Stock options and cost-sharing agreements.

• Author: Laffie, Lesli S.

According to the Tax Court in Xilinx Inc., 125 TC No. 4 (2005), the IRS abused its discretion in reallocating costs incurred by a domestic parent and its controlled Irish subsidiaries related to the issuance to, or exercise of stock options by, its employees. The Service had determined that the taxpayer was required, under its cost-sharing agreement, to take into account the spread (i.e., the stock's market price on the exercise date over the exercise price) on stock options exercised by the taxpayer's employees.

Overview: Although Sec. 482 authorizes the IRS to allocate income, deductions, credits or allowances among controlled entities to prevent tax evasion or to clearly reflect income, it operates to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining the former's true taxable income. True taxable income is determined using the standard of a taxpayer dealing at arm's length with an unrelated party. This is accomplished by analyzing the results of comparable transactions under comparable circumstances.

Holding: The Tax Court overruled the Service's argument that Sec. 482's legislative and regulatory history demonstrated Congress's intent to supplant the use of comparable transactions with internal measures of cost and profit. Rather, the court held that it was unnecessary and inappropriate to resort to such history, because Regs. Sec. 1.482-1(b)(1) is unambiguous. In addition, it held that such history supports a...