and Submitted October 16, 2018 San Francisco, California
from Decisions of the United States Tax Court Nos. 6253-12,
T. Catterall (argued), Richard Farber, and Gilbert S.
Rothenberg, Attorneys; Travis A. Greaves, Deputy Assistant
Attorney General; Richard E. Zuckerman, Principal Deputy
Assistant Attorney General; Tax Division, United States
Department of Justice, Washington, D.C.; for
M. Falk (argued), Mayer Brown LLP, Palo Alto, California;
Thomas Kittle-Kamp and William G. McGarrity, Mayer Brown LLP,
Chicago, Illinois; Brian D. Netter and Travis Crum, Mayer
Brown LLP, Washington, D.C.; A. Duane Webber, Phillip J.
Taylor, and Joseph B. Judkins, Baker & McKenzie LLP,
Washington, D.C.; for Petitioner-Appellee.
C. Morse, University of Texas School of Law, Austin, Texas;
Stephen E. Shay and Allison Bray, Certified Law Students,
Harvard Law School, Cambridge, Massachusetts; for Amici
Curiae J. Richard Harvey, Reuven Avi-Yonah, Lily Batchelder,
Joshua Blank, Noël Cunningham, Victor Fleischer, Ari
Glogower, David Kamin, Mitchell Kane, Michael Knoll, Rebecca
Kysar, Leandra Lederman, Zachary Liscow, Ruth Mason, Susan
Morse, Daniel Shaviro, Stephen Shay, John Steines, David
Super, Clinton Wallace, and Bret Wells.
Jonathan E. Taylor, Gupta Wessler PLLC, Washington, D.C.;
Clint Wallace, Vanderbilt Hall, New York, New York; for Amici
Curiae Anne Alstott, Reuven Avi-Yonah, Lily Batchelder,
Joshua Blank, Noel Cunningham, Victor Fleischer, Ari
Glogower, David Kamin, Mitchell Kane, Sally Katzen, Edward
Kleinbard, Michael Knoll, Rebecca Kysar, Zachary Liscow,
Daniel Shaviro, John Steines, David Super, Clint Wallace, and
Larissa B. Neumann, Ronald B. Schrotenboer, and Kenneth B.
Clark, Fenwick & West LLP, Mountain View, California, for
Amicus Curiae Xilinx Inc.
Christopher J. Walker, The Ohio State University Moritz
College of Law, Columbus, Ohio; Kate Comerford Todd, Steven
P. Lehotsky, and Warren Postman, U.S. Chamber Litigation
Center, Washington, D.C.; for Amicus Curiae Chamber of
Commerce of the United States of America.
I. Forry, San Diego, California, for Amicus Curiae TechNet.
E. Loughran, Michael C. Durst, and Charles G. Cole, Steptoe
& Johnson LLP, Washington, D.C.; Bennett Evan Cooper,
Steptoe & Johnson LLP, Phoenix, Arizona; for Amici Curiae
Software and Information Industry Association, Financial
Executives International, Information Technology Industry
Council, Silicon Valley Tax Directors Group, Software Finance
and Tax Executives Counsel, National Association of
Manufacturers, American Chemistry Council, BSA | the Software
Alliance, National Foreign Trade Council, Biotechnology
Innovation Organization, Computing Technology Industry
Association, The Tax Council, United States Council for
International Business, Semiconductor Industry Association.
Kenneth P. Herzinger and Eric C. Wall, Orrick Herrington
& Sutcliffe LLP, San Francisco, California; Peter J.
Connors, Orrick Herrington & Sutcliffe LLP, New York, New
York; for Amici Curiae Charles W. Calomiris, Kevin H.
Hassett, and Sanjay Unni.
Roderick K. Donnelly and Neal A. Gordon, Morgan Lewis &
Bockius LLP, Palo Alto, California; Thomas M. Peterson,
Morgan Lewis & Bockius LLP, San Francisco, California;
for Amicus Curiae Cisco Systems Inc.
