United States v. 2010-03-22 | 06-74246 | XILINX, INC. V. CIR | precedential | opinion |

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
 XILINX, INC., AND CONSOLIDATED
SUBSIDIARIES,
Petitioner-Appellee, No. 06-74246
v.  Tax Ct. No.
702-03 COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant. 
 XILINX, INC., AND CONSOLIDATED
SUBSIDIARIES, No. 06-74269
Petitioner-Appellee, Tax Ct. No.
v.  4142-01
COMMISSIONER OF INTERNAL OPINION
REVENUE,
Respondent-Appellant. 
Appeal from a Decision of the
United States Tax Court
Maurice B. Foley, Tax Court Judge, Presiding
Argued and Submitted
March 12, 2008—San Francisco, California
Filed March 22, 2010
Before: Stephen Reinhardt, John T. Noonan, Jr. and
Raymond C. Fisher, Circuit Judges.
Opinion by Judge Noonan;
Concurrence by Judge Fisher;
Dissent by Judge Reinhardt
4597

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.
COUNSEL
Gilbert S. Rothenberg, Richard Farber and Arthur T. Catterall
(argued), Tax Division, Department of Justice, Washington,
D.C., for the respondent-appellant.
Ronald B. Schrotenboer, Kenneth B. Clark (argued) and Tyler
A. Baker, Fenwick & West LLP, Mountain View, California,
for the petitioner-appellee.
Alice E. Loughran, Steptoe & Johnson LLP, Washington,
D.C., for amici curiae Cisco Systems, Inc., and Altera Corpo-
ration.
A. Duane Webber, Baker & McKenzie LLP, Washington,
D.C., for amici curiae Software Finance and Tax Executives
Council and AeA.
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OPINION
NOONAN, Circuit Judge:
On this appeal from the tax court, we must decide whether,
under the tax regulations in effect during tax years 1997, 1998
and 1999, related companies engaged in a joint venture to
develop intangible property must include the value of certain
stock option compensation one participant gives to its
employees in the pool of costs to be shared under a cost shar-
ing agreement, even when companies operating at arm’s
length would not do so. The tax court found related compa-
nies are not required to share such costs and ruled that the
Commissioner of Internal Revenue’s attempt to allocate such
costs was arbitrary and capricious. We affirm.
I. BACKGROUND
Xilinx, Inc. (“Xilinx”) researches, develops, manufactures,
and markets integrated circuit devices and related develop-
ment software systems. Xilinx wanted to expand its position
in the European market and established Xilinx Ireland (“XI”)
in 1994 as an unlimited liability company under the laws of
Ireland. XI sold programmable logic devices and conducted
research and development (“R&D”). Two wholly owned Irish
subsidiaries of Xilinx owned XI during the tax years of 1997,
1998 and 1999, the only years at issue in this appeal.
In 1995, Xilinx and XI entered into a Cost and Risk Shar-
ing Agreement (“the Agreement”), which provided that all
right, title and interest in new technology developed by either
Xilinx or XI would be jointly owned. Under the Agreement,
each party was required to pay a percentage of the total R&D
costs in proportion to the anticipated benefits to each from the
new technology that was expected to be created. Specifically,
the Agreement required the parties to share: (1) direct costs,
defined as costs directly related to the R&D of new technol-
ogy, including, but not limited to, salaries, bonuses and other
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payroll costs and benefits; (2) indirect costs, defined as costs
incurred by departments not involved in R&D that generally
benefit R&D, including, but not limited to, administrative,
legal, accounting and insurance costs; and (3) costs incurred
to acquire products or intellectual property rights necessary to
conduct R&D. The Agreement did not specifically address
whether employee stock options (ESOs) were a cost to be
shared.
Xilinx offered ESOs to its employees under two plans.
