The common perception among private practitioners that the Ninth Circuit’s controversial decision in Altera v. Commissioner caused a circuit split that warrants a rehearing en banc is wrong, according to an IRS official.
Eli Hoory, special counsel (international), IRS Office of Chief Counsel, said one of the main arguments in Altera's petition for a rehearing en banc of Altera Corp., No. 16-70496, 16-70497 (9th Cir. 2019), is misleading. The rehearing petition argues that the Ninth Circuit’s decision, which reversed a 2015 Tax Court decision in favor of Altera, threatens the uniform application of federal tax law.
Speaking November 4 at a conference held by the Tax Executives Institute and San Jose State University in Palo Alto, California, Hoory noted that Tax Court decisions do not bind other circuit courts of appeal, and that another circuit would have to decide the issue differently for a circuit split to arise. Hoory’s comments echoed one of the arguments in the government’s response to Altera’s rehearing petition.
“Some in the practitioner community have suggested there is a circuit split, but the fact of the matter is there is not currently. The final regulations are the law of the land until proved otherwise,” Hoory said. “The Ninth Circuit is the only circuit that's ruled on them, [and] they've held them to be valid.”
In a 2-1 decision released in June, a Ninth Circuit panel reversed the Tax Court and upheld a 2003 regulation requiring that parties to a cost-sharing arrangement share stock-based compensation costs. According to the Tax Court decision, Treasury and the IRS violated the Administrative Procedure Act by failing to counter commentators’ empirical evidence that unrelated parties would never share stock-based compensation under the arm's-length standard. The Ninth Circuit held that rebutting these comments was unnecessary because section 482 — especially after the 1986 addition of the commensurate with income requirement — authorizes internal allocation methods that don't refer to arm's-length transactions.
Hoory questioned the argument, included in Altera’s rehearing petition, that "the Tax Court undoubtedly would apply its unanimous view that the regulation is invalid" in a case subject to appeal in a different circuit.
"There's every reason to think that the Tax Court may reconsider" if the same issue arises in another circuit, Hoory said. "If the Tax Court sticks to its guns, there's also every reason to think that the IRS and Treasury will do what they did in the Ninth Circuit — appeal in whatever circuit that pops up in."
Regarding the Ninth Circuit’s rejection of the government’s interpretation of the term "intangible" in another major cost-sharing case — Amazon.com Inc. v. Commissioner, No. 17-72922 — Hoory said the government achieved a significant increase in tax revenue despite its loss on the legal question. According to the Ninth Circuit’s August opinion, the Tax Court’s adjustments to Amazon’s comparable uncontrolled transaction method analysis increased the arm's-length buy-in from $255 million to $779 million. "That's a significant delta, almost 300 percent," Hoory said.
"A lot of energy gets spent focusing on the legal 'big win,' but there are also disputes — and sometimes very meaningful disputes — about the factual inputs, what levers are getting pulled, and this sort of gets lost in the conversation. But that's also a source of risk; it's something that gets evaluated, certainly from the government’s perspective, about where to invest resources," Hoory said. "And I would offer that's something that taxpayers might want to think about too, as to how aggressive are you going to pull the levers even under your legal interpretation."
Resource allocation considerations were also behind the IRS’s decision to withdraw a January 2018 directive that suspended adjustments resulting from inclusion of stock-based compensation costs in the shared cost pool of a cost-sharing arrangement, according to John Hinman, director of field operations for the IRS's transfer pricing practice. The 2019 memorandum instructed examiners to resume adjustments effective July 31.
"There were some folks out there commenting, ‘Oh, maybe the IRS sort of pulled back that directive too quickly,'" Hinman said. "The point here, I think, is that that first directive that said, 'Let's hold off on looking at stock-based compensation right now,' was all about resources. And then we got that [Altera] decision, so we said, 'It makes sense now [to] get back into that and address those issues.'"