“I.R.C. §482 consists of two sentences,” the Internal Revenue Service explains in a new Coordinated Issue Paper (CIP) issued March 20, 2008. “The first sentence authorizes the Secretary to allocate income and deductions among commonly controlled organizations as necessary to clearly reflect the income of those organizations.” The second sentence requires that—in the case when a U.S. company and foreign affiliate co-develop an intangible asset with certain benefits—they share the proportionate costs. In the case of stock-based compensation (SBC), the Service generally measures this expense according to the “spread value” (difference between fair market value on exercise date and the option’s exercise price) or “grant date value” (applying FAS 123 fair value approach).
The problem: Cost-sharing regulations did not specifically include SBC until 2003. In a case decided under the old (1995) regulations, Xilinx Inc. v. Comm’r 125 T.C. 37 (2005), the Tax Court held that the Service’s inclusion of SBC in the cost pool was “arbitrary and capricious,” because—on the basis of expert testimony—parties could make an arms-length arrangement not to share the spread or grant date value. The Service has appealed the decision to the Ninth Circuit, according to the new CIP, and even if it loses, plans to apply the decision only to cases that come under the 1995 regulations. “For cases under the 2003 SBC Regulations, such a decision would not be controlling.” Moreover, the case would not control those outside of the Ninth Circuit. A copy of the Xilinx opinion is available here, and is now among the over 2,700 federal and state valuation cases available at BVLaw™ .
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