Rationality wins, for a change

The Ninth Circuit opinion in Altera v. Commissioner has now come out, reversing a Tax Court decision in a transfer pricing / cost-sharing case that I previously discussed here. It’s a win for the government, and a win for good sense both in regulatory review generally and with respect to the particular issues posed here.

The majority opinion appears to have wholly adopted the viewpoints expressed in amicus briefs that multiple law professors signed, one lead-penned by Clint Wallace (I was among the signatories) and the other by Susan Morse. Whether or not the court thought about it this way, the fact that so many law profs were on one side, without any financial stake, remuneration, etc. (and I believe none were on the other side, at least on this basis) may conceivably have served as a useful signal. There have been quite a few recent international or state tax cases in which law profs were on both sides, and there the proper takeaway was indeed that, in those cases, the merits were far more substantially in dispute among experts than here.

In Altera, the Tax Court unfortunately lost its way, and adopted the views both that stock options cost the issuer zero (in which case I’d like some, please) and that particular details of exchanges between unrelated parties in wholly different contexts should be used mechanically as evidence of “arm’s length,” without an adequate analysis of actual comparability or of how incentives and circumstances might differ as between the settings. The Ninth Circuit’s Altera opinion does a nice job in explaining why the so-called comparable transactions, in which costs of incentive compensation were apparently ignored in particular deals between unrelated parties, weren’t actually comparable in any serious or realistic sense.

The majority opinion also offers a useful and instructive primer on both the history of, and the legislative rationales for, the U.S. transfer pricing rules, in particular as they apply to intangibles. And it sensibly explains why the trap that taxpayers tried to set for the government in the regulatory “notice and comment” stage, by submitting an avalanche of not very relevant material that they correctly guessed the Treasury preamble wouldn’t spend countless pages rebutting point by point, shouldn’t be treated as showing a process failure on the Treasury’s part.

The just-released decision is in effect a do-over. It came out the same way a couple of years ago, but Judge Stephen Reinhardt’s death, after he had signed the majority opinion but before it was reissued, persuaded the Ninth Circuit that the case should be reheard. Given the merits. I’m not at all surprised that Judge Graber, who replaced Reinhardt on the panel, ended up voting the same way.