Tax Notes Quotes Richard Skillman: Transfer Pricing Needs a "Save Shot"
Tax Notes Today quotes Richard W. Skillman during a panel discussion on the Altera decision at an International Tax Institute Luncheon on April 20th. For the complete article, please visit Tax Notes Today's website (subscription required).
Excerpt taken from the article "News Analysis: Transfer Pricing Needs a Save Shot" by Lee A. Sheppard for Tax Notes Today.
The decision was the subject of a lively debate between Michael Schler of Cravath, Swaine & Moore LLP and Richard Skillman of Caplin & Drysdale Chtd. at the April 20, 2016, International Tax Institute (ITI) luncheon in New York.
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"The arm's-length result is a platonic ideal," Skillman commented at ITI. "Where Treasury failed in the preamble, I believe, was in pretending that this was the arm's-length standard as usual, rather than coming out and acknowledging that it was embracing a more expansive and theoretical view of the arm's length standard," Skillman elaborated later.
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In Altera, incoming Chief Judge L. Paige Marvel took Treasury at its word that the validity of the 2003 regulation depends on its consistency with the arm's-length method as interpreted in Xilinx to mean whatever unrelated parties would do. The government had not bothered to adduce evidence about what unrelated parties would do, while the taxpayer trooped in everyone in Silicon Valley and his lawyer to argue that unrelated parties do not share equity-based compensation.
"That's not quite true," said Skillman at ITI. He noted that parties could agree to share predictable costs of equity-based compensation or use book values.
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At ITI, Skillman mused that the court might have meant process rather than substance in this statement. "It invalidated the regulation based on how it was explained by Treasury; nothing in the Tax Court's Altera decision suggests that the regulation would have been invalidated if Treasury hadn't maintained that it was consistent with the arm's-length standard," he wrote in his viewpoint.
Skillman, who could not predict how the Ninth Circuit would handle the case, argued that Altera would permit a taxpayer to have the benefit of the cost-sharing safe harbor while refusing to share the cost of equity-based compensation. In the BEPS context, Altera might mean that an island cash box would be allocated the residual extra-normal profit from valuable technology -- the irony being that only a related party would allow an island cash box to have the residual.
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In Altera, the cash box was literally on an island -- the taxpayer's subsidiary was in the Cayman Islands, removing treaty arguments from the case. Thus the treaty consistency argument about the 2003 regulation can wait for another day, in Skillman's view. But the Altera opinion may require a future court to interpret a U.S. treaty to require pricing according to the behavior of unrelated parties, regardless of generally accepted deviations contained in the OECD transfer pricing guidelines. Moreover, it doesn't matter whether the regulation is consistent with U.S. treaties because a U.S. resident taxpayer is allowed to choose treaty treatment over statute when it gives a better result.
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In adopting the cost-sharing regulation, "Treasury wasn't making an empirical judgment like that underlying the seatbelt regulation that was invalidated in State Farm," Skillman wrote in his viewpoint. Let's unpack that.
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The commensurate with income clause gives Treasury the clear power to make rules forcing related taxpayers to share all costs to qualify for the cost-sharing safe harbor. "Because the 1986 legislative history provides ample basis to conclude that Congress authorized Treasury to adopt a cost-sharing regulation that was inconsistent with the arm's-length standard, Treasury's assertion of consistency with that standard is irrelevant to the regulation's validity under this view of the legal basis for the regulation," Skillman wrote in his viewpoint.
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"If a regulation can be invalidated because of a flaw or gap in its preamble explanation, it will be open season, and in some cases easy pickings, to challenge the validity of many tax regulations that have gone unchallenged for years," Skillman wrote in his viewpoint.