Ninth Circuit Withdraws Altera Decision–Thus Leaving the Tax Court Decision in Force for Time Being

Could this be a case of déjà vu? 1

On August 7, 2018, the Ninth Circuit withdrew its July 24, 2018 opinion in Altera Corporation v. Commissioner to allow a reconstituted three-judge panel to reconsider the decision.

Tax Court Decision

In Altera Corporation v. Commissioner 145 T.C. No. 3, the Tax Court invalidated Regulation 1.482-7A(d)(2) which provides that in the context of qualified cost-sharing agreements the cost of employee stock compensation must be treated as a per se expense allocated between related parties.

The Tax Court in a 14-0 decision (reviewed by the entire court) held that the cost-sharing regulations were invalid under the Administration Procedure Act (APA) because the Treasury did not consider the evidence presented by commentators during the rulemaking process.

Ninth Circuit Overturned the Tax Court on July 24, 2018

On July 24, 2018, the Ninth Circuit by a vote of 2-1 reversed the Tax Court’s Altera decision that had invalidated Regulation 1.482-7A(d)(2). Prior to the release of the opinion, one of the two judges who voted to reverse the Tax Court died. The opinion noted that Judge Reinhardt fully participated in this case and formally concurred in the majority opinion prior to this death.

Ninth Circuit Opinion Withdrawn on August 7, 2018.

The two remaining judges (Thomas and O’Malley) differed on their views on the case. In fact, Judge O’Malley wrote a very strong dissent. The decision to withdraw the case was not done on motion of one of the parties but rather was done by the Court and appears to be an admission by the Court that they made a mistake in allowing Judge Reinhardt’s vote to be cast after he passed.

Observations

• It has been reported that a number of taxpayers previously disclosed in their filings with the Securities and Exchange Commission that they made changes to their tax provisions due to the Ninth Circuit opinion. These disclosures will now likely have to be reversed.
• Judge Reinhardt was the Judge in the Xilinx case who dissented when the Ninth Circuit ultimately affirmed the Tax Court opinion.
• This case has a significant implication for many businesses as evidenced by the numerous Amicus Curiae briefs submitted to the Court.
• The death of a Judge while a case is under consideration is handled differently by courts. In some courts, the Judge’s vote does not count unless the other two judges agree. The Ninth Circuit did not follow this approach. The Ninth Circuit has been criticized for the approach it took in Altera and a letter has been submitted requesting that Court change their practice (see letter from Steve Sachs to the Committee on Rules of Practice and Procedure). It is likely that the Ninth Circuit withdrew its opinion because of similar concerns expressed by allowing a deceased jurist to cast the tie breaking vote.

1 In Xilinx, the Ninth Circuit considered the 1995 and 1995 cost-sharing regulations. Xilinx, Inc., challenged the IRS’s allocation of employee stock options between Xilinx and its Irish subsidiary. 598 F.3d at 1992. The issue was whether §1.482-1 (1994) – which sets forth the arm’s length standard – could be reconciled with § 1.482-7(d)(1)(1995) – under which parties to a QCSA were required to share “all…costs” incurred in developing intangibles.

Initially the panel, in a 2-1 decision, voted to reverse the Tax Court, which had unanimously struck the 1995 cost-sharing regulations. Xilinx, Inc. v. Comm’r, 567 F.3d 482 (9th Cir. 2009), withdrawn 592 F.3d 1017 (9th Cir. 2010). However, the panel withdrew its first opinion after reconsideration, and the panel – over Judge Reinhardt’s dissent – ultimately affirmed the Tax Court in striking the regulations. Xilinx, 598 F.3d 1191.