Case Overview
In Altera (2019), the Ninth Circuit reversed the Tax Court and upheld Treasury’s 2003 cost-sharing rule requiring stock-based compensation (SBC) to be included in the shared intangible development cost pool of a qualified cost-sharing arrangement (QCSA). The court applied Chevron deference and rejected Administrative Procedure Act (APA) challenges.
Key Facts
- Altera entered into an R&D cost-sharing agreement effective May 23, 1997 with a Cayman Islands subsidiary, Altera International.
- Under the QCSA, participants shared intangible development costs in proportion to reasonably anticipated benefits.
- Altera and the IRS had an Advance Pricing Agreement covering 1997–2003 under which Altera shared SBC costs.
- After the Tax Court’s 2005 decision in Xilinx, Altera amended its agreement to suspend SBC cost-sharing unless the 2003 regulation was upheld.
- For 2004–2007, the IRS made §482 allocations increasing Altera’s income by $80.39M for unshared SBC; the Tax Court invalidated the regulation (2015), and the Ninth Circuit reversed (2019).
The Dispute
The dispute centered on whether Treasury validly required controlled participants in a QCSA to include SBC in the shared cost pool under the 2003 cost-sharing amendments (codified today as Treas. Reg. § 1.482-7A(d)(2)). Altera argued that the §482 “arm’s length” standard compels a comparability-based approach grounded in what unrelated parties do—and that commenters had provided evidence that uncontrolled parties do not share SBC in comparable arrangements. On that view, Treasury’s rulemaking was arbitrary and capricious under State Farm because it allegedly failed to engage with contrary evidence and significant comments.
The government argued that §482 (including the 1986 “commensurate with income” language for intangibles) permits Treasury to adopt internal allocation methods designed to align costs and income with economic activity, particularly when true comparables are scarce for high-profit intangibles. The case thus combined (i) deference and statutory authority questions (Chevron) and (ii) APA procedural validity (whether Treasury’s explanation and response to comments were adequate).
Holding
The Ninth Circuit held that §482 does not directly answer whether SBC must be shared in QCSAs, and that Treasury’s regulation was a permissible interpretation entitled to Chevron deference. It accepted Treasury’s approach of using an internal, benefits-based allocation method to achieve an arm’s-length result (tax parity/economic alignment) without requiring proof of a comparable uncontrolled practice.
On the APA claim, the court concluded Treasury’s “path may reasonably be discerned” and that comments focused on uncontrolled-party agreements did not undermine the rule given Treasury’s rationale for using an internal method in the QCSA/high-profit-intangibles context. Judge O’Malley dissented.
Takeaways for Practitioners
- For U.S. tax purposes, assume SBC is includible in QCSA intangible development costs under the cost-sharing regulations upheld in Altera.
- If a taxpayer is within the Ninth Circuit (or its case is appealable there), Altera is binding precedent; elsewhere it is highly persuasive and the IRS will still assert the regulation.
- Cost-sharing documentation should clearly define the cost pool (including SBC), the reasonably anticipated benefits (RAB) method, and true-up mechanics.
- APA-based challenges to Treasury transfer pricing rules face a high bar after Altera (at least on similar records).
Related Content
For practical documentation considerations around intangibles and development activities, see Documentation for Intangibles. For the conceptual benchmark underlying the dispute, see the Arm's Length Principle. The Ninth Circuit opinion is a key U.S. authority on APA/Chevron review in transfer pricing rulemaking.
Frequently Asked Questions
Q1: What did Altera decide about SBC in cost sharing?
It upheld Treasury’s 2003 rule requiring QCSA participants to include SBC in the shared intangible development cost pool (i.e., SBC must be cost-shared for the arrangement to be “qualified” under the regulation).
Q2: Did the court hold that comparables are irrelevant to arm’s-length analysis?
No. The court rejected the argument that §482 always requires a comparable-uncontrolled-transaction showing as a prerequisite to Treasury’s QCSA rules. It accepted that, in this context, Treasury could use an internal allocation method aimed at an arm’s-length result.
Q3: What was the APA fight?
The Tax Court found Treasury’s rulemaking arbitrary and capricious for failing to support and respond to comments suggesting uncontrolled parties do not share SBC. The Ninth Circuit disagreed, finding Treasury’s rationale sufficient under State Farm review.
Q4: Is Altera binding nationwide?
It is binding within the Ninth Circuit. Nationally, the regulation still applies and the IRS enforces it; outside the Ninth Circuit, other courts may treat Altera as persuasive authority.
Q5: Did the Supreme Court decide the issue?
No. The Supreme Court denied certiorari on June 22, 2020, leaving the Ninth Circuit’s judgment in place.