks and brand is one of the strategies that companies use to deal with patent expiration. Tr. 3264:21-3265:19 (Dolan); Tr. 6658:10-19 {Conley). 753. Technology driven companies use their trademarks and associated marketing IP strategically to maximize revenues, profits and market share while their patents and related IP have a distinct market advantage. When superior technology drives customers to a company's products, the trademarks and associated marketing IP become a store of customer goodwill in the brand, which carries the business into subsequent business phases·when competitors may have caught up technologically or the subject patents may have expired. Brands help by maintaining demand for the subject company's products while the technological IP renewal process takes place. Strong brands like Amazon help to facilitate the transition from one technology to the next. Ex. C-4628-R at 5-6 {Haigh). 754. Based on what was known regarding intellectual property management as of January 1, 2005, it was reasonable to expect that the IP transferred to AEHT would increase in value after that date. 755. Ex. C-4623-R at ii 12-62, 120 (Conley). Amazon's intellectual property portfolio had increased in value up to January 1, 2005. - 177 - Ex. C-4623-R at i 120 1111111 Docket No. 31197-12 (Conley). 756. Amazon's intellectual property portfolio did, in fact, increase in value after January 1, 2005. Ex, C-4623-R 11 13, 120 (Conley). 757. Amazon represented to third party licensors that its brand was one of its most valuable assets. Exs. C-4019-R at AMZCOM00075011, C-4020-R at AMZCOM00075392. TECHNOLOGY 758. The transferred IP included Amazon's technology platform, which included all of the software code that powers Amazon's retail websites and retail operations. Exs. 55-J, C- 4621-R at 1 20 (Felten). 759. Architecture, algorithmic knowledge, know-how, patents and trade secrets embodied in the code, customer and purchase data, and other aspects of the Transferred IP are separate intangible assets that contribute to the platform's useful life. Their value persists even when software code and components change. Ex. C-4622-R at 11 72-75 (Felten); Stip, 464-468, 675, 690-92, 693-98; Tr. 6829:1-19, 6832:1-8, 6839:1-16 (Holden). Amazon Technology Leaders 760. Jeffrey Holden, a software engineer, joined Amazon in - 178 - Docket No. 31197-12 1997 and le£t in 2006. Tr. 6818:1-13, 23 (Holden). He spent the £irst £our-and-a-ha!£ years at Amazon building and running supply chain optimization systems. Tr. 6829:24-6830:2 (Holden). He then ran aspects 0£ the consumer experience, including discovery, automated merchandising, search, Personalization, community, and ordering. Tr. 6829:22-6831:21 (Holden). By 2005 he had been appointed senior vice president Worldwide Discovery. Ex. 8-J at AMZCOM00041806; Tr. 6836:8-11, 6838:6-15 (Holden). Global discovery at Amazon helps customers find and discover products. Tr. 6836:8-6837:9 (Holden). discussion boards are part of discovery. 761. Tr. 6837:1-9 {Holden). Richard Dalzell joined Amazon in mid-1997. 5374:3-21, 5382:1-3 (Dalzell). Amazon's back-end systems. 762. Community features and Tr. He became responsible for Tr. 5384:6 (Dalzell). When Mr. Dalzell joined Amazon, the software was monolithic with circular dependencies. Tr. 5416:5-8 (Dalzell). While fine for a start-up, a shift to a second generation was needed to run a more mature operation. 5419:2-16 (Dalzell). Tr. 5416:3-5418:13, For the first few years after Mr. Dalzell joined Amazon, it was constantly rebuilding its software while actively using it. 763. Tr. 5419:2-16 (Dalzell). Peter Vosshall joined Amazon in 1998; he is currently a Vice President, and one of Amazon's eight Distinguished - 179 - __________........ Docket No. 31197-12 In 1998 his goal was to transition the company's Engineers. software from a monolithic to a services-based architecture. Tr. 1304:13-1305:4, 1378:24-1379:4 (Vosshall). Allan Vermeulen joined Amazon in 1999 as Director of 764. Platform Technologies. His goal was to improve Amazon's platform so that the company could break its code base apart from a monolith into modular components, to facilitate a move to a service-oriented architecture. Tr. 1529:16-18, 1586:24-1589:1 (Vermeulen) Mr. Vermeulen was promoted to Chief Technical Officer 765. in 2000. Tr. 1529:18-19 (Vermeulen). In 2003, Mr. Vermeulen took on a role leading engineering for AWS. Tr. 1529:19-21 (Vermeulen) 766. By 2003, Amazon sought to converge all of Amazon.corn's eCommerce offerings onto one platform where Amazon.com retail is a seller on the platform. Richard Dalzell were responsible for this goal. Jason Kilar and Ex. C-4122-R at "Inputs" Tab; Tr. 4590:20-4592:8 (Kilar). 