Tax Court Invalidates Treasury Regulation on Cost-Sharing Arrangements: Tax Court Strikes Down Treasury Rule Requiring Sharing of Stock-Based Compensation Costs in Qualified Cost-Sharing Arrangements Because the Rule Failed the Reasoned Decision-Making Standard

Sullivan & Cromwell LLP - July 31, 2015

On July 27, 2015, in Altera Corporation v. Commissioner, the United States Tax Court (the “Tax Court”) held that a Treasury Regulation requiring controlled parties that enter into qualified cost-sharing arrangements (“QCSAs”) to share stock-based compensation costs (the “SBC rule”) fails the reasoned decision-making standard enunciated by the Supreme Court in Motor Vehicles Mfrs. Ass’n of the U.S. v. State Farm Mut. Auto Ins. Co. (“State Farm”) and, as a result, is invalid.  Specifically, the Tax Court determined that Treasury had engaged in arbitrary and capricious decision-making in that (i) the SBC rule lacked a basis in fact, (ii) Treasury failed to rationally connect the choice it made in enacting the SBC rule with the facts found, (iii) Treasury failed to respond to significant comments when it issued the SBC rule, and (iv) Treasury’s conclusion that the SBC rule is consistent with the arm’s-length standard of Section 482 of the Code runs contrary to the evidence before Treasury.  As a result, the Tax Court invalidated the SBC rule and ruled that Altera was not required to share stock-based compensation costs with a Cayman Islands subsidiary pursuant to a QCSA between those entities.  Among the implications of the Tax Court’s decision is that Treasury Regulations are susceptible to challenge as violating the requirements of the Administrative Procedure Act (“APA”), particularly those Regulations which were enacted without being subject to the notice and comment rulemaking process.