Christopher Bowers, David Foster, Raj Madan, and Royce
Tidwell, Skadden Arps Slate Meagher & Flom LLP,
Washington, D.C.; Nathaniel Carden, Skadden Arps Slate
Meagher & Flom LLP, Chicago, Illinois; for Amicus Curiae
Before: Sidney R. Thomas, Chief Judge, and Susan P. Graber
Kathleen M. O'Malley, [**] Circuit Judges.
panel reversed a decision of the Tax Court that 26 C.F.R.
§ 1.482-7A(d)(2), under which related entities must
share the cost of employee stock compensation in order for
their cost-sharing arrangements to be classified as qualified
cost-sharing arrangements, was invalid under the
Administrative Procedure Act.
issue was the validity of the Treasury regulations
implementing 26 U.S.C. § 482, which provides for the
allocation of income and deductions among related entities.
The panel first held that the Commissioner of Internal
Revenue did not exceed the authority delegated to him by
Congress under 26 U.S.C. § 482. The panel explained that
§ 482 does not speak directly to whether the
Commissioner may require parties to a QCSA to share employee
stock compensation costs in order to receive the tax benefits
associated with entering into a QCSA. The panel held that the
Treasury reasonably interpreted § 482 as an
authorization to require internal allocation methods in the
QCSA context, provided that the costs and income allocated
are proportionate to the economic activity of the related
parties, and concluded that the regulations are a reasonable
method for achieving the results required by the statute.
Accordingly, the regulations were entitled to deference under
Chevron, U.S.A., Inc. v. Natural Resources Defense
Council, Inc., 467 U.S. 837 (1984).
panel next held that the regulations at issue were not
arbitrary and capricious under the Administrative Procedure
Judge O'Malley would find, as the Tax Court did, that 26
C.F.R. § 1.482-7A(d)(2) is invalid as arbitrary and
THOMAS, Chief Judge.
appeal presents the question of the validity of 26 C.F.R.
§ 1.482-7A(d)(2),  under which related business entities
must share the cost of employee stock compensation in order
for their cost-sharing arrangements to be classified as
qualified cost-sharing arrangements ("QCSA").
Although the case appears complex, the dispute between the
Department of the Treasury and the taxpayer is relatively
straightforward. The parties agree that, under the governing
tax statute, the "arm's length" standard
applies; but they disagree about how the standard may be met.
The taxpayer argues that Treasury must employ a specific
method to meet the arm's length standard: a comparability
analysis using comparable transactions between unrelated
business entities. Treasury disagrees that the arm's
length standard requires the specific comparability
method in all cases. Instead, the standard generally
requires that Treasury reach an arm's length
result of tax parity between controlled and
uncontrolled business entities. With respect to the
transactions at issue here, the governing statute allows
Treasury to apply a purely internal method of allocation,
distributing the costs of employee stock options in
proportion to the income enjoyed by each related taxpayer.
task, of course, is not to assess the better tax policy, nor
the wisdom of either approach, but rather to examine whether
Treasury's regulations are permitted under the statute.
Applying the familiar tools used to examine administrative
agency regulations, we conclude that the regulations
withstand scrutiny. Therefore, we reverse the judgment of the
many years, Congress and the Treasury have been concerned
with American businesses avoiding taxes through the creation
and use of related business entities. In the last several
decades, Congress has directed particular attention to the
potential for tax abuse by multinational corporations with
foreign subsidiaries. If, for example, the parent business
entity is in a high-tax jurisdiction, and the foreign
subsidiary is in a low-tax jurisdiction, the business
enterprise can shift costs and revenue between the related
entities so that more taxable income is allocated to the
lower tax jurisdiction. Similarly, a parent and foreign
subsidiary can enter into significant tax-avoiding cost
potential for tax abuse is generally not present when similar
transactions occur between unrelated business entities. In
those instances, each separate unrelated entity has the
incentive to maximize profit, and thus to allocate costs and
income consistent with economic realities. However, among
related parties, those incentives do not exist. Rather, among
related parties, after-tax maximization of profit may depend
on how costs and income are allocated between the parent and
the subsidiary regardless of economic reality, given that
after-tax profits are commonly shared.
