David Rosenbloom Comments on Altera Corp v. Commissioner and the Arm's Length Standard
07.31.2015
International Tax Monitor
The International Tax Monitor quoted H. David Rosenbloom concerning the Tax Court's decision in Altera Corp v. Commissioner and the implications it may have on Treasury rulemaking and the arm's length standard. For the complete article, please click on the link above to view a PDF.
Excerpt taken from the article.
David Rosenbloom of Caplin & Drysdale in Washington, D.C., questioned how Treasury's approach to rulemaking will change in light of Altera.
"I do not believe the court's approach to the case, with extensive analysis of APA principles and invocation of Supreme Court precedents involving regulations issued by other federal agencies, has much, if any, precedent in the tax area," Rosenbloom said in an e-mail.
"The Internal Revenue Service (and Treasury) are indisputably federal agencies, but the review of Treasury regulations has for decades proceeded along its own, pretty isolated, path. I wonder what the outcome will be if the court's approach in Altera is applied to other Treasury regulations, beyond those relating to cost sharing and even completely beyond transfer pricing. That would usher in an entirely new process, and maybe new standards, of review."
Implications for BEPS
Rosenbloom agreed that the opinion has implications for the OECD's project to combat base erosion and profit shifting.
"This court is very heavily influenced by Xilinx," he said. "Yet you would have to say that the court is applying an unusual version of the arm's-length standard and it's applying it in a way that opens up the arm's-length standard beyond what we've seen in the past."
Rosenbloom said the decision moves in the direction of applying the arm's-length standard to behavior as opposed to price—an approach taken in some guidance under the OECD's BEPS project that has drawn sharp criticism from taxpayers.
"This decision could be read as supporting the kinds of things that the developing countries are trying to do with BEPS, which is to get away from strict ‘arm's length' and look to where the value is really created."
He added, "That may not be bad, but I think if that's the way the law proceeds, it's going to be a two-edged sword. It's not always going to hurt the government; it's going to hurt taxpayers."
The fundamental supposition of the opinion, he said, is that in order to establish that a transaction is at arm's length, one must show evidence that uncontrolled parties would engage in the same behaviors.
If that is the metric, however, then it can work in reverse: It would be possible to invalidate a related-party agreement on the ground that unrelated parties never engage in such a transaction.
"The entire arm's-length method is based on methodological approaches that unrelated parties don't use," he said. "If unrelated parties are dealing with transactions between themselves, they're not looking for comparables; they price things based on what's in it for them."
What Is Arm's Length?
Said Rosenbloom: "I'm very skeptical that there are unrelated cost sharing agreements involving crown jewel intangibles, such as you have in Xilinx and Altera. You have agreements to do things but they are at the margins of the business."
Qualitative Differences
In Altera, he said, the more critical point is that "when you are dealing with two unrelated parties, it is just qualitatively different from a public company entering into a transaction with a wholly owned subsidiary."
When related parties are involved, there is just one publicly traded stock, he said, "and everybody involved in the transaction has a common interest in the value of that stock." When unrelated parties are involved, there are two publicly traded stocks and each company has a vital interest in the value of its own stock. The fact that unrelated parties don't share stock-based compensation "does not prove squat," he said.
"Of course they're not going to share each other's stock-based compensation," he said. "That involves taking a risk that goes way beyond whatever deal they have."
Excerpt taken from the article.
David Rosenbloom of Caplin & Drysdale in Washington, D.C., questioned how Treasury's approach to rulemaking will change in light of Altera.
"I do not believe the court's approach to the case, with extensive analysis of APA principles and invocation of Supreme Court precedents involving regulations issued by other federal agencies, has much, if any, precedent in the tax area," Rosenbloom said in an e-mail.
"The Internal Revenue Service (and Treasury) are indisputably federal agencies, but the review of Treasury regulations has for decades proceeded along its own, pretty isolated, path. I wonder what the outcome will be if the court's approach in Altera is applied to other Treasury regulations, beyond those relating to cost sharing and even completely beyond transfer pricing. That would usher in an entirely new process, and maybe new standards, of review."
Implications for BEPS
Rosenbloom agreed that the opinion has implications for the OECD's project to combat base erosion and profit shifting.
"This court is very heavily influenced by Xilinx," he said. "Yet you would have to say that the court is applying an unusual version of the arm's-length standard and it's applying it in a way that opens up the arm's-length standard beyond what we've seen in the past."
Rosenbloom said the decision moves in the direction of applying the arm's-length standard to behavior as opposed to price—an approach taken in some guidance under the OECD's BEPS project that has drawn sharp criticism from taxpayers.
"This decision could be read as supporting the kinds of things that the developing countries are trying to do with BEPS, which is to get away from strict ‘arm's length' and look to where the value is really created."
He added, "That may not be bad, but I think if that's the way the law proceeds, it's going to be a two-edged sword. It's not always going to hurt the government; it's going to hurt taxpayers."
The fundamental supposition of the opinion, he said, is that in order to establish that a transaction is at arm's length, one must show evidence that uncontrolled parties would engage in the same behaviors.
If that is the metric, however, then it can work in reverse: It would be possible to invalidate a related-party agreement on the ground that unrelated parties never engage in such a transaction.
"The entire arm's-length method is based on methodological approaches that unrelated parties don't use," he said. "If unrelated parties are dealing with transactions between themselves, they're not looking for comparables; they price things based on what's in it for them."
What Is Arm's Length?
Said Rosenbloom: "I'm very skeptical that there are unrelated cost sharing agreements involving crown jewel intangibles, such as you have in Xilinx and Altera. You have agreements to do things but they are at the margins of the business."
Qualitative Differences
In Altera, he said, the more critical point is that "when you are dealing with two unrelated parties, it is just qualitatively different from a public company entering into a transaction with a wholly owned subsidiary."
When related parties are involved, there is just one publicly traded stock, he said, "and everybody involved in the transaction has a common interest in the value of that stock." When unrelated parties are involved, there are two publicly traded stocks and each company has a vital interest in the value of its own stock. The fact that unrelated parties don't share stock-based compensation "does not prove squat," he said.
"Of course they're not going to share each other's stock-based compensation," he said. "That involves taking a risk that goes way beyond whatever deal they have."
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