## Facts

- Altera Corporation entered a cost-sharing agreement (CSA) with its Cayman Islands subsidiary to share intangible development costs and to license intangibles for use abroad.
- Treasury’s 2003 cost-sharing regulations under I.R.C. § 482 required participants in a qualified CSA to share all intangible development costs, including stock-based employee compensation.
- Altera shared stock-based compensation costs from 1997–2003 but, from 2004–2007, excluded those costs from the CSA cost pool.
- The IRS issued deficiency notices and reallocated income and expenses under § 482, asserting that stock-based compensation had to be shared in proportion to anticipated benefits, increasing Altera’s U.S. taxable income.
- The Tax Court set aside the regulation as invalid under the Administrative Procedure Act (APA), concluding Treasury acted arbitrarily and capriciously by failing to justify the rule in light of comments and evidence about unrelated-party practice.

## Issues

1. Whether Treasury exceeded its authority under I.R.C. § 482 by requiring cost-sharing participants to include stock-based employee compensation in the shared cost pool as a condition of qualified CSA treatment.
2. Whether the stock-based compensation cost-sharing requirement was arbitrary and capricious under the APA due to Treasury’s asserted failure to adequately address comments and evidence concerning arm’s-length behavior.

## Decision

- The Ninth Circuit reversed the Tax Court and upheld the regulation requiring inclusion of stock-based compensation in the CSA cost pool.
- The court held § 482 does not specify the method for implementing the arm’s-length standard in cost-sharing, leaving room for Treasury’s approach.
- Applying Chevron, the court concluded Treasury’s interpretation was reasonable and entitled to deference.
- The court held the regulation was not arbitrary and capricious because Treasury provided a reasoned explanation and addressed significant comments in the rulemaking record.
- A dissent would have affirmed the Tax Court, reasoning Treasury did not adequately reconcile the rule with evidence about uncontrolled-party practice.

## Legal Principles

- I.R.C. § 482 grants Treasury broad authority to allocate income and deductions among controlled entities to prevent tax evasion and clearly reflect income, guided by tax parity between controlled and uncontrolled taxpayers.
- The arm’s-length standard under § 482 does not invariably require an empirical comparable-uncontrolled-transaction analysis; Treasury may use internal or formula-based allocation methods when direct comparables are unavailable or unsuitable.
- Legislative Treasury regulations issued through notice-and-comment rulemaking receive Chevron deference when the statute is ambiguous and the agency’s construction is reasonable.
- Under the APA, a regulation is upheld if the agency examined relevant material, responded to significant comments, and articulated a rational connection between the record and the rule adopted.

## Conclusion

The Ninth Circuit sustained Treasury’s § 482 cost-sharing rule requiring related parties in qualified cost-sharing arrangements to share stock-based compensation costs, holding the rule within Treasury’s delegated authority, reasonable under Chevron, and supported by adequate APA-compliant explanation.


Altera Corp. & Subsidiaries v. Commissioner, 926 F.3d 1061 (9th Cir. 2019)