Petition for Writ of Certiorari — Altera Corporation & Subsidiaries, Petitioner v. Commissioner of Internal Revenue
Supreme Court briefFeb 10, 2020
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No.
In the Supreme Court of the United States
ALTERA CORPORATION & SUBSIDIARIES,
Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
On Petition for a Writ of Certiorari to
the United States Court of Appeals
for the Ninth Circuit
PETITION FOR A WRIT OF CERTIORARI
GINGER D. ANDERS
Munger Tolles & Olson LLP
1155 F Street NW
Washington, DC 20004
MARK R. YOHALEM
Munger Tolles & Olson LLP
350 S. Grand Avenue
Los Angeles, CA 90071
NICOLE A. SAHARSKY
Counsel of Record
BRIAN D. NETTER
MINH NGUYEN-DANG
Mayer Brown LLP
1999 K Street NW
Washington, DC 20006
(202) 263-3000
nsaharsky@mayerbrown.com
A. DUANE WEBBER
DONALD M. FALK
PHILLIP J. TAYLOR
Mayer Brown LLP
JOSEPH B. JUDKINS
3000 El Camino Real #300
Baker & McKenzie LLP
Palo Alto, CA 94306
815 Connecticut Avenue NW
Washington, DC 20006
THOMAS KITTLE-KAMP
WILLIAM G. MCGARRITY
Mayer Brown LLP
71 S. Wacker Drive
Chicago, IL 60606
Counsel for Petitioners
QUESTIONS PRESENTED
For nearly a century, federal tax treatment of
agreements between related companies (such as parents and subsidiaries) has depended on the “arm’slength” standard: If unrelated companies operating
at arm’s length would share a cost, then related companies must share the cost as well. 26 U.S.C. 482; 26
C.F.R. 1.482-1(b)(1). The United States has incorporated the arm’s-length standard into many tax treaties, and all major developed nations now follow it.
In 2003, the Treasury Department promulgated a
regulation, purporting to follow the arm’s-length
standard, in which it required related companies to
share the cost of stock-based employee compensation.
26 C.F.R. 1.482-7(d)(2) (2003). In a 15-0 decision, the
Tax Court invalidated the regulation as arbitrary and
capricious. On appeal, the government abandoned the
arm’s-length standard and proposed a new rationale
never advanced during the rulemaking process. A divided panel of the Ninth Circuit upheld the regulation
as “permissible” and therefore entitled to deference
under Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).
The questions presented are:
1. Whether the Treasury Department’s regulation
is arbitrary and capricious and thus invalid under the
Administrative Procedure Act, 5 U.S.C. 551 et seq.
2. Whether, under SEC v. Chenery Corp., 332 U.S.
194 (1947), the regulation may be upheld on a rationale the agency never advanced during rulemaking.
3. Whether a procedurally defective regulation
may be upheld under Chevron on the ground that the
agency has offered a “permissible” interpretation of
the statute in litigation.
ii
PARTIES TO THE PROCEEDING AND
CORPORATE DISCLOSURE STATEMENT
Petitioners are Altera Corporation and its subsidiaries. Petitioners are wholly-owned subsidiaries of
Intel Corporation. Intel Corporation is a publicly-held
company, and no publicly-held company owns 10% or
more of its stock.
Respondent is the Commissioner of Internal Revenue.
iii
RELATED PROCEEDINGS
United States Tax Court:
Altera Corp. v. Commissioner,
No. 31538-15 (Dec. 18, 2015)
Altera Corp. v. Commissioner,
No. 674-18 (Jan. 11, 2018)
iv
TABLE OF CONTENTS
Page
Introduction .................................................................1
Opinions below ............................................................3
Jurisdiction ..................................................................3
Statutory and regulatory provisions involved............3
Statement ....................................................................3
A. Multinational companies’ use of costsharing agreements ..........................................3
B. Tax treatment of related-company
transactions and the arm’s-length
standard ............................................................4
C. The Treasury Department’s regulation
on stock-based compensation ...........................6
D. The Tax Court’s decision ..................................8
E. The Ninth Circuit’s decision.............................9
Reasons for granting the petition ............................. 13
A. The Ninth Circuit’s decision violates
bedrock principles of administrative law ...... 14
1. The Ninth Circuit upheld an
arbitrary and capricious regulation ........ 14
2. The Ninth Circuit upheld the
regulation on a rationale advanced
for the first time in litigation .................. 17
3. The Ninth Circuit expanded Chevron
to attempt to solve those problems ......... 19
B. This case is exceptionally important ............. 22
1. This an egregious case of
administrative agency overreaching ....... 23
2. This issue affects a large number of
companies across the U.S. economy ........ 25
3. This issue is worth billions of dollars...... 26
v
TABLE OF CONTENTS
(continued)
Page
4.
This issue will have serious domestic
and international tax consequences ........ 28
5. The Court should grant certiorari
now ........................................................... 31
Conclusion ................................................................. 33
Appendix A – Court of appeals opinion
(June 7, 2019) ................................. 1a
Appendix B – Tax Court opinion
(July 27, 2015) .............................. 79a
Appendix C – Court of appeals order denying
rehearing (Nov. 12, 2019) ........... 140a
Appendix D – Statutory and regulatory
provisions .................................... 168a
Appendix E – Notice of proposed rulemaking
(July 22, 2002) ............................ 195a
Appendix F – Final rule (Aug. 26, 2003) .............. 225a
Appendix G – Withdrawn court of appeals
opinion (July 24, 2018) ............... 262a
Appendix H – Order withdrawing court of
appeals opinion (Aug. 7, 2018) ... 323a
Appendix I – Companies reporting the Altera
issue in SEC filings .................... 324a
Appendix J – U.S. tax treaties incorporating
the arm’s-length standard .......... 331a
vi
TABLE OF AUTHORITIES
Cases
Page(s)
Amazon.com, Inc. v. Commissioner,
148 T.C. 108 (2017) ................................................. 32
America’s Cmty. Bankers v. FDIC,
200 F.3d 822 (D.C. Cir. 2000) ................................. 21
American Trucking Ass’ns v. Federal Highway
Admin., 51 F.3d 405 (4th Cir. 1995) ...................... 21
Azar v. Allina Health Servs.,
139 S. Ct. 1804 (2019)............................................. 15
Barclays Bank PLC v. Franchise Tax Bd. of
Cal., 512 U.S. 298 (1994) ........................................ 29
Bowen v. Georgetown Univ. Hosp.,
488 U.S. 204 (1988)................................................. 21
Chevron, U.S.A., Inc. v. Natural Res. Def.
Council, Inc., 467 U.S. 837 (1984) .................. passim
Chisom v. Roemer, 501 U.S. 380 (1991) ................... 18
City of Arlington v. FCC, 569 U.S. 290 (2013) ......... 23
Commissioner v. First Sec. Bank of Utah, N.A.,
405 U.S. 394 (1972)............................................. 5, 28
Comsat Corp. v. FCC,
250 F.3d 931 (5th Cir. 2001) .................................. 21
Department of Commerce v. New York,
139 S. Ct. 2551 (2019)............................................. 15
Encino Motorcars, LLC v. Navarro,
136 S. Ct. 2117 (2016)..................................... passim
FCC v. Fox Television Stations, Inc.,
556 U.S. 502 (2009)................................................. 18
Fidelity Fed. Bank & Tr. v. Kehoe,
547 U.S. 1051 (2006)............................................... 27
Free Enter. Fund v. Public Co. Accounting
Oversight Bd., 561 U.S. 477 (2010) .................. 23, 25
vii
TABLE OF AUTHORITIES
(continued)
Cases – continued
Page(s)
Judulang v. Holder, 565 U.S. 42 (2011) ............... 2, 20
Kisor v. Wilkie, 139 S. Ct. 2400 (2019) ......... 22, 23, 24
Long Island Care at Home, Ltd. v. Coke,
551 U.S. 158 (2007)........................................... 15, 18
Mayo Found. for Med. Educ. & Research v.
United States, 562 U.S. 44 (2011) .................... 15, 24
Michigan v. EPA, 135 S. Ct. 2699 (2015) ................. 19
Motor Vehicle Mfrs. Ass’n of the U.S., Inc. v.
