In an unexpected 2-1 decision, Judge Reinhardt, who passed away in March of this past year, cast the Ninth Circuit’s deciding vote to reverse the Tax Court’s prior ruling in Altera. In 2015, the Tax Court invalidated Treasury Regulation 1.482-7A(d)(2)’s requirement that related parties allocate stock-based compensation costs when entering into cost-sharing agreements to develop intangible assets. The Tax Court’s decision in Altera centered on the IRS’s failure to support the regulation with examples of unrelated parties sharing stock-based compensation costs (comparable uncontrolled transactions). This failure was fatal, according to Judge Marvel of the Tax Court, because to require related taxpayers to share stock-based compensation absent any evidence of similar behavior by unrelated parties would mean the regulation did not seek parity between these groups of taxpayers, contrary to the long-standing arm’s-length principle for transfer pricing. As a result, the Tax Court held that the regulation did not meet the reasoned decision-making standard in the State Farm Supreme Court case.
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