Advisories September 3, 2019

Federal Tax Advisory: Treasury’s Section 482 Regulation Losses

Executive Summary
Minute Read

Do what Treasury said, not what it says it meant. Our Federal Tax Group explains why the circuit court affirmed one Tax Court decision and reversed another in the name of consistency – and why it means regulation preambles are more important than ever.

  • Affirming in Amazon, reversing in Altera
  • Holding the IRS to literal terms of the regulation
  • Similarity to the Supreme Court ruling on the census citizenship question
The Ninth Circuit recently affirmed the decision of the Tax Court in Amazon.com Inc. v. Commissioner, 148 T.C. 108 (2017). That means Amazon mostly won its transfer-pricing dispute with the IRS over how much its European subsidiary should pay for intangibles transferred in 2005 and 2006. In contrast, the same Ninth Circuit recently reversed the unanimous reviewed ruling of the Tax Court in Altera Corp. & Subsidiaries v. Commissioner, 145 T.C. 91 (2015). It also involved transfer pricing.

What is going on? The two recent rulings are consistent, even though the taxpayer lost one and not the other.

Altera involves a huge dispute about the meaning of the arm’s-length standard for pricing dealings with controlled taxpayers. Treasury regulations say that the related taxpayers should do what unrelated taxpayers would do, and Altera offered proof that unrelated taxpayers would not share stock-based compensation. But the IRS contended that is not what the regulation meant and that proof was not dispositive.

The Tax Court held the IRS to the literal terms of its regulation. The Ninth Circuit, 2–1, was willing to cut the IRS some slack based on general language Treasury used in adopting the regulation, which it read to telegraph the view argued in the trial by the IRS. Therefore, it ruled that the cost sharing need not literally depend on finding a comparable.

In Amazon.com, the IRS similarly relied on a part of the same regulation that did not clearly support its position that residual intangibles like going-concern value were within the special “commensurate with income” rule of Section 482. But in this case, both the Tax Court and the Ninth Circuit found that Treasury had never indicated the regulation meant what the IRS argued it meant until after it was adopted.

So both results are based on what the agency said when it was adopting a regulation. This is what is known as the State Farm/Chenery issue in the application of the Chevron doctrine. It also tripped up the Secretary of Commerce in the recent Supreme Court ruling against the citizenship question on the 2020 census.

The takeaway is that Treasury preambles to regulations are more important than ever before. And even more important are the notices of proposed rulemaking. Because if the public did not know what the Treasury was thinking it was doing before it adopted a regulation, it could never comment. Both Altera and Amazon.com support that point.

For more information, please contact Jack Cummings at 919.862.2302.
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