Multinational corporations use cost-sharing arrangements (“CSA’s”) to spread costs between a parent and one or more offshore subsidiaries. Aggressively structured, CSA’s might exclude the value of stock-based compensation from shared costs, which can have the effect of increasing the compensation deduction that a company is entitled to claim on its domestic corporate returns. Because higher deductions lead to lower tax liabilities, the IRS has frowned on this practice.   

A recent decision in the United States Court of Appeals for the Ninth Circuit has handed the IRS a major victory in the treatment of stock-based compensation in CSA’s. That decision is precedent in the states that are within the Ninth Circuit’s jurisdiction, but it may ultimately control how the IRS treats CSA’s throughout the country. The tax attorneys at Baltimore’s Rosenberg Martin Greenberg LLP are now reviewing and restructuring CSA’s for compliance with this decision.

Stock-Based Compensation in CSA’s

Even a small or closely held company that is headquartered in the United States may have foreign subsidiaries. That company might allocate costs to develop new intellectual property or other assets between the domestic and international entities in exchange for the foreign subsidiaries’ right to derive revenue from the asset. The CSA that defines this arrangement might exclude the costs of stock-based compensation from the list of allowable shared costs.  This structure has even greater tax reduction benefits for the U.S. parent companies that have a larger number of employees with stock-based compensation.

The Altera Memo, the Tax Court, and the Ninth Circuit Decision

Altera Corp. challenged the IRS’s application of treasury regulations on cost-sharing and stock-based compensation. Altera specifically argued that those regulations are invalid and that the IRS did not follow the Administrative Procedures Act when it adopted them. The Tax Court, in July 2015 agreed with Altera, stating that the inclusion of stock-based compensation costs is a function of whether the underlying CSA reflects an arms-length consideration of costs that would realistically be shared. Altera argued that the IRS failed to connect the regulation with the facts that it had found, and its conclusion that the regulation reflects an arms-length standard is inconsistent with those facts.

The IRS appealed the Tax Court ruling, but in 2018 it issued its Altera Memo, which directed its audit teams to suspend new examinations of CSA’s until the underlying appeal was decided.

In June 2019, by a 2-1 ruling, the Ninth Circuit reversed the Tax Court’s decision and upheld the validity of the 2003 regulations. The effect of that ruling is that stock-based compensation costs are to be included as shared costs under CSA’s. This ruling might expose entities that rely on CSA’s to potentially millions of dollars in tax liabilities.

Call Rosenberg Martin Greenberg for Advice on Transfer Pricing Tax Issues and Cost-Sharing Agreements

Companies use multiple and varied tax structures to plan for and reduce their tax liabilities. The evolving application of the rules and regulations that govern the treatment of stock-based compensation in CSA’s reveals how the tax treatment of those structures can change and create adverse tax effects for parties that rely on them.

The tax attorneys of Rosenberg Martin Greenberg LLP monitor the evolution of these rules and apply their most current applications to give their clients the most favorable tax treatment under the law. Please see our website or call us for more information on stock-based compensation and CSA’s, or on any other cost-sharing tax strategies.

Additional Resources:

  1. Ninth Circuit Overturns Invalidation of Transfer-Pricing Regs.
  2. Withdrawal of Directive LB&I-04-0118-005.
  3. Altera Case Loss Doesn’t Mean End of Litigation Fight (Corrected).