Altera Corp. & Subsidiaries v. Comm'r
| Decision Date | 12 November 2019 |
| Docket Number | Nos. 16-70496,16-70497,s. 16-70496 |
| Citation | 941 F.3d 1200 (Mem) |
| Parties | ALTERA CORPORATION & SUBSIDIARIES, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. |
| Court | U.S. Court of Appeals — Ninth Circuit |
The full court has been advised of the petition for rehearing en banc. A judge requested a vote on whether to rehear the matter en banc. The matter failed to receive a majority of the votes of the nonrecused active judges in favor of en banc consideration. Fed. R. App. P. 35. Judges McKeown, Wardlaw, Bybee, Bea, Watford, Owens, Friedland, Miller, Collins, and Lee were recused and did not participate in the vote.
The petition for rehearing en banc is denied. Attached is the dissent from and statements respecting the denial of rehearing en banc.
Neither the laudable goal of preventing tax evasion nor the prospect of adding billions of dollars to the public coffers excuses the Department of the Treasury from complying with the Administrative Procedure Act. In 2003, Treasury promulgated a tax rule with no reasoned basis for its decision, pursuant to an explanation that ran contrary to the evidence before it. In 2019, a divided panel of our court upheld that rule based on a novel interpretation of the relevant statute, which Treasury developed only as an appellate litigating position, and which was never subject to notice and comment. As recognized by the unanimous en banc Tax Court, Treasury’s actions in this case are the epitome of arbitrary and capricious rulemaking. The panel majority’s decision tramples on the reliance interests of American businesses, threatens the uniform enforcement of the Tax Code, and drastically lowers the bar for compliance with the Administrative Procedure Act.
I respectfully dissent from our court’s denial of rehearing en banc.1
For almost a century, Congress has authorized Treasury to recalculate the taxes of related entities based on what their taxes would look like if they were unrelated entities. For the past fifty years, Treasury has made this determination by analyzing whether the results of a transaction between related entities are consistent with the results of a comparable transaction between entities operating at arm’s length. When a transaction does not meet this arm’s length standard, Treasury adjusts it for tax purposes by re-allocating the related entities’ costs and income.
In the late-1990s, Treasury decided that stock-based compensation—then a new phenomenon—was a type of cost it wanted to re-allocate under these calculations. The problem was, and remains, that unrelated entities do not share stock-based compensation costs. Treasury’s first attempt at such a re-allocation was therefore thrown out by the Tax Court and by this court because it was contrary to Treasury’s own regulations calling for application of the arm’s length standard. Perhaps preemptively recognizing this defect on the very face of its rules, Treasury attempted a mid-litigation cure of simply adding a cross reference to its arm’s length standard provision. That attempted cure is the 2003 rulemaking challenged here.
In 1928, Congress enacted 26 U.S.C. ("I.R.C.") § 482 to authorize Treasury to re-allocate reported income and costs between related entities where necessary to prevent them from improperly avoiding taxes by, for instance, shifting income to lower tax foreign jurisdictions. See H.R. Rep. No. 70-2, at 16–17 (1927); Comm’r v. First Sec. Bank of Utah, N.A. , 405 U.S. 394, 400, 92 S.Ct. 1085, 31 L.Ed.2d 318 (1972). Treasury soon promulgated regulations specifying that "[t]he standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm’s length with another uncontrolled taxpayer." Treas. Reg. 86, art. 45-1(b) (1935).2
In 1968, Treasury promulgated regulations specific to "qualified cost-sharing arrangements" (QCSAs)3 , such as the research and development agreement at issue in this case. See 33 Fed. Reg. 5848 (April 16, 1968). Treasury required that, "[i]n order for the sharing of costs and risks to be considered on an arm’s length basis, the terms and conditions must be comparable to those which would have been adopted by unrelated parties similarly situated had they entered into such an arrangement." Id. at 5854. The arm’s length standard thus requires an "essentially and intensely factual" inquiry that looks to comparable transactions between non-related entities to ensure tax parity. Procacci v. Comm’r , 94 T.C. 397, 412 (1990).
