Page 8 - Altera: Why the Government Can't Count on Chevron Step Two

COMMENTARY / SPECIAL REPORT
survey of its member companies’ arm’s-length co- development and joint venture agreements found none in which the parties agreed to share stock- based compensation. This was also part of the notice and comment record in Xilinx. The IRS did not refute or challenge the commentators’ evidence.
Several commentators identified arm’s-length agreements in which stock-based compensation was not shared or reimbursed. The IRS responded to those comments by stating that ‘‘the uncontrolled transactions do not share enough characteristics of qualified CSAs involving the development of high- profit intangibles to establish that parties at arm’s length would not take stock options into account in the context of an arrangement similar to a qualified CSA.’’44
The court found that the IRS was right back to the position it had argued in Xilinx. There, the court found that the IRS had no satisfactory answer to explain why unrelated parties would share the exercise spread or grant date value of stock-based compensation. The Tax Court went beyond that point, however, and in Xilinx invalidated the 1995 regulation without relying on transactions that were identical or substantially similar to CSAs. It relied on the comparable uncontrolled transaction method as well as other evidence. Indeed, in Xilinx the court examined a broad spectrum of evidence in determining that unrelated parties would not share stock-based compensation costs. Yet the later set of regulations ignored that fact-finding and the hold- ing in Xilinx.
The IRS went back to the drawing board after its defeat in Xilinx and chose to ignore or otherwise respond to the many relevant and significant com- ments. In Altera, the Tax Court found that the IRS’s failure to adequately respond to commentators dur- ing the notice and comment period frustrated the court’s review of the final regulation and was prejudicial to affected entities.45 Moreover, it found that the regulation was contrary to the evidence before the IRS. And the IRS provided no evidence to support its belief that unrelated parties to CSAs would generally share stock-based compensation costs.
V. Conclusion
In granting taxpayer’s motion for partial sum- mary judgment, the Tax Court stated:
Because the final rule lacks a basis in fact, Treasury failed to rationally connect the choice
44See SEC v. Chenery Corp., 318 U.S. 80 (1943); and Carpenter Family Investments LLC v. Commissioner, 136 T.C. 373 (2011).
45The Tax Court would toward the end of its opinion reject the harmless error rule in APA section 706.
it made with the facts found, Treasury failed to respond to significant comments when it is- sued the final rule, and Treasury’s conclusion that the final rule is consistent with the arm’s- length standard is contrary to all of the evi- dence before it, we conclude that the final rule fails to satisfy State Farm’s reasoned decision making standard and therefore is invalid. (ci- tations omitted). Indeed Treasury’s ‘‘ipse dixit conclusion, coupled with its failure to respond to contrary arguments resting on solid data, epitomizes arbitrary and capricious decision making.’’ [Citation omitted.]
Altera’s decision both on CSAs and transfer pric- ing in general, as well as its potentially broader impact on legislative regulations, may inspire cor- porate taxpayers to rethink their uncertain tax po- sition filings and Financial Accounting Standards Board Interpretation No. 48 tax reserves, tax accru- als, and related filings.46
The Tax Court, with no dissenters, has for a second time rejected a regulation under the CSA provision, reg. section 1.482-7, maintaining that stock-based compensation is a cost that must be shared by all controlled parties to the CSA. And the government has appealed Altera to the same circuit that invalidated the earlier version of the same regulation based on the same issue.
The Tax Court refused to hold that Chevron step two alone could save the regulation. Indeed, the rulemaking for the 2003 regulation did not reflect reasoned decision-making under either State Farm or Chevron step two. There was nothing in the administrative record that would support the posi- tion that unrelated parties to a CSA would in fact share stock-based compensation costs. Further, there was no demonstration of a tax administration rationale that could properly fill in the gap to validate the regulation.
46See generally August, ‘‘The Uncertain State of Uncertain Tax Positions,’’ 13 Business Entities 4 (May/June 2011); August, ‘‘Mandatory Disclosure of Uncertain Tax Positions on Income Tax Returns Filed by Corporate Taxpayers: The IRS’s New Weapon,’’ 25 Prac. Tax Law. 7 (Winter 2011); Paul Seraganian, ‘‘Schedule UTP and Evidentiary Privilege in the Tax Law,’’ 21 J. Int’l Tax 30 (Sept. 2010); August and Jason M. Grimes, ‘‘The Discovery Status of Tax Accrual Workpapers After Textron,’’ 12 Bus. Entities 10 (Jan./Feb. 2010); August, ‘‘Understanding FIN 48: Accounting for Uncertainty in Income Taxes,’’ 10 Bus. Entities 30 (May/June 2008); August, ‘‘Attorney-Client Privilege and Work-Product Doctrine,’’ 10 Bus. Entities 4 (July/Aug. 2008); August and Jordan David August, ‘‘Understanding FIN 48, Accounting for Uncertainty in Income Taxes, and Resulting Implications Under Sarbanes-Oxley,’’ 22 Prac. Tax Law. 19 (Sum- mer 2008); and August and Grimes, ‘‘Ability of IRS to Discover Tax Accrual and FIN 48 Workpapers,’’ 10 Bus. Entities 4 (Nov./ Dec. 2008).
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TAX NOTES, June 6, 2016