State Farm Mut. Auto. Ins.,
463 U.S. 29 (1983)........................................... passim
National Lifeline Ass’n v. FCC,
921 F.3d 1102 (D.C. Cir. 2019) ............................... 18
PDR Network, LLC v. Carlton & Harris
Chiropractic, Inc., 139 S. Ct. 2051 (2019) .............. 24
Procacci v. Commissioner, 94 T.C. 397 (1990) ........... 5
SEC v. Chenery Corp., 332 U.S. 194 (1947) ..... passim
United States v. Byrum, 408 U.S. 125 (1972) ........... 30
Wisconsin Cent. Ltd. v. United States,
138 S. Ct. 2067 (2018)............................................... 6
Xilinx Inc. v. Commissioner,
598 F.3d 1191 (9th Cir. 2010) .............................. 6, 7
Xilinx Inc. v. Commissioner, 125 T.C. 37 (2005) .... 6, 7
Yovino v. Rizo, 139 S. Ct. 706 (2019) ........................ 11
Treaty, statutes, regulations, and rule
Convention Concerning Double Taxation, Fr.-U.S.,
Apr. 27, 1932, art. IV, 49 Stat. 3145 (1935)............. 5
Administrative Procedure Act,
5 U.S.C. 551 et seq. ................................................... 3
viii
TABLE OF AUTHORITIES
(continued)
Statutes, regulations, and rule –
continued
Page(s)
5 U.S.C. 553(b) ..................................................... 15
5 U.S.C. 553(c)...................................................... 15
5 U.S.C. 706(2)(A) ................................................ 16
Internal Revenue Code of 1986, 26 U.S.C. 1 et seq.:
26 U.S.C. 482.................................................... 4, 10
26 U.S.C. 6213(a) ................................................... 8
Revenue Act of 1928, Pub. L. No. 70-562, § 45,
45 Stat. 791 ............................................................... 5
28 U.S.C. 1254(1)......................................................... 3
17 C.F.R.:
Section 229.303(a)(3)(i) ........................................ 25
Section 229.303(a)(3)(ii) ....................................... 25
26 C.F.R.:
Section 1.482-1(a)(1) .............................................. 5
Section 1.482-1(b)................................................. 28
Section 1.482-1(b)(1) .............................................. 5
Section 1.482-1(c) ............................................. 5, 28
Section 1.482-2(d)(4) (1968) ................................... 5
Section 1.482-7(d)(1) (1995) ................................... 6
Section 1.482-7(d)(1) (2003) ................................... 7
Section 1.482-7(d)(2) (2003) ....................... 7, 25, 27
Section 1.482-7(d)(3) ............................................ 27
Section 1.482-7A(d)(2) ............................................ 7
ix
TABLE OF AUTHORITIES
(continued)
Regulations and rule – continued
Page(s)
Section 482: Methods to Determine Taxable
Income in Connection With a Cost Sharing
Arrangement, 76 Fed. Reg. 80,082 (Dec. 22,
2011) ........................................................................ 27
Treas. Reg. 86, art. 45-1(b) (1935) .............................. 5
Sup. Ct. R. 10............................................................. 14
Other authorities
A10 Networks, Inc., Form 10-K (Mar. 18, 2019) ...... 25
Alphabet Inc., Form 10-K (Feb. 2, 2017) .................. 26
Anaplan, Inc., Form 10-K (Mar. 29, 2019) ............... 25
Aysha Bagchi, Google, Facebook, Apple Weigh in
on Altera Tax Case, Bloomberg Tax (Aug. 2,
2019), https://perma.cc/QAM8-ESXA..................... 25
Facebook Inc., Form 10-K (Jan. 30, 2020) ................ 26
IRS, APA Training: Cost Sharing (Oct. 15,
2001), https://perma.cc/3Q5W-TYHY....................... 4
IRS, Notice 88-123, A Study of Intercompany
Pricing Under Section 482 of the Code,
1988-2 C.B. 458 ............................................... passim
IRS, Report on Application and Administration
of Section 482 (1992) ............................................... 30
IRS, United States Income Tax Treaties – A to Z
(last updated Jan. 8, 2020),
https://perma.cc/24AF-LF9W ................................. 29
Sony Kassam, IRS’s Renewed Focus on CostSharing May Prompt New Tax Disputes,
Bloomberg Tax (Aug. 6, 2019),
https://perma.cc/G776-4G6Q .................................. 23
x
TABLE OF AUTHORITIES
(continued)
Other authorities – continued
Page(s)
Ltr. from Steven T. Mnuchin, Sec’y of the
Treas., to José Ángel Gurría, Sec’y-Gen.,
OECD (Dec. 3, 2019), https://perma.cc/2SF6P2UU ....................................................................... 30
Mem. from Douglas W. O’Donnell, Comm’r,
Large Business & Int’l Div., IRS, to Large
Business & Int’l Div. Examiners (Jan. 12,
2018), https://perma.cc/J67L-MB4D ...................... 31
OECD, OECD Model Tax Convention on Income
and on Capital (July 22, 2010),
https://perma.cc/3JW9-N5U3 ................................. 30
OECD, OECD Transfer Pricing Guidelines for
Multinational Enterprises and Tax
Administrations (July 10, 2017),
https://perma.cc/T9NB-L49H ........................... 29, 30
Natalie Olivo, Admin. Law Could Pave Way for
High Court Tax Regs Fight, Law360 (Nov. 15,
2019), https://perma.cc/LXL3-PLUP ...................... 22
Natalie Olivo, International Tax Cases to Watch
in 2018, Law360 (Jan. 2, 2018),
https://perma.cc/7TN5-8DJ8 .................................. 23
Peter J. Reilly, Ninth Circuit Pulls Back Big
IRS Victory Issued After Judge’s Death, Forbes
(Aug. 7, 2018), https://perma.cc/K6XS-7H4L......... 23
Richard Rubin & Theo Francis, Yearslong Tax
Dispute Could Cost Big Tech Companies
Billions, Wall Street J. (Sept. 3, 2019),
https://perma.cc/N6XL-Y5KM ................................ 23
xi
TABLE OF AUTHORITIES
(continued)
Other authorities – continued
Page(s)
Richard Rubin, Google’s Parent Could Be Big
Winner in Intel Tax Dispute, Wall Street J.
(Feb. 29, 2016), https://perma.cc/U7GZ-BJGD ...... 26
Twitter, Inc., Form 10-Q (Oct. 30, 2019) .................. 27
U.S. Dep’t of the Treas., Treasury Announces
Release of 2016 U.S. Model Income Tax Treaty
(Feb. 17, 2016), https://perma.cc/G9R7-B62G ....... 29
U.S. Dep’t of the Treas., United States Model
Income Tax Convention (Feb. 17, 2016),
https://perma.cc/GY49-H3ES ................................. 29
Carolina Vargas & Siri Bulusu, 2019 Outlook:
Four Legal Issues Tax Attorneys Are Watching,
Bloomberg Tax (Dec. 31, 2018),
https://perma.cc/7NKY-ZYLX................................. 23
In the Supreme Court of the United States
No.
ALTERA CORPORATION & SUBSIDIARIES,
Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
On Petition for a Writ of Certiorari to
the United States Court of Appeals
for the Ninth Circuit
PETITION FOR A WRIT OF CERTIORARI
INTRODUCTION
This is a clear case of administrative agency overreaching, rubber-stamped by a court of appeals. The
Treasury Department promulgated a regulation addressing a tax issue about stock-based compensation
that is worth billions of dollars. The agency purported
to apply a longstanding tax-law standard (the arm’slength standard), but provided no evidence to satisfy
that standard and ignored the voluminous evidence to
the contrary. In a 15-0 decision, the judges of the Tax
Court invalidated the regulation as a paradigmatic
example of arbitrary and capricious decisionmaking.
On appeal, the IRS recognized that it could not
prevail based on the settled legal standard and the administrative record. So it made a new statutory argument – one it had never advanced in the rulemaking.
A divided panel of the Ninth Circuit not only accepted
(1)
2
that new rationale, but gave it Chevron deference –
without ever solving the fundamental problems identified by the Tax Court.
The government and the Ninth Circuit did not follow the basic rules of administrative law set out by
this Court. Those rules exist for good reason. An
agency must give interested parties fair notice and an
opportunity to comment on a proposed rule, to ensure
that regulated entities understand their legal obligations, and to produce a rule that reflects the collective
expertise of industry participants. See Motor Vehicle
Mfrs. Ass’n of the U.S., Inc. v. State Farm Mut. Auto.
Ins., 463 U.S. 29, 46-57 (1983). If the agency wants to
change its longstanding position, it must acknowledge
and explain the change. Encino Motorcars, LLC v.
