The IRS scored a major victory in the recent transfer pricing case, Altera Corp. & Subsidiaries v. Commissioner, No. 16-70496 (9th Cir. 2018). The issue before the Ninth Circuit was the validity of transfer pricing regulations that require related companies to allocate expenses that unrelated parties do not share when dealing at arm’s length.
Altera Corp. is a U.S. corporation that entered into a cost sharing arrangement with its subsidiary, Altera International, a Cayman Islands corporation, under which Altera Corp. licensed intangible property to Altera International to use and exploit abroad. In exchange, Altera International paid royalties to Altera Corp. During the tax years at issue, Altera Corp. granted stock options and other stock-based compensation to certain employees, but the compensation costs were not included in the cost pool allocation under the operative cost-sharing agreement.
For the IRS to respect the allocation of income between related companies, compliance with transfer pricing rules is required. These requirements are generally based on arm’s-length standards that place a controlled taxpayer on a tax parity with an uncontrolled taxpayer. However, to be respected as a qualified cost-sharing arrangement, the regulations require the cost of stock-based compensation to be included in the cost pool. Although Altera Corp. argued that the allocation was inconsistent with an arm’s-length transaction between unrelated parties, the Ninth Circuit upheld the regulations as within the rule-making authority delegated by Congress to Treasury.
The Court decision is significant and may have a negative impact for multinational companies that have taken tax positions similar to Altera Corp.’s. Companies with similar arrangements should evaluate their current structures and consider whether modifications are necessary to conform with the Ninth Circuit decision and other transfer pricing rules.
If you have any questions about this post, please contact the Chair of our International Business and Tax Planning Practice Group, Robert C. Gabrielski, at firstname.lastname@example.org.
The opinions expressed here are based on the laws as of the date written. The laws are subject to change, and if they do, the statements expressed will be subject to change.
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