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Altera Corporation & Subsidiaries v. Commissioner of Internal Revenue

United States Court of Appeals, Ninth Circuit

November 12, 2019

Altera Corporation & Subsidiaries, Petitioner-Appellee,
Commissioner of Internal Revenue, Respondent-Appellant.

          Tax Ct. Nos. 6253-12 9963-12

          Arthur T. Catterall (argued), Richard Farber, Gilbert S. Rothenberg, and Francesca Ugolini, Attorneys; Travis A. Greaves, Deputy Assistant Attorney General; Richard E. Zuckerman, Principal Deputy Assistant Attorney General; Tax Division, United States Department of Justice, Washington, D.C.; for Respondent-Appellant.

          Donald M. Falk (argued), Mayer Brown LLP, Palo Alto, California; Thomas Kittle-Kamp and William G. McGarrity, Mayer Brown LLP, Chicago, Illinois; Brian D. Netter, Travis Crum, and Nicole A. Saharsky, Mayer Brown LLP, Washington, D.C.; A. Duane Webber, Phillip J. Taylor, and Joseph B. Judkins, Baker & McKenzie LLP, Washington, D.C.; Ginger D. Anders, Munger Tolles & Olson LLP, Washington, D.C.; Mark R. Yohalem, Munger Tolles & Olson LLP, Los Angeles, California; for Petitioner-Appellee.

          Susan C. Morse, University of Texas Law School, Austin, Texas; Stephen E. Shay and Allison Bray, Certified Law Students, Harvard Law School, Cambridge, Massachusetts; Clinton G. Wallace, Columbia, South Carolina; and Leandra Lederman, Bloomington, Indiana; for Amici Curiae Law Academics and Professors.

          Jonathan E. Taylor, Gupta Wessler PLLC, Washington, D.C.; Clint Wallace, Vanderbilt Hall, New York, New York; for Amici Curiae Anne Alstott, Reuven Avi-Yonah, Lily Batchelder, Joshua Blank, Noel Cunningham, Victor Fleischer, Ari Glogower, David Kamin, Mitchell Kane, Sally Katzen, Edward Kleinbard, Michael Knoll, Rebecca Kysar, Zachary Liscow, Daniel Shaviro, John Steines, David Super, Clint Wallace, and George Yin.

          Larissa B. Neumann, Ronald B. Schrotenboer, Kenneth B. Clark, Adam R. Gahtan, and Michael D. Knobler, Fenwick & West LLP, Mountain View, California, for Amicus Curiae Xilinx Inc.

          Christopher J. Walker, The Ohio State University Moritz College of Law, Columbus, Ohio; Kate Comerford Todd, Steven P. Lehotsky, and Warren Postman, U.S. Chamber Litigation Center, Washington, D.C.; for Amicus Curiae Chamber of Commerce of the United States of America.

          John I. Forry, San Diego, California, for Amicus Curiae TechNet.

          Charles G. Cole, Alice E. Loughran, Michael C. Durst, Gregory N. Kidder, and Mark C. Savignac, Steptoe & Johnson LLP, Washington, D.C.; Bennett Evan Cooper, Steptoe & Johnson LLP, Phoenix, Arizona; Alexander Volokh, Emory University School of Law, Atlanta, Georgia; for Amici Curiae Software and Information Industry Association, Financial Executives International, Information Technology Industry Council, Silicon Valley Tax Directors Group, Software Finance and Tax Executives Counsel, National Association of Manufacturers, American Chemistry Council, BSA | the Software Alliance, National Foreign Trade Council, Biotechnology Innovation Organization, Computing Technology Industry Association, The Tax Council, United States Council for International Business, and Semiconductor Industry Association.

          Kenneth P. Herzinger and Eric C. Wall, Orrick Herrington & Sutcliffe LLP, San Francisco, California; Peter J. Connors, Orrick Herrington & Sutcliffe LLP, New York, New York; for Amici Curiae Charles W. Calomiris, Kevin H. Hassett, and Sanjay Unni.

