US Appeals Court Overturns Cost Sharing Ruling

by Glen Shapiro, Law AndTax-News.com, New York

29 May 2009

A federal appeals court has overturned a decision in favour of semi-conductor firm Xilinx in a case which has implications for the way multinationals allocate costs between subsidiaries.

The case in question examined California-based Xilinx’s allocation of costs with its Irish subsidiary and dealt with cost sharing, a common practice for developing new intangibles and products for multinational companies. The case hung on whether stock options constitute intangible development costs that must be included in a cost sharing arrangement.

In a judgment published on August 30, 2005, the Tax Court found that Xilinx’s cost sharing agreement did not, as the IRS had argued, include any sharing of cost for stock option expenses and met the arm’s-length standard of the IRS Tax Regulations.

This issue was tried in July 2004 for the company’s fiscal years 1996 through 1999. The Tax Court concluded that the company was not liable for any tax, penalties or interest associated with the IRS assertions. The IRS subsequently filed a Notice of Appeal against this decision in August 2006.

In reversing the Tax Court’s decision, Ninth Circuit Judge Raymond Fisher wrote: "Companies in a cost-sharing arrangement must share all costs related to the joint venture.”

The case has been handed back to the Tax Court to decide on the tax and penalties due to the IRS.

Xilinx is one of a number of US technology companies being pursued by the IRS for outstanding taxes related to transfer pricing arrangements with Irish subsidiaries.

In January, the IRS and the Treasury issued long-awaited 'proposed and temporary' regulations under Section 482 of the Tax Code dealing with: Methods to Determine Taxable Income in Connection With a Cost Sharing Arrangement.

The temporary regulations affect domestic and foreign entities that enter into cost sharing arrangements and are particularly relevant to transactions involving intangible assets. The regulations are effective as of January 5, 2009.

The temporary regulations generally provide guidance regarding the application of section 482 and the arm’s length method to cost sharing arrangements.

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