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Commissioner Files Opening Brief in Ninth Circuit Appeal of Altera

In Altera Corp. v. Commissioner, 145 T.C. No. 3 (July 27, 2015), the Tax Court, in a unanimous reviewed opinion, held that regulations under Section 482 requiring parties to a qualified cost-sharing agreement (QCSA) to include stock-based compensation costs in the cost pool to comply with the arm’s-length standard were procedurally invalid because the US Deparment of Treasury and the Internal Revenue Service (IRS) did not engage in the “reasoned decisionmaking” required by the Administrative Procedures Act and the cases interpreting it. For a discussion of the Tax Court’s Altera opinion, see our prior On the Subject. The Commissioner of Internal Revenue (Commissioner) appealed this holding to the Ninth Circuit Court of Appeals; he filed his opening brief on June 27, 2016.

According to the Commissioner, the Tax Court’s holding was based on several related errors: (1) the Tax Court mistakenly concluded that promulgation of the QCSA regs required the IRS to engage in an “essentially empirical” analysis; (2) this led the court to apply the wrong standard; (3) in its analysis, the court relied heavily on its holding in Xilinx, Inc. v. Commissioner, 125 T.C. 37 (2005), that analysis of QCSAs must comport with the arm’s-length standard, meaning that a taxpayer can defend a QCSA by reference to comparable behavior between unrelated parties; and (4) the Tax Court failed to take into account that the finalization of the new QCSA regulations worked a “change in the legal landscape,” which should have altered the court’s analysis of the new regulations’ validity. Moreover, “the coordinating amendments [to the existing QCSA regulations] supersede [the Ninth Circuit’s] understanding of the arm’s-length standard as reflected in its own Xilinx opinion.” (more…)

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3M Company, IRS File Opening Briefs in “Blocked Income” Case

As noted in an earlier post, 3M Co. v. Commissioner, T.C. Dkt. No. 5816-13, involves 3M’s challenge to the Internal Revenue Service’s (IRS’s) determination that Brazilian legal restrictions on the payment of royalties from a subsidiary in that country to its US parent should not be taken into account in determining the arm’s-length royalty between 3M and its subsidiary under Treas. Reg. § 1.482-1(h)(2). The case has been submitted fully stipulated under Tax Court Rule 122, and the parties’ simultaneous opening briefs were filed on March 21, 2016.

Citing First Sec. Bank of Utah and cases following it, 3M first argues that “[c]ase law consistently holds that the Commissioner cannot employ section 482 to allocate income that the taxpayer has not received and cannot receive because a law prevents its payment or receipt.” Under this line of authority the IRS’s proposed allocation of royalty income to 3M is precluded by Brazilian law. This result is not changed by Treas. Reg. § 1.482-1(h)(2) because that regulation is invalid.

The regulation is “procedurally invalid,” 3M argues, because Treasury and the IRS failed to satisfy the requirements of § 553 of the Administrative Procedure Act (APA) when they promulgated the regulation. They did not respond to significant comments criticizing the proposed regulation; nor did they articulate a satisfactory justification or explanation for the regulation. They thus did not engage in the “reasoned decisionmaking” required by the APA and case law such as State Farm and Altera when an agency issues regulations. (more…)

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