Stock-based compensation cost-sharing regs. following Altera

By Sean Foley, J.D., Santa Clara, Calif., and Hardi Kuvadia, Philadelphia

Editor: Mary Van Leuven, J.D., LL.M.

Last year, the U.S. Supreme Court denied the petition for certiorari from an appeals court ruling against the taxpayer in Altera Corp., 926 F.3d 1061 (9th Cir. 2019), cert. denied, No. 19-1009 (U.S. 6/22/20). The decision means that the Supreme Court will not review the Ninth Circuit's opinion and will leave intact the decision upholding the validity of the 2003 version of the cost-sharing regulations. The regulations require related parties to share the costs of stock-based compensation (SBC) as a component of intangible development costs in cost-sharing arrangements (CSAs). Altera vindicates a long-standing IRS position on the inclusion of SBC costs.

Case history

Altera Corp. is a U.S. taxpayer (a computer chip manufacturer) that entered into a research-and-development (R&D) CSA with its Cayman Islands subsidiary. During each of the 2004-2007 tax years, Altera granted SBC to certain U.S. employees who performed R&D activities that were subject to the CSA. Costs related to SBC were borne entirely by Altera's U.S. entity and were not shared by the Cayman Islands subsidiary. With all SBC costs allocated to Altera in the United States, the company could deduct the costs to decrease the amount of income subject to U.S. corporate income tax at the then-applicable 35% corporate tax rate.

The IRS asserted that Altera's failure to share SBC costs violated Regs. Sec. 1.482-7A(d)(2), which was finalized in 2003 and required SBC costs to be included in the costs shared under a CSA. (The 2003 version of Regs. Sec. 1.482-7A(d)(2) was substantially similar to Regs. Sec. 1.482-7(d)(3), the regulation currently in effect).

Evolution of the SBC regulations

The 1968 regulations contained guidance regarding the sharing of costs and risks by CSA participants; however, there was no explicit mention of SBC. The IRS sought to require SBC inclusion under the 1968 regulations in Seagate Technology, Inc.,T.C. Memo. 2000-388. After losing on summary judgment, the IRS settled the case and in January 2002 issued an industry directive conceding the issue under the 1968 regulations. The 1968 regulations were replaced in 1995 with regulations that required CSA participants to include "all the costs"associated with intangible development costs, however, once again there was no explicit mention of SBC (Regs. Sec. 1.482-7(d)(1)).

The 1995 regulations were ultimately determined not to require sharing of SBC in Xilinx Inc.,125 T.C. 37 (2005), aff'd, 598 F.3d 1191 (9th Cir. 2010).During 2003, the IRS amended the regulations to explicitly state that CSA participants must include "all stock-based compensation." The 2003 regulations were first determined invalid in a rare 15-0 Tax Court opinion in Altera Corp.,145 T.C. 91 (2015), but were later determined to be valid by the Ninth Circuit.


The Supreme Court's denial of the petition for certiorari is important because the Ninth Circuit's decision stands. Companies in the Ninth Circuit must consider that circuit's decision concerning the inclusion of SBC in CSAs and cannot rely upon the 2015 Tax Court opinion. Companies outside the Ninth Circuit must now consider how this affects tax positions under the 2003 regulations. Consider the following topics:

  • Tax return filing positions;
  • Implications for platform contribution transaction valuations; and
  • Continued use of qualified CSAs.
Tax return filing positions

Taxpayers and practitioners evaluating the exclusion of SBC costs from CSAs must reconsider what level of authority such a position would occupy in light of the Tax Court's opinion invalidating the SBC regulations and the Ninth Circuit opinion validating the regulations. Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), and Sec. 6694 require at least substantial authority for any return position (or, alternatively, the position need only have a reasonable basis if adequately disclosed to the IRS). Analysis of the authority for a taxpayer's position will vary depending on the taxpayer's jurisdiction.

Under the Golsen rule, the Tax Court will follow the clearly established law of the court of appeals to which a case before it lies, even if that law contradicts Tax Court precedent (Golsen, 54 T.C. 742 (1970), aff'd on other grounds, 445 F.2d 985 (10th Cir. 1971), cert. denied, 404 U.S. 940 (1971)). Thus, for cases arising in the Ninth Circuit, the Tax Court will follow the Ninth Circuit's Altera decision and therefore treat the SBC regulations as valid. Federal district courts (and bankruptcy courts) in the Ninth Circuit are also bound to follow Ninth Circuit precedent, rendering those courts equally unsuitable for taxpayers seeking to challenge the regulations.

For taxpayers in the Ninth Circuit, the Tax Court's opinion "does not continue to be an authority to the extent it is overruled or modified" (Regs. Sec. 1.6662-4(d)(3)(iii)), although the authorities that the Tax Court cited may still provide support for the taxpayer's position. For taxpayers outside that circuit, however, the Tax Court opinion will continue to be an "authority" for this purpose, despite having been reversed or overruled. A taxpayer's location will therefore be an extremely important consideration for the Altera issue. Taxpayers outside the Ninth Circuit can continue to treat the 15—0 Tax Court opinion as an authority, but taxpayers in the Ninth Circuit cannot.

Taxpayers outside the Ninth Circuit, who can treat the Tax Court decision as authority, undoubtedly have an easier road to at least substantial authority or reasonable basis than their counterparts in the Ninth Circuit. But the regulations require taxpayers to weigh all authorities, and in this case, there is significantly more to consider than simply the Tax Court and Ninth Circuit opinions in Altera,including all the evidence submitted by the taxpayer in the Tax Court. Taxpayers would be well advised to fully consider the impact of all authorities, and to the extent that they chose not to share the costs of SBC under their CSAs, to have well-documented files supporting their positions.

