TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Wednesday, July 25, 2018

9th Circuit Reverses Tax Court In Altera, Revives Cost-Sharing Regs In Major Loss For Intel, Other Tech Companies

AlteraWall Street Journal, IRS Wins Court Case Over Intel Corp.:

The Internal Revenue Service won a court case closely watched by technology companies, as an appeals court upheld a regulation governing how corporations divide expenses between their domestic and foreign operations.

Tuesday’s ruling by a panel of the Ninth Circuit Court of Appeals in San Francisco represents a loss for Intel, whose Altera subsidiary challenged the regulation when it was a separate company [Altera Corp. v. Commissioner, Nos. 16-70496, 16-70497 (9th Cir. July 24, 2018)]. Tech companies had billions of dollars at stake in the case because the rules at issue determine where they report some deductions.

The U.S. Tax Court, which handles disputes between taxpayers and the IRS, ruled in favor of Intel [Altera Corp. v. Commissioner, 145 T.C. No. 3 (2015)]. The IRS appealed the decision.

“We conclude that the regulations withstand scrutiny under general administrative law principles, and we therefore reverse the decision of the Tax Court,” wrote Chief Judge Sidney Thomas.

He was joined by Judge Stephen Reinhardt, who cast his vote in the case before he died this year. Judge Kathleen O’Malley dissented, arguing that the IRS was “arbitrary and capricious” because it didn’t adequately explain its regulations.

Intel is disappointed in the decision and is considering its options for further judicial review, spokesman William Moss said in an email.

The case involved what’s known as share-based compensation and where it should be deducted as a business expense. The IRS wrote a regulation that required companies to deduct more of it abroad as opposed to deducting it in the U.S.

Especially under the international tax system that existed before this year, companies wanted to load up their U.S. operations with deductions against the 35% tax rate and pack their foreign operations with profit that would be taxed at lower rates.

The Altera case involved taxes on just $80 million of income, but the impact could be far larger. Alphabet Inc., the parent company of Google, said in 2016 that it could gain as much as $3.5 billion if Altera prevailed and other companies also told investors that they were tracking the case. ...

“I bet there’s a lot of money involved for everyone combined,” said Daniel Shaviro, a tax law professor at New York University.

The case will have a significant impact on audits of companies for tax years before 2018, when there was a larger gap between U.S. companies’ domestic tax rate and their foreign tax rates. The 2017 tax law, in many cases, narrowed those gaps.

Mr. Shaviro said the case marked a rare win for the IRS in cases concerning transfer pricing, or internal corporate transactions across borders. And, he said, it departs from a recent trend of judges being too critical of the IRS’s approach to regulation.

The court moved away from what’s known as the “arm’s length standard,” the idea that internal corporate transactions should be analyzed by comparing them to transactions that independent companies would make, said Eric Ryan of law firm DLA Piper LLP. “I just find the opinion surprising and a little dangerous,” he said. “I think now the Treasury and the IRS can use this decision and say the rules for transfer pricing are whatever we say they are. It’s just completely ungrounded now from any sort of standard.”

In the Altera tax case, the Tax Court ruled unanimously that the IRS didn’t respond appropriately to public comments.

“You can argue that in the past they were too deferential to the IRS,” Mr. Shaviro said of the courts. “But I do think there’s a tendency to nitpick and to ignore the expertise they have and the fact that there’s really no one else out there” taking the public’s side.

Dan Shaviro (NYU), Good News From the 9th Circuit — Altera Reversal:

[T]he 9th Circuit has reversed the — sorry for sounding shrill here, but it's justified — egregious and embarrassing Tax Court decision in Altera v. Commissioner. ...

The Tax Court decision did not merely permit taxpayers to game the system in a manner that is entirely contrary to the logic behind cost-sharing (which is itself flawed, but better than having absolutely no constraints). It also seemed to reward an aggressive taxpayer strategy that I was concerned we'd see more of in the future. (And we still may.) This is to spend lots of money making lots of bogus arguments in the notice and comment phase of regulatory issuance, and then to get the regulation struck down as "arbitrary and capricious" unless its preamble is written, not to inform taxpayers and advisors as has been the general past practice, but instead as a litigating document that responds carefully and fully to each argument made in notice and comment, no matter how meritless and frivolous.