concern about tax avoidance through the use of related
business entities is not new. In the Revenue Act of 1928,
Congress granted the Secretary of the Treasury the authority
to reallocate the reported income and costs of related
businesses "in order to prevent evasion of taxes or
clearly to reflect the income of any such trades or
businesses." Revenue Act of 1928, ch. 852, § 45, 45
Stat. 791, 806. This statute was designed to give Treasury
the flexibility it needed to prevent transaction-shuffling
between related entities for the purpose of decreasing tax
liability. See H.R. Rep. No. 70-2, at 16-17 (1927)
("[T]he Commissioner may, in the case of two or more
trades or businesses owned or controlled by the same
interests, apportion, allocate, or distribute the income or
deductions between or among them, as may be necessary in
order to prevent evasion (by the shifting of profits, the
making of fictitious sales, and other methods frequently
adopted for the purpose of 'milking'), and in order
clearly to reflect their true tax liability.");
accord S. Rep. No. 70-960, at 24 (1928). The purpose
of the statute was "to place a controlled taxpayer on a
tax parity with an uncontrolled taxpayer."
Comm'r v. First Sec. Bank of Utah, 405 U.S. 394,
400 (1972) (quoting 26 C.F.R. § 1.482-1(b)(1) (1971)).
In short, the primary aim of the statute was to prevent tax
evasion by related business taxpayers.
1934, the Commissioner adopted regulations implementing the
statute and first adopted the familiar "arm's
length" standard: "The standard to be applied in
every case is that of an uncontrolled taxpayer dealing at
arm's length with another uncontrolled taxpayer."
Treas. Reg. 86, art. 45-1(b) (1935). In the context of a
controlled transaction, the arm's length standard is
satisfied "if the results of the transaction are
consistent with the results that would have been realized if
uncontrolled taxpayers had engaged in the same transaction
under the same circumstances (arm's length result)."
26 C.F.R. § 1.482-1(b)(1). The relevant regulation also
noted: "However, because identical transactions can
rarely be located, whether a transaction produces an
arm's length result generally will be determined by
reference to the results of comparable transactions under
comparable circumstances." Id.
the Secretary adopted the arm's length standard, courts
did not hold related parties to that standard by exclusively
requiring the examination of comparable transactions. For
example, in Seminole Flavor Co. v. Commissioner, the
Tax Court rejected a strict application of the arm's
length standard in favor of an inquiry into whether the
allocation of income between related parties was "fair
and reasonable." 4 T.C. 1215, 1232 (1945); see also
id. at 1233 ("Whether any such business agreement
would have been entered into by petitioner with total
strangers is wholly problematical."); Grenada
Indus., Inc. v. Comm'r, 17 T.C. 231, 260 (1951)
("We approve an allocation . . . to the extent that such
gross income in fact exceeded the fair value of the services
rendered . . . ."). And in 1962, we collected various
allocation standards and outright rejected the superiority of
the arm's length bargaining analysis over all others:
[W]e do not agree . . . that "arm's length
bargaining" is the sole criterion for applying the
statutory language of [26 U.S.C. § 482] in determining
what the "true net income" is of each
"controlled taxpayer." Many decisions have been
reached under [§ 482] without reference to the phrase
"arm's length bargaining" and without reference
to Treasury Department Regulations and Rulings which state
that the talismanic combination of words-"arm's
length"-is the "standard to be applied in every
Frank v. Int'l Canadian Corp., 308 F.2d 520,
528-29 (9th Cir. 1962).
noted that "it was not any less proper . . . to use here
the 'reasonable return' standard than it was for
other courts to use 'full fair value,' 'fair
price including a reasonable profit,' 'method which
seems not unreasonable,' 'fair consideration which
reflects arm's length dealing, ''fair and
reasonable,' 'fair and reasonable' or 'fair
and fairly arrived at,' or 'judged as to
fairness,' all used in interpreting [the statute]."
