Respondents Brief — Altera Corporation & Subsidiaries, Petitioner v. Commissioner of Internal Revenue
Supreme Court briefMay 14, 2020
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No. 19-1009
In the Supreme Court of the United States
ALTERA CORPORATION & SUBSIDIARIES, PETITIONERS
v.
COMMISSIONER OF INTERNAL REVENUE
ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
BRIEF FOR THE RESPONDENT IN OPPOSITION
NOEL J. FRANCISCO
Solicitor General
Counsel of Record
RICHARD E. ZUCKERMAN
Principal Deputy Assistant
Attorney General
FRANCESCA UGOLINI
ARTHUR T. CATTERALL
Attorneys
Department of Justice
Washington, D.C. 20530-0001
SupremeCtBriefs@usdoj.gov
(202) 514-2217
QUESTION PRESENTED
Businesses controlled by common interests, such as
parent and subsidiary corporations, have an incentive to
manipulate the pricing of their internal transactions in
order to minimize tax obligations. Under 26 U.S.C. 482,
the Secretary of the Treasury may reallocate the “gross
income, deductions, credits, or allowances between or
among such * * * businesses,” if he determines that
reallocation is necessary “to prevent evasion of taxes or
clearly to reflect the income of any of such * * * businesses.” Section 482 further provides that, “[i]n the
case of any transfer (or license) of intangible property”
between controlled businesses, “the income with respect to such transfer or license shall be commensurate
with the income attributable to the intangible.” Ibid.
Regulations issued by the Department of the Treasury specify when reallocation under Section 482 will occur if controlled companies enter into agreements to
share the costs of developing intangible property. The
regulations generally require that each controlled company must assume a share of development costs in proportion to that company’s reasonably anticipated benefits from the arrangement. In 2003, the Treasury Department promulgated a final rule to clarify that stockbased employee compensation, like other forms of compensation, must be taken into account in determining
development costs for these purposes. 68 Fed. Reg.
51,171, 51,177-51,179 (Aug. 26, 2003); see 26 C.F.R.
1.482-7(d)(2) (2004). The question presented is as follows:
Whether the court of appeals correctly held that the
Treasury Department’s 2003 final rule was not arbitrary or capricious under the Administrative Procedure
Act, 5 U.S.C. 551 et seq.
(I)
TABLE OF CONTENTS
Page
Opinions below .............................................................................. 1
Jurisdiction .................................................................................... 1
Statement ...................................................................................... 2
Argument..................................................................................... 16
Conclusion ................................................................................... 30
TABLE OF AUTHORITIES
Cases:
Baltimore Gas & Elec. Co. v. Natural Res. Def.
Council, Inc., 462 U.S. 87 (1983) ....................................... 17
Bowman Transp., Inc. v. Arkansas-Best Freight
Sys., Inc., 419 U.S. 281 (1974) ........................................... 17
Chevron U.S.A. Inc. v. Natural Res. Def. Council,
Inc., 467 U.S. 837 (1984) ............................................... 12, 13
Department of Commerce v. New York,
139 S. Ct. 2551 (2019) ......................................................... 17
Encino Motorcars, LLC v. Navarro,
136 S. Ct. 2117 (2016) ......................................................... 17
FCC v. Fox Television Stations, Inc.,
556 U.S. 502 (2009).............................................................. 15
FERC v. Electric Power Supply Ass’n,
136 S. Ct. 760 (2016) ........................................................... 17
Frank v. International Canadian Corp.,
308 F.2d 520 (9th Cir. 1962) ................................................. 3
Mayo Found. for Med. Educ. & Research v. United
States, 562 U.S. 44 (2011) ................................................... 27
Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto.
Ins. Co., 463 U.S. 29 (1983) .............................. 12, 16, 17, 18
National Elec. Mfrs. Ass’n v. United States
Dep’t of Energy, 654 F.3d 496 (4th Cir. 2011) .................. 25
(III)
IV
Cases—Continued:
Page
National R.R. Passenger Corp. v. Boston & Maine
Corp., 503 U.S. 407 (1992) .................................................. 15
SEC v. Chenery Corp., 332 U.S. 194 (1947)............. 15, 23, 25
Xilinx Inc. v. Commissioner, 125 T.C. 37 (2005) ....... 7, 8, 12
Xilinx, Inc. v. Commissioner:
567 F.3d 482 (9th Cir. 2009), withdrawn,
592 F.3d 1017 (9th Cir. 2010) ................................... 8
598 F.3d 1191 (9th Cir. 2010) ........................................ 8
Statutes and regulations:
Administrative Procedure Act, 5 U.S.C. 551 et seq............ 12
5 U.S.C. 706(2)(A) ............................................................ 17
Internal Revenue Code (26 U.S.C.):
§ 83(h) (1970) ...................................................................... 7
§ 482 (2000)......................................................................... 5
§ 482 ......................................................................... passim
Revenue Act of 1928, ch. 852, § 45, 45 Stat. 806 ................... 2
Revenue Act of 1962, Pub. L. No. 87-834, 76 Stat. 960 ........ 3
Tax Reform Act of 1986, Pub. L. No. 99-514, Tit. XII,
Subtit. D, § 1231(e)(1), 100 Stat. 2562-2563.................. 4, 21
26 C.F.R.:
Section 1.482-1 (1996) ...................................................... 25
Section 1.482-1(a)(1) ........................................................ 23
Section 1.482-1(b)(1) (1995) .......................................... 6, 8
Section 1.482-1(b)(1) .......................................... 3, 8, 19, 23
Section 1.482-1(b)(2) (2004) .............................................. 9
Section 1.482-1(b)(2)(i) (2004)........................................... 9
Section 1.482-2(d)(2)(iii) (1969) ........................................ 4
Section 1.482-2(d)(4) (1969) .............................................. 4
Section 1.482-5(d)(3) (1996) ............................................ 18
Section 1.482-6(c)(3) (1995) ............................................... 6
V
Regulations—Continued:
Page
Section 1.482-7 (1996) .................................................. 8, 25
Section 1.482-7 (2004) ...................................................... 11
Section 1.482-7 ............................................................. 9, 25
Section 1.482-7(a)(2) (1996) ........................................ 7, 18
Section 1.482-7(a)(3) (2004) ...................................... 10, 21
Section 1.482-7(d)(1) (1996) ........................................ 7, 18
Section 1.482-7(d)(1) .......................................................... 8
Section 1.482-7(d)(2) (2004) ............................ 9, 21, 27, 28
Treas. Reg. 86, art. 45-1(b) (1935) .......................................... 3
Miscellaneous:
33 Fed. Reg. 5848 (Apr. 16, 1968) ...................................... 3, 4
59 Fed. Reg. 34,971 (July 8, 1994).......................................... 6
60 Fed. Reg. 65,553 (Dec. 20, 1995) ....................................... 6
67 Fed. Reg. 48,997 (July 29, 2002) .............8, 9, 18, 21, 24, 25
68 Fed. Reg. 51,171 (Aug. 26, 2003) ............................ passim
Fin. Accounting Standards Bd., Statement of Financial Accounting Standards No. 123: Accounting
for Stock-Based Compensation (Oct. 1995) ....................... 7
H.R. Conf. Rep. No. 2508, 87th Cong., 2d Sess. (1962) ....... 3
H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. Vol. II
(1986) ...................................................................................... 5
H.R. Rep. No. 1447, 87th Cong., 2d Sess. (1962) .................. 3
H.R. Rep. No. 426, 99th Cong., 1st Sess. (1985) ....... 5, 13, 21
Internal Revenue Service:
Field Service Advisory, 1997 WL 33107193
(Feb. 21, 1997) .............................................................. 7
Notice 88-123, 1988-2 C.B. 458 (1988) ................... 5, 6, 24
Richard W. Skillman, The Problems with Altera,
150 Tax Notes 347 (Jan. 18, 2016) ..................................... 18
VI
Miscellaneous—Continued:
Page
U.S. Treasury:
Resource Center: Treaties and TIEAS,
https://go.usa.gov/xvDNH (last visited
May 14, 2020) ............................................................. 30
Technical Explanation of the Convention
Between the United States of America and
the Republic of Poland for the Avoidance of
Double Taxation (2013), htttps://go.usa.gov/
xvDN3 ......................................................................... 30
In the Supreme Court of the United States
No. 19-1009
ALTERA CORPORATION & SUBSIDIARIES, PETITIONERS
v.
