Tax Court Invalidates Cost-Sharing Rules

In a rebuke to the Treasury and the Internal Revenue Service, the Tax Court has invalidated regulations under Section 482 of the Tax Code that require the sharing of stock-based compensation.

In a July 27, 2015 division opinion, Altera Corp. v. Commissioner, 145 T.C. No. 3, the 15-judge panel agreed with taxpayer Altera Corp. that the regulations were arbitrary and capricious because they were not the product of a reasoned decision-making standard as required by the Supreme Court in its State Farm decision.

The court ruled that Xilinx Inc. v. Commissioner, 125 T.C. 37 (2005) held that, under 1995 cost-sharing regulations, controlled entities entering into qualified cost-sharing agreements need not share stock-based compensation costs because parties operating at arm’s length would not do so. In 2003, the Treasury Department issued regulations requiring controlled parties entering into such cost-sharing agreements to share stock-based compensation costs.

The IRS made deficiency determinations based on Section 482 allocations it made under the regulations. Both the IRS and Altera filed cross-motions for partial summary judgment, with Altera contending that the regulation is arbitrary and capricious.

The court held that the regulation is a legislative rule, not an interpretive rule, and is therefore subject to the Administrative Procedures Act.

The Treasury failed to support its belief that unrelated parties would share stock-based compensation costs with any evidence in the administrative record, according to the court. “The final rule fails to satisfy State Farm’s reasoned decision-making standard and is therefore invalid,” it stated.