Tax Notes Quotes Clark Armitage on Stock-Based Compensation

Despite a pending request before the Ninth Circuit for an en banc rehearing in Altera v. Commissioner, the IRS will resume enforcement of a regulation that requires sharing of stock-based compensation costs by cost-sharing participants.

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Further Challenges

J. Clark Armitage of Caplin & Drysdale said he wasn’t surprised by the IRS announcement, noting that the Ninth Circuit’s decision “was clearly a meaningful win. I would have to think they’re pretty confident this is going to be a permanent outcome.”

Armitage said it’s likely that many other companies have contractual provisions with their foreign subsidiaries that they wouldn’t expense stock-based compensation costs unless the IRS won in Altera.

“It’s very possible that the IRS is aware of a number of those companies and had put making audit adjustments on hold, and will now communicate to those companies that they’re going to make adjustments for that issue,” Armitage said.

As for how companies may be gearing up to challenge any adjustments, Armitage said they’ll have to decide whether they want to be relatively aggressive in their reporting.

Another sticky issue is the effect on the treatment of stock-based compensation in other transfer pricing contexts, like when applying the comparable profits method, Armitage said.

“Those are probably a more unpredictable [situation] because you don’t know which entities necessarily have that issue, whereas with cost sharing it’s pretty likely that the issue exists,” Armitage explained. “The IRS could be pursuing that as well. One of the things that will be telling is if we get a practice unit from the IRS that tells examiners, 'Here’s the scope of the issue and what to look for' — or whether this memo was enough.”

Companies will likely develop several different approaches when challenging the Ninth Circuit’s decision, Armitage said.

“It’s always struck me that the basic argument shouldn’t be that because the IRS has always followed the arm’s-length standard, it must follow it in this case,” Armitage explained. “I see it instead as the regulation could produce a result that doesn’t reflect true taxable income, which is the standard in the statute.”

The business to be cost-shared “may be a tiny piece of the public company, and you’re imputing the economics of the entire company performance to this little piece,” Armitage continued. “There’s a disconnect there between the benefit from the appreciation or depreciation of the stock and the specific activity that is going on,” he added.

Armitage noted that that argument is weaker if both sides of the transaction grant stock-based compensation and the business to be cost-shared is a very large percentage of the taxpayer’s business. “But it’s still very possible you have an improper economic outcome and you don’t get true taxable income because of this regulation,” he said.

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