COMMISSIONER OF INTERNAL REVENUE
ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
BRIEF FOR THE RESPONDENT IN OPPOSITION
OPINIONS BELOW
The opinion of the court of appeals (Pet. App. 1a-78a)
is reported at 926 F.3d 1061. A prior opinion of the
court of appeals (Pet. App. 262a-322a) is not published
in the Federal Reporter but is available at 2018 WL
3542989. An order of the court of appeals withdrawing
the prior opinion (Pet. App. 323a) is reported at 898
F.3d 1266. The opinion of the Tax Court (Pet. App. 79a139a) is reported at 145 T.C. 91.
JURISDICTION
The judgment of the court of appeals was entered on
June 7, 2019. A petition for rehearing was denied on
November 12, 2019 (Pet. App. 140a-167a). The petition
for a writ of certiorari was filed on February 10, 2020.
The jurisdiction of this Court is invoked under 28 U.S.C.
1254(1).
(1)
2
STATEMENT
1. a. Businesses under common control, such as
parent and subsidiary corporations, have an incentive to
manipulate the pricing of their internal transactions in
order to minimize taxes—for example, by understating
the price at which the U.S. parent company licenses intellectual property to a foreign subsidiary. “[M]ultinational corporations with foreign subsidiaries” sometimes attempt to use such controlled-party transactions
to evade U.S. taxes. Pet. App. 7a.
In 1928, Congress first authorized the Secretary of
the Treasury to “reallocate the reported income and
costs of related businesses,” in order to address tax evasion and to ensure that income is accurately reported.
Pet. App. 7a; see Revenue Act of 1928, ch. 852, § 45,
45 Stat. 806. The substance of that provision is now codified as the first sentence of Section 482 of the Internal
Revenue Code:
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 indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such
organizations, trades, or businesses, if he determines
that such distribution, apportionment, or allocation
is necessary in order to prevent evasion of taxes or
clearly to reflect the income of any of such organizations, trades, or businesses.
26 U.S.C. 482.
In 1935, the Department of the Treasury (Treasury)
promulgated an implementing regulation that adopted
the so-called “arm’s length” standard for determining
3
whether the results of a transaction between entities
under common control accurately reflect the income of
each party: “The standard to be applied in every case
is that of an uncontrolled taxpayer dealing at arm’s
length with another uncontrolled taxpayer.” Treas.
Reg. 86, art. 45-1(b) (1935). The arm’s-length standard
continues to be applied “in every case.” 26 C.F.R. 1.4821(b)(1) (“In determining the true taxable income of a
controlled taxpayer, the standard to be applied in every
case is that of a taxpayer dealing at arm’s length with
an uncontrolled taxpayer.”). But the agency’s precise
methodology for applying the arm’s-length standard
has varied significantly over time.
For many years, the regulations did not provide any
detailed rules for applying the arm’s-length standard,
and the federal courts adopted a variety of approaches.
See Frank v. International Canadian Corp., 308 F.2d
520, 528-529 & nn.8-14 (9th Cir. 1962); Pet. App. 9a-10a.
During the legislative process leading to the Revenue
Act of 1962, Pub. L. No. 87-834, 76 Stat. 960, Members
of Congress expressed dissatisfaction with that lack of
clarity. See, e.g., H.R. Rep. No. 1447, 87th Cong., 2d
Sess. 28-30 (1962). Congress did not amend Section 482
at that time, but legislators encouraged Treasury to
“provide additional guidelines” by regulation. H.R.
Conf. Rep. No. 2508, 87th Cong., 2d Sess. 18-19 (1962).
In 1968, Treasury adopted a regulation that, for the
first time, called for the examination of “comparable”
transactions between uncontrolled parties. 33 Fed.
Reg. 5848, 5854 (Apr. 16, 1968). For controlled-party
transactions involving intangible property—which raise
acute concerns, given the distinctive nature of intangible property and the difficulty of valuing it accurately—
4
the 1968 regulations anticipated that “a sufficiently similar transaction” may be unavailable for comparison. Id.
at 5853. To address circumstances where that is so, the
regulations listed twelve factors that “may be considered in arriving at the amount of the arm’s length consideration.” Ibid.; see 26 C.F.R. 1.482-2(d)(2)(iii) (1969).
The 1968 regulations also introduced the concept of
a “bona fide cost sharing arrangement,” defined as an
agreement “between two or more members of a group
of controlled entities providing for the sharing of the
costs and risks of developing intangible property in return for a specified interest in the intangible property
that may be produced.” 33 Fed. Reg. at 5854; see
26 C.F.R. 1.482-2(d)(4) (1969). For example, a U.S. corporation and its foreign subsidiary might agree to share
the costs of research and development (R&D) for new
technology. The regulations stated that the Internal
Revenue Service (IRS) would “not make allocations”
under Section 482 with respect to such an arrangement,
“except as may be appropriate to reflect each participant’s arm’s length share of the costs and risks of developing the property.” 26 C.F.R. 1.482-2(d)(4) (1969).
The regulations provided that, “[i]n order for the sharing of costs and risk to be considered on an arm’s length
basis, the terms and conditions must be comparable to
those which would have been adopted by unrelated parties similarly situated had they entered into such an arrangement.” Ibid.
b. In 1986, Congress amended Section 482 by adding
a second sentence that specifically addressed controlledparty transactions involving transfers of intangible
property. See Tax Reform Act of 1986, Pub. L. No.
