Xilinx, Inc. v. Cir

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

XILINX, INC., AND CONSOLIDATED 

SUBSIDIARIES,

No. 06-74246

Petitioner-Appellee,

v.  Tax Ct. No.

702-03

COMMISSIONER OF INTERNAL

REVENUE,

Respondent-Appellant.



XILINX, INC., AND CONSOLIDATED 

SUBSIDIARIES,

No. 06-74269

Petitioner-Appellee,

v.  Tax Ct. No.

4142-01

COMMISSIONER OF INTERNAL

OPINION

REVENUE,

Respondent-Appellant.



Appeal from a Decision

of the United States Tax Court

Maurice B. Foley, Tax Court Judge, Presiding

Argued and Submitted

March 12, 2008—San Francisco, California

Filed May 27, 2009

Before: Stephen Reinhardt, John T. Noonan, Jr. and

Raymond C. Fisher, Circuit Judges.

Opinion by Judge Fisher;

Dissent by Judge Noonan

6151

XILINX, INC. v. CIR 6155

COUNSEL

Ronald B. Schrotenboer, Kenneth B. Clark (argued) and Tyler

A. Baker, Fenwick & West LLP, Mountain View, California,

for the petitioner-appellee.

Gilbert S. Rothenberg, Richard Farber and Arthur T. Catterall

(argued), Tax Division, Department of Justice, Washington,

D.C., for the respondent-appellant.

Alice E. Loughran, Steptoe & Johnson LLP, Washington,

D.C., for amici curiae Cisco Systems, Inc., and Altera Corpo-

ration.

A. Duane Webber, Baker & McKenzie LLP, Washington,

D.C., for amici curiae Software Finance and Tax Executives

Council and AeA.

OPINION

FISHER, Circuit Judge:

On this appeal from the tax court, we must decide whether,

under the tax regulations in effect during tax years 1997, 1998

and 1999, related companies engaged in a joint venture to

develop intangible property must include the value of certain

stock option compensation one participant gives to its

employees in the pool of costs to be shared under a cost shar-

ing agreement, even when companies operating at arm’s

length would not do so. The tax court found related compa-

nies are not required to share such costs and ruled that the

6156 XILINX, INC. v. CIR

Commissioner of Internal Revenue’s attempt to allocate such

costs was arbitrary and capricious. We reverse and hold: (1)

related companies in a cost sharing agreement to develop

intangibles must share all costs related to the joint venture,

even if unrelated companies would not do so; (2) stock

options for which companies claim tax deductions are a cost

under former 26 C.F.R. § 1.482-7(d)(1); and (3) such costs are

“related to” the intangible product development, as part of the

compensation package offered to employees involved in

activities under the joint venture.1

I. BACKGROUND

Xilinx, Inc. (“Xilinx”) researches, develops, manufactures,

markets and sells integrated circuit devices and related devel-

opment software systems. Xilinx wanted to expand its posi-

tion in the European market and established Xilinx Ireland

(“XI”) in 1994 as an unlimited liability company under the

laws of Ireland. XI sold programmable logic devices and con-

ducted research and development (“R&D”). Two wholly

owned Irish subsidiaries of Xilinx owned XI during the tax

years of 1997, 1998 and 1999, the only years at issue in this

appeal.

In 1995, Xilinx and XI entered into a Cost and Risk Shar-

ing Agreement (“the Agreement”), which provided that all

right, title and interest in new technology developed by either

Xilinx or XI would be jointly owned. Under the Agreement,

each party was required to pay a percentage of the total R&D

costs in proportion to the anticipated benefits to each from the

new technology that was expected to be created. Specifically,

the Agreement required the parties to share: (1) direct costs,

defined as costs directly related to the R&D of new technol-

1

For the purposes of this opinion, all citations and references to regula-

tions are to the regulations in effect during tax years 1997, 1998 and 1999.

The relevant regulations have been amended repeatedly since then, most

recently in 2009, see, e.g., T.D. 9441, 2009-7 I.R.B. 460.

XILINX, INC. v. CIR 6157

ogy, including, but not limited to, salaries, bonuses and other

payroll costs and benefits; (2) indirect costs, defined as costs

incurred by departments not involved in R&D that generally

benefit R&D, including, but not limited to, administrative,

legal, accounting and insurance costs; and (3) costs incurred

to acquire products or intellectual property rights necessary to

conduct R&D. The Agreement did not specifically address

whether employee stock options (ESOs) were a cost to be

shared.

Xilinx offered ESOs to its employees under two plans.

Under one plan, employees were granted options as part of

the employee hiring and retention program. The options were

of two varieties: incentive stock options (ISOs) and nonstatu-

tory stock options (NSOs). Employees could exercise these

options two ways: (1) by purchasing the stock at the market

price on the day the option was issued (“exercise price”)

regardless of its then-current market price or (2) by simulta-

neously exercising the option at the exercise price and selling

it at its then-current price, pocketing the difference. Under the

other plan, employees could acquire employee stock purchase

plan shares (ESPPs) by contributing to an account through

payroll deductions and purchasing stock at 85 percent of

either its exercise price or its market price on the purchase

date. Employees must always pay taxes on NSOs, see 26

U.S.C. § 83, but have to pay taxes on ISOs and ESPPs only

if they sell acquired stock shares before a specified waiting

period has expired (“a disqualifying disposition”), see 26

U.S.C. § 421(b). In determining the R&D costs to be shared

under the Agreement for tax years 1997, 1998 and 1999,

Xilinx did not include any amount related to ESOs.

In tax years 1997, 1998 and 1999, Xilinx deducted as busi-

ness expenses under 26 U.S.C. §§ 83 and 162 approximately

$41,000,000, $40,000,000 and $96,000,000, respectively,

based on its employees’ exercises of NSOs or disqualifying

dispositions of ISOs and ESPPs.2 It also claimed an R&D

2

Under 26 U.S.C. § 162(a)(1), employers may deduct from their taxable

income “all the ordinary and necessary expenses paid or incurred during

6158 XILINX, INC. v. CIR

credit under 26 U.S.C. § 41 for wages related to R&D activ-

ity, of which approximately $34,000,000, $23,000,000 and

$27,000,000 in the respective tax years were attributable to

exercised NSOs or disqualifying dispositions of ISOs and

ESPPs.3 Furthermore, in 1996 Xilinx and XI entered into two

agreements that allowed XI employees to acquire options for

Xilinx stock. Both agreements provided XI would pay Xilinx

for the “cost” of the XI employees’ exercise of the stock

options, which was to equal the stock’s market price on the

exercise date minus the exercise price. In the 1997, 1998 and

1999 tax years, XI paid Xilinx $402,978, $243,094 and

$808,059, respectively, under these agreements.

The Commissioner of Internal Revenue (“Commissioner”)

issued notices of deficiency against Xilinx for tax years 1997,

1998 and 1999, contending ESOs issued to its employees

involved in or supporting R&D activities were costs that

should have been shared between Xilinx and XI under the

Agreement. Specifically, the Commissioner concluded the

amount Xilinx deducted under 26 U.S.C. § 83(h) for its

employees’ exercises of NSOs or disqualifying dispositions of

ISOs and ESPPs should have been shared. By sharing those

costs with XI, Xilinx’s deduction would be reduced, thereby

increasing its taxable income. The Commissioner’s determi-

nation resulted in substantial tax deficiencies and accuracy-

related penalties under 26 U.S.C. § 6662(a).