Navarro, 136 S. Ct. 2117, 2125-2126 (2016). A reviewing court “must judge the propriety of [agency] action
solely by the grounds invoked by the agency.” SEC v.
Chenery Corp., 332 U.S. 194, 196 (1947). And when a
regulation is arbitrary and capricious, a reviewing
court cannot ignore the rule’s problems and “fix” the
rule by giving a new agency interpretation Chevron
deference. See Judulang v. Holder, 565 U.S. 42, 52 &
n.7 (2011).
The Ninth Circuit’s decision to ignore the settled
rules applicable to administrative agencies will have
serious consequences if uncorrected. The government
is seeking to impose billions of dollars in taxes on companies across the United States based on a position it
made up in litigation. The government’s new position
reflects a dramatic departure from its decades-long
approach to cost sharing and upends many companies’
research-and-development agreements. The destabilizing effects of the Ninth Circuit’s decision go well beyond the particular tax issue here, because the decision upsets settled principles of tax law embodied in
3
domestic law and in virtually all tax treaties with foreign nations. More broadly, the Ninth Circuit’s dramatic expansion of Chevron paves the way for other
administrative agencies to ignore the Administrative
Procedure Act (APA), 5 U.S.C. 551 et seq., and evade
meaningful judicial review.
The government’s bait-and-switch is indefensible.
The Ninth Circuit’s errors are glaring, and the issues
are exceptionally important. This Court should grant
certiorari.
OPINIONS BELOW
The opinion of the court of appeals (App., infra, 1a78a) is reported at 926 F.3d 1061. The opinion of the
Tax Court (App., infra, 79a-139a) is reported at 145
T.C. 91.
JURISDICTION
The judgment of the court of appeals was entered
on June 7, 2019. A timely petition for rehearing was
denied on November 12, 2019 (App., infra, 140a). The
jurisdiction of this Court is invoked under 28 U.S.C.
1254(1).
STATUTORY AND REGULATORY
PROVISIONS INVOLVED
Pertinent statutes and regulations are reprinted in
the appendix to this petition. App., infra, 168a-194a.
STATEMENT
A. Multinational Companies’ Use Of Cost-Sharing Agreements
Petitioner Altera Corporation was the U.S. parent
company of a group of companies that made programmable logic devices (electronic components used to
build circuits) and related hardware and software.
App., infra, 18a-19a, 82a-83a. Altera entered into
4
agreements with one of its foreign subsidiaries to
work together to develop intangible property. Ibid.
Under those agreements, the two companies would
share research-and-development costs, and each
would have rights in the property created. Ibid.
Agreements like that are common. Both related
and unrelated companies routinely enter into them to
share the costs and the risks of a new venture. IRS,
APA Training: Cost Sharing 5 (Oct. 15, 2001), https://
perma.cc/3Q5W-TYHY. If the venture is successful,
each company can use the jointly developed intellectual property without paying a royalty. Id. at 4. The
IRS has long recognized and encouraged the use of
these cost-sharing arrangements. See IRS, Notice 88123, A Study of Intercompany Pricing Under Section
482 of the Code, 1988-2 C.B. 458, 493 (White Paper).
B. Tax Treatment Of Related-Company Transactions And The Arm’s-Length Standard
1. This case concerns the federal tax treatment of
cost-sharing agreements between commonly controlled companies, such as a parent and subsidiary.
Those agreements create taxable income when one
company reimburses the other for its share of the
costs.
Federal tax law provides a straightforward way to
determine whether related companies must share a
cost: Whether the government can require related
companies to share a cost depends on whether unrelated companies would do so. That comes from the Internal Revenue Code itself. The Code authorizes the
Secretary of the Treasury to allocate income, deductions, credits, or allowances between related organizations “clearly to reflect the income” of each organization. 26 U.S.C. 482. “[C]learly to reflect the income”
reflects the tax parity principle – the principle that
5
related parties should be treated the same as unrelated parties for tax purposes. Commissioner v. First
Sec. Bank of Utah, N.A., 405 U.S. 394, 400 (1972); see
26 C.F.R. 1.482-1(a)(1) (defining tax parity).
The arm’s-length standard is the method used to
ensure tax parity. Treasury regulations require the
Commissioner to use the arm’s-length standard “in
every case” under Section 482. 26 C.F.R. 1.4821(b)(1). The regulations specify how that standard
works: Look to “the results of comparable transactions under comparable circumstances” – meaning
how unrelated parties actually behave. 26 C.F.R.
1.482-1(b)(1) and (c). That empirical analysis of unrelated-party behavior is “essentially and intensely factual.” Procacci v. Commissioner, 94 T.C. 397, 412
(1990).
2. The arm’s-length standard has been a settled
feature of federal tax law for nearly a century. The
Internal Revenue Code has included the tax parity
principle since 1928. Revenue Act of 1928, Pub. L. No.
70-562, § 45, 45 Stat. 791, 806. Since 1935, Treasury
regulations have required the Commissioner to use
the arm’s-length standard “in every case” to ensure
tax parity under the statute. Treas. Reg. 86, art. 451(b) (1935). And tax regulations have for decades applied the arm’s-length standard to cost-sharing arrangements. See 26 C.F.R. 1.482-2(d)(4) (1968).
The United States has incorporated the arm’slength standard into tax treaties for at least 80 years.
See, e.g., Convention Concerning Double Taxation,
Fr.-U.S., art. IV, Apr. 27, 1932, 49 Stat. 3145, 31453146 (1935); see also App., infra, 85a-86a. As a result,
the arm’s-length standard is the “international norm”
for determining the tax treatment of related-company
transactions. White Paper 475. The standard pro-
6
vides certainty about how to measure income and prevents double taxation when related companies operate in different jurisdictions. Ibid.
C. The Treasury Department’s Regulation On
Stock-Based Compensation
1. The question here is whether the government
can require related companies that have agreed to
share research-and-development costs to share stockbased compensation that one company pays to its employees.
In the 1990s, as stock options and other forms of
stock-based compensation became more common, the
Treasury Department decided to require related parties to treat stock-based compensation as a shared
cost. App., infra, 16a-17a. The problem for the government is that unrelated companies that enter into
joint research-and-development ventures do not treat
stock-based compensation as a shared cost. Id. at 34a.
That is because stock-based compensation is speculative, difficult to value, and dependent on factors outside the issuing company’s control. Id. at 133a; see
Wisconsin Cent. Ltd. v. United States, 138 S. Ct. 2067,
2070-2071 (2018) (explaining how stock options are
not like money). So the actual evidence of arm’slength transactions in the real world contradicts the
government’s position.
In 1995, the Treasury Department promulgated a
regulation requiring related taxpayers to share “all of
the costs” of developing intangible property, 26 C.F.R.
1.482-7(d)(1) (1995), and it interpreted “all of the
costs” to include stock-based compensation, Xilinx Inc.
v. Commissioner, 125 T.C. 37, 52 (2005), aff ’d, 598
F.3d 1191 (9th Cir. 2010).
7
The Tax Court rejected that interpretation, explaining that the government could not require related companies to share stock-based compensation
when it “presented no evidence or testimony” showing
that unrelated companies would do so. Xilinx, 125
T.C. at 54. The Ninth Circuit affirmed. 598 F.3d at
1197.
2. In 2003, the Treasury Department issued a new
cost-sharing regulation – the regulation at issue here.
That regulation expressly requires related parties
that enter into cost-sharing agreements to share
stock-based compensation. See 26 C.F.R. 1.4827(d)(2) (2003) (now numbered 26 C.F.R. 1.4827A(d)(2)) (operating expenses “include all costs attributable to compensation, including stock-based
compensation”); see also 26 C.F.R. 1.482-7(d)(1) (2003)
(requiring related parties in a cost-sharing agreement
to share all operating expenses).
In the notice of proposed rulemaking, the government asserted that the new rule would satisfy the
arm’s-length standard. App., infra, 210a. But industry groups, accounting firms, and tax experts disagreed. Id. at 229a. They provided overwhelming, undisputed evidence that unrelated parties do not share
stock-based compensation in any kind of transaction,
including in comparable research-and-development
agreements. Id. at 98a-101a; see id. at 229a-231a.