99-514, Tit. XII, Subtit. D, § 1231(e)(1), 100 Stat. 25622563. The version of that provision in effect during the
5
years at issue here stated: “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
(2000).
Unlike Treasury’s approach in the 1968 regulations,
the commensurate-with-income provision does not require consideration of comparable transactions between
uncontrolled parties. Congress declined to follow that
approach in this context because of the “recurrent problem [of] the absence of comparable arm’s length transactions between unrelated parties.” H.R. Rep. No. 426,
99th Cong., 1st Sess. 423-425 (1985) (1985 House Report). The commensurate-with-income provision instead requires only an internal comparison, focused on
evaluating the income that each controlled party will
earn from the intangible property.
The conference report accompanying these amendments explained that the commensurate-with-income
provision would not “preclude the use of certain bona
fide research and development cost-sharing arrangements” between controlled parties, as long as the “income allocated among the parties reasonably reflect[s]
the actual economic activity undertaken by each.” H.R.
Conf. Rep. No. 841, 99th Cong., 2d Sess. Vol. II, at 638
(1986). The report further stated that, “[u]nder such a
bona fide cost-sharing arrangement, the cost-sharer
would be expected to bear its portion of all research and
development costs,” and that the allocation of such costs
“generally should be proportionate to profit.” Ibid.
After the 1986 legislation was enacted, Treasury performed a comprehensive study of controlled transactions. See IRS Notice 88-123, 1988-2 C.B. 458 (1988)
6
(White Paper). That study “confirmed that Treasury
believed the commensurate with income standard to be
consistent with the arm’s length standard (and that
Treasury understood Congress to share that understanding),” even though the commensurate-with-income
standard relies on comparing the two sides of the
controlled-party transaction, rather than comparing the
controlled-party transaction to one or more identified
transactions between uncontrolled parties. Pet. App.
14a-15a; see, e.g., White Paper 476-477, 482 (referring
to the “traditional approach of looking to comparable
transactions,” and discussing an “alternative method of
analysis” for the arm’s-length standard that “does not
directly rely upon comparable transactions”).
c. In 1994 and 1995, Treasury issued new implementing regulations for Section 482. See 59 Fed. Reg.
34,971 (July 8, 1994); 60 Fed. Reg. 65,553 (Dec. 20,
1995). The 1994 rulemaking—which encompassed all of
the implementing regulations except for the cost-sharing
regulation—generally continued to use comparable transactions to determine an arm’s-length result, defined as
“the results that would have been realized if uncontrolled
taxpayers had engaged in the same transaction under
the same circumstances.” 26 C.F.R. 1.482-1(b)(1) (1995).
But Treasury also introduced alternative approaches
that were not dependent on the existence of comparable
uncontrolled transactions in some circumstances. See,
e.g., 26 C.F.R. 1.482-6(c)(3) (1995) (residual profit-split
method).
In 1995, Treasury revised the cost-sharing regulation and omitted the prior version’s reference to comparable transactions. See p. 4, supra. The revised regulation instead provided that the IRS would “not make
7
allocations with respect to a qualified cost sharing arrangement except to the extent necessary to make each
controlled participant’s share of the costs * * * of intangible development under the qualified cost sharing
arrangement equal to its share of reasonably anticipated benefits attributable to such development.”
26 C.F.R. 1.482-7(a)(2) (1996). The regulation defined
the term “[c]osts” to include “operating expenses.”
26 C.F.R. 1.482-7(d)(1) (1996).
d. The IRS subsequently took the position that the
cost of stock-based compensation for employees, like
other employee compensation costs, was part of the operating expenses that should be taken into account in
applying the cost-sharing regulation, and that requiring
such costs to be included in the cost-sharing pool was
consistent with the arm’s-length standard. See, e.g.,
IRS Field Service Advisory, 1997 WL 33107193 (Feb.
21, 1997). The “cost” aspect of that position accorded
with the historical treatment of employee stock options
as giving rise to a deductible compensation expense to
the employer under federal tax law in certain circumstances, see, e.g., 26 U.S.C. 83(h) (1970), as well as with
contemporary financial accounting standards, see Fin.
Accounting Standards Bd., Statement of Financial Accounting Standards No. 123: Accounting for StockBased Compensation 2 (Oct. 1995).
The IRS’s position did not prevail in litigation. In
Xilinx Inc. v. Commissioner, 125 T.C. 37 (2005), the
Tax Court held that the IRS could not require related
cost-sharers to share stock-based compensation costs
without evidence of comparable transactions in which
unrelated parties had shared such costs, and that the
record contained no such evidence. Id. at 54, 58-62.
That holding was based primarily on the Tax Court’s
8
understanding of 26 C.F.R. 1.482-1(b)(1) (1995) as requiring consideration of comparable transactions in essentially all cases, whenever “identical” transactions
were unavailable for comparison. Xilinx, 125 T.C. at 55.
The court thus rejected the Commissioner’s view that
identifying comparable transactions was unnecessary
because application of the regulation specifically addressing cost-sharing arrangements, 26 C.F.R. 1.482-7
(1996), would itself “ ‘produce[] an arm’s length result,’ ”
Xilinx, 125 T.C. at 54 (citation omitted).
A divided panel of the Ninth Circuit initially reversed,
holding that Section 1.482-7(d)(1), “as the more specific
of the two provisions, controls” over the more general
“arm’s length standard.” Xilinx, Inc. v. Commissioner,
567 F.3d 482, 496 (2009), withdrawn, 592 F.3d 1017 (9th
Cir. 2010). In response to the taxpayer’s petition for rehearing, the Commissioner agreed with that result but
disagreed with the majority’s reasoning, noting that the
arm’s-length standard applies “in every case.” 26 C.F.R.
1.482-1(b)(1) (1995). The panel then withdrew its opinion and issued a new one, this time affirming the Tax
Court—again by a 2-1 vote. In that opinion, the panel
majority concluded that the regulatory scheme “establish[es] an ambiguous standard for determining which
costs must be shared,” and that the ambiguity should be
resolved in favor of the comparability analysis referred
to in Section 1.482-1(b)(1), “based on the dominant purpose of the regulations.” Xilinx, Inc. v. Commissioner,
598 F.3d 1191, 1196 (9th Cir. 2010); see also id. at 11971199 (Fisher, J., concurring).
2. While the Xilinx litigation was pending, Treasury
undertook the rulemaking at issue here. See 67 Fed.
Reg. 48,997 (July 29, 2002) (notice of proposed rulemaking). A chief purpose of that rulemaking was to “clarify
9
that stock-based compensation is taken into account in
determining the operating expenses treated as a controlled participant’s intangible development costs for
purposes of the cost sharing provisions,” id. at 48,998—
as the Commissioner believed was already true under
the best reading of the then-existing regulations. The
rulemaking notice also explained that the cost-sharing
regulation, Section 1.482-7, “implements the commensurate with income standard” that had been added to
26 U.S.C. 482 in 1986, which Congress understood to be
“consistent[] with the arm’s length standard.” 67 Fed.