767. The shift of Amazon's platform from a monolithic to a services-oriented architecture began prior to 1998 and continues today. Tr. 5419:17-5420:13 (Dalzell); Tr. 1304:17-1305:4 (Vosshall). 768. In 2002 or 2003, Mr. Kilar was placed in charge of a - 180 - Docket No. 31197-12 new group that included Marketplace called Worldwide Application Software (WWAPs), Tr. 4583:12-4584:3 (Kilar). He was in charge of the top of the technology stack and Mr. Dalzell was in charge of the bottom stack. 769. Tr. 4647:1-7 (Kilar). Mr. Kilar was tasked with developing the best 3rd party selling platform in the market. Ex. C-4122-R [Waterfall Tab]; Tr, 4588:12-14 (Kilar). 770. A number of technical executives and business executives (from product to business development to customer support) were part of WWAPs. also worked for WWAPs. 771, Tr. 4651:1-22 (Kilar). Designers Tr. 4654:10-17 (Kilar). Brian Valentine joined Amazon after being at Microsoft for 19 years. Tr. 32:5-6 (Valentine). He took over work that was previously the responsibility of Messrs. Kilar, Holden, and Dalzell. 772, Tr. 136:7-137:20 (Valentine), In moving from Version 2 to Version 3 at Amazon, Mr. Valentine rewrote, moved, and replaced software. Tr, 105:3-16, 109:4-111:4 (Valentine). 773. Brad Porter, a distinguished engineer, joined Amazon in March of 2007. 774. Tr. 1938:21-22 (Porter). Amazon's technology gave it a head start for its platform development. Amazon already had direct experience with what is required to support multi-merchant, multi-channel, - 181 - _________....... Docket No. 31197-12 international growth, constant customer experience innovation, the boom and bust of the retail lifecycle, rebranding, improved promotion and reach, and driving down costs. Ex. C-479-J at AMZCOM00101243; Tr. 2029:5-2030:3 (Porter). 775. Mr. Valentine directed the move to Version 3 for over seven years and it was not completed when he left. 48:7 (Valentine); Ex. 2000-P. Tr. 46:7- In order to improve the website while it was operating, the website required small incremental changes. Tr. 46:21-48:7 (Valentine); 1988:4-22 (Porter). Respondent's Technology Experts 776. Dr. Edward Felten, a Princeton University professor, is an expert in computer science. 777. Tr. 6362:3-6 (Felten). Dr. Geoffrey Cohen is an expert in computer science and software. Tr. 6200:17-18 (Cohen). Software rndustry 778. Computer science is the formal engineering practice of building software and understanding the theory of software development. 779. Tr. 6817:5-16 (Holden). Software is the instructions that tells computers what to do in either human-readable (source code) or binary (object code) form. Stip. 448, 1101; Exs. C-4621-R at 1 13 (Felten), C-4619-R at 1 18 (Cohen). 780. "Hardware" refers to the tangible, physical equipment - 182 - Docket No. 31197-12 that makes up computers and networks. Ex. C-4621-R at i 13 (Felten). 781. Software can serve as a component of many different functions in an enterprise (e.g., products or services offered directly to customers, infrastructure or internal operational functions, and tools and processes used by developers to create, Further examples of corporate test, and configure systems). functions that employ software include accounting, payroll, human resources, supply chain management, inventory, fulfillment, forecasting, etc. 782. Ex. C-4619-R at i 25 (Cohen), Just as a car is assembled from a set of components, such as the transmission and brakes, most modern software projects are composed of smaller components. include: Advantages (1) reducing project complexity; (2) allowing components to be updated or replaced without affecting others; and (3) making it easier to organize and manage the software engineering process. 783. Ex. C-4619-R at 1 22 (Cohen). For projects involving multiple cooperating computers, or which are complex or mission-critical, developers will usually first design and specify the software project's "architecture." The architecture defines the requirements, interfaces, relationships, and communication patterns of how the various components in a larger software system interact with - 183 - 1111111111 Docket No. 31197-12 each other. Exs. C-4619-R at 1 23 (Cohen), C-4621-R at 1 32 (Felten); Tr. 143:5-144:15 (Valentine). 