On July 17, 2015, the US Tax Court (en banc) ruled in favor of the taxpayer in Altera Corporation v. Commissioner, 1 holding that Treas. Reg. 1.482-7(d)(2), which was issued in 2003 requiring participants in qualified cost-sharing arrangements (“QCSAs”) to share stock-based compensation costs to achieve an arm’s-length result, was arbitrary and capricious and therefore invalid.

Altera US, the parent company of an affiliated group of corporations, developed, manufactured and sold programmable logic devices (“PLDs”) and related hardware and software for use in programming the PLDs (“programming tools”). Altera US entered into a technology license agreement with its subsidiary, Altera International, granting Altera International the right to use and exploit, everywhere except the United States and Canada, all of Altera US’s intangible property relating to PLDs and programming tools.

In exchange for the right granted, Altera International paid royalties to Altera US each year through 2003. Under an existing R&D cost-sharing agreement, Altera US and Altera International agreed to pool their resources to conduct research and development relating to the PLDs and programming tools. Under the R&D cost-sharing agreement, Altera US and Altera International agreed to share the risks and costs of research and development activities they performed between May 23, 1997 through 2007. During each of taxable years ending December 31, 2004, December 30, 2005, December 29, 2006 and December 28, 2007, Altera US granted stock options and other stock-based compensation to certain of its employees.

Certain of these employees who received stock options and other stock-based compensation performed R&D activities subject to the R&D cost-sharing agreement.

The stock-based compensation was $24,549,315 (2004); $23,015,453 (2005); $11,365,388 (2006) and $15,463,565 (2007). The stock-based compensation was not included in the cost pool under the R&D cost-sharing agreement. The IRS audited petitioner and issued Notices of Deficiency with respect to the 2004-2007 taxable years.

The Notices of Deficiency allocated, pursuant to Section 482, income from Altera International to Altera US by increasing Altera International’s cost-sharing payments for 2004-2007.