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US Inbound: Altera decision reversal withdrawn

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The court has withdrawn its decision

The Ninth Circuit reversed, and then withdrew its reversal of, the Tax Court's unanimous 'reviewed by the court' decision in Altera Corp. v. Commissioner, 145 T.C. 91 (2015), and held in a 2-1 decision that Treas. Reg. § 1.482-7(d)(2), requiring related entities to share the cost of employee stock compensation (the 2003 Regulation) was a valid regulation.

The decision, and more so the court's opinion itself, came as major surprises, as did the court's subsequent withdrawal of its opinion.

The Ninth Circuit, in holding for the IRS, would have permitted the IRS to take the US off the § 482 arm's-length standard, which has long been the transfer pricing standard in the US and most foreign countries. It sanctioned a transfer pricing result based on internal analyses only and without regard to what unrelated parties do. So, while the IRS got the result it wanted in Altera, the rationale of the decision conflicts with the US government's rigorous defence of the arm's-length standard in the BEPS proceedings. Indeed, the decision highlights the inherent contradiction in the IRS's position – it wants a non-arm's length result, but under the cover of a purported application of the arm's-length standard. The IRS cannot have it both ways, as the decision made clear.

One of the judges in the majority, Judge Reinhardt, passed away four months before the case was officially decided and the opinions filed. A footnote stated that he fully participated in the case and formally concurred in the majority opinion prior to his death. However, it is not clear whether he had read the final opinion or the strong dissenting opinion by Judge O'Malley.

In a surprising post-decision development, a new judge was appointed to the court's three-judge Altera panel to replace Judge Reinhardt. The court's decision had already been published and its opinion filed only two weeks earlier. The new judge was presumably appointed to the panel in case there was need for a re-hearing. The second surprising post-decision development came a week later when the court announced that its opinion was being withdrawn "to allow time for the reconstituted panel to confer on this appeal". This second post-decision development was welcome, given the negative reaction of the tax community, the apparent conflict with the Ninth Circuit's earlier decision in Xilinx, and the conflict the opinion created with transfer pricing law in the rest of the US. Re-argument in the case is scheduled for October 16 2018.

The result, if sustained by the reconstituted Ninth Circuit panel, will likely result in two transfer pricing systems in the US: East of Rockies (arm's length) and West of Rockies (an anything goes 'internal dealings/ignore comparables/commensurate with income' system). We wonder what the IRS will do in its Advance Pricing Agreement Program and under Treas. Reg. § 1.6662-4 regarding the tax return transfer pricing documentation requirements. Will there be two standards, one for EOR and the other for WOR? It would also be interesting to hear the Treasury's explanations to foreign countries regarding the US's tax treaties (all of which adopt the arm's-length standard), and, better yet, its explanations to the Senate regarding the numerous pending tax treaties. It is the IRS itself, so far, that has won (or forced) the case that led to the two different US transfer pricing systems.

This will undoubtedly open up vast new transfer pricing opportunities, for example, to inbound (foreign-based) taxpayers with US subsidiaries. Only time will tell what the future holds.

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