Xilinx timely filed suit in the tax court. The tax court

denied cross motions for summary judgment. After a bench

the taxable year in carrying on any trade or business, including a reason-

able allowance for salaries or other compensation for personal services

actually rendered.” Under 26 U.S.C. § 83(h), employers may deduct under

§ 162 the value of any property transferred to an employee in connection

with the performance of employment.

3

Under 26 U.S.C. § 41(b)(2)(A), companies can claim a tax credit for

“wages paid or incurred to an employee for qualified [research] services

performed by such employee.”

XILINX, INC. v. CIR 6159

trial, the tax court found that two unrelated parties in a cost

sharing agreement would not share any costs related to ESOs.

After assuming ESOs were costs for purposes of 26 C.F.R.

§ 1.482-7(d)(1), the tax court then found 26 C.F.R. § 1.482-

1(b)(1) — which requires cost sharing agreements between

related parties to reflect how two unrelated parties operating

at arm’s length would behave — dispositive and concluded

the Commissioner’s allocation was arbitrary and capricious

because it included the ESOs in the pool of costs to be shared

under the Agreement, even though two unrelated companies

dealing with each other at arm’s length would not share those

costs.

The Commissioner timely appealed. On appeal, the parties

focused primarily on whether the requirement in 26 C.F.R.

§ 1.482-7(d)(1) that “all costs” be shared between related par-

ties in a cost sharing agreement or the requirement in 26

C.F.R. § 1.482-1(b)(1) that all transactions between related

parties reflect what two parties operating at arm’s length

would do controlled. After oral argument, we requested sup-

plemental briefing on whether ESOs were “costs” and

whether they were “related to” the intangible product devel-

opment for purposes of 26 C.F.R. § 1.482-7(d)(1), and

whether a literal application of 26 C.F.R. § 1.482-7(d)(1)

would conflict with a tax treaty between the United States and

Ireland that was in effect during the 1998 and 1999 tax years.

II. STANDARD OF REVIEW

“Decisions of the tax court are reviewed on the same basis

as decisions from civil bench trials in the district court.” DHL

Corp. v. Comm’r, 285 F.3d 1210, 1216 (9th Cir. 2002).

“Thus, we review the tax court’s conclusions of law de novo

and its factual findings for clear error.” Id.

III. DISCUSSION

The Commissioner does not dispute the tax court’s factual

finding that unrelated parties would not share ESOs as a cost.

6160 XILINX, INC. v. CIR

Instead, the Commissioner maintains ESOs are a cost that

must be shared under § 1.482-7(d)(1), even if unrelated par-

ties would not share them.

A. 26 C.F.R. §§ 1.482-1(b)(1) and 1.482-7(d)(1) Are

Irreconcilable, so § 1.482-7(d)(1), the More Specific of

the Two, Controls.

Congress has authorized the Secretary of the Treasury to

allocate income and deductions among related business enti-

ties to prevent tax avoidance.

In any case of two or more organizations, trades, or

businesses (whether or not incorporated, whether or

not organized in the United States, and whether or

not affiliated) owned or controlled directly or indi-

rectly by the same interests, the Secretary may dis-

tribute, apportion, or allocate gross income,

deductions, credits, or allowances between or among

such organizations, trades, or businesses, if he deter-

mines that such distribution, apportionment, or allo-

cation is necessary in order to prevent evasion of

taxes or clearly to reflect the income of any of such

organizations, trades, or businesses. In the case of

any transfer (or license) of intangible property

(within the meaning of section 936(h)(3)(B)), the

income with respect to such transfer or license shall

be commensurate with the income attributable to the

intangible.

26 U.S.C. § 482. The Secretary in turn promulgated regula-

tions authorizing the Commissioner to allocate income and

deductions among related entities. The introduction to these

regulations explains:

The purpose of section 482 is to ensure that taxpay-

ers clearly reflect income attributable to controlled

transactions and to prevent the avoidance of taxes

XILINX, INC. v. CIR 6161

with respect to such transactions. Section 482 places

a controlled taxpayer on a tax parity with an uncon-

trolled taxpayer by determining the true taxable

income of the controlled taxpayer. This section sets

forth general principles and guidelines to be fol-

lowed under section 482.

26 C.F.R. § 1.482-1(a)(1).4 The next subsection states that the

standard to be employed “in every case” to ensure taxpayers

accurately reflect income from controlled transactions and do

not avoid taxes through such transactions is an arm’s length

standard:

In determining the true taxable income of a con-

trolled taxpayer, the standard to be applied in every

case is that of a taxpayer dealing at arm’s length with

an uncontrolled taxpayer. A controlled transaction

meets the arm’s length standard if the results of the

transaction are consistent with the results that would

have been realized if uncontrolled taxpayers had

engaged in the same transaction under the same cir-

cumstances (arm’s length result). However, because

identical transactions can rarely be located, whether

a transaction produces an arm’s length result gener-

ally will be determined by reference to the results of

comparable transactions under comparable circum-

stances.

26 C.F.R. § 1.482-1(b)(1).

Another section, however, specifically governing cost shar-

ing agreements between controlled parties to develop intangi-

ble property authorizes the Internal Revenue Service “to make

4

Controlled taxpayer is defined as “any one of two or more taxpayers

owned or controlled directly or indirectly by the same interests, and

includes the taxpayer that owns or controls the other taxpayers.” 26 C.F.R.

§ 1.482-1(i)(5).

6162 XILINX, INC. v. CIR

each controlled participant’s share of the costs (as determined

under [§ 1.482-7(d)]) of intangible development under the

qualified cost sharing arrangement equal to its share of rea-

sonably anticipated benefits attributable to such development

. . . .” 26 C.F.R. § 1.482-7(a)(2). Controlled participants must

include “all” costs in the pool of costs to be shared propor-

tionally (the “all costs requirement”):

For purposes of this section, a controlled partici-

pant’s costs of developing intangibles for a taxable

year mean all of the costs incurred by that participant

related to the intangible development area, plus all of

the cost sharing payments it makes to other con-

trolled and uncontrolled participants, minus all of the

cost sharing payments it receives from other con-

trolled and uncontrolled participants. Costs incurred

related to the intangible development area consist of:

operating expenses, as defined in § 1.482-5(d)(3),

other than depreciation or amortization expense, plus

(to the extent not included in such operating

expenses, as defined in § 1.482-5(d)(3)) the charge

for the use of any tangible property made available

to the qualified cost sharing arrangement.

26 C.F.R. § 1.482-7(d)(1). “Operating expenses” are defined

as “includ[ing] all expenses not included in cost of goods sold

except for interest expense, foreign income taxes [and]

domestic income taxes, and any other expenses not related to

the operation of the relevant business activity.” 26 C.F.R.

§ 1.482-5(d)(3). How these various provisions interact is the

crux of the parties’ dispute.

