I.R.S. Commissioner's Unfortunate Comment on Xilinx Case

By Ron Cohen, CPA, MST
Partner
Greenstein, Rogoff, Olsen & Co., LLP

UPDATE: 1/14/10

Ninth Circuit pulls Xilinx decision construing prior regs to require cost-sharing of stock options

In a one-sentence order, the Ninth Circuit has without comment withdrawn its May 27, 2009, Xilinx decision. In that withdrawn decision, involving asserted deficiencies and penalties over a 4-year period of more than $126 million, the Court of Appeals for the Ninth Circuit had reversed the Tax Court and accepted IRS's Code Sec. 482 treatment under prior regs of employee stock options under a taxpayer's cost-sharing arrangement with its subsidiary. The Tax Court had held in Xilinx Inc. and Subsidiaries, (2005) 125 TC No. 4 that the regs did not authorize IRS to require the taxpayers to share the spread or the grant date value relating to employee stock options under the agreement.

Here’s the quote on June 2, 2009:

“First, for too many years, the IRS was in the position of not having the resources to go toe-to-toe with taxpayers operating in the international markets. They had deep pockets and could hire a cadre of legal and tax experts. Some observers said, “We were outmanned and outgunned.”

To meet this challenge, we must keep existing personnel current on emerging techniques and hire top examiners, lawyers, economists, special agents and financial specialists who can unravel the sophisticated and complex world of international tax issues.

These enforcement resources can produce real victories, such as the recent Xilinx decision by the 9th Circuit Court of Appeals surrounding a transfer pricing issue. The IRS claimed that Xilinx was liable for taxes and penalties relating to transactions between the company and its Irish subsidiary.”

Here’s the Commissioner’s whole speech of June 2, 2009:

http://www.irs.gov/newsroom/article/0,,id=209342,00.html

Here’s the complete Appeals Court case:

http://www.groco.com/readingroom/pdf/Xilinx.pdf

Comments by Ron Cohen:

To paint Xilinx as a company that abused the tax system and was caught by “enforcement resources” is completely unfair.

The Commissioner has forgotten that Xilinx WON this case in the Tax Court.  That decision was overruled by the Appeals Court and could (unlikely) be further appealed to the U.S. Supreme Court.

The I.R.S. regulations applicable to the Xilinx case pertain to “Cost-Sharing Arrangements” (“CSA”) and the allocation of stock-option deductions within a CSA. They were (and still are) so complex that reasonable disagreements on their meaning can’t be avoided.

In the Tax Court, the Judge found the I.R.S.’s position “arbitrary and capricious”, which is as close as a Judge will come to saying the I.R.S. is completely wrong, and arguing outside the Rule of Law!  That was a Tax Court Judge’s considered opinion, not just a lawyer’s hype.

Further, the Appeals Court stressed the I.R.S. should reconsider the “accuracy penalties” imposed on the taxpayer because the taxpayer was caught “off guard” by the lack of I.R.S. public guidance on this issue at the time.

Note that, years later, the I.R.S. modified their regulations on this issue, which, at least to me, is a clear indication that the regulations were, at a minimum, unclear at the time Xilinx was required apply the rules and file their tax returns.

The Commissioner should also note that even at the Appeals Court level, there was a written dissenting opinion agreeing with the taxpayer!

We are all hoping the I.R.S. will pursue tax evaders, collect unpaid tax and prosecute those folks to the full extent of the law.  No legitimate tax advisor has an issue with that approach.

However, even mentioning the Xilinx case –where the taxpayer had a reasonable dispute in a gray area of the tax law -- in the same speech as taxpayers that “push tax planning beyond acceptable bounds” (not in the quote  above, but earlier in the speech) is unreasonable and, in my view, a bit of unnecessary cheerleading for the I.R.S.

I happen to know the folks at Xilinx received “world-class” tax advice, and tried to do the “right” thing.

The real culprit is a tax code and regulations that are so complex, as proven by the Appeals Court decision overturning the Tax Court, even the Courts can’t agree on what they mean!  Note that the Appeals Court decision is 25 pages to explain and rule on the case plus 8 pages of dissenting opinion.  No clear victory there.

The Commissioner may also want to ponder the fact that the tax return years in dispute were 1997, 1998, and 1999.  It is now almost 12 years since the first tax year at issue of 1997.  12 years!  If the taxpayer appeals to the U.S. Supreme Court, more time will pass before the case is resolved.  I respectfully submit that’s not much to cheer about with respect to enforcement, regardless of how the Court decided.

With the exception of the Xilinx comment, I/we fully agree and support the Commissioner’s other thoughtful comments.  People who cheat should pay, no doubt.  However, a reference to Xilinx in such a speech was unnecessary, unwarranted and incorrect.

UPDATE: 6/10/09

Further, let me rant to explore, IF I had 20/20 hindsight, how should the taxpayer have been advised back in 1997 to meet I.R.S. and CPA Ethical Standards? (Xilinx is not and has not been our client.)

Perhaps the discussion would go as follows, again, with 20/20 hindsight:

CPA: Sorry CFO, my crystal ball -- that I’m required to use under I.R.S. Circular 230, FAS 109 & FAS 5 -- gave me a bad image last night.

CFO:  Really? Tell me more.

CPA: On that Cost-Sharing issue in your return, you’ll get audited, the I.R.S. will disagree, you’ll appeal and you’ll end up in the Tax Court.

CFO: Oh, Gosh.    I don’t like the sound of that…sounds expensive.  What happens there?

CPA: You’ll prevail and the Judge with criticize the I.R.S. for having illogical arguments.

CFO: Great, so what’s the “bad” part.

CPA: My crystal ball tells me that in the year 2009…

CFO:  Wait, 2009?   It’s 1997.  I’ll be retired and that’s at least two Presidents from now!

CPA: …Yes, but you’ll lose the case in the Appeals Court, with a dissenting opinion in your favor.  You can then decide whether to appeal to the U.S. Supreme Court.  My crystal ball does not yet tell me what the company will do.

CFO: Oh,  Darn!  Well, since we’ll win in the Tax Court, there will be no interest and penalties, right?; because our position is reasonable if the Tax Court Judge agreed, right?  It’s just so many legal technicalities, right?

CPA: No, not right.  Various penalties will apply.  Interest always applies to late taxes.  Then, according to my crystal ball, the I.R.S. Commissioner will mention your company, in a public speech to the O.E.C.D. in Washington, D.C. , as an example of I.R.S. enforcement success. His speech will travel all over the internet.

CFO:  Oh! That’s embarrassing. But I won in Tax Court!  Can they do that? My Board of Directors and shareholders won’t like that.  Is that fair?

CPA: Remember, I told you before…. “Fair” has little to do with it if you have to litigate?

CFO: Yeah, sorry, I forgot…..So, let me understand this.  After 12 years, we will win, but then we will lose, but then I can appeal, and it will be all over the press.

CPA: Yes, that’s right.

CFO:  So what do you advise?

CPA: Well, since I know you’ll lose at the Appeals Court, I have to speculate whether you’ll appeal to the Supreme Court and win again or lose there. Tax cases usually don’t get heard at the U.S. Supreme Court even if they are appealed. Maybe my crystal ball will tell me more in a month or two.  I’ll get back to you…but budget for lots of legal fees.

CFO:  Really?  Tell me again why we can’t move our parent company and research department to Singapore to avoid all this mess?

CPA:  Well, it’s complicated….

End

I can always be reached for questions or comments at (510) 797-8661 x237 or rcohen@groco.com.