          Roderick K. Donnelly and Neal A. Gordon, Morgan Lewis & Bockius LLP, Palo Alto, California; Thomas M. Peterson, Morgan Lewis & Bockius LLP, San Francisco, California; Michelle L. Andrighetto, Morgan Lewis & Bockius LLP, Boston, Massachusetts; Justin McGough, 3M Company, Saint Paul, Minnesota; Karen Robinson, Vice President, Legal, Adobe Inc., San Jose, California; Theodore J. Boutrous Jr. and Christopher Chorba, Gibson Dunn & Crutcher LLP (for Apple Inc.), Los Angeles, California; Armin D. Eberhard, Director, International Tax Planning and M&A, Applied Materials, Santa Clara, California; Desiree Ralls-Morrison, SVP, General Counsel & Corporate Secretary, Boston Scientific Corporation, Marlborough, Massachusetts; Thomas J. Vallone, Senior Vice President, Global Tax, Dell Technologies Inc., Round Rock, Texas; Andy Sherman, Dolby Laboratories Inc., San Francisco, California; Aaron Johnson, VP Legal, eBay, San Jose, California; Jacob Schatz, EVP, General Counsel and Corporate Secretary, Electronic Arts Inc., Redwood City, California; Katie Lodato, Vice President - Global Tax, Eli Lilly and Company, Indianapolis, Indiana; Dana L. Lasley, Emerson Electric Co., St. Louis, Missouri; Paul S. Grewal, VP & Deputy General Counsel, Facebook Inc., Menlo Park, California; John Whittle, Executive Vice President, General Counsel, Fortinet, Sunnyvale, California; Christine Henninger, General Mills Inc., Golden Valley, Minnesota; Nora Puckett, Google LLC, Mountain View, California; Kyle Bonacum, GoPro Inc., San Mateo, California; Joshua Mishoe, Vice President, Hewlett Packard Enterprise Company, Plano, Texas; Barbara Beckerman, International Paper Company, Memphis, Tennessee; Michael R. Peterson, President and Corporate Secretary, Johnson Controls Inc.; Mark Casper, Vice President and Deputy General Counsel, Maxim Integrated, San Jose, California; Matthew Fawcett, General Counsel, NetApp Inc., Sunnyvale, California; Margaret C. Wilson, Wilson Law Group LLC (for Oracle Corporation), Princeton, New Jersey; Maryanne Bifulco, Vice President, Transfer Pricing Counsel, PepsiCo Inc., Purchase, New York; Markus Green, Assistant GC, Government Relations/Litigation, Pfizer Inc., New York, New York; Lowell Yoder, McDermott Will & Emery (for Procter and Gamble Company), Chicago, Illinois; Beth Wapner, VP Tax, Qualcomm Incorporated, San Diego, California; Tanya Guazzo, S&P Global Inc., New York, New York; Russell Elmer, ServiceNow Inc., Santa Clara, California; Lora Blum, General Counsel, SurveyMonkey, San Mateo, California; Scott C. Taylor, EVP, General Counsel & Secretary, Symantec Corporation, Mountain View, California; Donald P. Lancaster, United Parcel Service Inc., Atlanta, Georgia; Lisa McFall, VP & Deputy General Counsel, Workday Inc., Pleasanton, California; for Amicus Curiae Cisco Systems Inc. and Thirty-Two Other Affected Companies.

          Christopher Bowers, David Foster, Raj Madan, and Royce Tidwell, Skadden Arps Slate Meagher & Flom LLP, Washington, D.C.; Nathaniel Carden, Skadden Arps Slate Meagher & Flom LLP, Chicago, Illinois; for Amicus Curiae Inc.

          Miriam L. Fisher, Melissa Arbus Sherry, and Eric J. Konopka, Latham & Watkins LLP, Washington, D.C., for Amici Curiae PricewaterhouseCoopers LLP, Deloitte Tax LLP, and KPMG LLP.

          Before: Sidney R. Thomas, Chief Judge, and Susan P. Graber and Kathleen M. O'Malley, [*] Circuit Judges.