[1] Section 1.482-1(b)(1) specifies that the true taxable

income of controlled parties is calculated based on how par-

ties operating at arm’s length would behave. The language is

unequivocal: this arm’s length standard is to be applied “in

every case.” In the context of cost sharing agreements, this

would require controlled parties to share only those costs

XILINX, INC. v. CIR 6163

uncontrolled parties would share. By implication, costs that

uncontrolled parties would not share need not be shared. In

contrast, § 1.482-7(d)(1) specifies that controlled parties in a

cost sharing agreement must share all “costs . . . related to the

intangible development area,” and that phrase is explicitly

defined to include virtually all expenses not included in the

cost of goods. The plain language does not permit any excep-

tions, even for costs that unrelated parties would not share.

Each provision’s plain language mandates a different result.

Accordingly, we conclude the two provisions establish dis-

tinct and irreconcilable standards for determining which costs

must be shared between controlled parties in cost sharing

agreements specifically related to intangible product develop-

ment.

The structure of the regulatory regime confirms this conclu-

sion. Section 1.482-1(b)(2) explains that “[s]ections 1.482-2

through 1.482-6 provide specific methods to be used to evalu-

ate whether transactions between or among members of the

controlled group satisfy the arm’s length standard, and if they

do not, to determine the arm’s length result.” Section 1.482-

1(c)(1)’s “best method rule” explains how the Commissioner

and taxpayers should determine which of these methods pro-

vides the most reliable measure of the arm’s length result:

“the two primary factors to take into account are the degree

of comparability between the controlled transaction (or tax-

payer) and any uncontrolled comparables, and the quality of

data and assumptions used in the analysis.” Notably, § 1.482-

7 is not included among the methods specified in § 1.482-

1(b)(2) for determining the arm’s length result, and the com-

prehensive definition of “costs . . . related to the intangible

development area” does not implicate the factors identified in

§ 1.482-1(c)(1). Thus, §§ 1.482-1 through 1.482-6 establish a

sophisticated methodology for comparing controlled transac-

tions to uncontrolled transactions that is generally applicable

when determining what items must be allocated among

related parties. The regulatory regime then addresses a partic-

ular type of controlled transaction — cost sharing agreements

6164 XILINX, INC. v. CIR

related to intangible product development — and establishes

a comprehensive definition of what costs must be shared that

does not turn on similar uncontrolled transactions. Section

1.482-7 thus appears to be a self-contained provision creating

an exception to the general methodology established in the

earlier provisions. As long as taxpayers comply with the

requirement of sharing all intangible development costs pro-

portionally to the expected benefit, see 26 C.F.R. § 1.482-

7(b)(2) (requiring “each participant’s share of intangible

development costs . . . reflect that participant’s share of antici-

pated benefits”), they are assured the district director will not

“make allocations” and revise the claimed tax liability attrib-

utable to the cost sharing agreement, 26 C.F.R. § 1.482-

7(a)(2). A bright line rule governs what costs must be shared,

rather than comparing the cost sharing agreement to similar

agreements between unrelated parties.

In fact, the regulatory history suggests the Secretary viewed

cost sharing agreements related to intangible product develop-

ment as a unique type of controlled transaction meriting a dis-

tinct method of analysis. The 1986 amendments to 26 U.S.C.

§ 482 reflected Congress’ particular concern over transfers

and licenses of intangible property, but the conference com-

mittee report explaining those amendments recognized that

“many important and difficult issues under section 482 [we]re

left unresolved by this legislation” and suggested “a compre-

hensive study of intercompany pricing rules . . . should be

conducted” and “careful consideration should be given to

whether the existing regulations could be modified in any

respect.” H.R. Conf. Rep. No. 99-841, reprinted in 1986

U.S.C.C.A.N. 4075, 4726. In response, the Internal Revenue

Service and Treasury Department conducted a detailed study

of controlled party transactions, publishing its results in 1988.

See I.R.S. Notice 88-123, 1988-2 C.B. 458. The study “pri-

marily considered transfers of intangibles, but it also

addressed the application of section 482 to other transac-

tions,” including cost sharing agreements. Intercompany

Transfer Pricing and Cost Sharing Regulations Under Section

XILINX, INC. v. CIR 6165

482, 57 Fed. Reg. 3571, 3572 (proposed Jan. 30, 1992). The

Secretary then promulgated the precursors of §§ 1.482-1

through 1.482-6 and § 1.482-7 in 1992 as a single proposed

regulation, id., but did not finalize the comprehensive all costs

requirement in § 1.482-7(d)(1) until December 1995, see T.D.

8632, 1996-4 I.R.B. 6, six months after the rest of the Section

482 regulations were finalized, see T.D. 8552, 1994-31 I.R.B.

4. The Secretary’s separate regulatory action addressing cost

sharing agreements related to intangible product development

lends further support to our conclusion that the all costs

requirement is different from the arm’s length standard gener-

ally applicable to other controlled transactions.5

[2] Because the all costs requirement is irreconcilable with

the arm’s length standard, we hold § 1.482-7(d)(1) controls,

in light of the “elementary tenet of statutory construction that

where there is no clear indication otherwise, a specific statute

will not be controlled or nullified by a general one,” Santiago

Salgado v. Garcia, 384 F.3d 769, 774 (9th Cir. 2004) (cita-

tions and internal quotation marks omitted); see also Long

5

The parties and amici spend considerable time parsing the legislative

history of 26 U.S.C. § 482. The statute, however, simply delegates author-

ity to the Secretary to adjust taxable income of controlled parties to pre-

vent tax evasion. It prescribes no particular methodology for doing so,

except in the case of transfers and licenses of intangible property (types

of transactions not at issue in this case), and does not mention cost sharing

agreements. The 1986 conference committee report acknowledged the

1986 amendments did not resolve every problem inherent in controlled

transactions and suggested the Secretary study the issue further and refine

the regulations as needed, which the Secretary did. Congress plainly did

not resolve how cost sharing agreements related to intangible development

should be evaluated, and we decline the parties’ invitation to interpret the

regulations by attempting to divine a hypothetical intent from a statute that

is silent on the issue we face. See Pac. Nw. Generating Coop v. Dep’t of

Labor, 550 F.3d 846, 860-61 (9th Cir. 2008) (“When relevant statutes are

silent on the salient question, we assume that Congress has implicitly left

a void for the agency to fill, and, therefore, we defer to the agency’s con-

struction of its governing statutes, unless that construction is unreason-

able.” (internal quotation marks and alteration omitted)).

6166 XILINX, INC. v. CIR

Island Care at Home, Ltd. v. Coke, 127 S.Ct. 2339, 2348

(2007) (applying this canon of construction to regulations).

Section 1.482-7 applies to cost sharing agreements related to

intangible development, which is the particular controlled

transaction at issue here, and specifies that “all costs . . .

related to the intangible development area” must be included

in the pool of costs to be shared. The general requirement in

§ 1.482-1(b)(1) that the arm’s length standard should apply in

every case involving a controlled transaction does not over-

ride such a specific provision.6

We are not persuaded by either party’s attempts to harmo-

nize the two provisions. Xilinx argues that § 1.482-1(b)(1)’s

“in every case” language requires us to construe § 1.482-

7(d)(1)’s all costs requirement to mean that parties must share

only those costs that parties operating at arm’s length would

share, suggesting § 1.482-7(d)(1) did not explicitly incorpo-

6

The dissent of our learned colleague, for whom we have the greatest

respect, contends we should instead apply the canon of construction that

doubts about the meaning of tax provisions should be resolved against the

government. Dissent at 6181 (citing United Dominion Indus., Inc. v.