784. The software architecture process is analogous to constructing a building. Both building and software architects play a large role early in major projects. (Cohen). Next, engineers design the code to ensure that it matches the architecture's tenets. code. Ex. C-4619-R at 1 23 Last, engineers write the Tr. 143:5-144:15 (Valentine). 785. In a traditional software business, discrete software products (e.g., Microsoft Office) are developed by teams of programmers and are released at relatively infrequent intervals (shrink-wrapped software). 786. Ex. C-4621-R at 1 52 (Felten). The internet has facilitated new business models that allow Amazon and others to employ software to offer products or services over the internet, or software as a service (SaaS). Such software typically runs on large computers known as servers. For large companies, these servers must be able to handle many thousands or even millions of customers using the provided services simultaneously. Scalability is a system's ability to operate effectively with increasingly large numbers of users. Exs. C-4619-R at i 26 (Cohen), C-2372-P at 1 32 (Iansiti). 787. In contrast to shrink-wrapped software's long release - 184 - ..... Docket No. 31197-12 cycle, Saas projects have different requirements, and are developed and deployed more continuously and incrementally. Saas users do not "buy" a discrete software product. Instead, they, like Amazon's customers, use whatever version the company is providing at that moment. Saas may be updated every day. Exs. C-4619-R at i 28 (Cohen), C-4621-R at i 14 (Felten). 788. Shrink-wrapped software companies get revenue from selling software. These companies are incentivized to develop and offer new products or new versions of existing products. Saas companies have no such direct economic incentive to develop and offer new versions of internal software as it typically creates pure costs, not direct revenues. Amazon and other Saas providers must carefully select which projects require further investment, and pursue such development only if it positively affects the enterprise by improving efficiency, reducing costs, or enabling additional revenues. Ex. C-4619-R at i 29 (Cohen); Tr. 54:21-55:11 (Valentine). NPI Process 789. The New Project Initiative (NPI) process was used at Amazon to allocate and prioritize technology resources across organizations. Tr. 171:10-174:17, 179:16-19 (Valentine); Tr. 3584:1-6 (Moore); Ex. C-4001-R. 790. Amazon used estimates of free cash flow to compute - 185 - Docket No. 31197-12 the net present value (NPV) and prioritize projects. Tr. 174:22-175, 178:5-19 (Valentine); Ex. C-4001-R. 791. In 2009, Amazon sought to build a European Fulfillment Network (EFN) to interconnect EU Fulfillment Centers (FCs) similar to the North American network. "SVP-Review" Tab. Ex. C-4001-R at EFN would allow fulfillment of any EU customer order, from any EU FC, based on inventory availability, transit times and transit costs. Ex. C-101-P at AMZCOM00074883. The estimated The EFN was a prerequisite to new country launches in the EU. Ex. C-4001-R at "SVP-Review" Tab. Amazon's Website and Key Functions 792. Amazon uses a large, complex array of hardware and software to offer items for sale to customers, coordinate with partners and associates, complete transactions, fulfill orders, manage inventory, search through catalogs, resolve customer inquiries, and numerous other vital functions. Ex. C-4621-R at i 14 (Felten); Tr. 2930:19-2931:23 (Szkutak). 793. The operation of Amazon's site requires many thousands of computers, connected to each other by special "data center" networks. The webpages seen by Amazon's customers are a result of many computers working together. These computers pull data from distinct data sources and create the correct --------- - 186 - __________........ Docket No. 31197-12 arrangement of text, images, and other media that make up the ' visual display. Ex. C-4621-R at!! 23-24 (Felten); Tr. 55:1858:9 (Valentine). 