Reg. at 48,998. Accordingly, the proposed amendments
also “include[d] express provisions to coordinate the
cost sharing rules of § 1.482-7 with the arm’s length
standard as set forth in § 1.482-1.” Ibid.
In 2003, after receiving written comments and holding a public hearing, Treasury issued a final rule.
68 Fed. Reg. 51,171 (Aug. 26, 2003). The final rule
amended Section 1.482-1(b)(2) to make clear—contra
the taxpayer’s position in Xilinx—that “Section 1.482-7
provides the specific method to be used to evaluate
whether a qualified cost sharing arrangement produces
results consistent with an arm’s length result.”
26 C.F.R. 1.482-1(b)(2)(i) (2004). The final rule also
amended Section 1.482-7 to confirm that “a controlled
participant’s operating expenses include all costs attributable to compensation, including stock-based compensation.” 26 C.F.R. 1.482-7(d)(2) (2004) (emphasis
added). And, consistent with the view the Commissioner
urged in Xilinx, the amendments provided that a qualified cost-sharing arrangement “produces results that
are consistent with an arm’s length result within the
meaning of § 1.482-1(b)(1) if, and only if, each controlled
10
participant’s share of the costs * * * of intangible development * * * equals its share of reasonably anticipated
benefits attributable to such development.” 26 C.F.R.
1.482-7(a)(3) (2004). Those amendments applied beginning with the 2004 tax year. See 68 Fed. Reg. at 51,176.
In the preamble to its final rulemaking, Treasury
noted that it had received comments objecting to “taking stock-based compensation into account” in this context, based primarily on “third-party evidence” that uncontrolled parties dealing at arm’s length “do not take
stock-based compensation into account” in crafting allegedly comparable development agreements. 68 Fed.
Reg. at 51,172. In response, Treasury explained that it
“continue[d] to believe that requiring stock-based compensation to be taken into account for purposes of [qualified cost-sharing arrangements] is consistent with the
legislative intent underlying Section 482 and with the
arm’s length standard.” Ibid. Treasury also reiterated
that it understood the 1986 statutory amendment to reflect a congressional judgment “to respect cost sharing
arrangements as consistent with the commensurate
with income standard, and therefore consistent with the
arm’s length standard,” if all development-related costs
—“determined on a comprehensive basis”—are shared
in proportion to anticipated benefits. Ibid. Treasury
also stated that unrelated parties “dealing at arm’s
length in such an arrangement * * * generally would
not distinguish between stock-based compensation and
other forms of compensation.” Id. at 51,173; see ibid.
(“Treasury and the IRS believe that if a significant element of [employee] compensation consists of stockbased compensation, the party committing employees
to the arrangement generally would not agree to do so
on terms that ignore the stock-based compensation.”).
11
3. a. This case arises from the IRS’s application of
the cost-sharing regulation, as amended by the 2003
final rule, to petitioners—Altera Corporation (Altera)
and its U.S. subsidiaries—for tax years 2004 to 2007.
During the relevant period, Altera was the publicly
traded parent company of a multinational enterprise
that “designed, manufactured, marketed, and sold programmable logic devices, which are electronic components that are used to build circuits.” Pet. App. 18a.
One of its subsidiaries during that period was Altera International, Inc., a Cayman Islands company incorporated in January 1997 (Altera-Cayman). Ibid.; see Gov’t
C.A. E.R. 129. In May 1997, Altera and Altera-Cayman
entered into a cost-sharing arrangement for R&D, in
which Altera retained the right to exploit any fruits of
the R&D in the United States and Canada while permitting Altera-Cayman to do the same in the rest of the
world. Pet. App. 18a-19a; Gov’t C.A. E.R. 108-109.
On their 2004-2007 federal income-tax returns, petitioners accounted for Altera’s cost-sharing arrangement
with Altera-Cayman by reporting cost-sharing payments
from Altera-Cayman that were based on a cost-sharing
pool that did not include Altera’s R&D-related stockbased compensation costs. Pet. App. 20a. In two notices
of deficiency covering those years, the IRS increased
the group’s income to reflect the increased cost-sharing
payments required by application of the cost-sharing
regulation, 26 C.F.R. 1.482-7 (2004), as amended in
2003. Pet. App. 20a. Petitioners timely filed Tax Court
petitions challenging the deficiency notices. Ibid.
b. The Tax Court found for petitioners. Pet. App.
79a-139a. As relevant here, the court held that the
agency’s 2003 final rule amending the cost-sharing reg-
12
ulation was arbitrary and capricious under the Administrative Procedure Act (APA), 5 U.S.C. 551 et seq., because the agency had failed to engage in “reasoned decisionmaking.” Pet. App. 111a (citing Motor Vehicle
Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co., 463 U.S.
29, 43 (1983)). The court understood its prior decision
in Xilinx to have held that “the arm’s-length standard
always requires an analysis of what unrelated entities
do under comparable circumstances.” Id. at 118a (citing
Xilinx, 125 T.C. at 53-55). Stating that “Treasury necessarily decided an empirical question,” ibid., the court
concluded that Treasury could not adopt a regulation
that requires the sharing of stock-based employee compensation costs absent evidence (which the administrative record did not contain) demonstrating that unrelated parties would share such costs in comparable circumstances, see id. at 121a-127a. After concluding that
the rule was invalid under State Farm, the court stated
that, for the same reasons, the rule would also be an unreasonable interpretation of the statute under Chevron
U.S.A. Inc. v. Natural Resources Defense Council, Inc.,
467 U.S. 837 (1984). Pet. App. 138a n.29.
4. The court of appeals reversed, upholding the 2003
final rule. Pet. App. 1a-78a. 1
a. After reviewing the extensive history of Section
482 and its implementing regulations, Pet. App. 7a-18a,
the court of appeals determined that the statute “does
In July 2018, after Judge Reinhardt’s death, a divided panel that
included Judge Reinhardt as a member of the majority had issued
an opinion that also reversed the Tax Court. Pet. App. 262a-322a;
see id. at 262a n.*. That opinion was later withdrawn, id. at 323a; a
third judge chosen at random was added to the panel, id. at 1a n.*;
and the reconstituted panel issued a similar divided opinion in June
2019, after supplemental briefing and re-argument.
