United States: Cost-Sharing Regulations Revived By Ninth Circuit

Last Updated: August 6 2018
Article by Larry R. Kemm

The Ninth Circuit Court of Appeals reversed the Tax Court in Altera Corp. in the latest chapter of the dispute over the validity of cost-sharing regulations. The decision, issued on July 24, revives certain regulatory provisions previously invalidated by the Tax Court. (See Altera Corp. v. Commissioner, Dkt. Nos. 16-70597 & 16-70497 (9th Cir. 2018) rev'g 145 T.C. 91 (2015)). These regulations govern the allocation of stock-based compensation costs to a foreign subsidiary in qualified cost-sharing agreements (QCSA). U.S. corporations enter into QCSAs to allocate research and development costs with a foreign subsidiary usually located in a low tax jurisdiction and to grant the foreign subsidiary rights to exploit the developed property internationally. The Ninth Circuit Court of Appeals' decision to uphold the validity of Treas. Reg. § 1.482-7A(d)(2) means that parties to a QCSA must allocate stock-based compensation between themselves. By avoiding an allocation of stock-based compensation costs to the foreign subsidiary, profits could otherwise be maximized in the low tax foreign jurisdiction and taxes of the U.S. parent would be significantly reduced.

As background, Altera Corporation challenged transfer pricing adjustments proposed by the IRS, arguing in part that Treas. Reg. § 1.482-7A(d)(2), which provides that parties to a QCSA must allocate stock-based compensation between themselves, was invalid. Siding with the taxpayer, the Tax Court in Altera Corp. concluded that the requirement to include stock-based compensation costs in a QCSA under final regulations issued in 2003 had an insufficient factual basis and conflicted with comments received on the proposed regulations that unrelated parties do not share such costs. As a result, the Tax Court concluded that the rule was arbitrary and capricious and therefore invalid under the Administrative Procedure Act (APA) and existing Supreme Court authority (citing Motor Vehicles Mfrs. Ass’n v. State Farm, 463 U.S. 29 (1983); Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984)).

The issue concerning the inclusion of stock-based compensation costs in QCSAs has been hotly contested and was the subject of two prior high profile cases, Xilinx Inc. v. Commissioner, 125 T.C. No. 4 (2005), aff’d 598 F.3d 1191 (9th Cir. 2010), and Seagate Technology (which was ultimately conceded by the IRS). However, those cases dealt with the issue prior to the 2003 issuance of final regulations requiring the inclusion of stock-based compensation costs in QCSAs.

On appeal, the government argued that the Tax Court erroneously relied on its prior opinion in Xilinx for the proposition that the arm’s-length standard, as articulated in transfer pricing regulations, always requires an analysis of what unrelated parties do under comparable circumstances. Further, the government argued that the requirement to share all R&D-related costs in a prescribed ratio in order to achieve an arm’s-length result is substantively valid based on a permissible construction of Section 482 that requires only a comparison of the two sides of the related-party transaction under scrutiny (relying on the "commensurate with income" standard applicable to income generated by intangible property). Finally, the government argued that the regulatory amendments are procedurally valid under the APA because they are the product of reasoned decision-making, and that the arm’s-length standard does not require (in the context of a QCSA) an analysis of what unrelated entities do under comparable circumstances.

The Ninth Circuit agreed. In a 2-1 decision, Chief Judge Sidney Thomas writing for the majority reversed the Tax Court and held that the IRS did not exceed the authority delegated to the IRS under Section 482, that the Commissioner's exercise of rulemaking authority complied with the APA, and that the regulation was entitled to deference under the Chevron doctrine.

The Ninth Circuit emphasized the historic origins of Section 482 authorizing the IRS to apportion, allocate, or distribute income or deductions among two or more businesses owned or controlled by the same interest in order to prevent evasion and to reflect the true tax liability of the commonly controlled interests. In tracing this principle through the iterations of regulations that were issued, the court noted that application of the arm's length standard based on comparability has never been used to the exclusion of other, more flexible approaches. Further, in connection with allocations attributable to intangibles, the court observed that "Congress intended the commensurate with income standard to displace a comparability analysis where comparable transactions cannot be found."

With respect to whether Treasury complied with the APA, the Ninth Circuit rejected the Tax Court's finding that the IRS did not consider and respond to significant comments received during the period for public comment. Rather, the court cited to the fact that Treasury clearly indicated it was relying on the commensurate with income provision in its published notice of proposed rulemaking, and that it was attempting to synthesize potentially disparate standards found within Section 482 in coordinating the new regulations with the arm's-length standard. To the extent commenters attacked the proposed regulations as inconsistent with the traditional arm's-length standard because unrelated parties do not share stock compensation costs, Chief Judge Thomas noted "Treasury's refusal to credit oppositional comments is not fatal to a holding that it complied with the APA." He concluded, "[b]ecause the comments had no bearing on 'relevant factors' to the rulemaking, nor any bearing on the final rule, there was no APA violation."

Finally, applying a Chevron analysis, the Ninth Circuit found that Section 482 does not speak to whether the IRS may require parties to a QCSA to share stock compensation costs, thus giving deference to the agency's action so long as it is based on a permissible construction of the statute. Because the legislative history of Section 482 supports Treasury's application of the commensurate with income standard in the context of QCSAs, the Ninth Circuit found that "Treasury's decision to dispense with a comparability analysis was reasonable." Therefore, the contested regulations are not arbitrary and capricious.

The Altera decision does not likely represent the last word on the validity of the cost-sharing regulations. Altera could seek en banc review, but such review is rarely granted in the Ninth Circuit. Further, because no other circuit has ruled on this issue, it is doubtful that the Supreme Court would entertain hearing the issue at this time. However, the ruling has significant implications for multinational corporations with R&D costs shared under a QCSA. Indeed, public financial filings indicate that U.S. based multinationals have billions of dollars riding on this issue. Thus, in time, other circuit courts of appeal will surely address this issue as well.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions