Page 9 - Altera And Cost-Sharing Requirements Under Section 482 By Jerald David August

Xilinx deducted under Section 83(h) for its employees’ exercises of NSOs or disqualifying dispositions of ISOs and ESPPs should have been shared. By sharing those costs with XI, Xilinx’s deduction would be reduced, thereby increasing its taxable income. The Ser- vice’s determination resulted in substantial tax deficiencies and accu- racy-related penalties under Section 6662(a).
Tax Court Holds Regulation Invalid.
Xilinx filed a petition in the U.S. Tax Court. After a bench trial, the court heldthattwounrelatedpartiesinacost- sharing agreement would not share any costs related to the stock based com- pensation. Assuming the value of the stock-based compensation costs were “costs” under the CSA regulations, the court held that the regulation failed to meet the arms-length standard of Reg. 1.482-1(b)(1) and that the commensu- rate-with-income standard was never intended to supplant the arms-length standard and that unrelated parties would not share the exercise spread or grant date value of the stock-based compensation.
Appeal to the Ninth Circuit. Pre- dictably, in light of the holding that its recently issued CSA regulation was invalid, the Service appealed to the
21 The change was included in the “super-royalty” provisions set forth in Sections 367(d)(2)(A) (out- bound transfers of intangibles), and 936(h)(5)(C)(i)(I) (transfers between possessions corporations and U.S. based affiliates).
22 H. Rep’t No. 99-426, 99th Cong., 1st Sess. 423 (1985) (“Transfers between related parties do not involve the same risks as transfers to unrelated parties. There is thus a powerful incentive to establish a relatively low royalty without adequate provision for adjustment as the revenues of the intangible vary. 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 or pos- sessions corporation be commensurate with the income attributable to the intangible.”) See Staff of Joint Comm. on Tax’n, General Explanation of the Tax Reform Act of 1986, 100th Cong., 1st Sess. pages 1015-1017. See also Notice 88-123, 1988-2 CB 458 (“White Paper” study for intangi- ble property arrangements between related par- ties which addressed, inter alia, CSAs). The Service concluded that a comprehensive revision of the intercompany pricing regulations was nec-
Ninth Circuit Court of Appeals. On appeal, the parties focused primarily on whether the requirement in Reg. 1.482-7(d)(1) that “all costs” be shared between related parties in a cost shar- ing agreement controlled, or whether the controlling requirement was, under Reg. 1.482-1(b)(1), that all transac- tions between related parties reflect what two parties operating at arm’s length would do.
The Ninth Circuit initially reversed the Tax Court’s decision. 36 The major- ity opinion (Judge Fisher) reasoned that “[b]ecausetheallcostsrequirement[of the 1995 cost-sharing regulations] is irreconcilable with the arm’s length stan- dard,” the more specific all costs require- ment controls. But this opinion (and reversal) was later withdrawn, and the Tax Court’s decision was thereby affirmed. 37 The new opinion, issued by Judge Noonan who filed a dissent in the earlier decision, was based on his orig- inal dissenting opinion, but without claiming that inconsistencies in the reg- ulations should be resolved against the government.
The Service had argued that looking to “comparable transactions” in resolv- ing this issue was not really appropriate or helpful since unrelated parties have materially difficult economic circum-
essary. The White Paper was particularly con- cerned with the treatment of intangibles.
23 See Section 1059A, which provides that with respect to imported property, the costs taken into account in determining the basis or inventory for imported goods in a transaction among related parties as defined within Section 482 includes the price actually paid or payable plus to the extent not included such price certain packaging costs, commissions, and other attributable expenses. See TD 8260, 9/7/89.
24 Prop. Reg. 1.482-2(d)(4)(1966).
25 Reg. 1.482-2(d)(4)((1968); “[w]here a member of a group of controlled entities acquires an interest in intangible property as a participating party in a bona fide cost sharing arrangement with respect to the development of such intangible property, the district director shall not make allocations with respect to such acquisition except as may be appropriate to reflect each participant’s arm’s- length share of the costs and risks of developing the property ... . In order for the arrangement to qualify as a bona fide arrangement, it must reflect an effort in good faith by the participating mem- bers to bear their respective shares of all the costs and risks of development on an arm’s- length basis.”
stances and therefore will negotiate not to share certain costs in large part due to the uncertain values that will be achieved through the issuance of options and similar rights. But, where the parties are related, as is the case in a Section 482 situation, the price uncertainty of the stock awards is already shared or borne by the related parties, at least in certain aspects. In a concurring opinion, Judge Fisher concluded that “Xilinx’s understanding of the regulations is the more reasonable even if the Commis- sioner’s current interpretation may be theoreticallyplausible.”So,thestandard was still based on unrelated parties entering into a CSA.
2003 Cost-Sharing Regulations
In July 2002, the IRS issued a notice of proposed rule-making and notice of a public hearing (NPRM) on proposed amendments to the 1995 Regulations essentially involving the treatment of stock-based compensation (SBC) for QCSAs and for purposes of the com- parability factors to be considered under the comparable profits method. 38 The NPRM set a public hearing for 11/20/2002 and announced that the 1995 Regulations needed to reassess the arms-length standard for sharing CSA costs under Reg. 1.482-7(d)(1).
In response to the NPRM, various individuals and organizations filed writ- ten comments. Several of the commen- tators informed the government that they knew of no transactions between unrelated parties, including any cost- sharing arrangement, service agreement, or other contract, that required one par- ty to pay or reimburse the other party for amounts attributable to stock-based compensation. An industry survey was submitted by the American Electronics Association and found that none of its members who were involved in arm’s- length co-development and joint venture agreements shared stock-based com- pensation. For those agreements that did not explicitly address the treatment of stock-based compensation, the com- panies reviewed their accounting records
COST-SHARING
12 BUSINESS ENTITIES
January/February 2016