United States, 532 U.S. 822, 839 (Thomas, J., concurring)). This canon,

however, applies where language in a revenue provision is ambiguous.

See, e.g., Bowers v. New York & Albany Lighterage Co., 273 U.S. 346,

348-49 (1927) (interpreting meaning of “proceeding” in tax provision

establishing statute of limitations for collection of back taxes); United

States v. Merriam, 263 U.S. 179, 184 (1923) (interpreting meaning of “be-

quest” to determine if gift was taxable income). We have not found any

case resorting to this canon to resolve a conflict between two unambigu-

ous tax provisions.

In any event, it is not the only canon of construction relevant to revenue

provisions. There is a countervailing tradition under which tax provisions

that merely create “an exception from a general revenue duty for the bene-

fit of some taxpayers” are construed in favor of the government. United

Dominion, 532 U.S. at 839 n.1 (Stevens, J., dissenting) (citing cases). In

this case, we are determining how related parties in a cost sharing agree-

ment must apportion business costs, which offset taxable income as a

deduction under 26 U.S.C. § 162(a). Thus, even if these competing canons

apply when two unambiguous provisions conflict, it would be more appro-

priate to resolve the conflict in favor of the government.

XILINX, INC. v. CIR 6167

rate an arm’s length standard because that requirement is

implicit, and controlling, in light of § 1.482-1(b)(1). Although

this explanation at first seems plausible, we are not ultimately

persuaded. To read such a qualification into the precise and

comprehensive language of §§ 1.482-5(d)(3) and 1.482-

7(d)(1) would ignore the plain meaning and context of the

cost sharing provisions, specifically “all” costs “related to”

intangible development. “All” means “the entire number,

amount or quantity” or “every,” American Heritage College

Dictionary 35 (3d ed. 2000), and “related” means “[b]eing

connected [or] associated,” id. at 1152. These terms, taken

together with the regulation’s sub-definitions, describe a fixed

set of costs that must be shared in their totality and that will

not vary based on the type of intangible property being devel-

oped. Transporting an arm’s length standard into § 1.482-

7(d)(1) would transform this apparently all encompassing and

self-contained description of the costs to be shared into a

methodology under which the costs to be shared would not be

fixed by these defined terms but would rather ultimately be

defined by the conduct of unrelated parties. Significantly,

achieving an arm’s length result is not itself the regulatory

regime’s goal; rather, its purpose is to prevent tax evasion by

ensuring taxpayers accurately reflect taxable income attribut-

able to controlled transactions.7 See 26 C.F.R. § 1.482-1(a)(1).

During the regulatory process, the Secretary concluded cost

sharing agreements related to intangible development merited

separate attention. The plain language in the finalized

§ 1.482-7 articulates a bright line rule, which appears to

reflect a judgment that intangible product development

through cost sharing agreements presents a special case

7

Although the second sentence of § 1.482-1(a)(1) does note that Section

482 places controlled taxpayers on a tax parity with uncontrolled taxpay-

ers, the first sentence of § 1.482-1(a)(1) states that “[t]he purpose of Sec-

tion 482 is to ensure that taxpayers clearly reflect income attributable to

controlled transactions and to prevent the avoidance of taxes with respect

to such transactions.” Thus, we disagree with our dissenting colleague that

the regulatory regime’s singular purpose is to ensure tax parity. Dissent at

6180.

6168 XILINX, INC. v. CIR

requiring a distinct approach to ensure related parties do not

evade taxes. Under the circumstances, we are reluctant to

import a general standard into a comprehensive definition

contained in a highly specific regulation.8

On the other hand, the Commissioner argues that the word

“generally” in § 1.482-1(b)(1) means there are exceptions to

using “the results of comparable transactions under compara-

ble circumstances” to determine the arm’s length result and

that § 1.482-7(d)(1)’s all costs requirement is such an excep-

tion. In context, however, the sentence containing the lan-

guage quoted above conveys that identical transactions

between unrelated parties — which are the ideal for determin-

ing “the results that would have been realized if controlled

taxpayers had engaged in the same transaction under the same

circumstances (arm’s length result),” § 1.482-1(b)(1) — are

rare, so comparable transactions are “generally” the only fea-

sible way to determine the arm’s length result. Moreover,

§ 1.482-1(b)(2) does not list § 1.482-7 among the sections

providing specific methods for calculating the arm’s length

result, so the Commissioner’s suggestion that § 1.482-

7(d)(1)’s all costs requirement is simply another method of

determining the arm’s length result is implausible. See Bou-

dette v. Barnette, 923 F.2d 754, 756-57 (9th Cir. 1991) (hold-

ing “when a statute designates certain . . . manners of

operation, all omissions should be understood as exclusions”).

Finally, the Commissioner has presented no evidence that any

companies operating at arm’s length share ESO costs and

does not challenge the tax court’s finding that unrelated par-

8

We do not address the parties’ dispute over whether we should defer

to the Commissioner’s interpretation of the regulations, which was not

announced until these tax proceedings began. See Bowen v. Georgetown

Univ. Hosp., 488 U.S. 204, 212-13 (declining to defer to proffered agency

interpretation that “appear[ed] to be nothing more than an agency’s conve-

nient litigating position”). We conclude the all costs requirement is not

affected by unrelated parties’ conduct based on the regulatory regime’s

plain language, structure and development, not on the Commissioner’s

proffered construction.

XILINX, INC. v. CIR 6169

ties would not do so. If unrelated parties operating at arm’s

length would not share the ESO cost, requiring controlled par-

ties to share it is simply not an arm’s length result. See 26

C.F.R. § 1.482-1(b)(1) (defining “arm’s length result” as con-

sistent “with the results that would have been realized if

uncontrolled taxpayers had engaged in the same transaction

under the same circumstances”).9

We also disagree with the dissent that the United States-

Ireland Tax Treaty and the Treasury Department’s Technical

Explanation of that treaty are useful “guides” in determining

which of the two irreconcilable standards governs.10 Dissent

at 6181-84. To be sure, the Technical Explanation, which was

issued while the tax regulations at issue in this case were in

effect, states that the treaty incorporates the arm’s length prin-

ciple from United States tax law, “refers to the arm’s length

standard as decisive” and “makes no specific mention of the

9

The arm’s length standard is a regulatory gloss on the Secretary’s stat-

utory authority to allocate income to avoid tax evasion, and the Secretary

has since modified the regulations to state explicitly that ESOs are costs

that must be shared and that the all costs requirement is an arm’s length

result, see 26 C.F.R. § 1.482-7T(a) & (d)(1)(iii) (2009), despite the

absence of any evidence that unrelated parties share ESOs. Congress and

regulators may adopt a technical definition of a term that is distinct from

its plain meaning, see, e.g., Ernzen v. United States, 922 F.2d 1433, 1436

(9th Cir. 1991) (discussing technical statutory definition of “contribution”

in 26 U.S.C. § 72(r)), but we are concerned here only with the regulations

in effect in 1997, 1998 and 1999, which did not explicitly define an “arm’s

length” result to require sharing of ESOs.