Under one plan, employees were granted options as part of
the employee hiring and retention program. The options were
of two varieties: incentive stock options (ISOs) and nonstatu-
tory stock options (NSOs). Employees could exercise these
options two ways: (1) by purchasing the stock at the market
price on the day the option was issued (“exercise price”)
regardless of its then-current market price or (2) by simulta-
neously exercising the option at the exercise price and selling
it at its then-current price, pocketing the difference. Under the
other plan, employees could acquire employee stock purchase
plan shares (ESPPs) by contributing to an account through
payroll deductions and purchasing stock at 85 percent of
either its exercise price or its market price on the purchase
date. Employees must always pay taxes on NSOs, see 26
U.S.C. § 83, but have to pay taxes on ISOs and ESPPs only
if they sell acquired stock shares before a specified waiting
period has expired (“a disqualifying disposition”), see 26
U.S.C. § 421(b). In determining the R&D costs to be shared
under the Agreement for tax years 1997, 1998 and 1999,
Xilinx did not include any amount related to ESOs.
In tax years 1997, 1998 and 1999, Xilinx deducted as busi-
ness expenses under 26 U.S.C. §§ 83 and 162 approximately
$41,000,000, $40,000,000 and $96,000,000, respectively,
based on its employees’ exercises of NSOs or disqualifying
dispositions of ISOs and ESPPs.1 It also claimed an R&D
1Under 26 U.S.C. § 162(a)(1), employers may deduct from their taxable
income “all the ordinary and necessary expenses paid or incurred during
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credit under 26 U.S.C. § 41 for wages related to R&D activ-
ity, of which approximately $34,000,000, $23,000,000 and
$27,000,000 in the respective tax years were attributable to
exercised NSOs or disqualifying dispositions of ISOs and
ESPPs.2 Furthermore, in 1996 Xilinx and XI entered into two
agreements that allowed XI employees to acquire options for
Xilinx stock. Both agreements provided XI would pay Xilinx
for the “cost” of the XI employees’ exercise of the stock
options, which was to equal the stock’s market price on the
exercise date minus the exercise price. In the 1997, 1998 and
1999 tax years, XI paid Xilinx $402,978, $243,094 and
$808,059, respectively, under these agreements.
The Commissioner of Internal Revenue (“Commissioner”)
issued notices of deficiency against Xilinx for tax years 1997,
1998 and 1999, contending ESOs issued to its employees
involved in or supporting R&D activities were costs that
should have been shared between Xilinx and XI under the
Agreement. Specifically, the Commissioner concluded the
amount Xilinx deducted under 26 U.S.C. § 83(h) for its
employees’ exercises of NSOs or disqualifying dispositions of
ISOs and ESPPs should have been shared. By sharing those
costs with XI, Xilinx’s deduction would be reduced, thereby
increasing its taxable income. The Commissioner’s determi-
nation resulted in substantial tax deficiencies and accuracy-
related penalties under 26 U.S.C. § 6662(a).
Xilinx timely filed suit in the tax court. The tax court
denied cross motions for summary judgment. After a bench
the taxable year in carrying on any trade or business, including a reason-
able allowance for salaries or other compensation for personal services
actually rendered.” Under 26 U.S.C. § 83(h), employers may deduct under
§ 162 the value of any property transferred to an employee in connection
with the performance of employment.
2Under 26 U.S.C. § 41(b)(2)(A), companies can claim a tax credit for
“wages paid or incurred to an employee for qualified [research] services
performed by such employee.”
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trial, the tax court found that two unrelated parties in a cost
sharing agreement would not share any costs related to ESOs.
After assuming ESOs were costs for purposes of 26 C.F.R.
§ 1.482-7(d)(1), the tax court then found 26 C.F.R. § 1.482-
1(b)(1) — which requires cost sharing agreements between
related parties to reflect how two unrelated parties operating
at arm’s length would behave — dispositive and concluded
the Commissioner’s allocation was arbitrary and capricious
because it included the ESOs in the pool of costs to be shared
under the Agreement, even though two unrelated companies
dealing with each other at arm’s length would not share those
costs.
