US Tax Court again invalidates cost-sharing regs on stock-based compensation

In a significant blow to the IRS, the US Tax Court has invalidated 2003 cost-sharing regulations that require related parties to share stock-based compensation costs in qualified cost-sharing agreements, finding that the regulations do not meet the standard of reasoned decisionmaking.

Treasury could not reasonably conclude that the regulations were consistent with the arm’s-length standard, the Court said, in its 70-page decision, Altera Corp. v. Commissioner, 145 T.C. No. 3 (27 July 2015).

The decision revisits issues raised in Xilinx Inc. v. Commissioner, 125 T.C. 37 (2005), aff’d, 598 F.3d 1191 (9th Cir. 2010), where the Tax Court held under 1995 regulations that controlled entities entering into qualified cost-sharing agreements are not required to share stock-based compensation costs because parties operating at arm’s length would not do so.

After Xilinx was decided, the IRS rewrote its regulations to explicitly require sharing of stock-based compensation in the cost pool.

According to the Tax Court, though, the new regulations are also invalid because they are contrary to the evidence that was before Treasury when it wrote the regulations.

The Court said that files maintained by Treasury lacked evidence — such as expert opinions, empirical data, articles, or actual agreements between related parties — supporting Treasury’s view that unrelated parties entering into qualified cost-sharing agreements would share stock-based compensation costs.

Treasury also failed, when it issued the final regulations, to respond to “numerous relevant and significant” comments that disputed its position, or to explain its decisions, the Court said.

Moreover, Treasury failed to articulate why it chose to treat all qualified cost-sharing agreements identically, rather than just focusing on high-profit intangibles where stock-based compensation was a significant element of the compensation, the Court said.

The Court also said it would reach the same result regardless of whether it reviewed the regulations using the standards set out in Motor Vehicle Mfrs. Ass’n of the U.S. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29 (1983) or in Chevron, USA., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984). As a result, the Court declined to say which test should be applied in the case.

See:

• Altera Corp. v. Commissioner, 145 T.C. No. 3 (27 July 2015)