10

Although the dissent does not argue the treaty and Technical Explana-

tion trump § 1.482-7, it maintains those documents can “obviate a poten-

tial conflict” between the regulations. Dissent at 6186. This is possible,

however, only if they override § 1.482-7’s plain language, and the dissent

cites no authority in support of the novel proposition that an agency’s

interpretation of a treaty should supplant a duly enacted regulation. Treaty

interpretations are undoubtedly entitled to great weight when construing

an ambiguous treaty, see Sumitomo Shoji Am., Inc. v. Avagliano, 457 U.S.

176, 184-85 (1982), but § 1.482-7 was promulgated through notice-and-

comment rulemaking and therefore has the force and effect of law, see

United States v. Mead Corp., 533 U.S. 218, 226-27 (2001).

6170 XILINX, INC. v. CIR

[all costs requirement].” Dissent at 6183-84.11 The dissent

maintains the general arm’s length standard should trump the

specific all costs requirement because it is hard to believe the

Treasury Department “conceal[ed] from its treaty parties that

[the arm’s length standard] had an exception when stock

options were in question.” Dissent at 6185. But this argument

rests on the false premise that Treasury officials involved in

the treaty negotiations believed the all costs requirement was

inconsistent with the arm’s length standard articulated in

§§ 1.482-1 through 1.482-6. The dissent overlooks several

details: (1) the Commissioner has always argued, before the

tax court and on appeal, that the all costs requirement is con-

sistent with the arm’s length standard in § 1.482-1(b)(1); (2)

the Treasury Department has never publicly differentiated

between the two standards; and (3) the current regulations

explicitly state the all costs requirement is consistent with the

arm’s length standard, see 26 C.F.R. § 1.482-7T(a) &

(d)(1)(iii) (2009). By all appearances, the Treasury Depart-

ment’s consistent view over the years has been that requiring

related parties in a cost sharing arrangement to share ESO

costs is not incompatible with (1) international norms or (2)

the regulatory arm’s length standard under domestic tax law.

Obviously, we have concluded the second view is not sup-

ported by the plain language of the regulations in effect dur-

ing 1997, 1998 and 1999 (and we express no opinion on the

first). But the dissent goes a step further by projecting our

conclusion 12 years into the past and assuming the Treasury

officials involved in negotiating and interpreting the tax treaty

agreed with it, without offering any basis for doing so. As we

have explained, we do not believe the Secretary accidentally

11

These observations are not materially different from § 1.482-1(b)(1)’s

statement that the arm’s length standard applies “in every case.” The

dilemma in this case is that the arm’s length standard, as articulated by the

tax regulations in effect at the time the Technical Explanation was issued,

is irreconcilable with the all costs requirement. A document that essen-

tially mirrors language in the general regulation stating the general stan-

dard should always govern does not, in our view, offer much insight into

which of two conflicting regulations should control.

XILINX, INC. v. CIR 6171

promulgated a highly specific regulation that plainly requires

related parties in cost sharing agreements to share all costs.

The treaty documents do not alter our view.

[3] In sum, we conclude the arm’s length regulation,

§ 1.482-1(b)(1), and the all costs regulation, § 1.482-7(d)(1),

cannot be harmonized. Accordingly, we hold § 1.482-7(d)(1),

being the more specific of the two, controls.

B. Section 1.482-7(d)(1) Does Not Violate the United

States-Ireland Tax Treaty.

[4] As noted, we requested supplemental briefing on

whether § 1.482-7(d)(1) might be preempted for the tax years

the United States-Ireland Tax Treaty was in effect. The tax

treaty establishes that the appropriate standard for determin-

ing whether to reallocate profits from controlled transactions

involving controlled parties is whether “conditions are made

or imposed between the two enterprises in their commercial

or financial relations that differ from those that would be

made between independent enterprises.” See 1997 United

States-Ireland Tax Treaty, Art. 9, RIA Int. Tax Treaty 3057.

The Department of the Treasury’s treaty explanation confirms

that this standard is identical to the arm’s length standard in

§ 1.482-1(b)(1). See Department of the Treasury Technical

Explanation of the 1997 United States-Ireland Tax Treaty,

RIA Int. Tax Treaty 3095. Nonetheless, § 1.482-7(d)(1) does

not conflict with the tax treaty in these circumstances, because

the treaty expressly allows a contracting state to apply its

domestic laws to its own citizens, even if those laws conflict

with the treaty. See 1997 United States-Ireland Tax Treaty,

Art. 1(4), RIA Int. Tax Treaty 3057 (“Notwithstanding any

provision of [this treaty], a Contracting State may tax its resi-

dents . . . and its citizens, as if the [treaty] had not come into

effect.”). Xilinx is not a foreign entity, so applying § 1.482-

7(d)(1) to it does not violate the treaty, even if the regulation’s

all costs requirement is at odds with the treaty’s arm’s length

standard.

6172 XILINX, INC. v. CIR

C. ESOs for Which Companies Claim Tax Deductions

Are Costs and Are Related to the Research and

Development Activity, to the Extent They Are Given

to Employees Involved In or Supporting that Activity.

Because § 1.482-7(d)(1) controls, the Commissioner prop-

erly allocated the ESO amounts only if they are “costs

incurred by [Xilinx] related to the intangible development

area.”

1. Certain ESO amounts are a cost.

Xilinx relies on the considerable evidence and testimony

presented to the tax court that unrelated parties in a cost shar-

ing agreement do not treat ESOs as costs to be shared. This

evidence is beside the point — whether or not unrelated par-

ties share an item is immaterial to whether it is a cost to either

party. Xilinx also maintains ESOs are not costs because two

provisions of § 1.482-7 allow taxpayers to use any accounting

method as long as it is used consistently.12 Xilinx reads these

provisions to allow a taxpayer to establish conclusively what

is or is not a cost by using a particular accounting method and

sticking with it. Xilinx then argues that under one particular

business accounting method, which was widely accepted

when Congress passed 26 U.S.C. § 482 in the 1980s and was

still an acceptable method during the tax years at issue, ESOs

are not treated as costs.

[5] Xilinx’s argument that § 1.482-7’s accounting require-

ments allow taxpayers to self-define what is and is not a cost

12

Those two subsections establish accounting requirements that taxpay-

ers in a qualified cost sharing agreement must meet. First, they must “use

a consistent accounting method to measure costs and benefits.” 26 C.F.R.

§ 1.482-7(i). Second, they must maintain documentation to establish “[t]he

accounting method used to determine the costs and benefits of the intangi-

ble development . . . and, to the extent that the method materially differs

from U.S. generally accepted accounting principles, an explanation of

such material differences.” 26 C.F.R. § 1.482-7(j)(2)(i)(D).

XILINX, INC. v. CIR 6173

by consistently using a particular accounting method is cre-

ative but unsound. The accounting requirements are minimum

eligibility requirements for a qualified cost sharing agreement.

It does not logically follow that whatever accounting method

a taxpayer uses, even a nonstandard one, conclusively estab-

lishes what is a cost, even if that method differs from how the

regulation defines costs. Rather, the regulation’s accounting

requirements are clearly intended to ensure the government

has a basis upon which to verify whether taxpayers who

obtain the benefit of a qualified cost sharing agreement are

accurately reporting and sharing costs, i.e., not treating items

that are costs under the regulation as something other than

costs.

