A story in the Nov. 14 issue of Transfer Pricing Reporton Altera Corp.’s case in U.S. Tax Court goes to the very heart of a question the OECD is considering in its plan to combat base erosion and profit shifting: When an intercompany transaction has no analog in the real world, how does one apply the arm’s-length standard?
Altera is disputing the validity of IRS cost sharing regulations issued in 2003 that require companies engaged in cost sharing with foreign affiliates to share, in the pool of costs, expenses for stock-based compensation. The company, a California-based manufacturer of programmable semiconductors and related products, points to a large body of evidence showing that unrelated parties engaged in joint research and development efforts do not share such costs, and that the regulation thus violates the arm’s-length standard. The IRS, for its part, argues this evidence is irrelevant because the third-party transactions do not, in fact, mirror cost sharing between related companies.
One could argue that cost sharing is a prime example of a transaction requiring the use of special measures that go beyond the arm's length principle to value appropriately. While the OECD’s BEPS action plan contemplates such measures, the IRS in its cost sharing rules does not. Throughout the regulations in 1.482-7 and in its arguments in the Altera litigation, the IRS insists that its approach in cost sharing—which ignores the practices of third parties—is arm’s-length.
As practitioners have noted, the IRS could have declared cost sharing an administrative safe harbor, sparing itself the need to square stock option cost sharing with arm’s-length treatment. One wonders whether the IRS needs to continue to pay lip service to “arm’s length” when even Pascal Saint-Amans, the tax chief of the OECD—the standards setter for international tax policy—has said he is “agnostic” toward the principle.
The OECD’s BEPS plan and other important issues facing transfer pricing practitioners will be covered at Bloomberg BNA-Baker & McKenzie Global Transfer Pricing Conference in Paris March 31-April 1. To see the agenda and to register, visit http://www.bna.com/agenda-m17179870460/.
Molly Moses, Managing Editor, Transfer Pricing Report
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