794. Amazon's platform technology is a key business function and value driver and consists of highly complex software tools that operate the website's various features. The software tools that underlie this platform are an integrated system that is continually improved, enhanced, and modified. Its key strengths are: the speed of operations of the website features, the breadth of functionality, the ease of access, and flexibility to respond to user needs. Ex. C-57-P at IRS_000160; Stip. 442. 795. Amazon's catalog is a set of databases in which information about millions of for-sale items is stored, described, reconciled, updated, and retrieved, and is one of Amazon's key business functions and value drivers. Its breadth of product information is unusual among e-retailers. Exs. C-57- p at IRS_000160, C-4621-R at i 24 (Felten); Stip. 456. 796. "Pricing" involves constant adjustments based on competitive monitoring and cross-site mapping of products to ensure that Amazon's offers are attractive. Ex. C-4621-R at i 24 (Felten); Stip. 485. 797. "Search and browse," a key business function and - 187 - Docket No. 31197-12 value driver for the website, helps customers find products and navigate the site effectively. c- Exs. C-57-P at IRS_000160, 4621-R at i 24 (Felten); Stip. 442, 490-91; Tr. 1883:11-14 (Kufeld). 798. "Personalization and Recommendations" customizes each customer's experience on the site based on individual and aggregate customer data and presents the customer with products that may interest them. Ex. C-4621-R at ii 24, 41 (Felten}; Stip. 646, 650. 799. "Ordering" takes orders, accepts payment, and initiates fulfillment using self-developed software. Ex. c- 4621-R at i 24 (Felten); Stip. 442, 680-81. 800. "Payments" manages the customer and merchant transactions. 801. Ex. C-4621-R at 1 24 (Felten); Stip. 710. "Identities" manages customer accounts. Ex. C-4621-R at i·24 (Felten). 802. Amazon's web design and user interface are a key business function and value driver for Amazon. creates the websites' look and feel. This function The basic features and tools are developed in the US, and then rolled out to Amazon's other sites. 803. Ex. C-57-P at IRS_000099, IRS_000160; Stip. 442. Customer service software is a key business function and value driver for Amazon. - It uses internally developed - 188 - Docket No. 31197-12 software to track and respond to a wide variety of customer concerns. Amazon places a high priority upon customer service. It has developed extremely complex software that provides customer service representatives with tools to respond efficiently to, increasing customer satisfaction and leading to more repeat purchases. Stip. 442; Ex. C-57-P at IRS_000099, IRS_000161; Tr. 7276:1-8, 7279:1-16 (Blackburn). 804. Amazon had a whole set of software and process around customer returns. 805. Tr. 7268:7-23 (Blackburn). Remaining key business and value drivers for Amazon include fulfillment, customer data analysis, and data analytics software. Stip. 442; Ex. C-57-P at IRS_000099-100, IRS 000160- 161. 806. Much of Amazon's software development history involves gradually building up these individual services and marshaling them effectively to work together to produce the pages customers see as they use the site. Ex. C-4621-R at 1 25 (Felten) 807. Few companies had built or operated a site of the same scale and complexity as Amazon which had sales of $6.9 billion in 2004. AMZCOM00041812. Exs. C-4622-R at 1 48 (Felten), 8-J at The scale and complexity of Amazon's site and software made the company's technology especially valuable. --------- - 189 - Docket No. 31197-12 Exs. C-4621-R at 'l[ 26 (Felten), C-4622-R at 'l[ 48 (Felten); Tr. 1377:9-1378:15 (Vosshall). Because the Amazon site operated at unusual scale and 808. complexity, Amazon would tend to change the technologies underlying its site cautiously and incrementally. As a result, the expected lifetime of Amazon's current technology would be lengthened. Amazon would not make drastic modifications to its site, even for Ordering, its "new Obidos." Ex. C-4621-R at 'l[ 26 (Felten); Stip. 694-97. 809. Different components of the platform were updated at different times. Tr. 132:13-133:16 (Valentine). Innovation at Amazon 810. Amazon has always been a leader and innovator in the eCommerce space. 811. Ex. C-4622-R at 'l[ 49 (Felten). As an innovative IT pioneer and a company passionate about the user experience, Amazon e-was perceived as the gold standard in eCommerce. Ex. C-479-J at AMZCOM00101230; Tr. 2012:22-2014:9 (Porter). 