9th Circuit Overturns U.S. Tax Court Decision in Altera Corp v. Commissioner


On June 7, 2019, the U.S. Court of Appeals for the 9th Circuit, in a split 2-1 opinion, overturned the U.S. Tax Court decision in Altera Corp v. Commissioner 145 T.C. No. 3 (July 27, 2015). The 9th Circuit’s decision held that companies in cost-sharing arrangements should share the cost of employee stock-based compensation.[1] 

Altera has challenged the ruling and petitioned for a rehearing en banc (where 11 9th Circuit judges hear the case). If Altera fails to convince the majority of the 9th Circuit judges, their next option would be to appeal their case to the U.S. Supreme Court.



In the initial U.S. Tax Court ruling of Altera Corp. v. Commissioner, the court invalidated the requirement in the Treasury Regulations Section 1.482 for taxpayers in a cost-sharing arrangement to include stock-based compensation. The court held that the regulations were invalid because the Treasury Department and the IRS did not meet the “reasoned decision-making” standard required by the Administrative Procedures Act.[2] Specifically, the court argued that the regulations fall under legislative rule and, therefore, there is a reasonable expectation for an agency to give interested parties an opportunity to participate in the rule-making process. The court ruled that Treasury and Internal Revenue Services (IRS) did not consider public comments on the proposed cost-sharing regulations and, as such, it did not meet the “reasoned decision-making standard” set forth by the Administrative Procedures Act. Further, the U.S. Tax Court disagreed with the IRS’s argument that empirical analysis is not always necessary in determining the arm’s-length standard. The court reasoned that the arms-length standard is based on the notion of how unrelated parties interact in comparable circumstances, and, therefore, an empirical analysis is necessary in determining the arm’s-length standard.[3]


Ninth Circuit Decision

In its decision, the 9th Circuit focused on the development of the tax code, the perceived intent by Congress, and the Tax Reform Act of 1986 that led to the addition of the ‘commensurate with income’ language in the Treasury Regulations Section 1.482. In their majority opinion, the 9th Circuit argued that in its formulation of the cost-sharing rules, Treasury considered the difficulty in finding reliable comparable uncontrolled transactions between third parties for unique intangibles. In this regard, the 9th Circuit concluded that it was the intent by Congress and Treasury to allow for a more subjective approach to the arm’s-length standard when dealing with cost-sharing arrangements. The 9th Circuit agreed with Treasury’s interpretation of the arm’s-length standard and its use of the commensurate with income principle whereby it is within the IRS’s authority to solely apply an internal method of allocation (without the use of a comparable analysis) that distributes costs between the parties in proportion to their income. Ultimately, the 9th Circuit held that Treasury’s requirement for stock-based compensation expenses to be shared under a cost-sharing arrangement was reasonable, despite any empirical evidence that showed that unrelated parties dealing under a similar arrangement would not share such an expense.

Regarding the U.S. Tax Court’s decision on Treasury’s adherence to the Administrative Procedures Act, the 9th Circuit held that Treasury in fact met the act’s requirements. The 9th Circuit agreed with Treasury that public comments were not particularly relevant during the formulation of the cost-sharing regulations.

The 9th Circuit decision was consistent with its July 2018 initial ruling (also a 2-1 split opinion), which was withdrawn after one of the three-panel judges (Judge Stephen Reinhardt) passed away prior to the final publication of the decision.[4] The three-judge panel was reconstituted later in the year, replacing Judge Reinhardt with Judge Susan Graber, and in October of 2018 the case was heard again by the panel. Given that Judge Reinhardt was in the majority opinion, there was an initial expectation that the court’s original opinion could be reversed. However, Judge Graber also sided with the majority opinion that ultimately overturned the 2015 U.S. Tax Court decision.


BDO Insight

The 9th Circuit ruling will have wide ranging effects on companies engaged in cost-sharing arrangements with related parties. U.S. taxpayers currently engaged in cost-sharing arrangements with related parties should review their treatment of stock-based compensation costs in these arrangements.  As stated earlier, while an appeal to the 9th Circuit decision has been made, taxpayers should consider including stock-based compensation in their current cost-sharing arrangements with related parties. Please contact a BDO Transfer Pricing specialist if you would like assistance understanding the effects of this decision.



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[1] Altera Corp. v. Commissioner Nos. 16-70496, 16-70497. (9th Cir. June 7, 2019)
[2] Altera Corp. v. Commissioner, 145 T.C. 91 (2015)
[3] The Court came to this ruling in part on the basis of case law (i.e., Xilinx, Inc. v. Commissioner, 125 T.C. 37 (2005)).
[4] Altera Corp. v. Commissioner Nos. 16-70496, 16-70497. (9th Cir. July 24, 2018)