The Commissioner timely appealed. On appeal, the parties
focused primarily on whether the requirement in 26 C.F.R.
§ 1.482-7(d)(1) that “all costs” be shared between related par-
ties in a cost sharing agreement or whether the controlling
requirement was 26 C.F.R. § 1.482-1(b)(1) that all transac-
tions between related parties reflect what two parties operat-
ing at arm’s length would do. After oral argument, we
requested supplemental briefing on whether ESOs were
“costs” and whether they were “related to” the intangible
product development for purposes of 26 C.F.R. § 1.482-
7(d)(1), and whether a literal application of 26 C.F.R.
§ 1.482-7(d)(1) would conflict with a tax treaty between the
United States and Ireland that was in effect during the 1998
and 1999 tax years.
II. STANDARD OF REVIEW
“Decisions of the tax court are reviewed on the same basis
as decisions from civil bench trials in the district court.” DHL
Corp. v. Comm’r, 285 F.3d 1210, 1216 (9th Cir. 2002).
“Thus, we review the tax court’s conclusions of law de novo
and its factual findings for clear error.” Id.
III. DISCUSSION
The Commissioner does not dispute the tax court’s factual
finding that unrelated parties would not share ESOs as a cost.
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Instead, the Commissioner maintains ESOs are a cost that
must be shared under § 1.482-7(d)(1), even if unrelated par-
ties would not share them.
[1] Ambiguity. Congress has authorized the Secretary of
the Treasury to allocate income and deductions among related
business entities to prevent tax avoidance.
In any case of two or more organizations, trades, or
businesses (whether or not incorporated, whether or
not organized in the United States, and whether or
not affiliated) owned or controlled directly or indi-
rectly by the same interests, the Secretary may dis-
tribute, apportion, or allocate gross income,
deductions, credits, or allowances between or among
such organizations, trades, or businesses, if he deter-
mines that such distribution, apportionment, or allo-
cation is necessary in order to prevent evasion of
taxes or clearly to reflect the income of any of such
organizations, trades, or businesses. In the case of
any transfer (or license) of intangible property
(within the meaning of section 936(h)(3)(B)), the
income with respect to such transfer or license shall
be commensurate with the income attributable to the
intangible.
26 U.S.C. § 482. The Secretary in turn promulgated regula-
tions authorizing the Commissioner to allocate income and
deductions among related entities. The introduction to these
regulations explains:
The purpose of section 482 is to ensure that taxpay-
ers clearly reflect income attributable to controlled
transactions and to prevent the avoidance of taxes
with respect to such transactions. Section 482 places
a controlled taxpayer on a tax parity with an uncon-
trolled taxpayer by determining the true taxable
income of the controlled taxpayer. This section sets
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forth general principles and guidelines to be fol-
lowed under section 482.
26 C.F.R. § 1.482-1(a)(1).3 The next subsection states that the
standard to be employed “in every case” to ensure taxpayers
accurately reflect income from controlled transactions and do
not avoid taxes through such transactions is an arm’s length
standard:
In determining the true taxable income of a con-
trolled taxpayer, the standard to be applied in every
case is that of a taxpayer dealing at arm’s length with
an uncontrolled taxpayer. A controlled transaction
meets the arm’s length standard if the results of the
transaction are consistent with the results that would
have been realized if uncontrolled taxpayers had
engaged in the same transaction under the same cir-
cumstances (arm’s length result). However, because
identical transactions can rarely be located, whether
a transaction produces an arm’s length result gener-
ally will be determined by reference to the results of
comparable transactions under comparable circum-
stances.
26 C.F.R. § 1.482-1(b)(1).
Another section, however, specifically governing cost shar-
ing agreements between controlled parties to develop intangi-
ble property, authorizes the Internal Revenue Service “to
make each controlled participant’s share of the costs (as deter-
mined under paragraph (d) of this section) of intangible devel-
opment under the qualified cost sharing arrangement equal to
its share of reasonably anticipated benefits attributable to such
3Controlled taxpayer is defined as “any one of two or more taxpayers
owned or controlled directly or indirectly by the same interests, and
includes the taxpayer that owns or controls the other taxpayers.” 26 C.F.R.