Id. (footnotes omitted). We later limited
Frank to situations in which "it would have
been difficult for the court to hypothesize an
arm's-length transaction." Oil Base, Inc. v.
Comm'r, 362 F.2d 212, 214 n.5 (9th Cir. 1966).
However, Frank's central point remained: the
arm's length standard based on comparable transactions
was not the sole basis of reallocating costs and
income under the statute.
1960s, the problem of abusive transfer pricing practices
created a new adherence to a stricter arm's length
standard. In response to concerns about the undertaxation of
multinational business entities, Congress considered
reworking the Tax Code to resolve the difficulty posed by the
application of the arm's length standard to related party
transactions. H.R. Rep. No. 87-1447, at 28-30 (1962).
However, it instead asked Treasury to "explore the
possibility of developing and promulgating regulations . . .
which would provide additional guidelines and formulas for
the allocation of income and deductions" under 26 U.S.C.
§ 482. H.R. Rep. No. 87-2508, at 19 (1962) (Conf. Rep.),
as reprinted in 1962 U.S.C.C.A.N. 3732, 3739.
Legislators believed that § 482 authorized the Secretary
to employ a profit-split allocation method without amendment.
Id.; H.R. Rep. No. 87-1447, at 28-29. In 1968,
following Congress's entreaty, Treasury finalized the
first regulation tailored to the issue of intangible property
development in QCSAs. 26 C.F.R. § 1.482-2(d) (1968).
1968 regulations "constituted a radical and
unprecedented approach to the problem they
addressed-notwithstanding their being couched in terms of the
'arm's length standard,' and notwithstanding that
that standard had been the nominal standard under the
regulations for some 30 years." Stanley I. Langbein,
The Unitary Method and the Myth of Arm's Length,
30 Tax Notes 625, 644 (1986). In addition to three arm's
length pricing methods, the 1968 regulations included a
"fourth method," which was essentially open-ended:
"Where none of the three methods of pricing . . . can
reasonably be applied under the facts and circumstances as
they exist in a particular case, some appropriate method of
pricing other than those described . . ., or variations on
such methods, can be used." 26 C.F.R. §
the promulgation of the 1968 regulation, courts continued to
employ a comparability analysis, but not to the exclusion of
other methodologies. Reuven S. Avi-Yonah, The Rise &
Fall of Arm's Length: A Study in the Evolution of U.S.
International Taxation, 15 Va. Tax Rev. 89, 108-29
(1995). Indeed, a study determined that direct comparable
transactions were located and applied in only 3% of the
Internal Revenue Service's adjustments prior to the 1986
amendment. U.S. Gen. Accounting Office., GGD-81-81, IRS Could
Better Protect U.S. Tax Interests in Determining the Income
of Multinational Corporations (1981). The decades following
the 1968 regulations involved
a gradual realization by all parties concerned, but
especially Congress and the IRS, that the [comparability
method of meeting the arm's length standard], firmly
established . . . as the sole standard under section 482, did
not work in a large number of cases, and in other cases its
misguided application produced inappropriate results. The
result was a deliberate decision to retreat from the standard
while still paying lip service to it.
supra, at 112; see also James P. Fuller,
Section 482: Revisited Again, 45 Tax L. Rev. 421,
453 (1990) ("[T]he 1986 Act's commensurate with
income standard is not really a new approach to §
as controlled transactions increased in frequency and
complexity, particularly with respect to intangible property,
Congress determined that legislative action was necessary.
The Tax Reform Act of 1986 reflected Congress's view that
strict adherence to the comparability method of meeting the
arm's length standard prevented tax parity. Thus, the Tax
Reform Act of 1986 added a sentence to § 482 that
largely forms the basis of the present dispute, providing
In the case of any transfer (or license) of intangible
property (within the meaning of section 936(h)(3)(B)), the
income with respect to such transfer or license shall be
commensurate with the income attributable to the intangible.
