The petition states the questions presented as:
1. Whether the Treasury Department’s regulation is arbitrary and capricious and thus invalid under the Administrative Procedure Act, 5 U.S.C. 551 et seq.
2. Whether, under SEC v. Chenery Corp., 332 U.S. 194 (1947), the regulation may be upheld on a rationale the agency never advanced during rulemaking.
3. Whether a procedurally defective regulation may be upheld under Chevron on the ground that the agency has offered a “permissible” interpretation of the statute in litigation.I think there is less to those issues than presented by Altera in its petition. I will think about it more and present my ideas when I have time to think them through and articulate them. At the inception of my thought process, I do think that there are some conceptual threshold issues that the petition just assumes away. I will deal with that in later comments.
In the meantime, I do note that Chevron was a key basis for the Ninth Circuit decision, the petition does not make a frontal assault the concept of Chevron deference. Rather, based on the questions presented, Altera attacks on procedural regularity grounds (even if the interpretation in the regulation is a reasonable interpretation of the statute, the regulation failed procedural regularity).
Added 2/13/20 11:00 am:
I add a few comments. I will not attempt a more detailed analysis because: (i) it would take too much time and energy; and (ii) my more detailed analysis will not affect the trajectory of Altera. But feeling that my summary comments might spark at least some thoughts about the issue, I offer them. I cite and link to my prior offerings that may offer more detail.
1. The petition, in my opinion, overdoes the Tax Court’s unanimous (15-judge) decision, as if the drill is to count votes rather than assess the quality of the positions. The Tax Court’s unanimous opinion does not mean it was correctly decided. And, the Tax Court has zero special expertise in administrative law and the APA, and shows (in my opinion) that lack of expertise in its Altera opinion.
2. Most interesting to me is that the petition avoids the legislative-interpretive distinction that Tax Court stumbled on early in its opinion. The Ninth Circuit avoided it also. Avoiding that nonsense was good. The regulation is an interpretive rule and as an interpretive rule is subject to Chevron review alone (or, where Chevron does not apply, perhaps Skidmore review if that is even meaningful). However, since the interpretation was adopted as a notice and comment regulation (thus confirming that it is entitled to Chevron review), the regulation is subject to arbitrary and capricious reasoned decisionmaking review (often called State Farm review) just as legislative rules (which must be regulations adopted with notice and comment). And to close the loop, merely because an interpretive rule is adopted as a notice and comment regulation does not make the rule a legislative rule. For further on my thoughts along this line, see: Townsend, John A., The Report of the Death of the Interpretive Regulation Is an Exaggeration (January 25, 2020). Available at SSRN: https://ssrn.com/abstract=3400489. The Tax Court was just wrong in declaring the regulation a legislative rule. See Legislative Rules And Chevron Deference An Oxymoron? (Federal Tax Procedure Blog 1/31/20; 2/10/20), here; and Ninth Circuit Reverses Unanimous Tax Court in Altera (Federal Tax Procedure Blog 6/7/19; 6/20/19; 7/2/19), here.
3. Bottom line, the substantive argument in the petition posits a syllogism. Major Premise: the arm’s length standard is the § 482 standard, separate from and uninformed by the commensurate with income statutory text. Minor Premise: arm’s length parties would not include stock based compensation in cost sharing agreements (CSAs) based on costs. The conclusion, on the premises, is compelled, Altera urges. Pretty simple. (Altera hopes.)
4. I think there is weakness in both premises. Let’s analyze the Minor Premise, just from logic. Assume two unrelated parties enter a 50-50 profit sharing CSA for wholly new technology not relying upon either party’s previously developed technology. Party 1's employees will do all of the work and Party 2 will just pay Party 1 for 50% of its employee cash related costs from the start up of the CSA venture. Party 1 is not compensated for its previously accrued costs of bringing a skilled work-force to the venture (this may be gratuitous to this discussion, but think about it anyway), nor for any stock-based compensation the employees accrue while working on the project. Assume that Party 1's compensation model for its workers is that they are paid in cash salaries and cash bonuses very low relative to what they can expect their overall compensation to be if Party 1 makes outstanding profits (whether from this venture or from its other activities unrelated to this venture). So, during the four-year expected period of the Party 1 - Party 2 venture, a hypothetical typical mid-level Party 1 employee might expect to get annually $300,000 per annum cash compensation (all-in with cash bonuses and all related out of pocket cash costs such as employer costs for employment taxes, insurance, etc.) and $1,000,000 stock compensation (a noncash cost). Would Party 1 accept a $150,00 annual buy-in from an unrelated party for that Party 1 employee? Based on economic presumed equivalency, the Party 1 is paying costs of $1,150,000 for that employee in the Party 1 - Party 2 venture. If Altera’s minor premise is that unrelated parties would not consider and include some cost related to the extra noncash compensation, then I suggest that is nonsense. I think this Judge Thomas’ (for the majority in Ninth Circuit Altera opinion, p. 1084) point in quoting the preamble to the final rule:
Treasury articulated why treating stock-based compensation as a cost led to arm's length results. It first noted that stock-based compensation is a "critical element" of R&D costs for parties to a QCSA and noted that such compensation is "clearly related to the intangible development area." Compensatory Stock Options Under Section 482 (Preamble to Final Rule), 68 Fed. Reg. at 51,173. Logic supports these conclusions. Parties dealing at arm's length, as Treasury explained, would not "ignore" stock-based compensation if such compensation were a "significant element" of the compensation costs one party incurs and another party agrees to reimburse when developing high-profit intangibles. Id. Rather, "through bargaining," each party would ensure that the cost-sharing agreement is in its best interest, meaning that the parties will consider the internal costs of stock compensation without requiring the other party to recognize those costs. Id.Now, I am sure many will argue that such a large divergence between cash compensation and stock-based compensation may not be the real world in most cases. But, the point is the same even if the divergence is smaller. In the example, Party 1 would not logically ignore stock based compensation in reaching a CSA with an unrelated party. (And that even ignores the value beyond actual compensation that Party 1 brings to the table with an assembled and skilled work force (assembled over the years at great cost), for which unrelated parties would demand and give, respectively, compensation; and this points to one of the real problems with these type of related party intangible development costs for potential high profit intangible--there really are no comparable transactions.)