812. Amazon's software development model employs continuous, incremental innovation, built upon the foundation of the existing technology. Ex. C-4622-R at 'l[ 68 (Felten); Tr. 1491:11-18 (Maccormack). 813, Amazon continuously innovates to create new features - 190 - Docket No. 31197-12 for customers. Tr. 3538:8-22 (Moore); Tr. 4595:18-4596:6, 4602:4-25 (Kilar); Tr. 6842:21-6843:16 (Holden); Stip. 531. 814. One cannot draw a bright line between innovation and maintenance. Maintenance and innovation are both expected parts of software's ordinary evolution. Ex. C-4622-R at 1 50 (Felten); Tr. 6388:18-6389:12 (Felten); Tr. 6832:1-8 (Holden). 815. Amazon encouraged engineers to assume that their software lives forever and need continuous innovative maintenance. 816. Tr. 6832:1-8 (Holden). When Prime was created, Amazon formed an initial project to create it and a second team to continue to innovate it forever. 817. time. Tr. 6832:9-15 (Holden). Typically software functionality is created over Tr. 6828:21-23 (Holden). 818. A company operating a complex, large-scale platform expects to continue innovating because a software platform's chief function is serving as a vehicle for innovation. Ex. c- 4622-R at$ 46 (Felten}. 819, Amazon expected to have to continue maintaining and innovating to ensure its software platform continues to meet its business needs. Ex. C-4622-R at 1 45 (Felten); Tr. 2924:11- 2925:15 (Szkutak). 820. Amazon, like other Saas companies, constantly evolved - 191 - --------- Docket No. 31197-12 its software rather than replacing it wholesale. Ex. C-4622-R at i 45 (Felten); Tr. 5448:15-5449:23 (Dalzell); Tr. 1943:11-12, 1955:14-15 (Porter); Tr. 6827:22-6829:9 (Holden). 821. Amazon would launch a feature to try it out. customers loved it, Amazon would expand on it. If customers did not like it, Amazon would remove it from the site. happened every day all the time. 822. If That Tr. 3538:8-22 (Moore}. Rewriting pieces of software and rapidly releasing the code without interrupting the site's operation was a regular part of Amazon's engineering practices. Ex. C-4621-R at 1 28 (Felten}; Tr. 46:21-47:11 (Valentine); Tr. 5419:8-16 (Dalzell). 823. Amazon makes trade-offs between perfect software and quick releases. Tr. 6376:10-18 (Felten); Tr. 1351:15-22 (Voss hall); Tr. 1613: 25-1614: 18 (Vermeulen) • "Technical debt" is when software is made public prior to perfection. Tr. 6376:19-23 (Felten); Tr. 1351:15-22 (Vosshall); Tr. 1613:251614:18 (Vermeulen); Ex. C-4622-R at 1 69 (Felten). When software has technical debt, Amazon understands that it will need to fix the software later. Tr. 6376:21-23 (Felten); Tr. 1351:15-22 (Vosshall); 1613:25-1614:18 (Vermeulen). 824. Amazon accepted operational pain as part of being on the cutting edge and the need for continuous innovation. Amazon engineers valued components that worked, and accepted modifying - 192 - • Docket No. 31197-12 and rewriting that component as a regular part of the development process. Ex. C-4622-R at i 70 (Felten); Tr. 1351:15-22 (Vosshall); Tr. 1613:25-1614:18 (Vermeulen). 825. Every holiday season during Amazon's early years was spent in a crisis mode. 826. Ex. C-4622-R at i 48 (Felten). That a component of the technology platform has collapsed, or is anticipated to collapse, absent some innovation, is a reality of the fast-paced world of the Internet. Amazon's entire existence has been characterized by the challenges of innovating due to running into unexpected walls and growing so fast that the entire structure seems in danger of failure at any moment. 827. Ex. C-4622-R at i 47 (Felten). Amazon launches software even though it envisions further improvements and updates. Amazon could never get it right at the beginning, and had to continue iterating, even while working on new versions. Tr. 232:12-25 (Valentine); Tr. 1351:15-22 (Vosshall); Tr. 1613:25-1614:18 (Vermeulen). 828. It was impressive how fast Amazon was able to make changes to the website by September 2006. Amazon changed content on the website every hour of every day. By September 2006, Amazon could immediately roll back a broken software update. 829. Tr. 148:3-149:17 (Valentine); Ex. 2000-P. Amazon will never be finished improving its software. - 193 - ---------- Docket No. 31197-12 Its end goals are unobtainable, so its engineers will keep incrementing and iteratively moving forward. Tr. 1616:1-9 (Vermeulen). 