Tax Reform Act of 1986, 26 U.S.C. § 482 (1986) (as
House Ways and Means Committee recommended the addition of
the commensurate with income clause because it was
"concerned" that the current code and regulations
"may not be operating to assure adequate allocations to
the U.S. taxable entity of income attributable to
intangibles." H.R. Rep. No. 99-426, at 423 (1985). The
clause was intended to correct a "recurrent
problem"-"the absence of comparable arm's
length transactions between unrelated parties, and the
inconsistent results of attempting to impose an arm's
length concept in the absence of comparables."
Id. at 423-24.
House Report makes clear that the committee intended the
commensurate with income standard to displace a comparability
analysis where comparable transactions cannot be found:
A fundamental problem is the fact that the relationship
between related parties is different from that of unrelated
parties. . . . [M]ultinational companies operate as an
economic unit, and not "as if" they were unrelated
to their foreign subsidiaries. . . .
. . . .
Certain judicial interpretations of section 482 suggest that
pricing arrangements between unrelated parties for items of
the same apparent general category as those involved in the
related party transfer may in some circumstances be
considered a "safe harbor" for related party
pricing arrangements, even though there are significant
differences in the volume and risks involved, or in other
factors. While the committee is concerned that such decisions
may unduly emphasize the concept of comparables even in
situations involving highly standardized commodities or
services, it believes that such an approach is sufficiently
troublesome where transfers of intangibles are concerned that
a statutory modification to the intercompany pricing rules
regarding transfers of intangibles is necessary.
. . . .
. . . There are extreme difficulties in determining whether
the arm's length transfers between unrelated parties are
comparable. The committee thus concludes that it is
appropriate to require that the payment made on a transfer of
intangibles to a related foreign corporation . . . be
commensurate with the income attributable to the intangible.
. . .
. . . .
. . . [T]he committee intends to make it clear that industry
norms or other unrelated party transactions do not provide a
safe-harbor minimum payment for related party intangible
transfers. Where taxpayers transfer intangibles with a high
profit potential, the compensation for the intangibles should
be greater than industry averages or norms.
Id. at 424-25 (footnote and citation
first response to the Tax Reform Act was the "White
Paper," an intensive study published in 1988. A
Study of Intercompany Pricing Under Section 482 of the
Code, I.R.S. Notice 88-123, 1988-2 C.B. 458 ("White
Paper"). The White Paper confirmed that Treasury
believed the commensurate with income standard to be
consistent with the arm's length standard (and that
Treasury understood Congress to share that understanding).
Id. at 475. Treasury wrote that a comparability
analysis must be performed where possible, id. at
474, but it also suggested a "clear and convincing
evidence" standard for comparable transactions,
indicating that a comparability analysis would rarely be
possible. Id. at 478.
White Paper signaled a shift in the interpretation of the
arm's length standard as it had been defined following
the 1968 regulations. Treasury advanced a new allocation
method, the "basic arm's length return method,"
White Paper at 488, that would apply only in the absence of
comparable transactions and would essentially split profits
between the related parties, id. at 490.
Commentators understood that, by attempting to synthesize the
arm's length standard and the commensurate with income
provision, Treasury was moving away from a view that the
arm's length standard always requires a comparability
analysis. Marc M. Levey, Stanley C. Ruchelman, & William
R. Seto, Transfer Pricing of Intangibles After the
Section 482 White Paper, 71 J. Tax'n 38, 38 (1989);
Josh O. Ungerman, Comment, The White Paper: The Stealth
Bomber of the Section 482 Arsenal, 42 Sw. L.J. 1107,
and 1995, Treasury issued new regulations that defined the
arm's length standard as result-oriented, meaning that
the goal is parity in taxable income rather than
parity in the method of allocation itself. 26 C.F.R. §
1.482-1(b)(1) (1994) ("A controlled transaction meets
the arm's length standard if the results of the
transaction are consistent with the results that would have
been realized if uncontrolled taxpayers had engaged in the
same transaction under the same circumstances (arm's
length result)."). However, the arm's length
standard remained "the standard to be applied in every
regulations also set forth methods by which income could be
allocated among related parties in a manner consistent with
the arm's length standard. Id. §
1.482-1(b)(2)(i) (1994). According to Treasury, the 1994
regulations defined the arm's length standard in terms of
"the results that would have been realized if
uncontrolled taxpayers had engaged in the same transaction
under the same circumstances." Compensatory Stock
Options Under Section 482, 67 Fed. Reg. 48, 997-01, 48, 998
(proposed July 29, 2002).