The Ninth Circuit is to be commended for getting it right. Now, it's true that it relies on the Chevron standard for reviewing administrative regulations, which may well be on the Supreme Court's chopping block in the near future. But in this particular case, it shouldn't matter, as the IRS regulation at issue, concerning the treatment of incentive compensation in cost-sharing arrangements between affiliates, was not only a reasonable interpretation, but clearly the most reasonable interpretation, and indeed perhaps the only reasonable one.

Chris Walker (Ohio State), Nearly Four Months After His Death, Judge Reinhardt Casts the Deciding Vote in an Important Tax Exceptionalism Case: Altera v. Commissioner of Internal Revenue:

My co-blogger Andy Grewal had a short post about one aspect of the case last year: the amici law professors’ suggestion to remand without vacatur. And two groups of tax professors filed amicus briefs in support of the IRS, and those briefs are definitely worth reading (here and here). Importantly, both briefs reject tax exceptionalism, as the Ninth Circuit majority also purports to do here, and instead argue that the IRS action under review is substantially and procedurally proper under the Administrative Procedure Act and Internal Revenue Code. ...

I’m very uncomfortable with the judicial decisionmaking process here. This is a 2-1 decision with Judge Reinhardt casting the deciding vote in the majority. Judge Reinhardt passed away on March 29, 2018, nearly four months before the opinion was published. As the opinion’s author is Chief Judge Thomas, who has always struck me as a careful and deliberate judge, I’m sure he conferred with all of his colleagues on the Ninth Circuit before deciding to publish this decision. The case was argued way back in October 2017, so the panel no doubt weighed the costs of additional delay and reargument.

And, to be sure, the opinion itself notes that “Judge Reinhardt fully participated in this case and formally concurred in the majority opinion prior to his death.” In other words, I infer that Chief Judge Thomas had likely circulated his opinion prior to Judge Reinhardt’s death, and Judge Reinhardt had reviewed it and sent the formal “I’m pleased to join” notification. But Judge O’Malley likely hadn’t drafted, or at least circulated, her dissent prior to Judge Reinhardt’s death, hence the four-month delay in publication.

As Howard Bashman has noted, #appellatetwitter folks disagree about what to do with judges’ votes in opinions issued after they die. Consider me firmly among those who find this practice of dead-hand voting quite unsettling, especially to cast the deciding vote and even more so if the deceased judge did not have an opportunity to review and respond to the dissent. On the substance of the administrative law issues implicated by this case, I wouldn’t be surprised to see the Ninth Circuit reconsider the case en banc and/or the Supreme Court deciding to review the case. But I wonder how this procedural oddity will factor, if at all, into the decision to grant further review.

Leandra Lederman (Indiana), Reversing the U.S. Tax Court, 9th Circuit Rules for IRS in Altera:

In my view, this is the right outcome. (Full disclosure: Susan Morse and Stephen Shay spearheaded an amicus brief in the Ninth Circuit in favor of the Commissioner, in which I joined, along with Dick HarveyRuth Mason, and Bret Wells.) Treasury did consider and respond to the comments it received on the regulation; it simply had a different approach to the substance of the regulation than the taxpayers commenting did. ...

It is worth noting that the court did not address larger questions of the applicability of the APA or Chevron in tax cases, stating in a footnote (and citing Stephanie Hoffer & Chris Walker and Kristin Hickman):

Because the Commissioner does not contest the applicability of the APA or Chevron in this context, this case does not require us to decide the broader questions of the precise contours of the application of APA to the Commissioner’s administration of the tax system or the continued vitality of the theory of tax exceptionalism.

Miller & Chevalier Tax Appellate Blog, Ninth Circuit Reverses Altera and Revives Cost-Sharing Regulations:

It is likely that the taxpayer will seek rehearing of the decision by the full Ninth Circuit, especially since such a rehearing petition was successful a decade ago in Xilinx. A rehearing petition would be due on September 7. If the taxpayer elects not to seek rehearing, a petition for certiorari would be due October 22.

(Hat Tip: Ann Murphy.)

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