1
13
not speak directly” to whether Treasury may reallocate
a controlled taxpayer’s income when the taxpayer fails
to include stock-based employee compensation costs in
the pool of shared costs for a qualified cost-sharing arrangement, id. at 24a. The court therefore found the
statute “ambiguous,” in the sense of leaving “ ‘a gap for
[the] agency to fill.’ ” Ibid. (quoting, indirectly, Chevron, 467 U.S. at 843). The court proceeded to “Chevron
step two,” id. at 25a, and found that the cost-sharing
regulation, as amended by the 2003 final rule, reflected
a reasonable interpretation of Section 482, id. at 25a31a. The court emphasized that the purpose of Congress’s 1986 amendment to Section 482, which added
the commensurate-with-income provision governing
transfers and licenses of intangible property (see pp. 4-5,
supra), “was to ensure that income follows economic activity.” Id. at 26a. In the court’s view, Treasury had
acted reasonably in this context by “adopt[ing] a methodology” for allocating income that likewise “follow [s]
actual economic activity,” ibid., which could be achieved
only if all development-related costs—including stockbased compensation costs—were included in the costsharing pool.
The court of appeals also held that the agency had
reasonably interpreted Section 482 not to require consideration of allegedly comparable transactions between uncontrolled parties. Pet. App. 26a. The court
explained that, by adding the commensurate-withincome provision to Section 482, Congress had “granted
Treasury authority to develop methods that did not rely
on analysis of * * * comparable transactions,” given the
“ ‘extreme difficulties’ ” of locating truly comparable
transactions involving intangible property. Id. at 26a27a (quoting 1985 House Report 425). The court also
14
explained that “historically” the methods used to determine an arm’s-length result have been “fluid” and have
not always relied on comparable uncontrolled transactions. Id. at 28a. The court found that this “historic
versatility of methodology” supported Treasury’s interpretation of the statute as authorizing “an internal
method of allocation” for cost-sharing arrangements,
focused on the controlled parties themselves, rather
than on an “analysis of comparable transactions.” Id. at
28a-29a.
b. Applying “State Farm scrutiny,” the court of appeals concluded that Treasury, in promulgating the
2003 final rule, had “complied with the procedural requirements of the APA.” Pet. App. 32a. Petitioners
contended that Treasury had not adequately responded
to comments asserting that unrelated parties would not
share the cost of stock-based employee compensation.
In rejecting that argument, see id. at 33a-37a, the court
explained that those comments (and petitioners’ APA
challenge based on them) “overlook[ed] Treasury’s decision to do away with analysis of comparable transactions” in the cost-sharing context—a decision that
Treasury had made “clear enough” in the rulemaking
preambles’ discussions of the statutory scheme and legislative history. Id. at 36a. The court also noted with
approval Treasury’s conclusion during the rulemaking
that the purportedly comparable transactions identified
by commenters were not sufficiently similar to qualified
cost-sharing arrangements “to provide grounds for accurate comparison,” which “reinforced Treasury’s
premise for adopting the purely internal methodology.”
Id. at 37a.
Petitioners contended that Treasury was attempting
to substitute a new rationale on appeal for the reasoning
15
it had given in the rulemaking, in contravention of SEC
v. Chenery Corp., 332 U.S. 194 (1947). Petitioners also
argued that the agency had failed to acknowledge and
explain a significant change in policy during the rulemaking, in contravention of FCC v. Fox Television Stations,
Inc., 556 U.S. 502 (2009). The court of appeals rejected
those arguments. See Pet. App. 37a-40a, 42a-44a.
The court of appeals found that Treasury’s position
on appeal—that the agency “was statutorily authorized
to dispense with comparability analysis” in this context,
Pet. App. 38a (citation omitted)—was the same position
the agency had adopted as “a necessary presupposition
of [its] decision” to promulgate the 2003 final rule. Ibid.
(quoting National R.R. Passenger Corp. v. Boston &
Maine Corp., 503 U.S. 407, 420 (1992)). The court further explained that “Treasury asserted then, and still
asserts in this litigation, that using an internal method
of reallocation is consistent with the arm’s length standard.” Id. at 39a. The court rejected petitioners’ Fox
Television challenge for similar reasons: “If the arm’s
length standard allows the Commissioner to allocate
costs between related parties without a comparability
analysis, there is no policy change, merely a clarification of the same policy.” Id. at 44a.
c. Judge O’Malley dissented. Pet. App. 47a-78a.
She would have held that Treasury’s explanation of the
2003 final rule was deficient under State Farm because
Treasury had not provided an adequate explanation for
what she described as a “change [in] its longstanding
practice of employing the arm’s length standard and using a comparability analysis to get there.” Id. at 49a;
see id. at 58a-67a. She also would have held that the
“regulations are impermissible under Chevron,” based
16
on the theory that the commensurate-with-income provision in Section 482 applies only to licenses or transfers
of “already existing intangible property” and thus is inapplicable to cost-sharing arrangements to develop intangible property. Id. at 67a, 70a.
d. The court of appeals denied petitioners’ request
for rehearing en banc. Pet. App. 146a. Judge Milan
Smith, joined by Judges Callahan and Bade, dissented
from the denial of rehearing, largely for the reasons
given in Judge O’Malley’s dissent and the Tax Court’s
decision. Id. at 146a-167a. Judge Smith also explained
that, because the Tax Court could give effect to its own
view of the law in any future case that would be appealable to a different court of appeals, the “meaning of the
arm’s length standard” in this context would remain an
open question “outside the Ninth Circuit.” Id. at 165a.
ARGUMENT
The court of appeals correctly held that Treasury’s
2003 final rule, in which the agency amended its regulations to clarify that controlled parties must include the
cost of stock-based employee compensation within the
pool of shared costs for a qualified cost-sharing arrangement, was not arbitrary or capricious under the
APA. The court’s decision does not conflict with the decision of this Court or of any other court of appeals. Indeed, no other Article III court has reviewed the regulatory amendments at issue here, and the Tax Court has
not yet had the opportunity to reconsider its prior position in light of the decision below. Further review is not
warranted.
1. Petitioners principally contend (Pet. 14-16) that,
in upholding the challenged rule, the court of appeals
misapplied this Court’s decision in Motor Vehicle Man-
17
ufacturers Ass’n v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29 (1983). The court of appeals
considered petitioners’ State Farm arguments and correctly rejected them. Pet. App. 33a-37a.
a. The APA requires courts to “hold unlawful and set
aside” agency action that is “arbitrary, capricious, an
abuse of discretion, or otherwise not in accordance with
law.” 5 U.S.C. 706(2)(A). The “scope of review under the
‘arbitrary and capricious’ standard is narrow,” FERC v.
Electric Power Supply Ass’n, 136 S. Ct. 760, 782 (2016)
(quoting State Farm, 463 U.S. at 43), and a reviewing
court “may not substitute [its] judgment for that of the”
agency to which Congress has entrusted the authority to
make administrative policy, Department of Commerce v.