§ 1.482-1(i)(5).
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development . . . .” 26 C.F.R. § 1.482-7(a)(2). Controlled par-
ticipants, under paragraph (d) of § 1.482-7, must include “all”
costs in the pool of costs to be shared proportionally (the “all
costs requirement”):
For purposes of this section, a controlled partici-
pant’s costs of developing intangibles for a taxable
year mean all of the costs incurred by that participant
related to the intangible development area, plus all of
the cost sharing payments it makes to other con-
trolled and uncontrolled participants, minus all of the
cost sharing payments it receives from other con-
trolled and uncontrolled participants. Costs incurred
related to the intangible development area consist of:
operating expenses, as defined in § 1.482-5(d)(3),
other than depreciation or amortization expense, plus
(to the extent not included in such operating
expenses, as defined in § 1.482-5(d)(3)) the charge
for the use of any tangible property made available
to the qualified cost sharing arrangement.
26 C.F.R. § 1.482-7(d)(1). “Operating expenses” are defined
as “includ[ing] all expenses not included in cost of goods sold
except for interest expense, foreign income taxes, domestic
income taxes, and any other expenses not related to the opera-
tion of the relevant business activity.” 26 C.F.R. § 1.482-
5(d)(3). How these various provisions interact is the crux of
the parties’ dispute.
[2] Section 1.482-1(b)(1) specifies that the true taxable
income of controlled parties is calculated based on how par-
ties operating at arm’s length would behave. The language is
unequivocal: this arm’s length standard is to be applied “in
every case.” In the context of cost sharing agreements, this
rule would require controlled parties to share only those costs
uncontrolled parties would share. By implication, costs that
uncontrolled parties would not share need not be shared. In
contrast, § 1.482-7(d)(1) specifies that controlled parties in a
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cost sharing agreement must share all “costs . . . related to the
intangible development area,” and that phrase is explicitly
defined to include virtually all expenses not included in the
cost of goods. The plain language does not permit any excep-
tions, even for costs that unrelated parties would not share.
Each provision’s plain language mandates a different result.
Accordingly, we conclude that when related to each other, the
two provisions establish an ambiguous standard for determin-
ing which costs must be shared between controlled parties in
cost sharing agreements specifically related to intangible
product development.
Given the resultant ambiguity, our choice is to:
1. Apply a rule of thumb: the specific controls the
general.
2. Resolve the ambiguity based on the dominant
purpose of the regulations.
The first alternative is a simple solution. It is plausible. But
it is wrong. It converts a canon of construction into something
like a statute.
[3] Often the specific controls the general. This rule has
been used by the Supreme Court. E.g., Long Island Care At
Home, Ltd. v. Coke, 127 S. Ct. 2339, 2348 (2007). Apply this
simple rule here, and section 1.482-7(d)(1) controls. The con-
flict dissolves. The Commissioner is vindicated.
[4] This simple solution is all too pat. It gives controlling
importance to a single canon of construction. But, as every
judge knows, the canons of construction are many and their
interaction complex. The canons “are not mandatory rules.”
Chickasaw Nation v. United States, 534 U.S. 84, 94 (2001).
They are guides “designed to help judges determine the Leg-
islature’s intent.” Id. They can be “overcome” by “other cir-
cumstances” manifesting that intent. Id. The canons are “tools
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designed to help courts better determine what Congress
intended, not to lead courts to interpret the law contrary to
that intent.” Scheidler v. National Org. of Women, Inc., 547
U.S. 9, 23 (2006). In the light of these principles, two consid-
erations show the Commissioner’s position to be untenable.
