Xilinx, Inc. v. Commissioner of Internal Revenue
United States Court of Appeals for the Ninth Circuit
598 F.3d 1191 (2010)

- Written by Solveig Singleton, JD
Facts
Xilinx, Inc. (plaintiff) developed circuitry and software. Xilinx established Xilinx Ireland (XI), an Irish technology company. XI was owned by two wholly owned Irish subsidiaries of Xilinx. In 1995, Xilinx and XI executed a cost-sharing agreement (agreement). Technologies developed by either firm were to be jointly owned, and each firm was to pay a share of research and development (R&D) costs proportionate to anticipated benefits. Listed costs to be shared included salaries, bonuses, and payroll costs, but employee stock options (ESOs) were not listed. Xilinx did not include amounts related to ESOs in its R&D costs shared under the agreement. Xilinx deducted business expenses arising from exercise of ESOs of $41 million for 1997, $40 million for 1998, and $96 million for 1999. Xilinx counted amounts arising from exercise of ESOs as wages related to R&D in claiming tax credits. Also, Xilinx and XI agreed to allow XI employees to obtain Xilinx stock options. XI paid Xilinx about $400,000 in 1997, $200,000 in 1998, and $800,000 in 1999 to cover the cost of XI employees’ exercise of these options. Internal Revenue Code § 482 enabled the commissioner of Internal Revenue (commissioner) (defendant) to reallocate income across organizations controlled by a common interest to prevent tax evasion and ensure parity with uncontrolled entities. The commissioner asserted that Xilinx should have shared the costs of ESOs with XI for 1997, 1998, and 1999, reducing Xilinx’s deductions. Xilinx sued in Tax Court. The court found that XI and Xilinx would not have shared the costs of ESOs had they been unrelated and applied Treasury Regulation 26 C.F.R. § 1.482-1(b), which required true taxable income to be calculated based on how parties operating at arm’s length would behave “in every case” (the arm’s-length principle). The court held that the commissioner’s ruling was arbitrary and capricious. The commissioner appealed, urging the court to apply 26 C.F.R. § 1.482-7A(d)(1), which required parties to a cost-sharing agreement related to development of intangible property to share all costs. The Treasury notes on the United States Ireland Tax Treaty (treaty) explained that the arm’s-length principle was intended to be incorporated in the treaty.
Rule of Law
Issue
Holding and Reasoning (Noonan, J.)
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