Altera Corp. has failed in its bid to persuade the Ninth Circuit to reconsider its controversial decision after a majority of the non-recused participating judges voted to reject the company’s petition.
According to the court’s November 12 order, only three of the judges considering Altera’s July petition voted for a rehearing of Altera Corp. v. Commissioner, Nos. 16-70496, 16-70497 (9th Cir. 2019). After the Ninth Circuit panel reversed a 2015 Tax Court decision and held that the stock-based compensation rule in Treasury’s 2003 cost-sharing regulations was valid, Altera filed a rehearing petition alleging that the 2-1 decision undermines the uniformity of federal tax law and conflicts with Ninth Circuit precedent. Altera has invested significant resources in challenging the Ninth Circuit’s decision, leading some to speculate that a petition for certiorari with the Supreme Court is likely.
In its response to Altera‘s petition, the government argued that the panel correctly held that section 482 authorizes internal profit allocation methods and that the decision did not conflict with precedent. The Ninth Circuit panel agreed with the government that Treasury had no obligation to rebut evidence submitted by taxpayers that unrelated parties don’t share stock-based compensation because section 482’s commensurate with income requirement is not a comparables-based standard.
The Ninth Circuit’s rules of appellate procedure generally allow for a rehearing en banc only when necessary to maintain uniformity in the court’s decisions or in cases that involve a question of exceptional importance.
Some commentators welcomed the Ninth Circuit’s decision, including some of the academics who joined an amici brief filed in favor of the government.
“The Ninth Circuit reached the right decision in denying a rehearing en banc. The arguments raised by the taxpayers were considered carefully, by the original panel and on rehearing after the death of Judge Reinhardt, and rejected,” according to Stephen E. Shay of Harvard Law School. Similarly, Susan Morse of the University of Texas School of Law said, “The denial of Altera’s en banc petition seems straightforward to me. Stronger legal arguments support the Ninth Circuit’s decision in the case.”
Noting the recusal of 10 active judges, John Colvin of Colvin + Hallett suggested that the vote may have been closer if the recused judges had participated.
Strong Dissent
However, the published order includes a strongly worded dissent by Judge Milan J. Smith that rehashes many of the arguments — including that a cost-sharing arrangement is not a “transfer or license” subject to the commensurate with income standard — made in Judge Kathleen M. O’Malley’s dissenting opinion and a series of amici briefs filed in favor of Altera’s petition. One of the two judges joining the dissenting opinion, Judge Consuelo Callahan, wrote the August opinion in Amazon.com Inc. v. Commissioner, No. 17-72922 (9th Cir. 2019), which rejected the government’s appeal in another high-profile cost-sharing case decided by the Ninth Circuit.
“The panel majority’s decision tramples on the reliance interests of American businesses, threatens the uniform enforcement of the Tax Code, and drastically lowers the bar for compliance with the Administrative Procedure Act,” Smith’s dissenting opinion says. The opinion also predicts that the issue will inevitably lead to a circuit split, a prospect that IRS officials have questioned.
Smith’s dissent suggests that attempts to reconcile the arm’s-length standard with the commensurate with income standard in a Treasury white paper published in 1988 provide the authoritative interpretation of the amended statute, which was adopted by an act of Congress in 1986. It was significant, according to the dissent, that the conference report to the law adding the commensurate with income standard said that Treasury should conduct a comprehensive study of the U.S. transfer pricing system and consider the necessity of regulatory changes. The opinion does not address language in the House Ways and Means Committee report stating that the shortcomings of comparables-based approaches were the reason why the legislative change was necessary.
“This amendment appeared to introduce a new standard for allocating costs — a ‘commensurate with income’ standard — which might have constituted a departure from the traditional arm’s-length analysis,” the dissent says. “But soon after, in 1988, Treasury dispelled such notions by publishing what came to be known as the ‘white paper.’”
Smith’s opinion forcefully rejects the government’s claim that it relied on the commensurate with income standard in issuing the 2003 regulations, noting that “at no point in Treasury’s 2003 rulemaking did it reverse its long-standing interpretation of the commensurate with income standard as consistent with the traditional arm’s-length standard.” The preamble to the 2003 regulations states that “the legislative history of the Tax Reform Act of 1986 expressed Congress‘s intent to respect cost-sharing arrangements as consistent with the commensurate with income standard, and therefore consistent with the arm’s-length standard, if and to the extent that the participants’ shares of income ‘reasonably reflect the actual economic activity undertaken by each.’”
“The panel majority’s opinion impermissibly upholds the 2003 rule based on a host of rationales and interpretive maneuvers amounting to ‘a [purportedly] reasoned basis for the agency’s action that the agency itself has not given,’” the dissent says, quoting Motor Vehicle Manufacturers Association v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29 (1983).
Colvin said that the dissenting opinion may have been intended to increase the likelihood of a successful cert petition.
“I read the dissent as a request to the Supreme Court to take the case because it has implications for [Administrative Procedure Act] cases outside of the narrow tax context, especially the dissent’s argument that the [Department of Justice Appellate Division and Ninth Circuit’s] majority position was a post hoc pivot from the rationale that had been advanced during the rulemaking process,” Colvin said.