New York, 139 S. Ct. 2551, 2569 (2019). The reviewing
court instead must “confine [itself ] to ensuring that [the
agency] remained ‘within the bounds of reasoned decisionmaking.’ ” Ibid. (quoting Baltimore Gas & Elec. Co.
v. Natural Res. Def. Council, Inc., 462 U.S. 87, 105
(1983)). That reasoned-decisionmaking requirement “is
satisfied when the agency’s explanation is clear enough
that its ‘path may reasonably be discerned.’ ” Encino
Motorcars, LLC v. Navarro, 136 S. Ct. 2117, 2125 (2016)
(quoting Bowman Transp., Inc. v. Arkansas-Best Freight
Sys., Inc., 419 U.S. 281, 286 (1974)).
The court of appeals correctly identified those governing legal precepts and correctly applied them to
Treasury’s 2003 final rule. See, e.g., Pet. App. 33a (explaining that, “[u]nder State Farm, the touchstone of ‘arbitrary and capricious’ review under the APA is ‘reasoned decisionmaking’ ”) (citation omitted). As explained
above (see pp. 8-10, supra), Treasury undertook the rulemaking challenged here in order to “clarify,” in light of
the Xilinx litigation, what the agency already believed to
18
be the best understanding of the pre-amendment version
of the regulations. 67 Fed. Reg. at 48,998. Before the
2003 final rule was promulgated, the cost-sharing regulation stated that the IRS would “not make allocations
with respect to a qualified cost sharing arrangement except to the extent necessary to make each controlled
participant’s share of the costs * * * of intangible development under the * * * arrangement equal to its
share of reasonably anticipated benefits attributable to
such development.” 26 C.F.R. 1.482-7(a)(2) (1996). The
regulations specified that intangible development costs
included “operating expenses,” the definition of which in
turn encompassed employee compensation. 26 C.F.R.
1.482-7(d)(1) (1996); see 26 C.F.R. 1.482-5(d)(3) (1996)
(defining operating expenses to include generally “all
expenses not included in cost of goods sold,” except
interest and taxes). The regulations did not suggest
that stock-based employee compensation should be
treated differently from other forms of employee compensation.
The purpose and effect of the 2003 amendments was
to make explicit what the Commissioner maintained
was implicit in the pre-amendment regulations—
namely, that related participants in a qualified costsharing arrangement must share all R&D-related costs
in proportion to their shares of reasonably anticipated
benefits in order to achieve the paradigmatic arm’slength result, and that stock-based compensation gives
rise to a cost for these purposes. Neither of those determinations required the agency to “examine * * *
relevant data” or to engage in fact-finding, State Farm,
463 U.S. at 43, because the agency was not “making an
empirical judgment like that underlying the seatbelt
regulation that was invalidated in State Farm,” Richard
19
W. Skillman, The Problems with Altera, 150 Tax Notes
347, 353 (Jan. 18, 2016). The agency was instead clarifying its implementation of 26 U.S.C. 482 in the specific
context of qualified cost-sharing arrangements.
b. Petitioners’ attacks on the 2003 final rule largely
conflate (i) the arm’s-length standard, i.e., the longstanding rule that, “[i]n determining the true taxable
income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s
length with an uncontrolled taxpayer,” 26 C.F.R. 1.4821(b)(1); and (ii) the use of comparability analysis, i.e.,
the examination of actual, identified transactions
between uncontrolled entities as a means of achieving
an arm’s-length result. Petitioners contend that, by
eschewing comparability analysis in the context of
controlled-party agreements to develop intangible
property, Treasury has abandoned the arm’s-length
standard itself. Those arguments reflect a misunderstanding of the relationship between the two concepts.
During the rulemaking, the agency stated that it
“d[id] not agree with the comments that assert that taking stock-based compensation into account in the [qualified cost sharing arrangement] context would be inconsistent with the arm’s length standard in the absence of
evidence that parties at arm’s length take stock-based
compensation into account in similar circumstances.”
68 Fed. Reg. at 51,172. Treasury explained that,
“[w]hile the results actually realized in similar transactions under similar circumstances ordinarily provide
significant evidence in determining whether a controlled transaction meets the arm’s length standard, in
the case of [qualified cost-sharing arrangements] such
data may not be available.” Id. at 51,172-51,173. Treas-
20
ury further explained that “[t]he uncontrolled transactions cited by commentators do not share enough characteristics” with the typical qualified cost-sharing arrangement “to establish that parties at arm’s length
would not take stock options into account in the context
of [such] an arrangement.” Id. at 51,173. The agency
viewed the commensurate-with-income statutory provision implemented in the regulation, not as an alternative to the arm’s-length standard, but as an alternative
to comparability analysis as a means of achieving an
arm’s length result. See ibid. (explaining that the costsharing regulations “have as their focus reaching results consistent with what parties at arm’s length generally would do”). The court of appeals upheld the final
rule on the same rationale. See Pet. App. 36a-37a, 39a.
c. Petitioners contend (Pet. 15-16) that Treasury
could not require participants in a qualified costsharing arrangement to share stock-based employee
compensation costs without “an empirical and factual
analysis of real-world behavior of unrelated parties,”
and that the 2003 final rule was unsupported by empirical data and contrary to the evidence before the
agency. As noted above, that argument reflects petitioners’ conflation of the arm’s-length standard (which
continues to apply in this context) and the analysis of
specific comparable transactions between unrelated
parties. See Pet. App. 26a-28a, 34a, 36a-37a. Comparing a controlled-party transaction to an identified transaction between uncontrolled parties is one method of
determining an arm’s-length result, but it is not the only
method.
In particular, Section 482 states that, for controlledparty transactions involving “any transfer (or license)
of intangible property[,] * * * the income with respect
21
to such transfer or license shall be commensurate with
the income attributable to the intangible.” 26 U.S.C.
482. Congress added that language in 1986, in part out
of concern that the comparability approach reflected in
Treasury’s prior regulations was ill-suited to controlledparty transactions involving transfers of intangible property (for which truly comparable transactions may be difficult or impossible to find). See Tax Reform Act of 1986,
§ 1231(e)(1), 100 Stat. 2562-2563; 1985 House Report 423425; pp. 4-5, supra.
By its plain terms, Section 482 does not require any
analysis of identified comparable transactions between
unrelated parties. And the cost-sharing regulation
challenged here implements the commensurate-withincome provision, as Treasury explained in the rulemaking process. See 67 Fed. Reg. at 48,998. The amended
regulatory text—both as initially proposed and as finally
adopted—makes plain that a qualified cost-sharing arrangement produces results that are consistent with an
arm’s-length result “if and only if ” it complies with the
rules set forth in the cost-sharing regulation itself,
which does not contemplate any analysis of allegedly
comparable transactions and which mandates the inclusion of stock-based employee compensation in operating costs. 26 C.F.R. 1.482-7(a)(3) and (d)(2) (2004); see
68 Fed. Reg. at 51,177-51,178; 67 Fed. Reg. at 49,002.
Petitioners suggest (Pet. 15-16) that the agency led
interested parties to believe that it would rely on data
about specific comparable transactions between unrelated parties, and that tax professionals who submitted
comments “took the government at its word.” As just
explained, however, the proposed text of the rule refutes that suggestion. An interested party who read the
notice of proposed rulemaking, including the text of the
22
proposed rule, could not reasonably have expected
Treasury to rely on any analysis of actual, allegedly
comparable transactions between uncontrolled parties.
