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.