Student Blog: Altera Challenges the CSA

by Michael Waalkes, RBFL Student Editor


Altera Corp. v. Commissioneris a challenge to the validity of 26 C.F.R. § 1.482-7A(d)(2), which is a part of the framework governing cost-sharing arrangements (CSAs), a tax reduction technique often used by multinational companies. In a CSA, an American parent company and its foreign subsidiary reach an agreement to pool and share the research and development (R&D) costs of developing an intangible (usually intellectual property). The two entities then allocate the expenses of the R&D between them in proportion to what they expect to receive in income from the intangible. This has important tax consequences. Multinational corporations often incorporate foreign subsidiaries in low-tax jurisdictions, and thus are incentivized to allocate taxable income to those foreign subsidiaries, while keeping deductible expenses associated with the more heavily-taxed U.S. parent.


This is where the Internal Revenue Service (IRS) comes in. Under IRC § 482, the IRS has the authority to reallocate income and expenses between related entities to prevent tax evasion. Companies can avoid IRS reallocations by satisfying the requirements to qualify for a regulatory safe harbor (a “qualified CSA”). One of those requirements is that related CSA-participants share employee stock compensation costs. Tech companies with high R&D costs, such as Google and Facebook, are heavily reliant on employee stock compensation as an incentive for attracting and retaining highly skilled employees. From a tax perspective, companies want to avoid including stock compensation costs in the shared pool of their CSAs, as the expenses are far more useful as deductible set-off against their U.S. income. But on the other hand, companies want to qualify for the safe harbor and avoid the unpredictability and high transaction costs of dealing with IRS audit and assessment procedures.


Altera Corp., a software firm (since acquired in 2015 by Intel), made the decision to challenge the stock compensation provision of the safe harbor regulation, disputing a proposed IRS assessment in Tax Court. Altera’s primary substantive argument (it also asserted a violation of the Administrative Procedures Act) was that the regulation was inconsistent with a traditional test known as the “arm’s length standard”. Under this standard, costs need only be shared in a CSA if they would be shared in a comparable transaction conducted by unrelated parties (i.e. parties transacting at “arm’s length”). Stock compensation simply can’t meet that test. Any entity engaged in a rational arm’s length transaction would almost certainly not agree to share the cost of stock of an unrelated company not under its control.


The Tax Court focused on this inconsistency and, in a unanimous 15-0 panel ruling for Altera, found the regulation to be arbitrary and capricious. The IRS subsequently appealed to the 9th Circuit. After twice hearing oral arguments, the 9th Circuit panel reversed the Tax Court and upheld the regulation under Chevrondeference. Chief Judge Sidney Thomas issued a wide-ranging opinion, delving into IRC 482’s legislative history and finding the regulation justified by a strong congressional interest in achieving arm’s length results, rather than using a particular arm’s length method.


The reaction to the 9th Circuit’s opinion has been swift. Many companies have disclosed substantial anticipated losses in quarterly filings, as the IRS has announced it will begin auditing taxpayers on the stock compensation issue. Altera itself, meanwhile, has filed a petition for rehearing en banc, which is currently pending in the 9th Circuit. If unsuccessful, Altera may well seek certiorari from the Supreme Court, making this an issue to watch in the remainder of 2019 and beyond.




Altera Corp. v. Comm’r, 926 F.3d 1061 (9th Cir. 2019)

Altera Corp. v. Comm’r, 145 T.C. 91, 94 (2015)

I.R.C. § 482

26 C.F.R § 1.482-7

Seth Brian, Altera Corp. v. Commissioner: A Rare Government Victory in Transfer Pricing, 87 U. Cin. L. Rev. 1123 (2019)

Susan C. Morse & Stephen E Shay, The Ninth Circuit Reverses the Tax Court Decision inAltera, Procedurally Taxing(July 31, 2018)

Richard Rubin & Theo Francis, Yearslong Tax Dispute Could Cost Big Tech Companies Billions, Wall St. Journal(Sep. 3, 2019)(subscription needed)

Facebook, Quarterly Rep. (Form 10-Q) at 23-25 (July 25, 2019)

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