Cf., e.g., Pet. C.A. Supp. E.R. 167 (commenter recognizing that “[t]he proposed regulation would make any evidence of comparable transactions irrelevant” in this
context). And Treasury did not “ignore[]” (Pet. 16) the
comments it received about supposedly comparable
transactions between unrelated parties. The agency instead explained that those comments did not cast doubt
on the soundness of the agency’s approach for the reasons stated above, i.e., because the arm’s-length standard can be implemented through means other than comparability analysis, and because the purportedly comparable transactions identified by the commenters were
not sufficiently similar to qualified cost-sharing arrangements to provide a reliable basis for comparison.
See pp. 19-20, supra.
In the preamble to its final rule, Treasury also expressed the view that, if uncontrolled parties agree to
share the costs of developing intangible property, and
one of the parties is considering a commitment of several employees to the arrangement, that party would
not do so “unless the other party agrees to reimburse
its share of the compensation costs of the employees.”
68 Fed. Reg. at 51,173. Treasury then stated its “belie[f ] that if a significant element of that compensation
consists of stock-based compensation,” then “the party
committing employees to the arrangement generally
would not agree to do so on terms that ignore the stockbased compensation.” Ibid. That statement was consistent with the underlying premise of the commensuratewith-income provision (i.e., that uncontrolled parties,
23
when collaborating in a profit-seeking endeavor, will ordinarily allocate the associated costs in a manner proportionate to the income each expects to receive), and it
explained “why treating stock-based compensation as a
cost [leads] to [an] arm’s length result[],” Pet. App. 40a,
as defined in Section 1.482-1(b)(1).
The 2003 final rule implements a statutory authority—
Section 482’s commensurate-with-income provision—that
does not require any empirical analysis of identified
comparable transactions between unrelated parties.
Petitioners’ principal State Farm challenge to the rule
faults the agency for disregarding evidence about supposedly comparable uncontrolled transactions. The
court of appeals recognized, however, that the purportedly comparable transactions cited by some commenters “actually reinforced the original justification for
adopting a purely internal methodology—the lack of
transactions comparable to those occurring between
parties to a [qualified cost-sharing arrangement].” Pet.
App. 37a. The court explained that, “[b]ecause of this
lack of similar transactions, Treasury justifiably chose
to employ methodology that did not depend on nonexistent comparables to satisfy the commensurate with
income test and achieve tax parity.” Ibid.; see 26 C.F.R.
1.482-1(a)(1) (identifying “tax parity” purpose).
2. Petitioners also seek (Pet. i) review of the question whether, “under SEC v. Chenery Corp., 332 U.S.
194 (1947), [a] regulation may be upheld on a rationale
the agency never advanced during rulemaking.” This
case does not implicate that question. The court of appeals recognized that a reviewing court “must judge the
propriety of agency action solely by the grounds invoked by the agency.” Pet. App. 37a-38a (quoting
Chenery, 332 U.S. at 196) (brackets omitted). The court
24
further recognized, however, that Treasury’s position in
litigation was consistent with the rationale the agency
had offered for its action during the rulemaking. See
id. at 37a-40a. The court thus upheld Treasury’s action
on grounds that the agency itself had invoked. And petitioners’ fact-bound disagreement with the court of appeals’ understanding of the administrative record does
not warrant this Court’s review.
The court of appeals was plainly correct to reject petitioners’ Chenery argument. In the rulemaking process, Treasury explained that the cost-sharing regulation implements the commensurate-with-income provision that was added to Section 482 in 1986. 67 Fed. Reg.
at 48,998. The agency stated that Congress intended
that the commensurate-with-income provision would be
applied to cost-sharing arrangements “consistently
with the arm’s length standard,” ibid., even though the
commensurate-with-income provision does not require
consideration of comparable transactions between uncontrolled parties. See Pet. App. 14a-15a; White Paper
482. In the preamble to the 2003 final rule, Treasury
reiterated its view that requiring stock-based employee
compensation to be taken into account for qualified
cost-sharing arrangements was “consistent with the
legislative intent underlying section 482 and with the
arm’s length standard.” 68 Fed. Reg. at 51,172.
In defending the 2003 final rule in litigation, Treasury repeated its understanding of Congress’s intent regarding the operation of the arm’s-length standard in
this context, and explained that its determination in
that regard was not empirical. See Pet. App. 39a (observing that Treasury “asserted then, and still asserts
in this litigation, that using an internal method of reallocation is consistent with the arm’s length standard”);
25
see also, e.g., Gov’t C.A. Br. 57-64 (explaining and defending the reasoning set forth by the agency in the
rulemaking notices). Petitioners are thus wrong in suggesting (Pet. 17) that Treasury “abandon[ed]” the
arm’s-length standard. The agency has consistently
maintained that application of the cost-sharing regulation implementing the commensurate-with-income provision would produce an arm’s-length result, even
though the regulation does not contemplate analyzing
identified transactions between uncontrolled parties. 2
Finally, petitioners observe (Pet. 17) that the preamble to the final rule “mentioned the ‘commensurate with
the income’ language only once.” The notice of proposed rulemaking refers to that provision numerous
times. In any event, once would be enough. An agency
must set forth the basis of its action “with such clarity
as to be understandable,” Chenery, 332 U.S. at 196, and
the agency did so here. Neither Chenery nor any other
principle of administrative law required Treasury also
“to provide ‘exhaustive, contemporaneous legal arguments to preemptively defend its action.’ ” Pet. App. 38a
(quoting National Elec. Mfrs. Ass’n v. United States
Dep’t of Energy, 654 F.3d 496, 515 (4th Cir. 2011)).
Treasury took the same position (albeit unsuccessfully) in defending the pre-amendment versions of Sections 1.482-1 and 1.482-7 in the
Xilinx litigation. See pp. 7-8, supra. A principal purpose of the 2003
final rule was to “clarify” what the agency believed to be the best
reading of the pre-amendment regulations. 67 Fed. Reg. at 48,998.
And petitioners can hardly claim to have been surprised by the
agency’s view that stock-based employee compensation costs must
be included in shared costs in this context, since Altera had entered
into an agreement with the IRS in December 1999 for the pre-2004
tax years in which its own stock-based compensation costs were included in the pool of shared costs for its cost-sharing arrangement
with Altera-Cayman. Pet. App. 19a; see Gov’t C.A. E.R. 139.
