By Donald M. Falk, Mayer Brown LLP
Today, the National Chamber Litigation Center filed an amicus brief urging the U.S. Court of Appeals for the Ninth Circuit to reconsider a decision that undermined the fundamental basis for determining how trillions of dollars in cross-border transactions between U.S. companies and their overseas affiliates are taxed. The decision of the three-judge panel virtually guarantees double taxation by permitting related corporations to be taxed differently from unrelated corporations. The case is Xilinx, Inc. v. Comm'r of Internal Revenue.
The case arises out of a tax deficiency assessed by the IRS against circuit device manufacturer Xilinx, Inc. for claiming business expense deductions for the exercise of stock options issued to its employees involved in research and development (R&D). The IRS contended that under Section 428 of the Internal Revenue Code, Xilinx should have shared the cost of the employee stock options (ESOs) with its foreign subsidiary Xilinx Ireland, thereby reducing the taxpayer company's deductions and increasing its taxable income.
On May 27, 2009, a Ninth Circuit panel ruled 2-1 that employee stock options (ESOs) issued to employees involved in R&D are costs that should be shared with a taxpayer company's foreign subsidiary. In reaching its decision, the panel rejected the "arm's length standard" for allocating costs between a U.S. company and its foreign subsidiary. Under the "arm's length standard," income and deductions associated with transactions between companies that are under common control, yet subject to different taxing authorities, may be adjusted to reflect the allocations that would have resulted had independent companies engaged in the same transaction.
In its amicus brief, NCLC argued that the Ninth Circuit's abandonment of the "arm's length standard" is a significant departure from domestic tax law, international treaty obligations, and the settled expectations of U.S. companies and their foreign subsidiaries. NCLC explained that the arm's length standard is incorporated in U.S. bilateral income tax treaties and provides the unifying principle of transfer pricing among taxing authorities worldwide. The United States has assured its treaty partners that Section 482 of the Internal Revenue Code embodied the arm's length standard. In reliance on that universal principle, thousands of U.S. companies and their overseas affiliates engage in transactions valued in the trillions of dollars.
NCLC warned that unless the full Ninth Circuit rehears the case en banc, the panel's decision will impair trust in the United States as a treaty partner and lead to the double taxation of U.S. companies and their foreign affiliates.
* * *The author, Donald M. Falk, is a Partner at Mayer Brown LLP in Palo Alto, CA. For further information, please contact Donald at (650) 331-2000.The National Chamber Litigation Center (NCLC) is the leading voice of business in the courts. For more information about this and other NCLC litigation, please contact Amar Sarwal, (202) 463-5337, asarwal@uschamber.com.
