It’s rare that decisions regarding transfer pricing make big news. But this one is different. An IRS victory in the Ninth Circuit against chip company Xilinx Inc. earlier this week may change the way that companies allocate their costs for purposes of transfer pricing. The decision already has international tax practitioners abuzz.
The facts of the case aren’t terribly good, causing some practitioners to wonder if it’s a case of “bad facts making bad law.” But here goes: Xilinx allocated part of its R&D costs to a subsidiary in Ireland, where corporate rates are much lower than those in the US. So far, so good. Lots of companies do this sort of thing.
Here’s where it turned ugly: for purposes of stock options, Xilinx kept the entire value of tax deductions related to the options inside the US. In other words, none of the deductions were allocated to the Irish company. This, of course, made the IRS go “Hmmm.”
Xilinx argued that these unrelated companies wouldn’t have shared the costs of the stock options. The IRS said differently. A lower court sided with Xilinx but an appellate court overturned that ruling by a vote of 2-1. Not an overwhelming victory for IRS but still a victory.
What gives tax practitioners pause is that the ruling could be considered to give IRS broad powers to adjust corporate tax returns. In an environment that is increasingly hostile for US corporations with foreign subsidiaries in countries with lower tax rates, it could be unsettling that discretion to allocate costs may now be called into question. My guess is that little will happen immediately, pending Xilinx’ decision as to an appeal. The company hasn’t yet indicated that it will appeal but I think we’d all be surprised if it didn’t.
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What Xilinx did was to transfer some profits to a low-tax environment while keeping (deductible) expenses in a high-tax environment. I guess the IRS was trying to say you can’t have it both ways. Whatever the arguments are, I’m sure they’re arcane and not all that entertaining for us observers to watch and listen to.
I guess Congress needs to clarify this. Not that they ever will, but the confusions of multi-national corporate operations so need some clarification.