Professional Tax Research Solutions from the Founder of Kleinrock. tax and accounting research
Parker Tax Pro Library
Accounting News Tax Analysts professional tax research software Like us on Facebook Follow us on Twitter View our profile on LinkedIn Find us on Pinterest
federal tax research
Professional Tax Software
tax and accounting
Tax Research Articles Tax Research Parker's Tax Research Articles Accounting Research CPA Client Letters Tax Research Software Client Testimonials Tax Research Software Federal Tax Research tax research


Accounting Software for Accountants, CPA, Bookeepers, and Enrolled Agents

CPA Tax Software

        

 

Final Section 482 Reg Invalid; Fails to Satisfy "Reasoned Decision Making" Standard.

(Parker Tax Publishing August 5, 2015)

In issuing Reg. Sec. 1.482-7(d)(2), which requires controlled parties entering into qualified cost-sharing agreements to share stock-based compensation (SBC) costs, the IRS failed to support its belief that unrelated parties would share SBC costs, failed to satisfy the reasoned decision making standard in Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mutual Auto Ins. Co., 463 U.S. 29 (1983), and had no reasonable explanation for adopting the regulation; thus the regulation is invalid. Altera Corporation and Subs v. Comm'r, 145 T.C. No. 3 (2015).

Background

Altera Corporation (Altera U.S.) is the parent company of an affiliated group of corporations filing a consolidated tax return. Altera International is a Cayman Islands subsidiary of Altera U.S. In 1997, Altera U.S. and Altera International entered into concurrent agreements: a master technology license agreement (technology license agreement) and a technology research and development cost-sharing agreement (R&D cost sharing agreement).

Under the technology license agreement, Altera U.S. licensed to Altera International the right to use and exploit, everywhere except the United States and Canada, all of Altera U.S.'s intangible property relating to programmable logic devices and programming tools that existed before the R&D cost-sharing agreement (pre-cost-sharing intangible property). In exchange for the rights granted under the technology license agreement, Altera International paid royalties to Altera U.S. As of December 31, 2003, Altera International owned a fully paid-up license to use the pre-cost-sharing intangible property in its territory.

Under a cost-sharing agreement, Altera U.S. and Altera International agreed to pool their respective resources to conduct R&D using pre-cost-sharing intangible property owned by Altera International. Under the R&D cost sharing agreement, Altera U.S. and Altera International agreed to share the risks and costs of R&D activities they performed on or after May 23, 1997. The R&D cost-sharing agreement was in effect from May 23, 1997, through 2007.

From 2004 through 2007, Altera U.S. granted stock options and other stock-based compensation (SBC) to certain employees. Some of the employees of Altera U.S. who performed R&D activities subject to the R&D cost sharing agreement received stock options or other SBC. The employees' cash compensation was included in the cost pool under the R&D cost sharing agreement, but Altera U.S. did not share the SBC costs with Altera International. Altera International made cost-sharing payments to Altera U.S. during 2004-2007 of approximately $648 million.

The IRS assessed a deficiency in Altera U.S.'s taxes for 2004-2007 based on Code Sec. 482 allocations made by the IRS pursuant to Reg. Sec. 1.482-7(d)(2). The regulation, which was issued in 2003, requires participants in qualified cost-sharing arrangements (QCSAs) to share SBC costs to achieve an arm's-length result. Code Sec. 482 authorizes the IRS to allocate income and expenses among related entities to prevent tax evasion and to ensure that taxpayers clearly reflect income relating to transactions between related parties. Under Reg. Sec. 1.482-1(b)(1), in determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer.

Analysis

Altera U.S. argued that Reg. Sec. 1.482-7(d)(2) did not apply because the regulation is arbitrary and capricious under Administrative Procedure Act (APA) Section 706(2)(A) and Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29 (1983). The IRS countered that the final regulation was valid under Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984), or alternatively, under State Farm.

In State Farm, the U.S. Supreme Court said that, pursuant to APA Section 706(2)(A), a court must hold unlawful and set aside agency actions, findings, and conclusions that the court finds to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. A court's review under this standard is narrow and a court cannot substitute its judgment for that of the agency. However, the Supreme Court said, a reviewing court must ensure that the agency engaged in reasoned decision making and, to engage in reasoned decision making, the agency must examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.

The Tax Court sided with Altera U.S. and held that Reg. Sec. 1.482-7(d)(2) was invalid. The court pointed out that it had previously considered whether controlled taxpayers must include SBC in the pool of costs to be shared. In Xilinx Inc. v. Comm'r, 125 T.C. 37 (2005), aff'd, 598 F.3d 1191 (9th Cir. 2010), the court held that, under 1995 cost-sharing regulations, controlled entities entering into QCSAs need not share SBC costs because parties operating at arm's length would not do so. Under Reg. 1.482-7(d)(2), the court noted, a QCSA produces an arm's-length result only if controlled parties entering into QCSAs share SBC costs.

In reviewing the validity of Reg. Sec. 1.482-7(d)(2), the Tax Court said it was immaterial whether State Farm or Chevron supplied the standard for review because Chevron incorporates the reasoned decision making standard of State Farm and the validity of the regulation turned on whether the IRS reasonably concluded that the regulation was consistent with the arm's length standard. According to the court, the final regulation had to, in any event, satisfy State Farm's reasoned decision making standard.

The Tax Court concluded that the final regulation did not meet this standard because, in issuing it, the IRS failed to support its belief that unrelated parties would share SBC costs. According to the court, there was no evidence in the administrative record to support such reasoning, the IRS failed to articulate why all QCSAs should be treated identically, and the IRS failed to respond to significant comments. Additionally, the court said, the IRS's explanation for its decision to issue the regulation ran counter to the evidence before it.

For a discussion of the rules relating to transfers of intangible property to foreign corporations, see Parker Tax ¶47,560. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com


Professional tax research

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Parker Tax Research

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Parker Tax Research Library

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

    ®2012-2017 Parker Tax Publishing. Use of content subject to Website Terms and Conditions.

IRS Codes and Regs
Tax Court Cases IRS guidance