Implications for platform contribution transactions

Taxpayers making a change to the treatment of SBCs for their CSAs to follow the 2003 regulations should also consider the potential implications of the change for their platform contribution transactions (PCTs), sometimes known as buy-in payments. PCT valuations using transfer-pricing methods that relied on financial projections, such as the commonly used income method, are directly affected by the inclusion or exclusion of SBC in the financial projections. If the financial projections used in the income method excluded SBC that is now going to be included in cost-sharing payments, then the value of the PCT was likely overstated.

The first step for taxpayers evaluating potential inconsistent treatment of SBC expenses in their PCTs is to perform an analysis of how SBCs were treated in their PCTs. A good place to start is a review of the PCT agreement. However, many taxpayers will find that their agreements are silent on SBC. PCT agreements that do not directly address SBC may nonetheless include terms that allow for adjustments to the PCT to avoid double taxation, conform to transfer-pricing regulations, and adhere to the arm's-length standard.

As a next step, taxpayers should revisit the economic analysis of the PCT payment to assess any quantitative impact a change in the treatment of SBC has on the PCT valuation. Finally, taxpayers must consider the potential reactions to their PCT strategy by the tax authority in the tax jurisdiction of the foreign cost-sharing participant or participants. This is an increasingly important consideration in the wake of the many recent intangible property migrations related to base-erosion and profit-shifting (BEPS) rules.

Should taxpayers terminate CSAs?

The principal objection to including SBC in intangible development costs was that doing so overstated intangible development costs and therefore resulted in higher U.S. taxable income than would have been incurred if the parties had transacted on an arm's-length basis. This argument is particularly persuasive for taxpayers that are required to use the default method of accounting for SBC. Under the default method, SBC costs are determined based on the SBC deductions allowable for U.S. federal income tax purposes (e.g., generally, the spread at the time of exercise for stock options and the fair market value of the stock at the time of vesting for restricted stock). To the extent a company's stock appreciates significantly between the grant date and the exercise or vesting date, this measure of SBC costs could be substantially more than the cumulative expense that would be recorded for financial statement purposes. Unrelated parties would be unlikely to agree to share costs based on the unknown (and uncapped) future value of the other party's stock.

One remedy for this problem has been available all along: Taxpayers may adopt a contractual CSA that does not qualify under Regs. Sec. 1.482-7 (a nonqualified CSA, or NQCSA, instead of a qualified CSA, or QCSA). This can be accomplished by failing to satisfy the administrative rules of Regs. Sec. 1.482-7(k) or by marking up the associated R&D costs. Whether an NQCSA satisfies the arm's-length standard is determined based on Sec. 482 regulations other than Regs. Sec. 1.482-7. Thus, to the extent one participant makes intangibles available to another participant, an appropriate charge should be determined consistent with Regs. Secs. 1.482-4 through -6. In addition, to the extent one party performs development activities that benefit another party, an appropriate service charge is determined under Regs. Sec. 1.482-9. If such a service charge is determined under a cost-based method, any activities that benefit both the service provider and the related party must be allocated using an appropriate method. Generally, costs under Regs. Sec. 1.482-9 are determined in accordance with U.S. GAAP, so using a GAAP-based approach for valuing SBC in the cost base would typically be appropriate.

The benefits of switching to an NQCSA could be significant. The OECD's BEPS project has resulted in the adoption of economic substance requirements, as well as the amendment of the OECD's transfer-pricing guidelines to require a cost-sharing participant to perform activities related to the development, enhancement, maintenance, protection, and exploitation of intangibles to be entitled to a full return on its legal ownership of the developed intangibles. These developments have caused many multinationals to transfer the foreign participation in QCSAs from tax havens to treaty jurisdictions where the multinational maintains a significant employee presence. To the extent that the requirement to share SBC costs under Regs. Sec. 1.482-7 results in a foreign participant's being responsible for intangible development costs in a given year that exceed the arm's-length charge for the benefits it receives, a QCSA could result in a double disallowance of deductions for the excess.

Because the charges under an NQCSA would be determined under the general arm's-length standard, on the other hand, the risk of the multinational enterprise's losing deductions in any year should be reduced, as both countries would apply a more flexible and consistent approach than the formulaic rules of Regs. Sec. 1.482-7. However, it is also important to consider other implications of an NQCSA, including the loss of certain special netting rules that can be helpful in the context of the Sec. 59A(d) base-erosion and anti-abuse tax.

Circuit location is key

The Supreme Court's denial of Altera's petition could have significant tax and financial reporting consequences for companies that have excluded SBC costs from CSA intangible development cost pools. While the Ninth Circuit's decision regarding the validity of Regs. Sec. 1.482-7A(d)(2) is controlling precedent in the Ninth Circuit, the regulation's validity remains open to challenge in other circuits. For now, this means different things for different taxpayers. Return filing positions may depend in part on whether a taxpayer is located within the Ninth Circuit, while other issues — such as whether including SBC could reduce PCT payments or whether to continue in a QCSA — may depend on a taxpayer's specific facts. All these issues can involve significant complexity, and all should be considered as taxpayers work through the implications of the end to the Alterasaga.


Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.

For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or

Contributors are members of or associated with KPMG LLP.

The information in these articles is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230 because the content is issued for general informational purposes only. The information is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. The articles represent the views of the author or authors only, and do not necessarily represent the views or professional advice of KPMG LLP.

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