1995 regulation provided that "[i]ntangible development
costs" included "all of the costs incurred by [a
controlled] participant related to the intangible development
area." 26 C.F.R. § 1.482-7(d)(1) (1995). By
contrast to the 1994 regulation, the 1995
regulation-consistent with the 1986 Conference Report
-"implement[ed] the commensurate with income standard in
the context of cost sharing arrangements" by
"requir[ing] that controlled participants in a [QCSA]
share all costs incurred that are related to the development
of intangibles in proportion to their shares of the
reasonably anticipated benefits attributable to that
development." Compensatory Stock Options Under Section
482, 67 Fed. Reg. at 48, 998.
the Tax Reform Act nor the implementing regulations
specifically addressed allocation of employee stock
compensation, which is the issue in this dispute. However,
that omission was unsurprising given that the practice did
not develop on a major scale until the 1990s. Zvi Bodie,
Robert S. Kaplan, & Robert C. Merton, For the Last
Time: Stock Options Are an Expense, Harv. Bus. Rev.,
Mar. 2003, at 62, 67. Beginning in 1997, the Secretary
interpreted the "all . . . costs" language to
include stock-based compensation, meaning that controlled
taxpayers had to share the costs (and associated deductions)
of providing employee stock compensation. Xilinx, Inc. v.
Comm'r, 598 F.3d 1191, 1193-94 (9th Cir. 2010).
2003, Treasury issued the cost-sharing regulations that are
challenged in this case. Treasury intended for the 2003
amendments to clarify, rather than to overhaul, the 1994 and
1995 regulations. The clarifications were twofold. First, the
amendments directly classified employee stock compensation as
a cost to be allocated between QCSA participants.
Compensatory Stock Options Under Section 482 (Proposed), 67
Fed. Reg. at 48, 998; 26 C.F.R. § 1.482-7A(d)(2).
Second, the "coordinating amendments" clarified
Treasury's belief that the cost-sharing regulations,
including § 1.482-7A(d)(2), operate to produce an
arm's length result. Compensatory Stock Options Under
Section 482 (Proposed), 67 Fed. Reg. at 48, 998; 26 C.F.R.
§ 1.482-7A provides that costs shared by related parties
to a QCSA are not subject to IRS reallocation for tax
purposes if each entity's share of the intangible
property development costs equals each entity's
reasonably anticipated benefits. Section 1.482-7A(a)(3)
incorporates and coordinates with the arm's length
A qualified cost sharing arrangement produces results that
are consistent with an arm's length result . . . if, and
only if, each controlled participant's share of the costs
(as determined under paragraph (d) of this section) of
intangible development under the qualified cost sharing
arrangement equals its share of reasonably anticipated
benefits attributable to such development . . . .
Section 1.482-7A(d)(2) provides that parties to a QCSA must
allocate stock-based compensation between themselves:
[In a QCSA], a controlled participant's operating
expenses include all costs attributable to compensation,
including stock-based compensation. As used in this section,
the term stock-based compensation means any compensation
provided by a controlled participant to an employee or
independent contractor in the form of equity instruments,
options to acquire stock (stock options), or rights with
respect to (or determined by reference to) equity instruments
or stock options, including but not limited to property to
which section 83 applies and stock options to which section
421 applies, regardless of whether ultimately settled in the
form of cash, stock, or other property.
regulations, and the procedure employed in adopting them,
form the basis of the present controversy.