Also, the official accounting method upon which Xilinx

relies, Accounting Principles Board Opinion No. 25 (1972)

(“APB 25”), was superseded by Statement of Financial

Accounting Standards No. 123 (1995) (“SFAS 123”).

Although SFAS 123 allowed taxpayers to employ APB 25’s

methodology (under which these ESOs have zero cost) during

the relevant tax years, SFAS 123 explained that the APB 25

method was no longer the preferred method for valuing ESOs,

going so far as to require companies employing APB 25 also

to report the cost of ESOs under SFAS 123’s preferred fair

value based method. Xilinx used APB 25 and treated the

ESOs as a zero cost on its books, but it also complied with

SFAS 123 and reported the ESO cost under the SFAS 123 fair

value method in footnotes to its public income statements.

Thus, although Xilinx did not violate business accounting

practices in ascribing zero cost on its books to ESOs, the pre-

ferred business accounting practice during the relevant tax

years treated ESOs as costs.

[6] In the end, Xilinx’s argument is undermined by the reg-

ulatory language and its own tax returns. “Costs incurred

related to the intangible development area [are] . . . operating

expenses as defined in § 1-482.5(d)(3),” 26 C.F.R. § 1.482-

7(d)(1), which provides that “operating expenses” include “all

6174 XILINX, INC. v. CIR

expenses not included in cost of goods sold except for . . . any

. . . expenses not related to the operation of the relevant busi-

ness activity,” 26 C.F.R. § 1-482.5(d)(3).13 Xilinx stipulated

that it did not include the value of the ESOs in the cost of

goods sold, and it claimed tax deductions under 26 U.S.C.

§§ 83 and 162 for the exercised NSOs and the disqualifying

dispositions of the ISOs and ESPPs as business “expenses.”14

See 26 U.S.C. § 162(a)(1) (allowing employers to deduct “all

the ordinary and necessary expenses paid or incurred”

(emphasis added)). Xilinx could not have claimed deductions

on these ESOs unless they were an “expense,” which is the

key term in the definition of “cost” under § 1.482-7(d)(1).

Moreover, Xilinx required XI to pay it for the value of the

ESOs XI employees exercised. Requiring reimbursement for

ESOs granted to another company’s employees further sup-

ports the conclusion that the ESOs are costs. In short, the pre-

ferred business accounting method in effect during the

relevant tax years treated ESOs as costs, and Xilinx itself

treated certain amounts of ESOs as “expenses” in claiming

them as a tax deduction. Accordingly, we hold the ESO value

that Xilinx deducted as a business expense is a “cost” for the

purposes of § 1.482-7(d)(1).15

13

For the sake of clarity, we analyze whether the ESOs are a “cost” and

whether they are “related to” the joint venture separately. We recognize

that this distinction is not altogether appropriate, because the meaning of

“cost” turns on whether an item is an “operating expense,” the definition

of which focuses on whether the expense is “related to” the “relevant busi-

ness activity.” The proper construction of “cost” therefore turns on

whether it is “related to” the activity. Because we conclude ESOs are “re-

lated to” the intangible product development area, however, our separate

analysis of the two questions poses no problem.

14

The Commissioner stipulated that the exercise (as opposed to disquali-

fying dispositions) of ISOs and ESPPs are not “operating expenses” within

the meaning of § 1.482-5(d)(3). Accordingly, we have no occasion to

decide whether those items are “costs” that must be shared.

15

Xilinx also suggests the ESOs should not be treated as costs because

they require no cash outlay. Presumably, however, Xilinx could obtain full

market value for the stock shares it allows its employees to obtain at a

lower price, so, at a minimum, the difference between the exercise price

and the then-current market price is an opportunity cost to Xilinx. In any

event, ESOs were treated as costs during the relevant tax years under tax

accounting principles and the preferred business accounting methodology.

XILINX, INC. v. CIR 6175

2. ESOs are related to the intangible development area.

[7] The tax court found the ESOs are part of Xilinx’s

employee recruitment and retention program, and Xilinx does

not suggest salaries or benefits, like healthcare and retirement

contributions, for employees involved in R&D activities are

not “related to” their work on the R&D activities. It is diffi-

cult to view ESOs as anything but part of Xilinx’s employee

compensation package, because it is a benefit conferred in

exchange for services rendered. ESOs are just as “related to”

(“connected [or] associated” with) an employee’s work as any

other employment benefit or compensation. See American

Heritage College Dictionary 1152 (3d ed. 2000). In fact,

Xilinx claimed the ESOs as part of a tax credit available for

“wages paid or incurred to an employee for qualified

[research] services performed by such employee.” 26 U.S.C.

§ 41(b)(2)(A). Xilinx’s inclusion of ESOs as part of employee

wages for the R&D tax credit undermines its attempt to avoid

tax liability by arguing those ESOs are not “related to” the

same research activity. Although “related to” in 26 C.F.R. §

1.482-7(d)(1) and “for” in 26 U.S.C. § 41(b)(2)(A) are not

identical terms, they convey essentially the same thing in the

context of each provision: the expense must be part of the

compensation given to an employee involved in the relevant

activity.

Accordingly, Xilinx’s arguments that its ESOs have noth-

ing to do with R&D, are issued company wide and are not

viewed by the employees who receive them as related to their

R&D are misplaced. The same can be said of any component

of an employee’s compensation package. For example, health

benefits given to a company’s employees are not tied to any

particular task an employee performs, yet the cost of those

benefits borne by the employer is still related to the work its

employees do. (The cost of health benefits was specifically

included among the items to be shared between Xilinx and XI

as part of the total R&D costs.) For employees who work on

6176 XILINX, INC. v. CIR

R&D, the cost of health benefits for that employee is plainly

related to the company’s R&D activities.

Xilinx also focuses on the considerable evidence it pre-

sented to the tax court proving companies operating at arm’s

length do not share the cost of ESOs. It maintains those com-

panies would share ESO costs if they were in fact related to

a joint venture, just as they share all other costs related to the

project, and points out that not even the United States allows

contractors hired to conduct R&D to bill the government for

the cost of ESOs. Xilinx believes the reason companies oper-

ating at arm’s length do not share ESOs must be that the cost

is not related to the joint venture. The evidence presented to

the tax court, however, suggests three reasons why companies

operating at arm’s length do not share ESO costs, none of

which have anything to do with whether the cost is related to

the joint venture. First, as Xilinx has pointed out, unlike most

costs, companies bear no out-of-pocket expense for ESOs (in

fact, the exercise of ESOs results in cash inflow). Even

though companies can estimate the accounting cost of ESOs,

the tax court found those costs cannot be measured precisely,

so companies operating at arm’s length may elect not to share

ESOs, because agreeing how to value something with no pres-

ent out-of-pocket cost might be a sticking point in negotiating

an agreement. Second, the tax court noted the cost of ESOs

is tied to the value of one company’s stock, so sharing this

cost might create a perverse incentive for the other company

to minimize the economic value of the joint venture in order

to keep its partner’s stock value low and thereby limit its own

share of the cost for its partner’s ESOs. Finally, a company

operating at arm’s length has an incentive not to share ESO

costs, to the extent those costs can be deducted as a business

expense. What company would not like to bear the full cost

of something that imposes no out-of-pocket expense and con-

fers the benefit of a tax deduction? Although the record con-

clusively establishes that companies in a joint venture

operating at arm’s length do not share ESO costs, none of the

XILINX, INC. v. CIR 6177

possible explanations for this fact demonstrate ESO costs are

unrelated to the joint venture.

