by Sid Paruthi, CA, Moss Adams
On November 11, 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 multinational groups as it determines that stock-based compensation should be shared between related parties in the context of cost-sharing arrangements.
Background
Altera entered into a research and development cost-sharing arrangement with its subsidiary in the Cayman Islands, Altera International. For tax years 2004–2007, Altera granted stock-based compensation to certain employees but didn’t include the costs in the pool of costs to be shared under the cost-sharing arrangement.
The IRS asserted that Altera’s failure to include such costs violated the Treasury regulations issued in 2003 that require taxpayers to do so.
In July 2015, the US Tax Court held that the regulations made sharing stock-based compensation in a cost-sharing arrangement invalid. The court, in a unanimous decision, found that 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 cost-sharing arrangements.
Response
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 stated that Treasury violated the Administrative Procedure Act in the implementation of the regulation promulgated in 2003.
Key takeaways
The decision to deny the rehearing of the petition is a big win for the Treasury. It will affect all taxpayers with cost-sharing arrangements because these taxpayers will now be required to include stock-based compensation in the context of a cost-sharing arrangement. The decision will especially affect companies in the technology industry, where cost-sharing arrangements 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.
— Sid Paruthi is a Managing Director and National Service Line Leader for Transfer Pricing Services at Moss Adams LLP.
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