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News & Alerts

Tax News

Wed, 26 Aug 2015 04:00:00 GMT

The Tax Court Strikes Down Cost-Sharing Regulations’ Requirement to Share Stock-Based Compensation Costs

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In a partial summary judgment decision rendered on July 27, 2015, the United States Tax Court (“Tax Court”) struck down the 2003 amendment to the Internal Revenue Code (“IRC”) § 482 cost sharing regulations that require controlled entities entering into qualified cost-sharing agreements (“QCSAs”) to share stock-based compensation costs.  The decision, which was reviewed by the Tax Court, validates Altera Corporation’s (“Altera-US”) position in Altera Corp. v. Commissioner that the final regulations (“T.D. 9088”) violate the arm’s-length standard due to a lack of evidence that unrelated parties ever share such costs.1


On October 20, 2003, the Internal Revenue Service (“Service”) published final regulations, T.D. 9088, which provided guidance on the treatment of stock-based compensation for the purpose of updating, clarifying, and improving regulatory guidance in the area of transfer pricing and the rules governing QCSA’s.  On the topic of cost-sharing, these regulations prescribed rules for measuring the costs associated with stock-based compensation.  T.D. 9088 was intended to align the rules of Treasury Regulation (“Treas. Reg.”) § 1.482-7, regarding QCSAs, with the commensurate-with-income standard and the arm's-length standard to the extent that the participants’ shares of income reasonably reflected the actual economic activity undertaken by each.

In 2005, the Tax Court rejected the Service’s treatment of employee stock options under the taxpayer’s cost-sharing arrangement with its subsidiaries in Xilinx Inc. et al. v. Commissioner.2 The Tax Court determined that the regulations applicable at the time did not allow the Service to require taxpayers to share the spread or grant date value relating to employee stock options under the cost-sharing agreement.  The Ninth Circuit supported the Tax Court’s decision that controlled entities entering into QCSAs were not required to share stock-based compensation costs because parties operating at arm’s-length would not do so.3

Case Details

Altera-US, a Delaware corporation, develops, manufactures, markets, and sells programmable logic devices (“PLDs”) and related hardware and software.  Altera-US is the parent company of Altera International, Inc. (“Altera-Cayman”), a subsidiary located in the Cayman Islands.  As part of a QCSA, Altera-US and Altera-Cayman entered into two agreements:  (i) a master technology license agreement (“Technology License Agreement”) and (ii) a technology research and development cost-sharing agreement (“R&D-CSA”).  The Technology License Agreement granted Altera-Cayman the right to license pre-existing intellectual property (“IP”) from Altera-US and allowed for the use and exploitation of this IP associated with the sale of PLDs outside of the U.S. and Canada.  Altera-Cayman paid royalties to Altera-US for the right to use this IP every year from 1997 to 2003.  After 2003, Altera-Cayman made the requisite payment to obtain a fully paid-up license to use the pre-existing IP in its territory. 

Under the R&D-CSA, Altera-US and Altera-Cayman agreed to combine their respective research and development (“R&D”) resources to further enhance the pre-existing IP and share in the costs and risks of the R&D activities conducted after May 23, 1997.  During the tax years 2004 through 2007, Altera-US granted stock-based compensation to its employees and did not share these costs with Altera-Cayman.  On audit, the  Service determined deficiencies in the calculation of the cost base to be shared by Altera-US and Altera-Cayman and made allocations pursuant to Treas. Reg. § 1.482-7(d)(2).  The taxpayer and the Service filed cross-motions for partial summary judgment. 

The case consolidates two separate deficiency notices and involves $80 million in adjustments to income for years 2004-2007 related to the grant of stock-based compensation by Altera-US.  The Service, at an oral argument, contended that IRC § 482 doesn’t require income to be allocated based solely on evidence of uncontrolled-party transactions, but rather on whether a transaction is priced at arm’s-length, and that such an evaluation could be made in any number of ways.  The Service maintained that T.D. 9088 regulations are governed by the commensurate-with-income standard of IRC § 482 and by requiring that stock-based compensation be shared among related parties, an “arm’s-length result” may be reached.  The Service asserted that unrelated parties entering into QCSAs to develop high-profit intangibles would share the costs of stock-based compensation if stock-based compensation was a significant element of compensation.  Altera-US contended that many QCSAs do not pertain to high-profit intangibles and that stock-based compensation is not a significant element of the compensation of taxpayers that enter into QCSAs. 