2
26
3. Petitioners also seek review (Pet. i) of the question 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.” That question likewise is not implicated
here. The court of appeals rejected petitioners’ premise
that Treasury had issued the 2003 regulation in a procedurally defective manner. Pet. App. 31a-44a (concluding that “the 2003 regulations are not arbitrary and
capricious under the standard of review imposed by the
APA”). The court separately found that Treasury’s resolution of the precise interpretive question this case
presents—i.e., whether stock-based compensation costs
should be included in the pool of shared costs for a qualified cost-sharing arrangement to develop intangible
property—was permissible under Chevron. See id. at
23a-31a. Neither of those holdings suggests that the
Ninth Circuit would sustain a “procedurally defective”
regulation under Chevron. And neither holding warrants further review, let alone supports petitioners’ extraordinary suggestion of summary reversal (Pet. 22).
Petitioners suggest (Pet. 20) that, because the “Tax
Court had invalidated the regulation under the APA’s
reasoned-decisionmaking standard,” the court of appeals should have addressed petitioners’ State Farm arguments before applying Chevron. But petitioners
identify no sound basis for requiring that order of operations. Petitioners’ assertion (ibid.) that the court of
appeals did not “independently analyze” petitioners’
State Farm arguments is belied by the extensive analysis the court devoted to those contentions. See Pet.
App. 31a (“Though Treasury’s interpretation of its statutory grant of authority was reasonable, we also must
27
examine whether the procedures used in its promulgation prove defective under the APA.”); id. at 31a-44a
(rejecting each of petitioners’ arguments).
Petitioners also contend (Pet. 21) that the court of
appeals “erred in giving Chevron deference to an
agency interpretation offered for the first time in litigation.” That argument is unfounded. In applying Chevron, the court first concluded that Section 482 does not
unambiguously specify whether the cost of stock-based
employee compensation must be included in the pool of
shared costs for a qualified cost-sharing arrangement.
Pet. App. 23a-25a. The relevant statutory provision
states simply that, in the case of a transfer or license of
intangible property between controlled parties, “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 court of appeals concluded that, in promulgating
the 2003 final rule, Treasury had reasonably construed
the statute as authorizing the agency to mandate that
any stock-based compensation costs be included, along
with other compensation costs, as operating expenses
associated with the development of intangible property.
Pet. App. 25a-29a; see 26 C.F.R. 1.482-7(d)(2) (2004).
The interpretation to which the court deferred was thus
the interpretation reflected in the regulation itself,
adopted after notice-and-comment rulemaking. Deferring to such an interpretation is not an “expan[sion]”
(Pet. 13) of Chevron but rather a routine application of
it. See Mayo Found. for Med. Educ. & Research v.
United States, 562 U.S. 44, 55-60 (2011) (holding that
“[t]he principles underlying * * * Chevron apply with
full force in the tax context,” and according Chevron
28
deference to a Treasury regulation that had been promulgated after notice-and-comment procedures).
Petitioners do not contend that Section 482 itself
compels a particular treatment of stock-based employee
compensation costs incurred in developing intangible
property with a related party. Nor do petitioners question Treasury’s statutory authority to adopt a regulation requiring that stock-based employee compensation
costs be treated for these purposes like other compensation costs. Petitioners likewise do not suggest that
the challenged regulation is ambiguous concerning the
treatment of stock-based employee compensation costs
(as the Ninth Circuit in Xilinx had previously found was
the case for the predecessor regulations). 3 Petitioners’
limited disagreement with the court of appeals’ casespecific application of Chevron does not warrant this
Court’s review.
4. Petitioners’ remaining arguments for granting
certiorari (Pet. 22-32) are unpersuasive. Petitioners do
not advance any substantial argument that the decision
below conflicts with the decision of any other court of
appeals. Cf. Pet. 21. No other court of appeals has addressed the 2003 final rule. And the decision below will
not bind the Tax Court (or any other court) in a case
appealable to a court of appeals other than the Ninth
Circuit. See Pet. App. 165a (Smith, J., dissenting from
Petitioners’ assertion (Pet. 23) that the agency “is seeking to impose tax liability essentially by administrative fiat, rather than
th[r]ough any formal agency action,” therefore is incorrect. The
cost-sharing regulation itself, amended in 2003 pursuant to noticeand-comment procedures, unambiguously dictates that “stockbased compensation” costs be treated for these purposes like other
employee compensation costs and included in the pool of shared
costs. 26 C.F.R. 1.482-7(d)(2) (2004).
3
29
the denial of rehearing en banc). If a substantial division of authority concerning the validity of the 2003 final
rule develops in the future, this Court’s review may be
warranted at that time. But petitioners identify no
pressing reason for the Court to intervene now.
Finally, there is no sound basis for petitioners’ prediction that the decision below will spawn “serious domestic and international tax consequences.” Pet. 28
(emphasis omitted). That forecast is based on petitioners’ erroneous premise (ibid.) that the court of appeals
“allowed [Treasury] to cast the [arm’s-length] standard
aside for stock-based compensation.” The court below
repeatedly explained, however, that the 2003 final rule
did not abandon the arm’s-length standard, but instead
permissibly provided that a methodology other than analyzing actual transactions between uncontrolled parties would be used to determine an arm’s-length result.
See, e.g., Pet. App. 28a (upholding as “reasonable” Treasury’s understanding “that Congress intended for it to depart from analysis of comparable transactions as the exclusive means of achieving an arm’s length result”).
The court of appeals also correctly determined, with
respect to petitioners’ claims about the prevalence of
the arm’s-length standard in international tax agreements, that “there is no evidence that [U.S.] treaty obligations bind [the United States] to the analysis of comparable transactions. As demonstrated by nearly a century of interpreting § 482 and its precursor, the arm’s
length standard is not necessarily confined to one methodology.” Pet. App. 31a. Indeed, for numerous recent
treaties, Treasury has issued technical explanations
stating that the commensurate-with-income provision
of Section 482 “operates consistently with the arm’s-
30
length standard,” and that the administrative implementation of that provision “in the regulations under
Code section 482 is in accordance with” the arm’s-length
standard. Ibid. (quoting U.S. Treasury, Technical Explanation of the Convention Between the United States
of America and the Republic of Poland for the Avoidance of Double Taxation 31 (2013)). 4 The cost-sharing
regulation, as amended by the 2003 final rule, is fully
consistent with the arm’s-length standard and with U.S.
tax treaties incorporating that standard.
CONCLUSION
The petition for a writ of certiorari should be denied.
Respectfully submitted.
NOEL J. FRANCISCO
Solicitor General
RICHARD E. ZUCKERMAN
Principal Deputy Assistant
Attorney General
FRANCESCA UGOLINI
ARTHUR T. CATTERALL
Attorneys
MAY 2020
https://go.usa.gov/xvDN3. Since the promulgation of the 2003
final rule, the United States has negotiated eight other income-tax
treaties for which it has issued similar technical explanations. The
treaties and technical explanations are available at https://go.usa.
gov/xvDNH.
4
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.