issue is Altera Corporation ("Altera") &
Subsidiaries' tax liability for the years 2004 through
2006. During the relevant period, Altera and its subsidiaries
designed, manufactured, marketed, and sold programmable logic
devices, which are electronic components that are used to
of 1997, Altera entered into a cost-sharing agreement with
one of its foreign subsidiaries, Altera International, Inc.,
a Cayman Islands corporation ("Altera
International"), which had been incorporated earlier
that year. Altera granted to Altera International a license
to use and exploit Altera's preexisting intangible
property everywhere in the world except the United States and
Canada. In exchange, Altera International paid royalties to
Altera. The parties agreed to pool their resources to share
research and development ("R&D") costs in
proportion to the benefits anticipated from new technologies.
The question in this appeal is whether Treasury was
permitted, for tax liability purposes, to re-allocate the
cost of employee stock-based compensation.
and the IRS agreed to an Advance Pricing Agreement covering
the 1997-2003 tax years. Pursuant to this agreement, Altera
shared with Altera International stock-based compensation
costs as part of the shared R&D costs. After the Treasury
regulations were amended in 2003, Altera and Altera
International amended their cost-sharing agreement to comply
with the modified regulations, continuing to share employee
stock compensation costs.
agreement was amended again in 2005 following the Tax
Court's opinion in Xilinx Inc. & Consolidated
Subsidiaries v. Commissioner, which involved a challenge
to the 1994-1995 cost-sharing regulations. 125 T.C. 37
(2005). The parties agreed to "suspend the payment of
any portion of [a] Cost Share . . . to the extent such
payment relates to the Inclusion of Stock-Based Compensation
in R&D Costs" unless and until a court upheld the
validity of the 2003 cost-sharing regulations. The following
provision explains Altera's reasoning:
The Parties believe that it is more likely than not that (i)
the Tax Court's conclusion in Xilinx v.
Commissioner, 125 T.C. [No.] 4 (2005), that the
arm's length standard controls the determination of costs
to be shared by controlled participants in a qualified cost
sharing arrangement should also apply to Treas. Reg. §
1.482-7(d)(2) (as amended by T.D. 9088), and (ii) the
Parties' inclusion of Stock-Based Compensation in R&D
Costs pursuant to Amendment I would be contrary to the
arm's length standard.
and its U.S. subsidiaries did not account for R&D-related
stock-based compensation costs on their consolidated
2004-2007 federal income tax returns. The IRS issued two
notices of deficiency to the group, applying §
1.482-7(d)(2) to increase the group's income by the
$ 24, 549, 315
$ 23, 015, 453
$ 17, 365, 388
$ 15, 463, 565
timely filed petitions in the Tax Court. The parties filed
cross-motions for summary judgment, and the Tax Court granted
Altera's motion. Sitting en banc, the Tax Court held that
§ 1.482-7A(d)(2) is invalid under the Administrative
Procedure Act ("APA"), 5 U.S.C. §§
701-706. Altera Corp. & Subsidiaries v.
Comm'r, 145 T.C. 91 (2015).
Court unanimously determined: (1) that the Commissioner's
allocation of income and expenses between related entities
must be consistent with the arm's length standard; and
(2) that the arm's length standard is not met unless the
Commissioner's allocation can be compared to an actual
transaction between unrelated entities. The Tax Court
reasoned that the Commissioner could not require related
parties to share stock compensation costs, because the
Commissioner had not considered any unrelated party
transactions in which the parties shared such costs. The Tax
Court held that the agency's decisionmaking process was
fundamentally flawed because: (1) it rested on speculation
rather than on hard data and expert opinions; and (2) it
failed to respond to significant public comments,
particularly those pointing out uncontrolled cost-sharing
arrangements in which the entities did not share stock
compensation costs. Id. at 133-34.
Court's decision rested largely on its own opinion in
Xilinx, in which it determined that the arm's
length standard mandates a comparability analysis.
Id. at 118 (citing Xilinx, 125 T.C. at
53-55). In its decision in this case, as well, the Tax Court
suggested that the Commissioner cannot require related
entities to share stock compensation costs unless and ...