That evidence included examples of agreements in
which unrelated companies did not share stock-based
compensation costs, App., infra, 99a-100a, 230a-232a;
results of surveys and SEC queries reporting no such
agreements, id. at 99a; statements from tax professionals that they knew of no such agreements, id. at
99a, 101a; federal government contracting regulations
that prohibit treating stock-based compensation as a
cost in cost-plus contracts, id. at 100a-101a, 229a-
8
230a; and detailed economic analyses explaining why
unrelated parties do not share stock-based compensation costs, id. at 101a.
In the final rule, the government dismissed all of
that evidence. App., infra, 229a-234a. It disregarded
the examples of arm’s-length transactions provided by
the commentators as insufficiently comparable. Id. at
231a. Instead of providing its own evidence, the government relied on its “belie[f ]” that unrelated parties
would share stock-based compensation costs, and on a
hypothetical comparable transaction the agency made
up to support its belief. Id. at 230a, 232a-233a.
The government never said that it was abandoning
the arm’s-length standard or adopting a new approach
to cost-sharing. Instead, it claimed that requiring related companies to share stock-based compensation
“is consistent with the arm’s length standard.” App.,
infra, 234a-235a, 238a, 246a; see id. at 228a (agency’s
statement that it was applying “established principles
under section 482”).
The IRS applied its new regulation to petitioners
and issued notices of deficiency for 2004 through 2007.
App., infra, 20a. Petitioners challenged those determinations in the Tax Court. Ibid.; see 26 U.S.C.
6213(a) (Tax Court’s jurisdiction).
D. The Tax Court’s Decision
In a 15-0 decision, the Tax Court invalidated the
regulation as arbitrary and capricious and therefore
invalid under the APA. App., infra, 79a-139a. The
Tax Court observed that the relevant statute and regulations require the government to use the arm’slength standard. Id. at 117a-118a. The court concluded that the government failed to justify its regulation under that standard, because the government
9
did not provide “any evidence of any actual transaction between unrelated parties” in which stock-based
compensation was shared, or any “expert opinions,
empirical data, or published or unpublished articles,
papers, surveys, or reports” supporting its view. Id.
at 102a-103a.
In fact, the Tax Court found that all the evidence
in the administrative record supported the opposite
view. App., infra, 135a-136a. When faced with that
evidence, the government simply ignored or discounted it, and failed to “meaningfully respond to numerous relevant and significant comments.” Id. at
130a-135a. The Tax Court emphasized that the
agency based its rule on its own “belief,” rather than
on any relevant experience or technical expertise. Id.
at 127a.
The Tax Court concluded that the government’s
“ipse dixit conclusion, coupled with its failure to respond to contrary arguments resting on solid data,
epitomize[d] arbitrary and capricious decisionmaking.” App., infra, 139a (internal quotation marks
omitted); see id. at 138a (concluding that “the final
rule fails to satisfy State Farm’s reasoned decisionmaking standard and therefore is invalid”). All
fifteen Tax Court judges understood the agency to be
using the settled arm’s-length standard; not one judge
read the regulation to dispense with that standard.
See id. at 118a-119a (“[T]he preamble to the final rule
does not justify the final rule on the basis of any modification or abandonment of the arm’s-length standard.”).
E. The Ninth Circuit’s Decision
1. On appeal, the IRS changed position. Rather
than attempt to justify the regulation under the settled arm’s-length standard, the IRS claimed that the
10
regulation had “changed the legal landscape” so that
now “comparability analysis plays no role in determining” what costs must be shared. IRS C.A. Br. 30.
The IRS asserted that a different part of the underlying statute allows it to make its own “internal” judgment about what would be an “arm’s length result,”
without consideration of what unrelated parties actually do in the real world. Id. at 50.1
That different part of the statute addresses how to
value transfers of intangible property from one related entity to another. It provides: “In the case of
any transfer (or license) of intangible property,” an organization’s “income with respect to such transfer or
license shall be commensurate with the income attributable to” that property. 26 U.S.C. 482. That language does not apply here; it is limited to transfers
and licenses of existing intangible property, and only
when there are no comparable transactions. App., infra, 52a-54a (O’Malley, J., dissenting).
The IRS previously had acknowledged that this
language was not intended to override the settled
arm’s-length standard. White Paper 475 & n.149 (concluding that Congress “intended no departure from
the arm’s length standard” when it enacted the “commensurate with the income” language). And in the final rulemaking, the Treasury Department stated that
the “commensurate with the income” language was
“consistent with the arm’s length standard.” App., infra, 230a (emphasis added).
Nonetheless, the IRS told the court of appeals that
the “commensurate with the income” language permits it to abandon the settled arm’s-length standard
The IRS suggested this argument to the Tax Court, IRS T.C.
Partial Summ. J. Mem. 41, but the Tax Court declined to consider it because it was not the basis for the rule, App., infra, 122a.
1
11
and make up a new way of deciding whether stockbased compensation costs should be shared. IRS C.A.
Br. 49-50. The IRS’s new rationale appeared nowhere
in the rulemaking record. If it had, many industry
groups, tax professionals, and other interested parties
would have had a chance to respond, and undoubtedly
would have explained the many problems that would
follow from abandoning the settled arm’s-length
standard.
2. A divided panel of the court of appeals accepted
the IRS’s argument. See App., infra, 262a-322a.
Judge Reinhardt was a member of the panel majority,
and the opinion was issued after his death. Id. at 262a
n.*; see Yovino v. Rizo, 139 S. Ct. 706, 707 n.* (2019)
(per curiam). The court withdrew the opinion and reheard the case with a new judge. App., infra, 323a.
3. The new panel of the court of appeals again reversed, again over a dissent. App., infra, 1a-78a. The
panel majority first asked (id. at 23a) whether the
IRS’s new interpretation of the statute was “permissible” under Chevron, U.S.A., Inc. v. Natural Resource
Defense Council, Inc., 467 U.S. 837 (1984) – even
though that interpretation had been raised for the
first time in litigation, and even though the Tax Court
had found the regulation procedurally defective and
therefore ineligible for Chevron deference.
Relying on the “commensurate with the income”
language and its own view of the statute’s “purpose,”
the panel accepted the IRS’s new interpretation.
App., infra, 25a-29a. The panel concluded that it was
“reasonable” for the IRS to ignore all evidence of what
unrelated parties do and use its own “purely internal
methodology” instead. Id. at 36a-37a.
12
After applying Chevron deference, the panel decided that the regulation was not arbitrary or capricious. It took the view that the passing “citations to
legislative history” of the “commensurate with the income” language gave sufficient notice during the rulemaking that the agency was “do[ing] away with analysis of comparable transactions.” App., infra, 36a37a. The panel also concluded that because the
agency abandoned the settled standard, it was not required to respond to the many comments about how
its rule does not meet that standard. Ibid. That is,
the panel used its Chevron analysis to excuse the
problems the Tax Court found with the regulation. Id.
at 37a.
In dissent, Judge O’Malley explained that the
panel violated foundational principles of administrative law by upholding the regulation on a “justification
[the agency] never provided” during the rulemaking
process. App., infra, 48a. She agreed with the Tax
Court that the regulation is arbitrary and capricious,
id. at 58a-67a, and explained that a court cannot save
an invalid regulation by giving it Chevron deference,
especially using an argument made for the first time
in litigation, id. at 70a, 75a.
4. The court of appeals denied rehearing en banc.
App., infra, 146a. Ten judges recused themselves.
Ibid.
Judge Milan Smith dissented, joined by Judges
Callahan and Bade. App., infra, 146a-167a. He explained that “[t]he APA does not allow an agency to
reclassify the reasoning it articulated to the public as
‘extraneous observations,’ ignore public comments
pointing out the failures in such reasoning, and then
defend its rule in litigation using reasoning the public
never had notice of.” Id. at 159a (citation omitted).
13
Like all fifteen Tax Court judges, Judge Smith and
the other dissenting judges described the agency’s actions in this case as “the epitome of arbitrary and capricious rulemaking,” App., infra, 146a, because the
agency said it was applying the “traditional arm’s
length standard,” yet “made no attempt to search for
evidence supporting its conclusion” and ignored the
record evidence that contradicted its view, id. at 156a157a. The agency’s rule cannot be resurrected using
Chevron deference, Judge Smith explained, both because the rule is procedurally invalid, and because the
agency’s interpretation was nothing more than a “convenient litigating position.” Id. at 158a-159a, 161a163a. And Judge Smith expressed concern about the
many “deleterious practical consequences” of the
panel’s decision, including that it “tramples on the
longstanding reliance interests of American businesses”; upsets domestic tax law; and calls into question many international treaties that incorporate the
arm’s-length standard. Id. at 164a-166a.
