The Altera U.S. Tax Court Decision
INSIGHT ARTICLE |
On July 27, 2015, the U.S. Tax Court invalidated a 2003 regulation1 issued by the IRS that requires the inclusion of stock-based compensation (SBC) in the pool of costs that taxpayers must take into account under a cost sharing arrangement. The court concluded that the IRS failed to prove third parties would have shared those same costs in an arm's-length arrangement, and concluded that the regulation was invalid from inception because it failed to satisfy the requirements of the Administrative Procedures Act.
To date, the IRS has not indicated whether or not they will appeal the decision (in general, they have 90 days to do so). Because the court decision arguably constitutes a change in tax law, or pending change in tax law depending on whether or not the IRS appeals, there could be immediate/near term cash tax and financial statement impacts to consider where taxpayers have historically accounted for SBC under a qualified cost-sharing agreement (QCSA).
Potential cash tax implications:
- Because the regulation was rendered invalid by the U.S. Tax Court, a court with national jurisdiction, the Altera opinion should allow taxpayers in all circuits, with the right facts and circumstances, to present a "good faith" challenge to the validity of the regulation at a "realistic possibility" of being sustained (the minimum threshold required to avoid accuracy related penalties).2
- As a result, taxpayers may be able to take a position based on the case on 2014 filings, 2015 estimated tax payment filings and on their 2015 tax return, which could lead to immediate/near term cash tax savings.
- Since the IRS has not acquiesced (i.e., can still appeal), any position taken by a taxpayer on their unfiled 2014, 2015 current year, or 2015 estimated tax filings will still be a position contrary to a regulation (albeit one that has been invalidated by the Tax Court).
- For procedural reasons only (this is key to the financial statement treatment discussed below), taxpayers choosing to apply the Altera court decision prior to guidance from the IRS on the matter should disclose the position on a properly completed Form 8275-R, Regulation Disclosure Statement, to avoid relevant penalties.
- Taxpayers, with certain facts and circumstances, may also be able to establish a position for claiming refunds of tax with respect to prior years (i.e., 2013 or earlier) for any open tax year.
- There is currently a debate regarding whether taxpayers may file amended returns to file refund claims. The transfer pricing regulations arguably prohibit refund claims based on "self-initiated" changes to the taxpayer's transfer pricing for a prior year.3 However, it is not clear whether this rule applies to a regulation that is declared invalid from inception. Moreover, it is not clear whether filing a refund claim based on an invalid regulation is a "self-initiated" change. Taxpayers should evaluate the application of this rule in each case.
- Altera could lead taxpayers to challenge other costs covered by the regulations such as management costs.4
In all cases, taxpayers must conduct a detailed review of the relevant language in their QSCAs to determine whether they can rely on Altera to remove SBC from the cost pool used in their QSCA.
Potential financial statement impacts:
- For financial statement purposes, the effect of a change in law must be taken into account as of the balance sheet date that includes the period in which the change occurred.
- As a result, a calendar year filer must have a process in place to evaluate the impacts of a change in tax law, and make the appropriate financial statement adjustments, if any are required, in their upcoming Sept. 30, 2015, 10Q filings.
- This date may or may not arrive prior to any guidance from the IRS on the matter.
- The potential financial statement impact can vary depending on the taxpayer's specific facts and circumstances.
- Depending on the strength of the taxpayer's position, taxpayers may need to record the financial statement impact of multiple open tax years in a single quarter. Taxpayers may need to reserve all or a portion of the position.
- A multi-year adjustment recorded in one quarter may qualify as a material adjustment for financial statement purposes.
- Companies should therefore ensure that a process exists to evaluate the impacts of changes in tax law, and should be able to document that process and demonstrate to their auditors that their financial accounting treatment of the change in law complies with the applicable accounting standards (U.S. GAAP, IFRS, etc.).
- Failure to do so may result in a significant deficiency, material weakness, or in the worst case, a restatement, if the impact of a change in law is material and not correctly accounted for in the period the tax law becomes effective.
Depending on the facts, taxpayers may be able to rely on Altera at a high level of confidence, or not at all, which will significantly impact not only their tax filing position but also the financial statement treatment of the position. As a result, impacted taxpayers should consult with their tax advisors to assess the strength of their facts in connection with a position based on Altera.