[8] Accordingly, we hold ESOs are related to the work per-

formed by the employees who receive them. The ESO costs

for employees who were involved in activities that would

contribute to the joint venture between Xilinx and XI there-

fore should have been shared. Based on the record before us,

however, we cannot conclusively determine whether the

Commissioner’s allocation is limited only to employees

involved in the joint venture and takes into account whether

employees spent all or only part of their time on tasks relevant

to the joint venture. Accordingly, we remand to the tax court

on the narrow issue of determining whether the Commission-

er’s allocation accurately reflects ESO costs for employees

involved in tasks related to the joint venture.

IV. CONCLUSION

We hold that 26 C.F.R. § 1.482-7(d)(1)’s all costs require-

ment is irreconcilable with 26 C.F.R. § 1.482-1(b)(1)’s

requirement that an arm’s length standard should apply in

every case and that § 1.482-7(d)(1), as the more specific of

the two provisions, controls. We further hold ESOs are “costs

. . . related to the intangible development area” and therefore

must be shared between controlled parties in a cost sharing

agreement. We therefore reverse the tax court, because the

Commissioner’s allocation was appropriate to the extent it

involved ESO costs Xilinx claimed as a business expense

deduction and was limited to ESOs for employees involved in

the joint venture. We remand so that the tax court may ensure

the Commissioner’s allocation is consistent with our holding.

[9] Xilinx may have been caught off guard by the defi-

ciency notices, which is understandable given the absence of

any public guidance that the Commissioner would interpret

the cost sharing regulation to require sharing of ESO costs.

This result is nonetheless mandated by the plain meaning of

6178 XILINX, INC. v. CIR

§ 1.482-7(d)(1), which we have concluded controls over

§ 1.482-1(b)(1). We are troubled, however, by the imposition

of accuracy related penalties here. Although we have con-

strued the regulations in a manner favorable to the Commis-

sioner, we rejected the Commissioner’s attempted

harmonization of §§ 1.482-1 and 1.482-7 along the way.

Moreover, the Secretary has since promulgated new regula-

tions “clarify[ing]” this issue by explicitly including ESOs as

costs to be shared.16 68 Fed. Reg. 51171-02, 2003-2 C.B. 841.

When even the government has found it necessary to clarify

the regulations, we have our doubts that imposing a penalty

on taxpayers for their failure to follow the letter of the law is

appropriate. On remand, the tax court may also consider any

defenses Xilinx raised against the Commissioner’s imposition

of accuracy related penalties.

REVERSED and REMANDED.

NOONAN, Circuit Judge, dissenting:

The Commissioner of Internal Revenue has issued regula-

tions that are irreconcilable. These are the regulations relevant

to this case. We have three alternatives:

1. Hold that when the Commissioner talks out of both

sides of his mouth, his speech is unintelligible and his regula-

tions are unenforceable.

16

The current temporary regulations provide that controlled taxpayers’

operating costs, which must be shared in a qualified cost sharing arrange-

ment, “include . . . stock-based compensation.” 26 C.F.R. § 1.482-

7T(d)(1)(iii) (2009). Such expenses must “equal . . . the amount allowable

to the controlled participant as a deduction for federal income tax purposes

with respect to that stock-based compensation.” 26 C.F.R. § 1.482-

7T(d)(3)(iii) (2009).

XILINX, INC. v. CIR 6179

2. Apply a rule of thumb: the specific controls the gen-

eral.

3. Resolve the conflict based on the dominant purpose of

the regulations, aided by the basic rule that ambiguous docu-

ments are to be interpreted against the drafter and further

enlightened by the way the Treasury has proceeded in drafting

tax treaties relevant to American parents and their foreign

subsidiaries.

The majority has chosen the second alternative. It is a sim-

ple solution. It is plausible. But it is wrong. It converts a

canon of construction into something like a statute. It ignores

the international context and the Treasury’s own practice. In

what follows, I will spell out this mistake and why I chose the

third alternative.

The problem. The majority put it well:

Section 1.482-1(b)(1) specifies that the true taxable

income of controlled parties is calculated based on

how parties operating at arm’s length would behave.

The language is unequivocal: this arm’s length stan-

dard is to be applied “in every case.” In the context

of cost sharing agreements, this would require con-

trolled parties to share only those costs uncontrolled

parties would share. By implication, costs that

uncontrolled parties would not share need not be

shared. In contrast, § 1.482-7(d)(1) specifies that

controlled parties in a cost sharing agreement must

share all “costs . . . related to the intangible develop-

ment area,” and that phrase is explicitly defined to

include virtually all expenses not included in the cost

of goods. The plain language does not permit any

exceptions, even for costs that unrelated parties

would not share. Each provision’s plain language

mandates a different result. Accordingly, we con-

clude the two provisions establish distinct and irrec-

6180 XILINX, INC. v. CIR

oncilable standards for determining which costs must

be shared between controlled parties in cost sharing

agreements specifically related to intangible product

development. Maj. Op. 6162-63.

The handy canon of construction. Often the specific con-

trols the general. This rule has been used by the Supreme

Court. E.g., Long Island Care At Home, Ltd. v. Coke, 127

S. Ct. 2339, 2348 (2007). Apply this simple rule here, and

section 1.482-7(d)(1) controls. The conflict dissolves. The

Commissioner is vindicated.

This simple solution is all too pat. It gives controlling

importance to a single canon of construction. But, as every

judge knows, the canons of construction are many and their

interaction complex. The canons “are not mandatory rules.”

Chickasaw Nation v. United States, 534 U.S. 84, 94 (2001).

They are guides “designed to help judges determine the Leg-

islature’s intent.” Id. They can be “overcome” by “other cir-

cumstances” manifesting that intent. Id. The canons are “tools

designed to help courts better determine what Congress

intended, not to lead courts to interpret the law contrary to

that intent.” Scheidler v. National Org. of Women, Inc., 547

U.S. 9, 23 (2006). In the light of these principles, three con-

siderations show the Commissioner’s position to be untena-

ble.

Purpose. First, the purpose of the regulation is paramount.

That purpose is parity between taxpayers in uncontrolled

transactions and taxpayers in controlled transactions. The reg-

ulations are not to be construed to stultify that purpose. If the

standard of arm’s length is trumped by 7(d)(1) the purpose of

the statute is frustrated. If Xilinx cannot deduct all its stock

option costs, Xilinx does not have parity with an independent

taxpayer. Under the majority’s holding, the law is interpreted

contrary to the intent of its maker.

A basic rule. Second, a very old canon of construction

applies in this case, “in which the complex statutory and regu-

XILINX, INC. v. CIR 6181

latory scheme leads itself to any number of interpretations.”

We resolve the inconsistencies against the government.

United Dominos Industries, Inc. v. United States, 532 U.S.