The Tax Court found that the final rule lacked factual basis because the Service failed to provide adequate evidence.  The Tax Court first noted that in its ruling of Xilinx the court, “…concluded that Congress never intended for the commensurate-with-income standard to supplant the arm’s length standard.” [4]  The Service failed to support its claims with any administrative record that showed unrelated parties would share stock-based compensation costs. The Service’s files associated with the final ruling did not contain any expert opinions, empirical data, published or unpublished articles, papers, surveys, or reports supporting the determination that stock-based compensation must be included in QCSAs to achieve an arm’s-length result.  The Service also failed to produce any agreements between unrelated parties in which one party reimbursed the other parties for amounts attributable to stock-based compensation. 

The Service did not dispute either of Altera-US’s claims that many QCSAs are not associated with high-profit intangibles and that stock-based compensation is an insignificant element of the compensation of taxpayers that enter into QCSAs.  Furthermore, the Service never claimed that it found any of the evidence submitted by commentators as invalid, implicitly accepting the commentators’ economic analyses, which argued against the sharing of stock-based compensation by unrelated parties.  

BDO Insights

Taxpayers should monitor the developments of this case and consider whether there is a position to file amended tax returns, especially for periods that may be closing due to the expiration of the statute of limitations. This decision may have significant implications with respect to the treatment of these, and other similar, costs going into the current and future tax years.

The Service’s unsuccessful attempt to argue that the commensurate-with-income approach will, essentially, result in an arm’s-length arrangement indicates that empirical evidence will be essential for any regulatory implementation of the arm’s-length standard.  The decision may also result in implications that go beyond the United States cost-sharing regulations, such as the Organization for Economic Cooperation and Development’s (“OECD”) proposals to combat base erosion and profit shifting (“BEPS”). 

For more information, please contact one of the following practice leaders:

Robert Pedersen
International Tax Practice Leader


Jerry Seade


Bob Brown


Joe Calianno
Partner and International Technical
Tax Practice Leader

Scott Hendon

Veena Parrikar
Principal, Transfer Pricing

Monika Loving

Kirk Hesser
Sr. Director, Transfer Pricing


Brad Rode

  Michiko Hamada
Sr. Director, Transfer Pricing


William F. Roth III


1 Altera Corporation v. Commissioner, 145 T.C. No. 3 (July 27, 2015).
2 Xilinx Inc. et al. v. Commissioner, 125 T.C. 37 (2005).
3 Xilinx v. Commissioner, 567 F.3d 482 (9th Cir. 2009); rev’g and remanding 125 T.C. 37, withdrawn, 592 .3d 1017 (9th Cir. 2010)

4 Xilinx Inc. et al. v. Commissioner, 125 T.C. 37 (2005).

Wed, 26 Aug 2015 04:00:00 GMT

The August edition of BDO China's China Tax Newsletter features recent tax-related news and developments in China, such as the adjustment or certain pre-tax deductions, further standardization of levying, and more. Articles include:

  • Clarification of Pre-tax Deduction of Education Expenses for Employees of High-tech Enterprises
  • Commence of Joint Reporting of Annual Investment Operation Information by Foreign Investment Enterprises in 2015
  • Adjustment of Certain Pre-tax Deductions and Exemption Standards of Individual Income Tax in Shenzhen
  • Release of Provision on Levying and Collection of Individual Income Tax on Electronic Red Envelopes
  • Further Standardization of Levying and Collection of Individual Income Tax of the Personnel Who Perform Cross-Province Construction Work in the Building and Installation Industry


Assurance News

Mon, 24 Aug 2015 04:00:00 GMT

Proposed Accounting Standards Update, Not-for-Profit Entities (Topic 958) and Health Care Entities (Topic 954)Presentation of Financial Statements of Not-for-Profit Entities (File Reference No. 2015-230) (“the ED”)

BDO supports the objective of the NFP financial statement project, but believes more implementation guidance is needed.

Tue, 18 Aug 2015 04:00:00 GMT

SEC Adopts Rule Requiring Pay Ratio Disclosures

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On August 5, 2015, the SEC adopted, by a 3-2 vote, a rule mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The rule amends Item 402 of Regulation S-K and requires issuers to disclose the following: 
  • The median annual total compensation of all employees except the chief executive officer;
  • The annual total compensation of the CEO; and
  • The ratio of the median annual total compensation of all employees to the annual total compensation of the CEO.

