Appeals Court Backs IRS in Transfer-Pricing Case

The decision could affect the tax liability of tech companies that do not share employee stock option costs between related entities.
Matthew HellerJuly 25, 2018

A federal appeals court has delivered a major setback to Intel’s subsidiary Altera in a high-stakes legal battle over Treasury Department regulations governing the sharing of employee stock compensation costs between related entities.

The IRS had issued notices of deficiency after Altera and an international subsidiary elected not to share the cost of employee stock options for the 2004-07 tax years, resulting in substantial tax savings on $80 million in income.

Altera’s petition for relief was granted by the U.S. Tax Court. But in a ruling Tuesday, the Ninth Circuit Court of Appeals sided with the IRS in upholding Treasury regulations that require related entities to share the cost of employee stock compensation in order to avoid an IRS adjustment.

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“We conclude that the regulations withstand scrutiny under general administrative law principles, and we therefore reverse the decision of the Tax Court,” Chief Judge Sidney Thomas wrote for a 2-1 majority.

According to The Wall Street Journal, the case has been closely watched by tech companies. Many of them, under the international tax system that existed before this year, loaded up their U.S. operations with deductions against the 35% tax rate and packed their foreign operations with profit that would be taxed at lower rates.

“The Altera case involved taxes on just $80 million of income, but the impact could be far larger,” the Journal said. “Alphabet Inc., the parent company of Google, said in 2016 that it could gain as much as $3.5 billion if Altera prevailed and other companies also told investors that they were tracking the case.”

Congress in 2003 clarified the tax code section governing “transfer pricing” to include employee stock compensation as a cost that would need to be shared between related entities in order for a cost-sharing arrangement to be approved by the IRS.

The Tax Court held the IRS was not authorized to adjust the Altera entities’ tax returns to reflect the sharing of employee stock compensation costs because the agency’s rule-making process was fundamentally flawed.