REASONS FOR GRANTING THE PETITION
The Treasury Department and the IRS violated
fundamental rules of administrative law in their rush
to fill the federal coffers. The Ninth Circuit made it
worse by expanding Chevron to defer to an interpretation offered for the first time in litigation and uphold
a procedurally invalid rule. The Ninth Circuit’s refusal to follow settled rules of administrative law, and
its new and expansive interpretation of Chevron, warrant this Court’s review.
If uncorrected, the Ninth Circuit’s decision will
have real and significant consequences. This is a paradigmatic case of agency overreaching that cries out
for this Court’s review. Nineteen federal judges described the agency’s actions here as the “epitome of
14
arbitrary and capricious rulemaking.” App., infra,
146a (Smith, J., dissenting from denial of rehearing);
id. at 49a (O’Malley, J., dissenting), id. at 139a (Tax
Court).
The underlying federal tax issue about stock-based
compensation is enormously important. It affects
many companies across the United States, with billions of dollars at stake. The agency’s decision to
abandon the arm’s-length standard in this context upsets domestic law and the settled expectations of the
United States’ treaty partners. The issues have been
fully vetted and are ready for this Court’s review. The
Court should grant certiorari now.
A. The Ninth Circuit’s Decision Violates Bedrock Principles Of Administrative Law
The Ninth Circuit committed three serious errors
that warrant this Court’s intervention. First, that
court upheld an arbitrary and capricious regulation
that is invalid under the APA. Second, the court upheld the regulation based on a rationale the agency
developed for the first time in litigation. Third, the
court tried to solve both of those problems through an
unwarranted expansion of Chevron. This Court
should grant certiorari to enforce the settled limits on
administrative agency action and stop the further expansion of Chevron. See Sup. Ct. R. 10(a) and (c).
1. The Ninth Circuit upheld an arbitrary
and capricious regulation
The Ninth Circuit exempted the Treasury Department and the IRS from the basic rules applicable to
administrative agency rulemaking, in violation of Motor Vehicle Manufacturers Association of the United
States, Inc. v. State Farm Mutual Automobile Insurance, 463 U.S. 29 (1983).
15
The APA mandates notice-and-comment rulemaking for regulations that have the force of law so that
regulated parties have “fair notice” and can provide
input to help the agency develop a well-reasoned,
workable rule. See Azar v. Allina Health Servs., 139
S. Ct. 1804, 1816 (2019); Long Island Care at Home,
Ltd. v. Coke, 551 U.S. 158, 174 (2007); see also 5
U.S.C. 553(b) and (c). The APA requires agencies to
give reasoned explanations for their decisions in the
rulemaking process “to ensure that [they] offer genuine justifications for important decisions, reasons that
can be scrutinized by courts and the interested public.” Department of Commerce v. New York, 139 S. Ct.
2551, 2575-2576 (2019). Those rules apply to the
Treasury Department and the IRS just as they apply
to every other administrative agency. See Mayo
Found. for Med. Educ. & Research v. United States,
562 U.S. 44, 55 (2011) (refusing to “carve out an approach to administrative review good for tax law
only”).
Throughout the rulemaking proceeding here, everyone understood that the settled arm’s-length standard applied. As a result, the agency could require related parties to share stock-based compensation only
if evidence established that unrelated parties operating at arm’s length would do so. The Treasury Department purported to apply the arm’s-length standard, and it stated that whether that standard is satisfied depends on an empirical and factual analysis of
real-world behavior of unrelated parties. See App., infra, 231a, 234a; see also id. at 225a-261a (mentioning
the arm’s-length standard 33 times).
Accounting firms, organizations of tax professionals, industry groups, and other experts took the government at its word. They provided extensive evidence demonstrating that unrelated parties would not
16
share stock-based compensation, including examples
of arm’s-length joint-development agreements in
which parties did not share it; surveys of their members and searches of databases finding no agreements
in which parties shared it; and model accounting procedures and federal government regulations prohibiting that sharing. App., infra, 99a-101a. The government did not question the accuracy or credibility of
any of that evidence. Id. at 135a. Instead, the government ignored or dismissed that evidence because
it was inconvenient. Id. at 134a-135a. The government had no empirical evidence of its own, so it cited
its own “belie[f ] ” and a hypothetical comparable
transaction. Id. at 232a-233a.
After examining the record, the Tax Court unanimously and correctly concluded that the regulation
“epitomizes arbitrary and capricious decisionmaking.”
App., infra, 139a (internal quotation marks omitted).
The Tax Court explained that the agency did not provide facts to support its view or respond to significant
comments, and the agency’s conclusion was “contrary
to all of the evidence before it.” Id. at 138a; see id. at
157a (Smith, J., dissenting from denial of rehearing)
(agency’s “stated reasons” for its rule were “belied by
the evidence”; “no empirical data support[ed] [its] conclusion”; and it “made no attempt to search for evidence supporting its conclusion”). That should have
“be[en] the end of [the] analysis,” id. at 157a (Smith,
J., dissenting from denial of rehearing), because the
APA requires a reviewing court to set aside a regulation that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law,” 5
U.S.C. 706(2)(A). Instead, the Ninth Circuit used
Chevron deference to give the agency the green light
to assess billions of dollars in taxes based on a rule
that flunks the APA.
17
2. The Ninth Circuit upheld the regulation
on a rationale advanced for the first time
in litigation
Rather than review the agency’s regulation on the
rulemaking record, the Ninth Circuit upheld the regulation on a new rationale that the government advanced for the first time in litigation, in violation of
SEC v. Chenery Corp., 332 U.S. 194 (1947).
After the IRS lost in the Tax Court, it abandoned
its longstanding position that it must satisfy the
arm’s-length standard. The government did not
“meaningfully dispute the Tax Court’s determination
that [its] analysis under the arm’s length standard
was inadequate and unsupported.” App., infra, 63a
(O’Malley, J., dissenting). Instead, it attempted to
achieve its desired result by interpreting the “commensurate with the income” language to allow it to
adopt its own “purely internal” rule. IRS C.A. Br. 4852. The government claimed that under its new interpretation, “comparability analysis plays no role in determining” what costs must be shared. Id. at 30.
No one involved in the rulemaking understood the
agency to be abandoning the settled arm’s-length
standard and interpreting “commensurate with the
income” to justify a new and different standard. As
the Tax Court explained, the government “d[id] not
justify the final rule on the basis of any modification
or abandonment of the arm’s-length standard.” App.,
infra, 118a-119a. Instead, the government purported
to use the arm’s-length standard, calling it an “established principle[]” of tax law. Id. at 228a. The final
rule mentioned the “commensurate with the income”
language only once, and only to reaffirm that it is “consistent with the arm’s length standard.” Id. at 230a.
18
The Ninth Circuit recognized that the agency
never articulated its new interpretation in the rulemaking record. App., infra, 46a. The best that court
could do is claim that the agency’s “citations to legislative history” made it “clear enough” that the Treasury Department had decided “to do away with analysis of comparable transactions.” Id. at 36a. But that
unsupported assertion is belied by the utter absence
of comments on the subject from the affected companies, tax professionals, and others who commented extensively on the proposed regulation. Tellingly, not
one of the fifteen Tax Court judges – experts who
closely analyzed the rulemaking record – understood
that record to reveal a proposal to change the settled
arm’s-length standard. See id. at 118a-119a.
If the agency wanted to change its longstanding
position, it was required to expressly acknowledge
and explain that change. See Encino Motorcars, LLC
v. Navarro, 136 S. Ct. 2117, 2125-2126 (2016); FCC v.
Fox Television Stations, Inc., 556 U.S. 502, 515 (2009);
State Farm, 463 U.S. at 42. Here, the agency did nothing of the sort, depriving the regulated community
and other interested parties of the notice required by
the APA and this Court’s precedents. See Coke, 551
U.S. at 174; National Lifeline Ass’n v. FCC, 921 F.3d
1102, 1115 (D.C. Cir. 2019). If the agency had provided the required notice, the regulated community no
doubt would have submitted extensive comments addressing the proposed change. See Chisom v. Roemer,
501 U.S. 380, 396 n.23 (1991).
As a result, the only way the court of appeals could
uphold the rule was by accepting the IRS’s “convenient litigating position” that “it permissibly jettisoned
the traditional arm’s length standard altogether.”
