Page 10 - Altera And Cost-Sharing Requirements Under Section 482 By Jerald David August

and found none in which any costs asso- ciated with stock-based compensation were shared. Several commentators also identified arm’s-length agreements in which stock-based compensation was not shared or reimbursed.39
Final (Revised) Cost-Sharing Regulations Issued In 2003
A revised final CSA regulation was issued in August 2003.40 Despite the Ser- vice’s defeat in Xilinx, Inc., the final reg- ulations refused to let go of its requirement that related parties to QCSAs must share SBCs under Reg. 1.482-7(d)(2). In addition Regs. 1.482- 1(b)(2)(i) through 1.482-7(a)(3) were added providing that a QCSA produces an arm’s-length result only where the parties’ costs are determined in accor- dance with the final rule.41
The 2003 final regulations provide twomethodsformeasuringthevalue of stock-based compensation: (1) a default method and (2) an elective method. Under the default method,“the costs attributable to stock-based com- pensation generally are included as intangible development costs upon the exercise of the option and measured by the spread between the option strike price and the price of the underlying stock.” Under the elective method, “the costs attributable to stock options are
taken into account in certain cases in accordance with the ‘fair value’ of the option, as reported for financial account- ing purposes either as a charge against income or in footnoted disclosures.” The elective method, however, is available only with respect to options on stock that is publicly traded “on an established United States securities market and is issued by a company whose financial statements are prepared in accordance with United States generally accepted accounting principles for the taxable year.”42
Lack of Expert Opinions, Data, or Reports. It would later haunt the Ser- vice in Altera Corp. that in issuing its 2003 final Regulation, the rule-making files did not contain any expert opin- ions, empirical data, or published or unpublished articles, papers, surveys, or reports supporting a determination that the amounts attributable to stock- basedcompensationmustbeincluded in the cost pool of QCSAs to achieve an arm’s-length result. Those files also did not contain any record that the IRS searched any database that could have contained agreements between unre- lated parties relating to joint undertak- ings or the provision of services. Additionally, the Service was unaware of any written contract between unrelated parties, whether in a cost-sharing arrangement or otherwise, that required
one party to pay or reimburse the oth- er party for amounts attributable to stock-based compensation; or any evi- dence of any actual transaction between unrelated parties, whether in a cost- sharing arrangement or otherwise, in which one party paid or reimbursed the other party for amounts attribut- able to stock-based compensation.
Nevertheless, in the Preamble to the 2003 final regulations, the government once more announced that SBC costs should be taken into account under Sec- tion 482 and that such treatment is con- sistent with the arm’s-length standard within the Code, tax treaties in which the U.S. is a party, and under the OECD transfer pricing guidelines. The legisla- tive history of the Tax Reform Act of 1986 reflected the intent on the part of Congress that the commensurate with income standard apply to CSAs pro- vided that the participants’ shares of income “reasonably reflect the actual economic activity undertaken by each.”43 Therefore, QCSAs must reflect all relevant costs, including such critical elements of cost as the cost of compen- sating employees for providing services related to the development of the intan- gibles pursuant to the QCSA, including stock-based compensation.
The IRS rejected an argument (uni- versally shared among the comments that it received to the rule-making announcement) that taking stock-based compensation into account in the QCSA context would be inconsistent with the arm’s-length standard in the absence of evidence that parties at arm’s length take stock-based compensation into account in similar circumstances. Reg. 1.482–1(b)(1)providesthata“controlled transaction meets the arm’s length stan- dard if the results of the transaction are consistent with the results that would have been realized if uncontrolled tax- payers had engaged in the same trans- action under the same circumstances.” However, there was little information that CSAs entered into by unrelated par- ties would share stock-based compen- sation costs of one member under a CSA.44 Indeed, the comments submitted
COST-SHARING
January/February 2016
BUSINESS ENTITIES 13