5. The major premise is not correct as presented. I do think the arm’s length standard is informed by the commensurate with income standard. In the example I gave, the two parties are entering a new venture to develop new technology from scratch. Altera’s argument is that the commensurate with income standard simply does not apply because no intangible property has been transferred to the venture. (See, e.g., Pet. p. 10 (“That different part of the statute addresses how to value transfers of intangible property from one related entity to another.”)). That argument at a minimum ignores the contribution of Party 1 of an assembled and skilled work force and organization, all assembled with great cost over the years, which brings value to the venture that is not reflected if only cash expenditures during the venture are considered. And, the argument ignores that the “separate part of the statute” does inform the general notion that Congress wanted a fair sharing based each party’s contributions so that the U.S. tax base is not eroded. The commensurate with income statutory language addresses most directly a direct transfer on intangibles from Party 1 to Party 2, related parties, and imposes a requirement Party 1 be compensated commensurate with the income from Party 2's exploitation of the property. That is wholly consistent with the Ninth Circuit’s holding in Altera permitting, in the example, Party 1 to be compensated under the CSA for all of of its costs – value brought to the table of the joint venture (not even considering the real value in the workforce which is not directly reflected in costs during the life of the venture) so that it can then share in all of the profits.
6. Turning to the reasons Altera asserts the petition should be granted (Pet. pp. 13 ff.), they relate to the arbitrary and capricious and reasoned decisionmaking standard (although the points noted above are within the scope of the arguments made). Bottom-line, the arguments are that, (i) in adopting the notice and comment regulation, the Treasury did not give fair notice before adopting the final regulation and (ii) the Ninth Circuit’s holding rests on a rationale not previously asserted by the agency (Treasury), thus violating the Chenery rule (SEC v. Chenery Corp., 332 U.S. 194 (1947)). The first point urges (Pet.p. 15) that, during the notice and comment process, “everyone understood that the settled arm’s-length standard applied” and that standard could only apply “if evidence established that unrelated parties operating at arm’s length would do so.” (Without getting into the merits of that argument, I think the law under § 482 has always been an abuse of discretion standard under which the taxpayer must prove that the allocations asserted by the IRS were not consistent with arm’s length transactions between unrelated parties; in other words, it is the taxpayer’s burden to show that parties dealing at arm’s length would not have negotiated the result asserted by the IRS.)
7. Altera asserts that, even without a conflict among the Circuits, the case is of sufficient importance that “The Court should grant certiorari now.” (Bold face in petition.) I suspect DOJ will assert that certiorari should await other Circuit’s views and that even the Tax Court may reconsider its holding in view of the Ninth Circuit’s opinion. (My own view is that the Tax Court has inched away from its more questionable statements in its opinion in Altera. See, e.g., my discussion of the Tax Court opinion in SIH Partners LLLP v. Commissioner, 150 T.C. 28 (2018), aff’d 923 F.3d 296 (3rd Cir. 2018), cert. den. ___ U.S. ___, ___ S.Ct. ___ (1/13/20), in my article linked above. So, I don't think we can assume, as the petition does, that (i) the Tax Court will not reverse its holding in cases not appealable to the Ninth Circuit or (ii) that a conflict in another Circuit will inevitably develop so that the Supreme Court should assume that Supreme Court review is just a matter of timing (then or now). Altera urges that it is so important, that the Supreme Court should review now. I am sure DOJ will engage on that issue in its brief in opposition.
8. Oh, and I suppose that DOJ might acquiesce in certiorari. I don't suspect that will happen (unless, to be fanciful, President Trump tweets that the Ninth Circuit opinion, adopted at the argument of DOJ Tax, is very unfair).
I will stop now and move on to more immediately productive efforts. I will await the Government’s brief in opposition and perhaps declaim more then.
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