App., infra, 159a (Smith, J., dissenting from denial of
19
rehearing). The problem, of course, is that a reviewing court “must judge the propriety of [the agency’s]
action solely by the grounds invoked by the agency” in
the administrative record. Chenery, 332 U.S. at 196;
see, e.g., Michigan v. EPA, 135 S. Ct. 2699, 2710
(2015) (noting “the foundational principle of administrative law that a court may uphold agency action only
on the grounds that the agency invoked when it took
the action”); State Farm, 463 U.S. at 50 (explaining
that “an agency’s action must be upheld, if at all, on
the basis articulated by the agency itself ”). That rule
ensures that an agency cannot say one thing in a rulemaking proceeding, and then change its mind as soon
as the rule is challenged in court – just what the
agency did here.
3. The Ninth Circuit impermissibly expanded Chevron to attempt to solve those
problems
It would have been bad enough if the Ninth Circuit
merely had overlooked the problems identified by the
Tax Court, or upheld the regulation on a new rationale not advanced during rulemaking. But the
Ninth Circuit went a step further, using the Chevron
deference doctrine to paper over the serious problems
with the regulation – problems that precluded the
court from applying Chevron in the first place.
Chevron is a limited doctrine, authorizing courts to
defer to an agency’s reasonable interpretation of a
statute Congress has authorized it to administer,
when the agency has set out that interpretation
through notice-and-comment rulemaking or a formal
adjudication. Chevron, U.S.A., Inc. v. Natural Res.
Def. Council, Inc., 467 U.S. 837, 844 (1984); see Encino
Motorcars, LLC, 136 S. Ct. at 2125. The Ninth Circuit’s decision expands Chevron beyond its breaking
point.
20
a. The Ninth Circuit began its legal analysis with
Chevron, asking whether the agency’s ultimate choice
to “do away with” the settled arm’s-length standard
was a “reasonable” one. App., infra, 22a-23a, 26a,
36a. But the Tax Court had invalidated the regulation under the APA’s reasoned-decisionmaking standard because the agency failed to support its rule with
facts, failed to explain its conclusions, and failed to account for contrary evidence in the rulemaking record.
Id. at 138a-139a.
A court cannot grant Chevron deference to a regulation that is “procedurally defective” because, for example, it failed to satisfy the reasoned-decisionmaking standard. Encino Motorcars, LLC, 136 S. Ct. at
2125. That is because a regulation invalidated under
the APA “cannot carry the force of law,” and so there
is nothing to which a court can defer. Id. at 2126. If
the rule were otherwise, the requirements of the APA
would be meaningless. This Court made just that
point in Judulang v. Holder, 565 U.S. 42 (2011), when
it rejected the government’s invitation to uphold an
immigration regulation under Chevron, id. at 52 n.7.
The Court explained that the regulation was arbitrary
and capricious and therefore necessarily failed the
second step of Chevron. Ibid.; see App., infra, 138a
n.29 (Tax Court made the same point in this case).
The Ninth Circuit eventually addressed whether
the Treasury Department’s regulation complies with
the APA. App., infra, 32a-38a. But it did not independently analyze that issue. Instead, it reasoned
that because the government’s new rationale was a
“permissible” one under Chevron, id. at 29a, the rulemaking proceeding became irrelevant. The government did not have to address the comments about how
the rule failed to satisfy the arm’s-length standard,
the court stated, because the government decided to
21
“do away with analysis of comparable transactions.”
Id. at 36a. The Ninth Circuit only concluded that the
APA was satisfied because it already had decided that
the IRS’s new view was an acceptable interpretation
of the statute. By upholding the regulation under
Chevron, the court retroactively excused the agency’s
failure to justify the regulation under the standard
the agency itself claimed to apply.
b. The Ninth Circuit also seriously erred in giving
Chevron deference to an agency interpretation offered
for the first time in litigation. Chevron deference is
available when an agency “proceed[s] through noticeand-comment rulemaking” because that “relatively
formal administrative procedure is a very good indicator that Congress intended the regulation to carry the
force of law.” Encino Motorcars, LLC, 136 S. Ct. at
2125 (internal quotation marks omitted). Deference
to an agency’s “litigating position” is “entirely inappropriate,” Bowen v. Georgetown Univ. Hosp., 488
U.S. 204, 212-213 (1988), because the agency’s formulation of its litigating position has none of the protections or benefits of the notice-and-comment process.
Nevertheless, the Ninth Circuit here used Chevron to
excuse any Chenery problem, on the ground that the
agency’s new rationale was “permissible” and therefore deserving of deference. App., infra, 29a; see id. at
38a.
The Ninth Circuit’s decision stands in clear contrast to decisions from other circuits, none of which
allows an agency to give Chevron deference to an
agency interpretation presented for the first time in
litigation. See, e.g., Comsat Corp. v. FCC, 250 F.3d
931, 938 n.7 (5th Cir. 2001); America’s Cmty. Bankers
v. FDIC, 200 F.3d 822, 825 (D.C. Cir. 2000); American
Trucking Ass’ns v. Federal Highway Admin., 51 F.3d
405, 411 (4th Cir. 1995). That consensus makes sense,
22
because when an agency violates Chenery, it deprives
the regulated parties of the fair notice required before
a court can defer to an agency’s interpretation. See
Kisor v. Wilkie, 139 S. Ct. 2400, 2417-2418 (2019) (“[A]
court may not defer to a new interpretation, whether
or not introduced in litigation, that creates unfair surprise to regulated parties.” (internal quotation marks
omitted)).
Because the agency’s new interpretation could not
be discerned from the final rule, the new interpretation escaped meaningful judicial scrutiny. See State
Farm, 463 U.S. at 43. The Tax Court never considered
whether “Treasury would be free to modify or abandon
the arm’s-length standard” because “it ha[d] not done
so” in the rulemaking proceeding. App., infra, 119a.
The court of appeals simply made up arguments in
support of the agency’s new interpretation, relying on
its own view of the statute’s purposes and some misunderstood snippets of legislative history. Id. at 26a29a; see id. at 67a (O’Malley, J., dissenting) (the IRS
urged the court of appeals to “recreate the record” and
interpret the statute “in a way it never asked the Tax
Court to do in order to supply a post-hoc justification
for its decisionmaking”).
The Ninth Circuit’s expansive application of Chevron warrants this Court’s plenary review. In the alternative, the Court should summarily reverse the
Ninth Circuit’s decision based on the settled legal
principles described above.
B. This Case Is Exceptionally Important
This case has garnered substantial media attention because of the importance of the issues involved.2
See, e.g., Natalie Olivo, Admin. Law Could Pave Way for High
Court Tax Regs Fight, Law360 (Nov. 15, 2019), https://perma.cc/
2
23
The many serious legal and practical consequences of
the Ninth Circuit’s decision justify this Court’s review.
1. This an egregious case of administrative
agency overreaching
Several Justices of this Court have expressed concern about the broad, often unchecked power of administrative agencies. See, e.g., Kisor, 139 S. Ct. at
2423 (noting the “far-reaching influence of agencies
and the opportunities such power carries for abuse”);
Free Enter. Fund v. Public Co. Accounting Oversight
Bd., 561 U.S. 477, 499 (2010) (noting that administrative agencies “wield[] vast power and touch[] almost
every aspect of daily life”); City of Arlington v. FCC,
569 U.S. 290, 315 (2013) (Roberts, C.J., dissenting)
(“[T]he danger posed by the growing power of the administrative state cannot be dismissed.”).
This case vividly illustrates just how far an agency
will go if left unchecked. The IRS is seeking to impose
tax liability essentially by administrative fiat, rather
than though any formal agency action. When the Tax
Court appropriately invalidated the Treasury Department’s regulation as arbitrary and capricious, the
agency ignored the Tax Court’s concerns and proposed
LXL3-PLUP; Richard Rubin & Theo Francis, Yearslong Tax Dispute Could Cost Big Tech Companies Billions, Wall Street J.
(Sept. 3, 2019), https://perma.cc/N6XL-Y5KM; Sony Kassam,
IRS’s Renewed Focus on Cost-Sharing May Prompt New Tax Disputes, Bloomberg Tax (Aug. 6, 2019), https://perma.cc/G7764G6Q; Carolina Vargas & Siri Bulusu, 2019 Outlook: Four Legal
Issues Tax Attorneys Are Watching, Bloomberg Tax (Dec. 31,
2018), https://perma.cc/7NKY-ZYLX; Peter J. Reilly, Ninth Circuit Pulls Back Big IRS Victory Issued After Judge’s Death,
Forbes (Aug. 7, 2018), https://perma.cc/K6XS-7H4L; Natalie
Olivo, International Tax Cases to Watch in 2018, Law360 (Jan.
