United States

3M challenges Treasury regulations based on Altera

Altera case spawns challenge to different transfer pricing regulation


In a Tax Court filing made June 29, 2016, 3M argued that certain transfer pricing regulations were invalid based on the same arguments that were successfully advanced in Altera Corp. v. Commissioner, where the court invalidated certain cost sharing regulations in part because the Treasury Department failed to adequately consider significant taxpayer comments. Taxpayers should take note because the Altera decision may become the basis for successful challenges of many other tax regulations.

In Altera, the issue at hand was whether Altera failed to include stock based compensation (SBC) in the cost pool allocated to its Cayman Island subsidiary under the company’s qualified cost-sharing arrangement (QCSA), thereby reducing its U.S. income. Treasury regulations issued in 2003 required controlled parties to share such SBC costs under QCSAs, but Altera argued that those regulations were arbitrary and capricious and, therefore, invalid.

The Tax Court ruled in favor of Altera and concluded that in issuing the regulations, the Treasury Department:

  • Failed to rationally connect the choice it made with the facts found
  • Failed to respond to significant comments when it issued the final rule
  • Failed to recognize that its conclusion that the final rule is consistent with the arm's-length standard is contrary to all of the evidence before it

Ultimately, the Tax Court concluded that the final Treasury rule failed to satisfy the reasoned decision-making standard established under relevant Supreme Court precedent, and therefore, was invalid.

Since the release of Altera in July 2015, the tax community has been left to consider if taxpayers might challenge other regulations using the reasoning in Altera, and the 3M case answers that question. At issue in the 3M case is whether royalties paid to 3M’s Brazilian subsidiary meet the requirements of certain transfer pricing regulations. Describing similar procedural weaknesses to those cited by the Tax Court in regarding the regulation at issue in Altera, 3M argues that Treasury and the IRS were arbitrary and capricious in issuing the relevant regulations because the government failed to provide sufficient, supporting rationale for the position taken in the regulations and failed to answer significant comments raised by commenters. In addition, 3M asserts that post hoc arguments to support the regulations are impermissible and that, for all of these reasons, the regulations are therefore invalid.

Whether the court determines the regulations satisfy the reasoned decision-making standard and whether it sustains 3M’s argument remains to be seen. Regardless, many taxpayers are likely to challenge Treasury regulations based on the reasoning accepted by the Altera court.


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