822, 839 (2001) (Thomas, J., concurring and citing, among

other cases, United States v. Merriam, 263 U.S. 179, 188

(1923) (“If the words are doubtful, the doubt must be resolved

against the Government and in favor of the taxpayer”)). This

canon of construction is framed in the cases just cited as par-

ticularly relevant to tax statutes. It is, however, not a conces-

sion to taxpayers. It is the way legal documents are read. The

draft is construed against the drafter.

Treasury practice. The purpose of the regulations and the

normative rules of interpretation deny recognition to the Com-

missioner’s position on 7(d)(1). Additionally, his own agency

has undercut him in the tax treaty between the United States

and Ireland, signed into law by President Clinton on July 28,

1997. The announced purpose of the tax treaty is “the avoid-

ance of double taxation and the prevention of fiscal evasion

with respect to income and capital gains.”

The treaty reads:

Article 9 Associated Enterprises

1. Where:

(a) an enterprise of a Contracting State

participates directly or indirectly in the

management, control or capital of an enter-

prise of the other Contracting State; or

(b) the same persons participate

directly or indirectly in the management,

control, or capital of an enterprise of a Con-

tracting State and an enterprise of the other

Contracting State, and in either case condi-

tions are made or imposed between the two

6182 XILINX, INC. v. CIR

enterprises in their commercial or financial

relations that differ from those that would

be made between independent enterprises,

then, any profits that, but for those condi-

tions, would have accrued to one of the

enterprises, but by reason of those condi-

tions have not so accrued, may be included

in the profits of that enterprise and taxed

accordingly.

2. Where a Contracting State includes in

profits of an enterprise of that State, and

taxes accordingly, profits on which an

enterprise of the other Contracting State has

been charged to tax in that other State, and

the other Contracting State agrees that the

profits so included are profits that would

have accrued to the enterprise of the first-

mentioned State if the conditions made

between the two enterprises had been those

that would have been made between inde-

pendent enterprises, then that other State

shall make an appropriate adjustment to the

amount of the tax charged therein on those

profits. In determining such adjustment,

due regard shall be had to the other provi-

sions of this Convention and the competent

authorities of the Contracting States shall if

necessary consult each other.

1997 United States-Ireland Tax Treaty, RIA Int. Tax Treaty

3057.

The treaty adopts as its standard the transactions “that

would be made between independent enterprises.” That stan-

dard is the arm’s length standard. No exceptions are provided.

Arm’s length is the international standard specifically govern-

ing Xilinx and XI.

XILINX, INC. v. CIR 6183

A tax treaty is negotiated by the United States with the

active participation of the Treasury. The Treasury’s reading of

the treaty is “entitled to great weight.” United States v. Stuart,

489 U.S. 353, 369 (1989) (quoting Sumitomo Shoji America,

Inc. v. Aragliano, 457 U.S. 176, 184-185 (1982)). Simulta-

neous with the signing of the treaty into law, the Treasury

issued its “Technical Explanation.” As to Article 9, the Expla-

nation reads:

This article incorporates in the Convention the

arm’s length principle reflected in the U.S. domestic

transfer pricing provision, particularly Code section

482. It provides that when related enterprises engage

in a transaction on terms that are not arm’s length,

the Contracting States may make appropriate adjust-

ments to the taxable income and tax liability of such

related enterprises to reflect what the income and tax

of these enterprises with respect to the transaction

would have been had there been an arm’s length

relationship between them.

...

The fact that a transaction is entered into between

such related enterprises does not, in and of itself

mean that a Contracting State may adjust the income

(or loss) of one or both of the enterprises under the

provisions of this Article. If the conditions of the

transaction are consistent with those that would be

made between independent persons, the income aris-

ing from that transaction should not be subject to

adjustment under this Article.

Similarly, the fact that associated enterprises may

have concluded arrangements, such as cost sharing

arrangements or general services agreement, is not in

itself an indication that the two enterprises have

entered into a non-arm’s length transaction that

6184 XILINX, INC. v. CIR

should give rise to an adjustment under paragraph 1.

Both related and unrelated parties enter into such

arrangements (e.g., joint venturers may share some

development costs). As with any other kind of trans-

action, when related parties enter into an arrange-

ment, the specific arrangement must be examined to

see whether or not it met the arm’s length standard.

In the event that it does not, an appropriate adjust-

ment may be made, which may include modifying

the terms of the agreement or recharacterizing the

transaction to reflect its substance.

It is understood that the “commensurate with

income” standard for determining appropriate trans-

fer prices for intangibles, added to Code section 482

by the Tax Reform Act of 1986, was designed to

operate consistently with the arm’s-length standard.

The implementation of this standard in the section

482 regulations is in accordance with the general

principles of paragraph 1 of Article 9 of the Conven-

tion, as interpreted by the OECD Transfer Pricing

Guidelines.

Department of the Treasury Technical Explanation of the

1997 United States-Ireland Tax Treaty, RIA Int. Tax Treaty

3095.

No fewer than five times, the Explanation refers to the

arm’s length standard as decisive. The Explanation adds that

as to “transaction[s] . . . that are consistent with those that

would be made between independent persons, the income

from the transfer should not be subject to adjustment under

this Article.” The Explanation makes no specific mention of

the “all-of-the-costs” standard. The Explanation glosses the

statute’s “commensurate with income standard” as “designed

to operate consistently with the arm’s length standard”: the

arm’s length standard is treated as the measure, with which

CWI is “designed to operate consistently.” This standard is

XILINX, INC. v. CIR 6185

further affirmed to be in accord with principles operative

under the Transfer Pricing Guidelines of the Organisation for

Economic Co-operation and Development.

It cannot easily or safely be supposed that the Treasury in

negotiating the treaty was unaware of the “all-of-the-costs”

regulation and its relation to stock options issued in connec-

tion with R&D. In oral argument before this court, counsel for

the Commissioner expressed the relation between the differ-

ent divisions of the Treasury by tightly clasping his two hands

together, a gesture effectively communicating their unity of

thought and action. The Commissioner as litigator cannot dis-

avow the position that the Treasury repeatedly took in the Ire-

land and other tax treaties of which we take judicial notice.

See, e.g., United States-France, Article 9 (RIA Int. Tax Treaty

2225); United States-Germany, Article 9 (RIA Int. Tax Treaty

1542); and United States-United Kingdom, Article 9 (RIA Int.

Tax Treaty 2546). In each of them, Article 9 takes transac-

tions between independent companies as the measure.

Using the standard of what independent companies would

do in their own cost-sharing arrangements, the Treasury could

not have meant to conceal from its treaty parties that this stan-

dard had an exception when stock options were in question.

There is good reason for the standard the Treasury chose: it

is an internationally comprehensible standard. It does not

require the treaty partner to recognize costs that may have no

recognition in its law. If double taxation of the income of par-

ent and subsidiary is to be avoided, a clear, simple, compre-

hensive standard is needed.

I do not reach the issue of whether the treaty obligations

“constitute binding federal law enforceable in United States

courts.” Medellin v. Texas, 128 S.Ct. 1346, 1356 (2008). Even

if the treaty and the Technical Explanation should be held not

to operate as law trumping the hapless regulation, 7(d)(3),

treaty and explanation act as guides. They tell us what the

Treasury has had in mind in the regulations at issue. They

6186 XILINX, INC. v. CIR

obviate a potential conflict. They illuminate what “tax parity”

entails.

No remand is necessary. I vote to affirm the decision of the

tax court.