         SUMMARY [**]


         The panel denied a petition for rehearing en banc on behalf of the court in a case in which the panel reversed the decision of the Tax Court.

         Judge M. Smith, joined by Judges Callahan and Bade, dissented from the denial of rehearing en banc. Title 26 of United States Code § 482 authorizes the Department of Treasury to re-allocate reported income and costs between related entities where necessary to prevent them from improperly avoiding taxes. Judge M. Smith agreed with the Tax Court's unanimous conclusion that the Treasury's implementing regulation § 1.482-7(d)(2) constituted arbitrary and capricious rulemaking in violation of the Administrative Procedure Act. Judge M. Smith observed that, in addition to being wrongly decided, the majority's decision engenders deleterious practical consequences, threatens the uniform enforcement of the Tax Code, invites an effective circuit split, ignores the reasonable reliance of businesses on the well-settled arm's length standard and subjects those businesses to double taxation, lowers the bar for compliance with the Administrative Procedure Act, and sends a signal that executive agencies can bypass proper notice-and-comment procedures through post-hoc rationalization.


         The full court has been advised of the petition for rehearing en banc. A judge requested a vote on whether to rehear the matter en banc. The matter failed to receive a majority of the votes of the nonrecused active judges in favor of en banc consideration. Fed. R. App. P. 35. Judges McKeown, Wardlaw, Bybee, Bea, Watford, Owens, Friedland, Miller, Collins, and Lee were recused and did not participate in the vote.

         The petition for rehearing en banc is denied. Attached is the dissent from and statements respecting the denial of rehearing en banc.

          M. SMITH, Circuit Judge, with whom CALLAHAN and BADE, Circuit Judges, join, dissenting from the denial of rehearing en banc:

         Neither the laudable goal of preventing tax evasion nor the prospect of adding billions of dollars to the public coffers excuses the Department of the Treasury from complying with the Administrative Procedure Act. In 2003, Treasury promulgated a tax rule with no reasoned basis for its decision, pursuant to an explanation that ran contrary to the evidence before it. In 2019, a divided panel of our court upheld that rule based on a novel interpretation of the relevant statute, which Treasury developed only as an appellate litigating position, and which was never subject to notice and comment. As recognized by the unanimous en banc Tax Court, Treasury's actions in this case are the epitome of arbitrary and capricious rulemaking. The panel majority's decision tramples on the reliance interests of American businesses, threatens the uniform enforcement of the Tax Code, and drastically lowers the bar for compliance with the Administrative Procedure Act.

         I respectfully dissent from our court's denial of rehearing en banc.[1]


         For almost a century, Congress has authorized Treasury to recalculate the taxes of related entities based on what their taxes would look like if they were unrelated entities. For the past fifty years, Treasury has made this determination by analyzing whether the results of a transaction between related entities are consistent with the results of a comparable transaction between entities operating at arm's length. When a transaction does not meet this arm's length standard, Treasury adjusts it for tax purposes by reallocating the related entities' costs and income.

         In the late-1990s, Treasury decided that stock-based compensation-then a new phenomenon-was a type of cost it wanted to re-allocate under these calculations. The problem was, and remains, that unrelated entities do not share stock-based compensation costs. Treasury's first attempt at such a re-allocation was therefore thrown out by the Tax Court and by this court because it was contrary to Treasury's own regulations calling for application of the arm's length standard. Perhaps preemptively recognizing this defect on the very face of its rules, Treasury attempted a mid-litigation cure of simply adding a cross reference to its arm's length standard provision. That attempted cure is the 2003 rulemaking challenged here.


         In 1928, Congress enacted 26 U.S.C. ("I.R.C.") § 482 to authorize Treasury to re-allocate reported income and costs between related entities where necessary to prevent them from improperly avoiding taxes by, for instance, shifting income to lower tax foreign jurisdictions. See H.R. Rep. No. 70-2, at 16-17 (1927); Comm'r v. First Sec. Bank of Utah, N.A., 405 U.S. 394, 400 (1972). Treasury soon promulgated regulations specifying that "[t]he standard to be applied in every case is that of an ...

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