Bryan C. Skarlatos quoted in "International Tax Cases To Watch In 2019", Law360

The Internal Revenue Service is facing several high-stakes cases in the coming year that concern whether the agency abused its discretion in reallocating income to U.S. entities from their foreign affiliates.

The Internal Revenue Service is facing several high-stakes cases in the coming year that concern whether the agency abused its discretion in reallocating income to U.S. entities from their foreign affiliates.

More than just taxable income is on the line in some of the cases. For example, chipmaker Altera is challenging the validity of a set of the agency's cost-sharing regulations, and a Coca-Cola case raises the question of whether the IRS can turn its back on a transfer pricing method after allowing it for years under an expired agreement.

At stake in Medtronic, along with a $1.36 billion tax deficiency, is the question of how much discretion a company has in applying the comparable uncontrolled price method, long favored by judges in transfer pricing cases.

Here are five international tax cases worth watching in 2019.

Altera’s Second Challenge to Cost-Sharing Rules

This closely watched case centers on a challenge brought by Altera Corp., an Intel subsidiary, against an IRS regulation that requires businesses to include stock-based compensation in their cost-sharing agreements with related parties.

California-based Altera had brought its case in response to deficiency notices saying payments from a Cayman Islands subsidiary under an agreement to share research and development costs were short $80 million in light of the cost-sharing rule. The U.S. Tax Court invalidated the regulation in July 2015 in a decision that is now on appeal before the Ninth Circuit.

The appeal goes to fundamental questions about the arm’s-length standard. Altera maintains the IRS ignored evidence in the form of agreements between unrelated parties that didn’t require sharing stock option costs, while the IRS argues that those agreements don’t resemble cost sharing and that true arm’s-length behavior would be to share stock option costs. A government attorney said during oral arguments in October that the appeal boils down to “what does arm’s-length mean, and who gets to say what it means?”

The arguments were the second round in the appeal, which has an unusual history. Judge Stephen Reinhardt, who had heard the first round of arguments in the case, died in March, but the court issued an opinion siding with the government in July, saying he had “fully participated” in the case as one of the 2-1 majority. Then the court withdrew the ruling in August, saying it wanted to allow a reconstituted panel to consider the case.

In the withdrawn decision, the majority on the Ninth Circuit panel disagreed with the U.S. Tax Court’s conclusion that the IRS had ignored significant evidence and public comments while issuing its cost-sharing rule.

During the October oral arguments, the new panel — which includes Judge Susan Graber, appointed to the case after the death of Judge Reinhardt — didn’t seem to focus much on rulemaking requirements under the Administrative Procedure Act, or APA, according to Kostelanetz and Fink LLP partner Bryan Skarlatos.

Based on that observation, he said the opinion from the new panel is likely to be the same as the withdrawn decision.

“Judge Graber did not seem to really get into the specific requirements under the APA, and that is the heart of the taxpayer’s case,” Skarlatos said.

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