In 1986, Congress amended § 482 to address the valuation of transfers of intangible property,4 providing that "[i]n the case of any transfer (or license) of intangible property ..., the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible." I.R.C. § 482. This amendment appeared to introduce a new standard for allocating costs—a "commensurate with income" standard—which might have constituted a departure from the traditional arm’s length analysis. But soon after, in 1988, Treasury dispelled such notions by publishing what came to be known as the "White Paper." See A Study of Intercompany Pricing Under Section 482 of the Code , I.R.S. Notice 88-123, 1988-2 C.B. 458. The phrase "arm’s length standard" appears throughout the White Paper, which reiterated that "intangible income must be allocated on the basis of comparable transactions if comparables exist." Id. at 474 (emphasis added). In short, although the amended § 482 referenced a seemingly unfamiliar "commensurate with income" standard, the White Paper emphasized that "Congress intended no departure from the arm’s length standard"—which is to say, an analysis based on comparability. Id. at 475.5
In 1995, Treasury promulgated a regulation requiring participants in a QCSA to share "all of the costs" of developing intangibles. Treas. Reg. § 1.482-7(d)(1) (1995). Beginning in 1997, Treasury interpreted stock-based compensation to be such a cost. See Xilinx, Inc. v. Comm’r , 598 F.3d 1191, 1193–94 (9th Cir. 2010).
Xilinx, Inc. challenged this interpretation, and the Tax Court ruled in Xilinx’s favor. Xilinx, Inc. v. Comm’r , 125 T.C. 37, 62 (2005). The Tax Court found as a factual matter that "two unrelated parties in a cost sharing agreement would not share any costs related to [stock-based compensation]." Xilinx , 598 F.3d at 1194. At the same time, it found that Treas. Reg. § 1.482-1(b)(1) —i.e., the arm’s length standard—still controlled over Treasury’s new all costs regulation. Id. It therefore found Treasury’s re-allocation of Xilinx’s stock-based compensation costs to be arbitrary and capricious. Id.
Our court affirmed the Tax Court, noting that the "purpose of the regulations is parity between taxpayers in uncontrolled transactions and taxpayers in controlled transactions," which is determined "based on how parties operating at arm’s length would behave." Id. at 1196. Because Treasury "d[id] not dispute" that "unrelated parties would not share [stock-based compensation]," we concluded that Treasury could not require related parties to share it. Id. at 1194, 1196. We therefore found the all costs provision inoperative.
In his concurrence, Judge Fisher noted that Treasury’s defense of the all costs provision relied on a rationale "not clearly articulated ... until" the commencement of litigation. Id. at 1198 (Fisher, J., concurring).
Judge Fisher was Id.6
In 2003, while the Xilinx litigation concerning the 1995 regulation was pending, Treasury published a rule codifying its decision that QCSA parties should share stock-based compensation costs. To achieve this, Treasury updated the arm’s length standard provision, Treas. Reg. § 1.482-1, with a cross-reference to its 1995 "all of the costs" provision, id. § 1.482-7,7 and specifically defined "operating expenses" thereunder to include stock-based compensation, id. § 1.482-7(d)(2). Compensatory Stock Options Under Section 482, 68 Fed. Reg. 51,171, 51,178 (Aug. 26, 2003). Treasury purported to "believe that requiring stock-based compensation to be taken into account for purposes of QCSAs is consistent with the legislative intent underlying section 482 and with the arm’s length standard," because "unrelated parties entering into QCSAs would generally share stock-based compensation costs." Id. at 51,173.
During the 2004–2007 taxable years, Appellee Altera Corporation (Altera) shared certain costs with one of its foreign subsidiaries, Altera International, pursuant to a research and development cost-sharing agreement. Relying on the Tax Court’s 2005 decision in Xilinx , the companies did not share the costs of stock-based compensation. After Altera filed consolidated income tax returns for these years, Treasury issued notices of deficiency on the grounds that it had to re-allocate over $100 million in income from Altera International to Altera to account for the unshared costs of stock-based compensation. Treasury asserted that this re-allocation was necessary under Treas. Reg. § 1.482-7(d)(2). Altera timely filed petitions in the Tax Court.
In a unanimous 15–0 decision, the Tax Court agreed with Altera and concluded that the regulation is arbitrary and capricious. Altera Corp. v. Comm’r , 145 T.C. 91, 133–34 (2015). The Tax Court determined that, during the rulemaking process, Treasury specifically justified its new stock-based compensation rule on the ground that it "was required by—or was at least consistent with—the arm’s-length standard." Id. at 121 & n.17 (...
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