Tuesday, October 10, 2017

Ninth Circuit oral argument on Altera

I have been reliably informed (and then was able to confirm for myself online) that the Ninth Circuit oral argument in the appeal of the Tax Court's misguided Altera decision is taking place this Wednesday.  I gather that Susan Morse and Steve Shay will be blogging about this, and I'll duly post links thereto.

I previously discussed the Altera decision here and here. Stripped to its substantive (as opposed to administrative law) essentials, it's a case in which the Tax Court ruled that an indisputably correct Treasury regulation, to the effect that the bulk of compensation costs in a cost-sharing deal between related parties should be included in the formula even if they're structured as incentive compensation, was arbitrary and capricious, hence an abuse of discretion. In effect, it's an abuse of discretion to say that 1 + 1 = 2, unless one spends pages of regulatory preamble explaining why taxpayers were incorrect when they filed briefs at the notice and comment stage arguing that 1 + 1 = 1.

The Tax Court relied upon aspects of true arm's length deals that had zero pertinence or relevance to related party paper-shuffling agreements, and accepted expert testimony to the effect that incentive compensation that in fact is worth millions of dollars should be viewed as having a cost of zero.  Here's hoping that the Ninth Circuit straightens things out.

UPDATE: Here is the link for the Morse-Shay posting, further explaining why the Tax Court so clearly erred in striking down the regulation at issue in Altera.

Leandra Lederman adds her comments here.

1 comment:

Robert Kantowitz said...

Sorry, Dan, but all of the sensible arguments fail for two reasons.

First, it is the job of Congress to "get it right," or, for that matter, to get it wrong, not the job of courts or Treasury to replace the congressional standard of empirical behavior as between unrelated parties with an ideal standard.

Second, as to your observation that 1+1=2, you know that however true that is (at least in some systems of mathematics), it is not dispositive in a tax law that has many non-economic elements. To be specific, the fundamental principle here is that related parties should be held to the behavior in which they would engage had they not been related (not that they should be treated as if they were a single entity). The notion that, in order to figure that out, one should assume that where entities participate in a chain of value creation, they generally each have certain costs such as employee compensation that they would try to recoup is a subordinate notion that is not relevant where there is overwhelming evidence as to how unrelated parties actually behave. The government's arguments to the Ninth Circuit that (i) the way in which unrelated parties actually behave is irrelevant and (ii) Congress was really throwing out the arm's length standard but couldn't say so because treaties use that standard are remarkable for their hubris.

The government's suggestion at oral argument that the absence of "mutuality of risk" distinguishes related parties from unrelated parties was clever but, again, if there is to be a divergence from how unrelated parties would behave to how a single company would behave, that is Congress's decision to make.

More broadly, Altera is important for the proposition that Treasury is subject to the APA just as every other government agency is, which was hardly addressed at oral argument.