830. Incremental software development is better than a waterfall approach for most business, eCornmerce, and personal systems. problems. Incremental development reflects the way that we solve Ex. C-4622-R at 1 46, n. 36 (Felten). Amazon uses an incremental development model, which is associated with higher quality products in an environment where things are changing very, very quickly. 831. Amazon's technology problems in 2004 were the same as in 1997, and now. 832, Tr. 1491:11-1492:13 (Maccormack). Tr. 5441:2-5442:3 (Dalzell). Amazon was a pioneer in building a large-scale distributed system. Tr. 2012:22-2014:9 (Porter); Ex. C-479-J at AMZCOM00101230. 833. Amazon was a retailer and a technology company that held the promise of being able to create a unique specialized store for each customer. Tr. 5376:9-18, 5377:18-5378:16, 5380:9-12 (Dalzell); Tr. 5051:3-11 (Cornell); Tr. 5893:24-25 (Vogels); Tr. 234:21-235:8 (Valentine). 834. Both before and after 2005, Amazon extensively used recommendation algorithms to personalize its website to each customer's interests and provide shopping recommendations based - 194 - ....... Docket No. 31197-12 on a customer's purchase history, what they put in their shopping cart, and what they searched for. Ex. 3600-R at IRS_027986; Tr. 3686:20-3687:2 (Moore). 835. (Dalzell). Amazon is as quantitative as possible. Tr. 5412:2-13 Amazon made many important decisions with data; using math to distinguish between right and wrong or better and worse answers. The math did the heavy lifting, while judgment and opinion served as junior partners. AMZCOM00041884. Ex. 9-J at Amazon's approach was algorithmic. Tr. 6841:1- 2 (Holden); Tr. 3686:20-25 (Moore). 836. its path. Amazon is very data-centric and uses data to drive Tr. 5456:23-25 (Dalzell); Tr. 114:13-15 (Valentine); Tr. 414:4-7 (Greeley); Tr. 1060:7-1061:18 (Kleber); Tr. 2018:1-9 (Porter); Tr. 2908:18-20, 2934:21-2935:10 (Szkutak). Everything was informed by the output. Data was a Tr. 5457:1-5 (Dalzell). byproduct of every piece of Amazon's technology; that data informed what Amazon built next. 837. Tr. 5457:13-5458:20 (Dalzell). Amazon was familiar with solving problems that might initially have seemed insurmountable and implementing clever solutions to get more out of its existing infrastructure. C-4622-R at 1 49 (Felten). Ex. Amazon extended the time that it was able to use Oracle databases to store customer information through an iterative, surgical process that focused on replacing - 195 - • .... Docket No. 31197-12 components when they became the critical failure point and preserving the rest'of the solution for as long as possible. This process was the norm at Amazon. Amazon continued to use oracle databases during the timeframe until at least 2006. Ex. C-4622-R at 1 60 (Felten); Tr. 6853:16-20 (Holden). In 1998 or 1999, a supply chain team decoupled the 838. software from Oracle databases so Amazon could distribute the data over multiple databases and handle a lot more transaction volume. Tr. 6825:15-6826:3, 6826:15-24 (Holden). In 2000, Amazon built customer Master Service to 839. separate the software tools that relied on customer data from its Oracle database. Tr. 1305:12-19, 1308:14-23 (Vosshall). By 2001, Amazon was working to extend and leverage Customer Master Service's framework to other services. (Vosshall). Tr. 1381:9-18, 1387:6-9 Amazon used partitioning to extend the usefulness of Customer Master Service. Tr. 1174:1-7 (Birman); Tr. 1602:23- 1603:12 (Vermeulen). 840. It was reasonable to expect as of January 1, 2005, that Amazon would solve its technology challenges. Tr. 6444:15- 6445:4 (Felten). R & 841. D Budget Amazon always invested heavily in technology; the company spent the amount it needed to spend on technology to be - 196 - • Docket No. 31197-12 the most customer-centric company in the world. The goal was to build customer facing applications as fast as possible. Tr. 5406:3-5407:23 (Dalzell), 842. The technology discussions in finance centered on providing the resources necessary to meet the challenges. Tr. 2924:5-2926:8 (Szkutak). 843. There were no discussions among senior executives at Amazon about problems that would cause the Amazon platform to collapse, but they always discussed problems that diminished customer experience. 844. Tr. 2930:11-2931:19 (Szkutak). If technology problems were material to the financial performance of Amazon, then it would be incumbent on management to disclose it. 845. Tr. 7556:11-17 (Timmins). Amazon does not stop developing technology, but continues to improve and add new functionality to the service while making sure it scales. 