US IRS advises on transfer pricing adjustments for Altera-related ‘reverse claw-backs’

A US Internal Revenue Service Office of Chief Counsel memorandum published on July 16 offers taxpayer advice with respect to transfer pricing issues related to cost sharing agreements containing “reverse claw-back” provisions.

Reverse claw-back provisions operate essentially the opposite of “claw-back” provisions, which are commonly included in cost sharing arrangements to claw back or remove from cost pools stock-based compensation if a related regulation is invalidated after the agreement is executed. The reverse claw back requires taxpayers to put such stock-based compensation back in the cost pools in the event of a relevant triggering event, e.g.., if a court upholds the validity of the applicable regulation.

Some taxpayers amended their cost sharing agreements to include reverse claw-back provisions following the Tax Court’s 2015 decision in Altera, which invalidated the underlying regulation. The Ninth Circuit Court of Appeals subsequently reversed the Tax Court, upholding the regulation. The US Supreme Court declined to review – a decision which carries implications for cost sharing and stock options.

The IRS Chief Counsel Office’s memo examines cost sharing agreement transfer pricing issues relating to stock-based compensation costs involving agreements that include reverse claw-back provisions that are triggered by a final Altera decision or other event.

In the memo, the IRS states that it may, under the current regulations, make allocations to adjust the results of a cost sharing transaction so that they are consistent with the arm’s length result. If the IRS makes such an allocation, the allocation will be reflected for tax purposes in the year in which the intangible development costs were incurred.

If the IRS adjusts the results of a cost sharing transaction for a tax year to account for stock-based compensation costs, the memo adds, that adjustment should be treated as reducing the amount of any reverse claw-back true-up obligation by a corresponding amount to avoid an overpayment of the stock-based compensation costs.

Finally, the memo notes that if allocations to adjust the results of a cost sharing transaction in the appropriate year are not possible, the IRS may make other adjustments to reflect the contract or to ensure that the results are consistent with an arm’s length result.