In a redetermination of an earlier, withdrawn decision, the Ninth Circuit again reversed a decision of the Tax Court and held regulations are valid that require related entities to share the cost of employee stock compensation for their cost-sharing agreements to be considered qualified under Sec. 482.
Facts: Altera Corp. (subsequently acquired by Intel Corp.) and its subsidiaries designed, manufactured, marketed, and sold electronic components. In May 1997, Altera entered into a cost-sharing agreement with one of its subsidiaries, Altera International, which was incorporated in the Cayman Islands that year. Altera granted to Altera International a license to use Alteras intangible property. In exchange, Altera International paid Altera royalties. The parties agreed to share research and development (R&D) costs in proportion to anticipated benefits from resulting products.
Altera and the IRS agreed to an advance pricing agreement covering the 1997-2003 tax years. In compliance with the regulations at the time, Altera shared stock-based compensation costs with Altera International as part of the R&D costs. After the regulations were amended in 2003, the related parties amended their cost-sharing agreement, continuing to share stock compensation costs. They again amended the agreement in 2005 to suspend sharing the stock-based compensation until a court specifically addressed the validity of the 2003 amendments, relying on the Tax Court's opinion in Xilinx, Inc., 125 T.C. 37 (2005), aff'd, 598 F.3d 1191 (9th Cir. 2010). Xilinx involved a challenge to the allocation of employee stock compensation costs.
Altera 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 Regs. Sec. 1.482-7(d)(2) to increase the group's income by nearly $80.4 million. The Altera group challenged the IRS's determination in Tax Court.
The Tax Court held that Regs. Sec. 1.482-7A(d)(2), which requires related parties to a cost-sharing arrangement to allocate between themselves stock-based compensation, is invalid under the Administrative Procedure Act (APA) (Altera Corp., 145 T.C. 91 (2015)). The Tax Court determined that the IRS's allocation of income and expenses between related entities must be consistent with the arm's-length standard, which requires comparison with an actual transaction between unrelated...