These disclosures are collectively referred to as the “pay ratio” disclosures and are intended to help inform shareholders when evaluating a CEO’s compensation.  The rule is generally consistent with the one the SEC proposed in 2013.  The adopting release is available here on the SEC’s website.
The pay ratio disclosures are required in any annual report, proxy, or registration statement that requires disclosure of executive compensation pursuant to Item 402 of Regulation S-K.  However, emerging growth companies, smaller reporting companies, foreign private issuers, Multijurisdictional Disclosure System filers, and registered investment companies are exempt from the requirements.  In addition, companies filing initial registration statements (whether in an initial public offering or on Form 10) are not required to provide the pay ratio disclosures.  Certain transition relief is available for newly public companies, companies with business combination activity, and those exiting smaller reporting company or emerging growth company status.
Companies are required to provide the pay ratio disclosures for their first fiscal year beginning on or after January 1, 2017.  For example, a registrant with a fiscal year ending on December 31 would be first required to include the pay ratio information relating to compensation for fiscal year 2017 in its proxy or information statement for its 2018 annual meeting of shareholders and to include or incorporate by reference this information in its 2017 Form 10-K.
The rule requires a registrant to (1) identify the employee whose annual total compensation level is the median of all of its employees except its CEO, (2) compute the median employee’s total compensation, and (3) compute a ratio in which the median employee’s total compensation is equal to 1 and the CEO’s total compensation is a calculated number.  For example, if the of the median employee’s total compensation is $45,790 and the CEO’s total compensation is $12,260,000, then the pay ratio disclosed would be “1 to 268”. The ratio could also be expressed narratively, such as “the CEO’s annual total compensation is 268 times that of the median of the annual total compensation of all employees”.
Subject to certain exceptions described below, the median employee is identified by an analysis of the annual compensation of all persons, including all U.S. and non-U.S. full-time, part-time, seasonal, and temporary workers, employed by the registrant and its consolidated subsidiaries as of any date within the last three months of its fiscal year.1  The individual compensation amounts used to identify the median employee may be annualized for permanent employees who were employed for less than the full fiscal year.  Such amounts for seasonal and temporary workers may not be annualized.  Similarly, such amounts for part-time workers may not be adjusted to the full time equivalent amount.  The rule permits registrants to identify the median employee in a variety of ways.  For example, a registrant is permitted to analyze its entire employee population, use a statistical sampling methodology, or any other reasonable method.  Moreover, the median employee can be determined using a consistently applied compensation measure (e.g., amounts derived from the registrant’s payroll or tax records), rather than each employee’s total compensation.  Once the median employee is identified, that person’s annual total compensation pursuant to Item 402(c)(2)(x)2 must be calculated and disclosed.  The rule permits companies to make estimates when calculating the elements of annual total compensation in accordance with Item 402.  Disclosure of the methodology and material assumptions and estimates used to identify the median employee and/or determine the compensation amounts is required.  Registrants are permitted to supplement the disclosure with additional narrative discussion or other ratios as long as the information is clearly identified and is not given greater prominence than the pay ratio disclosures.
The final rule contains changes from the proposal that are intended to provide companies with flexibility to meet the rule’s requirements in a number of other ways, including the ability to:
  • Identify the median employee only once every three years.  However, if there has been any change in the employee population or employee compensation arrangements which may result in a significant change to the pay ratio, the median employee should be re-identified.  If the median employee’s compensation significantly changes during the three year period, the company may use another employee with substantially similar compensation as the median employee.
  • Exclude non-U.S. employees from countries in which obtaining the required information to calculate the pay ratio would violate the particular jurisdiction’s data privacy laws or regulations (i.e., the data privacy exception).  This exception can only be applied if the Company obtains a legal opinion supporting the assertion that obtaining the necessary information violates the local laws.
  • Exclude up to 5% of its total employees who are non-U.S. employees (i.e., the de minimis exception), which includes any non-U.S. employees excluded under the data privacy exception.  This exception can only be applied on a jurisdiction by jurisdiction basis, so that if one employee in a jurisdiction is excluded all must be excluded.
  • Apply an adjustment to account for differences between the cost-of-living in the CEO’s jurisdiction and the cost-of-living in other jurisdictions when identifying the median employee.  If applied, the same adjustment would be made to the median employee’s annual total compensation used to calculate the pay ratio.  However, disclosure of the compensation amount and pay ratio without the cost-of-living adjustment is still required.

For questions related to matters discussed above, please contact Jeff Lenz or Paula Hamric.

1 Independent contractors and leased employees are excluded from this population.
2 Total compensation per Item 402(c)(2)(x) includes salary, bonus, the aggregate grant date fair value of options or stock awarded during the period, earnings for services performed under non-equity incentive plans and all earnings on any outstanding awards, certain amounts related to defined benefit and actuarial pension plans, and any other compensation not included in the aforementioned categories.


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