Ninth Circuit Overturns Altera and Revives Regulations on Cost Sharing of Stock-Based Compensation

July 30, 2018

On August 2, 2018, the U.S. Court of Appeals for the Ninth Circuit issued an order selecting Judge Susan P. Graber to replace the late Judge Stephen Reinhardt on the three-judge panel presiding over Altera Corp. v. Commissioner. On August 7, 2018, the court withdrew its opinion in Altera on procedural grounds to allow time for the reconstituted panel to confer on the case.

On July 24, 2018, the U.S. Court of Appeals for the Ninth Circuit, in a 2-to-1 opinion, ruled in Altera Corp. v. Commissioner1 that Treasury Regulations involving transfer pricing promulgated in 2003 (the Regulations)2 complied with the Administrative Procedure Act (APA) and were entitled to deference under Chevron.3 The Regulations required related entities to share the costs of employee stock-based compensation in order for their cost-sharing arrangements to be classified as qualified cost-sharing arrangements under Section 4824 and the relevant Treasury Regulations. The Ninth Circuit's decision in Altera reversed an earlier decision of the United States Tax Court,5 which had held that the Regulations were invalid in part because the Treasury Department (Treasury) did not satisfy a reasoned decision-making standard in promulgating them as required by the APA. The Tax Court found that Treasury failed to adequately consider and respond in the notice-and-comment process to evidence that unrelated third-parties do not share costs of stock-based compensation.

Contrary to the Tax Court's decision, the Ninth Circuit first determined that Treasury had complied with the APA in promulgating the Regulations by adequately considering (and dismissing) the evidence of arm's-length transactions provided by commentators, and instead employing a purely internal, "commensurate with income" standard.6 The Ninth Circuit noted that "[n]one of the comments at issue address why Treasury was mistaken in its understanding that it was authorized to use a method that did not include comparables." The Ninth Circuit further noted that, in the preamble to the Regulations, Treasury "set forth its understanding that it should not examine comparable transactions when they do not in fact exist and should instead focus on a fair and reasonable allocation of costs and income," which gave interested parties sufficient notice of Treasury's intent and basis for dismissing the commentators' evidence.7 Accordingly, the Ninth Circuit found that the Regulations were not arbitrary and capricious, and therefore complied with the APA.

The Ninth Circuit then applied the two-part Chevron analysis to hold that the Regulations were a permissible interpretation of Section 482. The court first applied traditional rules of statutory construction to conclude that Section 482 itself did not specifically address whether parties to a qualified cost-sharing arrangement must share stock-based compensation costs, and that the text of the statute and legislative history indicate that Congress intended to give Treasury flexibility to combat improper allocation of costs and income between related parties. Second, the court held that Treasury's interpretation of Section 482 in the Regulations was permissible (and not arbitrary, capricious or manifestly contrary to the statute) under the "commensurate with income" standard. The court stated that "Treasury's determination that uncontrolled cost-sharing arrangements do not provide helpful guidance regarding allocations of employee stock compensation" was entirely consistent with Congress's rationale for amending Section 482 to incorporate the commensurate with income standard.8

For further information, please contact Greg Broome (, 415-947-2139); Eileen Marshall (, 202-973-8884); Myra Sutanto Shen (, 650-565-3815); Jonathan Zhu (, 650-849-3388); or any member of the tax practice at Wilson Sonsini Goodrich & Rosati.

Joe Mandry, Tim Shapiro, and Devin Heckman contributed to the preparation of this alert.

1 Nos. 16-70496, 16-70497 (9th Cir. July 24, 2018).
2 Treas. Reg. §§ 1.482-7A(d)(2), 1.482-7A(a)(3) (to the extent incorporating Treas. Reg. § 1.482-7A(d)(2)).
3 Chevron v. National Resources Defense Council, 467 U.S. 837 (1984).
4 All Section references herein are to the Internal Revenue Code of 1986, as amended.
5 Altera Corp. v. Commissioner, 145 T.C. 91 (2015).
6 Altera, Nos. 16-70496, 16-70497 at 37.
7 Id. at 32.
8 Id. at 40. Circuit Judge O'Malley based her dissenting opinion in part on the observation that the commensurate with income standard of Section 482 was intended to apply only to a transfer or license of intangible property, and therefore does not apply to qualified cost-sharing arrangements. Id. at 63 (O'Malley, J., dissenting).