Transnational Tech Company’s Battle with the IRS

The Altera Group is in a battle with the IRS over its handling of employee stock-based compensation and a unit in the low tax Cayman Islands. Both parties are currently engaged in a battle within the walls of the U.S. Tax Court.

The dispute concentrates on “transfer pricing,” an accounting technique used by transnational companies to set the price of partially finished goods sent from one branch of the company to another. According to records made public, Altera Corporation allocated their assets and money globally with the goal of reducing their tax bills, most likely on the advice of financial advisors and tax attorneys. Because of the commonality of transfer pricing practices, many IRS tax lawyers believe many other tech companies will be closely watching the case.

The IRS argues that from the years 2004 to 2007, Altera falsely reported expenses for employee stock-based compensation in the US, where the expenses were actually tax deductible, according to court records. The IRS seeks $27 million in tax payments from the company.

The IRS claims that the organization should divide its employee costs between its US division and its Cayman Islands unit, which would, thereby, force Altera to lose their tax deductibility of employee costs appropriated for the Caymand Island extension. However, Altera is challenging rules in Tax Court that were written in 2003. These rules require stock-based compensation to be shared between a US company and a subsidiary, on the terms that the rule is impossible to follow.

According to tax lawyers, most companies are following the 2003 rule by splitting employee costs with foreign subsidiaries. Nonetheless, many companies have provisions in place that would bring about tax treatment adjustments if the 2003 rules are deemed invalid. Tax attorneys believe that this is a very important issue to many companies, especially technology oriented companies with money that crosses borders. However, Altera and its tax attorneys certainly face an uphill battle to be the first company to challenge the 2003 rules in the U.S. Tax Court.

The case is similar to a past case regarding Xilinx Company. Xilinx had sued the IRS in January 2003, prior to the issued rules on transfer pricing, and then, won on appeal in March 2010, earning a one-time tax savings.

But the IRS should not stay completely confident with the case…

Multinational companies continually move goods and assets between units in different countries with payments following. Although the transfers are done internally within the company, they have to be allotted for to reflect the separate legal status of foreign units. Transfer pricing manages the pricing of these transfers by shifting profits from high-tax countries to low-tax countries to reduce their total costs. This practice is legal, although the IRS points out that some procedures cross the line. International “arms length” standards were set to prevent abuse by keeping transfer prices near the open market price. With the guidance of a tax lawyer, IRS standards can be followed with the interest of the business in mind, as well.

Some tax lawyers believe that since the IRS lost the case with Xilinx in 2003 and another transfer pricing case in 2009, the IRS may have a difficult time litigating the case. This may potentially mark room for companies to alter their transfer pricing operations. Last year, Samuel Maraca, who revamped IRS policies on transfer pricing, began running the IRS transfer pricing division. Tax lawyers and companies alike are curious as to how this will affect the case.

Neither the attorneys for the IRS, nor the Altera’s tax lawyers accepted the offer to comment upon the case. No trial date has been set as of Tuesday. For now, translation technology companies nail-bitingly await the trail, and more importantly, the results of the case, as the future of their dealings with the IRS could be affected with the upcoming decision.

 

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