A version of this article was previously published with MNETax.com in November 2019.
On November 11, 2019, the US Court of Appeals for the Ninth Circuit panel reached a decision to reject the request for an en banc hearing in the Altera Corp v. Commissioner transfer pricing case. The decision will have a major impact on businesses with cost sharing arrangements (CSAs) as it determines that stock-based compensation should be shared between related parties in the context of CSAs.
Altera entered into a research and development CSA with its subsidiary in the Cayman Islands, Altera International (AI). For tax years 2004–2007, Altera granted stock-based compensation to certain employees, but didn’t include such costs in the pool of costs to be shared under the CSA.
The IRS asserted that Altera’s failure to include such costs violated the US Department of the Treasury (Treasury) regulations issued in 2003 that require taxpayers to do so.
In July 2015, the US Tax Court held that the rule made sharing stock-based compensation in a CSA invalid. The court, in a unanimous decision, found that the Treasury and the IRS failed to provide a reasonable basis for the rule consistent with the arm’s-length principle.
However, on July 24, 2018, the Ninth Circuit overturned this decision in a 2–1 opinion, stating that income tax regulations under Section 1.482-7 required stock-based compensation to be shared under CSAs.
Following this decision, Altera filed a petition seeking an en banc hearing that was supported by a number of companies, including Alphabet Inc., Apple, and others.
Following the Ninth Circuit panel’s request denial, the three dissenting judges clearly mentioned that the Treasury violated the Administrative Procedure Act in the implementation of the regulation promulgated in 2003.
The decision to deny the rehearing of the petition is a big win for the Treasury. It will impact all taxpayers with CSAs that weren’t sharing stock-based compensation, because these taxpayers will now be required to do so. The decision will especially impact companies in the technology industry, where CSAs are common.
As part of their dissent, Judges Milan D. Smith, Consuelo Callahan, and Bridget Bade noted that the majority opinion would upset both domestic and international tax law. They believe the Treasury, IRS, and relevant foreign tax agencies will all need to address the issue of income between related entities operating in different countries.
They also feel that the majority opinion upsets the international uniformity by interpreting Section 482 as allowing for the use of a purely internal standard to make cost and income allocations, i.e., without ever inquiring as to the behavior of parties operating at arm’s length.
The key question now is whether this decision marks the end of the Altera’s case, or if a petition will be filed with the Supreme Court within the time limit of 90 days from the November 11 decision.
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