2, 2018), https://perma.cc/7TN5-8DJ8.
24
a new rationale to the Ninth Circuit, hoping the Ninth
Circuit would bite – and the Ninth Circuit did.
If ever the government should have played by the
rules, it is in this case. The tax issue affects companies across the United States, and vast sums of money
are at stake. The companies and tax professionals affected by the regulation took the Treasury Department at its word in the rulemaking process – then
were blindsided by the government’s about-face in litigation. That is a reckless way to make any rule, and
it is a particularly reckless way to proceed when an
agency is effecting a wholesale “change[] [in] the legal
landscape” (IRS C.A. Br. 30) in order to charge billions
more in taxes. The IRS cannot say one thing in rulemaking and another in litigation. The days of tax exceptionalism are gone; the IRS must play by the same
rules as everyone else. See Mayo, 562 U.S. at 55.
This case is particularly troubling because of the
Ninth Circuit’s extravagant interpretation of Chevron. The Ninth Circuit used Chevron to legitimize a
new interpretation presented for the first time in litigation, even though it was directly contrary to the
agency’s rationale in the rulemaking record. And the
Ninth Circuit used Chevron to retroactively excuse serious failures in the administrative process.
Several Justices have questioned the continuing
vitality of the Chevron doctrine. E.g., Kisor, 139 S. Ct.
at 2446 n.114 (Gorsuch, J., concurring); PDR Network,
LLC v. Carlton & Harris Chiropractic, Inc., 139 S. Ct.
2051, 2057 (2019) (Thomas, J., concurring). The
Ninth Circuit’s decision takes Chevron well beyond its
original scope, to become a cure-all for any agency
woes. This Court should not allow the Ninth Circuit’s
decision to go unchecked, paving the way for other administrative agencies to evade the requirements of notice-and-comment rulemaking and judicial review and
25
further expanding the “vast power” of the administrative state. Free Enter. Fund, 561 U.S. at 499.
2. This issue affects a large number of companies across the U.S. economy
Whether related parties must share stock-based
compensation is an important and recurring issue.
Multinational companies often use cost-sharing
agreements when parents and subsidiaries work together to develop intangible property. E.g., Aysha
Bagchi, Google, Facebook, Apple Weigh in on Altera
Tax Case, Bloomberg Tax (Aug. 2, 2019), https://
perma.cc/QAM8-ESXA. Many of those companies
grant their employees stock options or some other
form of stock-based compensation (a term the regulation defines very broadly, to include any compensation
in the form of stock, stock options, or other forms of
equity, see 26 C.F.R. 1.482-7(d)(2) (2003)).
In public filings with the SEC, over 80 companies
have disclosed that the outcome of this case may materially affect their financial statements. See App., infra, 324a-330a; see also 17 C.F.R. 229.303(a)(3)(i) and
(ii) (requirement to report on issues that companies
“reasonably expect[]” to “materially affect[]” income).
Those companies span a wide range of industries,
from technology (e.g., Apple, Microsoft) to pharmaceuticals (e.g., Gilead Sciences, McKesson) to apparel
(e.g., Skechers, Stitch Fix) and beyond. This list includes not only household names, but also smaller
companies. E.g., A10 Networks, Inc., Form 10-K at 43
(Mar. 18, 2019) (company that makes network hardware); Anaplan, Inc., Form 10-K at 54 (Mar. 29, 2019)
(company that provides cloud-computing services).
Additional companies have expressed their interest in this matter through court filings. Beyond the
companies mentioned above, 24 companies have
26
stated in amicus filings that the stock-based compensation regulation affects them. See Cisco et al. C.A.
Reh’g Amicus Br. 2 (Cisco Br.); Amazon C.A. Amicus
Br. vi. Further, industry groups representing “companies from virtually every sector of our economy”
have indicated that a wide swath of their members are
“subject to the Treasury regulations at issue.” Nat’l
Ass’n of Mfrs. et al. C.A. Reh’g Amicus Br. 1-2, 18-19
(NAM Br.).
These companies relied on the arm’s-length standard when they entered into cost-sharing agreements.
The Ninth Circuit “trample[d] on [their] reliance interests” when it approved the government’s abandonment of that settled standard for stock-based compensation. App., infra, 146a (Smith, J., dissenting from
denial of rehearing).
3. This issue is worth billions of dollars
The amount of money at stake is enormous. The
Ninth Circuit’s decision will require companies to pay
billions of dollars in additional taxes. See, e.g., Richard Rubin, Google’s Parent Could Be Big Winner in Intel Tax Dispute, Wall Street J. (Feb. 29, 2016), https://
perma.cc/U7GZ-BJGD.
Public SEC filings document the vast sums of
money involved. Although relatively few companies
have publicly quantified the potential impact, those
that have establish that the issue is worth billions of
dollars. Two companies have estimated that the issue
is worth over $1 billion to each of them individually.
See Alphabet Inc., Form 10-K at 78 (Feb. 2, 2017) (reporting $4.4 billion at stake through 2016); Facebook
Inc., Form 10-K at 59 (Jan. 30, 2020) (reporting $1.1
billion at stake through 2019). And fourteen other
companies (including Altera) estimate the impact to
be in the tens of millions of dollars. See App., infra,
27
324a-330a. Some of those estimates are for only specific reporting periods, so the total impact on those
companies is likely much, much larger. E.g., Twitter,
Inc., Form 10-Q at 37 (Oct. 30, 2019) (recording $80
million impact for the first nine months of 2019). And
those estimates necessarily understate the full
amount at stake, because not all of the public companies that have filed disclosures have quantified the financial impact, and many affected companies are private companies that are not required to file SEC disclosures.
Further, those estimates are only for past tax
years. They do not include the future tax amounts,
which will continue to be substantial. Although this
case concerns the 2003 regulation, the Treasury Department promulgated a new cost-sharing regulation
in 2011 with no material changes. See Section 482:
Methods to Determine Taxable Income in Connection
With a Cost Sharing Arrangement, 76 Fed. Reg.
80,082 (Dec. 22, 2011). The 2011 regulation includes
the same rule for stock-based compensation as the
2003 regulation, without offering any new analysis or
evidence. Ibid.; compare 26 C.F.R. 1.482-7(d)(3) (current version), with 26 C.F.R. 1.482-7(d)(2) (2003). So
the stock-based compensation issue will continue to
have great prospective significance.
The “enormous potential liability” here is a “strong
factor” in favor of granting certiorari. Fidelity Fed.
Bank & Tr. v. Kehoe, 547 U.S. 1051, 1051 (2006)
(Scalia, J., joined by Alito, J., concurring in the denial
of certiorari). This Court routinely has granted certiorari in cases with similar financial stakes. For example, this Term the Court granted review of a statutory-interpretation issue worth billions of dollars in
Moda Health Plan, Inc. v. United States, No. 18-1028
(argued Dec. 10, 2019). See Pet. at 33, Moda, supra.
28
And in recent years, the Court has granted certiorari
in several other cases with similar financial impacts.3
The number of companies affected and amount of
money at stake amply justify this Court’s review.
4. This issue will have serious domestic and
international tax consequences
The arm’s-length standard has been a settled feature of tax law for decades. See, e.g., Commissioner v.
First Sec. Bank of Utah, N.A., 405 U.S. 394, 400
(1972). The IRS itself previously conceded that the
arm’s-length standard is “[i]mplicit” in the statute,
IRS C.A. Br. 49-50, and federal regulations still require its use, 26 C.F.R. 1.482-1(b) and (c). Yet the
Ninth Circuit allowed the agency to cast the standard
aside for stock-based compensation. And nothing in
the Ninth Circuit’s decision limits the government’s
abandonment of the arm’s-length standard to the
stock-based compensation context.
U.S. companies “engage annually in trillions of dollars of cross-border intercompany transactions,”
transactions that up to this point incorporated the settled arm’s-length transaction standard. NAM Br. 18;
see Cisco Br. 2. The Ninth Circuit’s decision calls into
question the domestic tax treatment of all of those related-company transactions.
See, e.g., Pet. at 27, 29, Ohio v. American Express Co., 138 S.