846. Tr. 2923:1-19 (Szkutak). In the mid-2000s, Amazon was investing approximately per year in technology. Exs. C-475-R at AMZCOM00076263, C-4622-R at! 26 (Felten). "Reuse" in Software Engineering 847. "Software reuse" is a core strategy in modern software engineering that emphasizes the continued use of software over creating new software. - 197 - Exs. C-4621-R at� 15 Docket No. 31197-12 (Felten), C-4619-R at 1 36 (Cohen); Tr. 6443:24-6444:12 (Felten). Rewriting code often involves building on prior 848. versions' architecture or framework, rather than starting from scratch, increasing a company's return on its software investment. Tr. 6373:10-16 (Felten). Amazon's old technology had value for understanding and improving future technology and software. Tr. 5459:2-5460:8 (Dalzell); Exs. C-4621-R at 1 15 (Felten), C-4619-R at 1 37 (Cohen). 849. Examples of software code reuse include when it is rewritten, adapted, restructured, or otherwise changed to fix bugs, to improve security, to add new functionality, to operate more quickly, and to adjust to changes in hardware. R at 1 27 (Felten). Ex. C-4621- Industry practice is to rewrite software component by component, rather than starting from scratch. Component-based design works hand in hand with code reuse to allow software components to be rewritten in a piece-meal fashion. This preserves valuable functionality and avoids service interruption. Ex. C-4621-R at 1 28 (Felten). For example, instead of rewriting Ordering from scratch, Amazon re­ wrote it incrementally. 850. Stip. 693-94, 697-98. "Modular design" or "component-based software engineering" are related to reuse. - 198 - Each component performs a Docket No. 31197-12 specific job, and the components are designed to fit together to Ex. C-4621-R at 1 18 (Felten). construct the complete system. 851. Amazon consciously moved to a component-based service-oriented architecture in Gurupa to promote this iterative development model. 852. project. Ex. C-4621-R at i 28 (Felten). Architecture can also be reused beyond a single In some ways, it can be reused more easily, because it consists of a conceptual model of interrelationships than a concrete set of source code. Ex. C-4619-R at 1 42 (Cohen). Refactoring 853. Refactoring is restructuring software. Tr. 6828:18- 21 (Holden); Tr. 5913:10-14 (Vogels); Ex. C-477-R at AMZCOM00089699; Stip. 453, 1092. 854. Refactoring cleans up software and increases its performance. 855. Tr. 6829:1-8 (Holden). Through the refactoring process, companies can reorganize their source code. one common goal is identifying code that could be used by multiple projects, extracting it, and creating a separate component for re-use in multiple software projects. 856. Ex. C-4619-R at 1 41 (Cohen). Amazon constantly refactored its software. 6827:22-6828:17, 6829:8-9, 6839:1-16 (Holden). continue indefinitely. Tr. 6828:13-17 (Holden). - 199 - Tr. The work will Docket No. 31197-12 Single Global Platform 857. In 2002, Amazon aimed to create a "single global platform" that would bring all of Amazon's eCommerce offerings to one platform. Tr. 4590:20-4591:16, 4656:15-24 (Kilar); Tr. 6839:1-9 (Holden); Exs. C-4122-R at "Outputs" Tab, C-2048-P, C4622-R at i 23 (Felten). beginning of 2006. Progress on this goal was made by the Tr. 4593:3-17, 4641:19-4642:5, 4656:15- 4657:3 (Kilar). 858. Single global platform was a refactoring of the systems at Amazon to get to a single system behind a hardened API. Tr. 6827:2-8 (Holden). It is a way of getting software into a state where you can more rapidly innovate. (Holden). Single global platform was an initial try to refactor Amazon's software into services. 859. Tr. 6827:2-25 Tr. 6826:6-11 (Holden). Single global platform included the hardware and software architecture that Amazon intended to use to implement Merchant.com. Ex. C-126-J atAMZCOM00000400. Amazon believed that the Merchant.com business would capitalize on the investment to move towards a single global platform. Exs. C- 475-R at AMZCOM00076267, C-4622-R at i 23 (Felten). 860. By October 2004, Amazon had many projects under way to ensure that it had offered the same features to itself and all of its sellers. Exs. C-126-J at AMZCOM00000413, C-475-R at - 200 -