Ct. 2274 (2018) (No. 16-1454) (issue affected “22.2 billion transactions on credit cards” each year, which lead to over “$52 billion
in credit-card transaction fees”); EnerNOC Pet. at 32-33, FERC
v. Electric Power Supply Ass’n, 136 S. Ct. 760 (2016) (No. 14-841)
(decision below threatened “billions of dollars” in investments by
private companies and the federal government); Nazarian Pet. at
18, Hughes v. Talen Energy Mktg., LLC, 136 S. Ct. 1288 (2016)
(No. 14-614) (decision below “jeopardize[d] * * * billions in private investment”).
3
29
The potential international tax consequences are
even more serious. The arm’s-length standard is “the
international standard” for allocating income between
related companies. OECD, OECD Transfer Pricing
Guidelines for Multinational Enterprises and Tax Administrations 33 (July 10, 2017), https://perma.cc/
T9NB-L49H (OECD Guidelines). It is “used by all major developed nations.” Barclays Bank PLC v. Franchise Tax Bd. of Cal., 512 U.S. 298, 305 (1994).
Since 1935, the United States has exported the
arm’s-length standard to the rest of the world through
tax treaties. IRS, Notice 88-123, A Study of Intercompany Pricing Under Section 482 of the Code, 1988-2
C.B. 458, 475 (White Paper). The United States includes the arm’s-length standard in its model tax convention, which is “the baseline text the Treasury Department uses when it negotiates tax treaties.” U.S.
Dep’t of the Treas., Treasury Announces Release of
2016 U.S. Model Income Tax Treaty (Feb. 17, 2016),
https://perma.cc/G9R7-B62G; see U.S. Dep’t of the
Treas., United States Model Income Tax Convention,
art. 9 (Feb. 17, 2016), https://perma.cc/GY49-H3ES.
As a result, the arm’s-length standard appears in
almost every U.S. tax treaty. See App., infra, 331a338a (listing 57 U.S. tax treaties that incorporate the
arm’s-length standard).4 The arm’s-length standard
also is incorporated into “most tax treaties to which
the United States is not a party.” White Paper 475.
And it is included in the model tax convention published by the OECD, which represents a “consensus
The IRS’s website lists U.S. tax treaties; all but one (with the
former U.S.S.R.) incorporate the arm’s-length standard. See
IRS, United States Income Tax Treaties – A to Z (last updated
Jan. 8, 2020), https://perma.cc/24AF-LF9W.
4
30
on international taxation principles.” OECD Guidelines 16; see OECD, OECD Model Tax Convention on
Income and on Capital, art. 9 (July 22, 2010),
https://perma.cc/3JW9-N5U3.
The arm’s-length standard fosters certainty and
predictability and prevents double taxation when
multinational companies operate in more than one jurisdiction. OECD Guidelines 38; White Paper 475.
The IRS itself has warned that “[a]ny deviation from
the arm’s length standard would contradict longstanding international norms and would raise substantial concerns among U.S. treaty partners.” IRS,
Report on Application and Administration of Section
482 at 4-12 (1992). In fact, in the preamble to the final
rule here, the agency explained that it was required
to use “the arm’s length standard” to comply with “the
obligations of the United States under its income tax
treaties.” App., infra, 230a.
Although the IRS abandoned that view in this litigation, the Secretary of the Treasury continues to emphasize the importance of the arm’s-length standard
in international negotiations. When a dispute recently arose at the OECD about taxation of digital services, the Secretary urged foreign nations to adhere to
the arm’s-length standard, calling it a “longstanding
pillar[] of the international tax system upon which
U.S. taxpayers rely.” Ltr. from Steven T. Mnuchin,
Sec’y of the Treas., to José Ángel Gurría, Sec’y-Gen.,
OECD 1 (Dec. 3, 2019), https://perma.cc/2SF6-P2UU.
This Court has warned that “depart[ing] from an
interpretation of tax law which has been generally accepted” “could have potentially far-reaching consequences.” United States v. Byrum, 408 U.S. 125, 135
(1972). Here, the Ninth Circuit’s decision threatens
the international consensus on use of the arm’s-length
standard. “If * * * ‘arm’s length’ can be anything one
31
country declares it to be, then there is no way to fairly
resolve disputes [about how to allocate income between related parties] or mitigate double taxation.”
Foreign Tax Officials C.A. Reh’g Amicus Br. 16.
5. The Court should grant certiorari now
This Court should grant review now. The issues
have been fully vetted. The Treasury Department and
the IRS have pursued the stock-based compensation
issue aggressively. Fifteen judges on the Tax Court
and two panels of the court of appeals considered the
issues, and the panel’s ultimate decision prompted a
vehement dissent from three additional judges on the
court of appeals. Many interested parties filed amicus
briefs, providing the court of appeals with a wide variety of perspectives and arguments on the issues. See
Docket, Altera Corp. v. Commissioner, Nos. 16-70496
& 16-70497 (9th Cir.) (sixteen amicus briefs filed in
this case).
The Court should review the Ninth Circuit’s decision rather than waiting for the issue to arise in another circuit. Although the stock-based compensation
issue affects companies throughout the United States,
most of them are in the Ninth Circuit. For example,
of the 82 companies that mention this case in their
public filings, 67 are in the Ninth Circuit. App., infra,
324a-330a. More than $5 billion is at stake just for
Ninth Circuit companies alone. See ibid. If the Court
does not review the Ninth Circuit’s decision, those
companies will be out of luck.
Both the government and taxpayers have treated
this as the definitive case on the validity of the regulation. The IRS put all cases involving stock-based
compensation on hold pending the resolution of this
case. See Mem. from Douglas W. O’Donnell, Comm’r,
Large Business & Int’l Div., IRS, to Large Business &
32
Int’l Div. Examiners 1 (Jan. 12, 2018), https://perma.
cc/J67L-MB4D.5 Many companies are treating this
case as determinative: They have amended their costsharing agreements to provide for sharing of stockbased compensation costs, while also filing protective
refund claims to take advantage of a favorable ruling
in this case. See Amazon.com, Inc. v. Commissioner,
148 T.C. 108, 149 (2017).
Further, there are no cases pending that could
reach another court of appeals anytime soon. That is
because the government and taxpayers are awaiting
final resolution of this case. Accordingly, it could be
years before another court of appeals might consider
the issue. This Court should step in now.
*****
The Ninth Circuit permitted a startling departure
from accepted rules of administrative law, and its expansion of Chevron validates the concerns many Justices have raised about that doctrine. The Tax Court
rejected the agency’s position in an opinion that was
striking for its “uncommon unanimity and severity of
censure,” yet the court of appeals simply “assume[d]
away” the regulation’s problems, “send[ing] a signal
that executive agencies can bypass proper notice-andcomment procedures as long as they come up with a
clever post-hoc rationalization by the time their rules
are litigated.” App., infra, 160a, 165a, 167a (Smith,
J., dissenting from denial of rehearing). It is time for
this Court to step in.
For example, the IRS sought to impose taxes on petitioners for
additional tax years, and the Tax Court stayed those cases pending the outcome of this one. See Order at 1-2, Altera Corp. v.
Commissioner, No. 31538-15 (T.C. Oct. 31, 2016).
5
33
CONCLUSION
The petition for a writ of certiorari should be
granted. In the alternative, the Court should grant
the petition and summarily reverse the decision of the
court of appeals.
Respectfully submitted.
GINGER D. ANDERS
Munger Tolles & Olson LLP
1155 F Street NW
Washington, DC 20004
MARK R. YOHALEM
Munger Tolles & Olson LLP
350 S. Grand Avenue
Los Angeles, CA 90071
NICOLE A. SAHARSKY
Counsel of Record
BRIAN D. NETTER
MINH NGUYEN-DANG
Mayer Brown LLP
1999 K Street NW
Washington, DC 20006
(202) 263-3000
nsaharsky@mayerbrown.com
A. DUANE WEBBER
DONALD M. FALK
PHILLIP J. TAYLOR
Mayer Brown LLP
JOSEPH B. JUDKINS
3000 El Camino Real #300
Baker & McKenzie LLP
Palo Alto, CA 94306
815 Connecticut Avenue NW
Washington, DC 20006
THOMAS KITTLE-KAMP
WILLIAM G. MCGARRITY
Mayer Brown LLP
71 S. Wacker Drive
Chicago, IL 60606
FEBRUARY 2020
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.