[5] Purpose. Purpose is paramount. The purpose of the
regulations is parity between taxpayers in uncontrolled trans-
actions and taxpayers in controlled transactions. The regula-
tions are not to be construed to stultify that purpose. If the
standard of arm’s length is trumped by 7(d)(1), the purpose of
the statute is frustrated. If Xilinx cannot deduct all its stock
option costs, Xilinx does not have tax parity with an indepen-
dent taxpayer.
[6] Treaties. The “arm’s length” standard used in the
United States Ireland Tax Treaty RIA Int. Tax Treaty 3057,
aids in understanding the mind and practice of the Treasury.
A tax treaty is negotiated by the United States with the active
participation of the Treasury. The Treasury’s reading of the
treaty is “entitled to great weight.” United States v. Stuart,
489 U.S. 353, 369 (1989) (quoting Sumitomo Shoji America,
Inc. v. Aragliano, 457 U.S. 176, 184-185 (1982)). Simulta-
neous with the signing of the treaty into law, the Treasury
issued its “Technical Explanation.” As to Article 9, the Expla-
nation reads:
This article incorporates in the Convention the
arm’s length principle reflected in the U.S. domestic
transfer pricing provision, particularly Code section
482.
Department of the Treasury Technical Explanation of the
1997 United States-Ireland Tax Treaty, RIA Int. Tax Treaty
3095. See also, e.g., United States-France, Article 9 (RIA Int.
Tax Treaty 2225); United States-Germany, Article 9 (RIA Int.
Tax Treaty 1542); and United States-United Kingdom, Article
9 (RIA Int. Tax Treaty 2546).
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We do not, however, need to decide in this case whether
the treaty obligations “constitute binding federal law enforce-
able in United States courts.” Medellin v. Texas, 128 S. Ct.
1346, 1356 (2008). It is enough that our foreign treaty part-
ners and responsible negotiators in the Treasury thought that
arm’s length should function as the readily understandable
international measure.
The judgment of the tax court is AFFIRMED.
FISHER, Circuit Judge, concurring:
I concur, but write to explain my particular reasons for
rejecting the Commissioner’s position in this case.
The parties provide dueling interpretations of the “arm’s
length standard” as applied to the ESO costs that Xilinx and
XI did not share. Xilinx contends that the undisputed fact that
there are no comparable transactions in which unrelated par-
ties share ESO costs is dispositive because, under the arm’s
length standard, controlled parties need share only those costs
uncontrolled parties share. By implication, Xilinx argues,
costs that uncontrolled parties would not share need not be
shared.
On the other hand, the Commissioner argues that the com-
parable transactions analysis is not always dispositive. The
Commissioner reads the arm’s length standard as focused on
what unrelated parties would do under the same circum-
stances, and contends that analyzing comparable transactions
is unhelpful in situations where related and unrelated parties
always occupy materially different circumstances. As applied
to sharing ESO costs, the Commissioner argues (consistent
with the tax court’s findings) that the reason unrelated parties
do not, and would not, share ESO costs is that they are unwill-
ing to expose themselves to an obligation that will vary with
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an unrelated company’s stock price. Related companies are
less prone to this concern precisely because they are related
— i.e., because XI is wholly owned by Xilinx, it is already
exposed to variations in Xilinx’s overall stock price, at least
in some respects. In situations like these, the Commissioner
reasons, the arm’s length result must be determined by some
method other than analyzing what unrelated companies do in
their joint development transactions.
Under Xilinx’s interpretation, § 1.482-1(b)(1) and § 1.482-
7(d)(1) are irreconcilable. The latter specifies that controlled
parties in a cost sharing agreement must share all “costs . . .
related to the intangible development area,” and that phrase is
explicitly defined to include virtually all expenses not
included in the cost of goods. The plain language does not
permit any exceptions, even for costs that unrelated parties
would not share, so each provision mandates a different
result.
Under the Commissioner’s interpretation, § 1.482-7(d)(1)’s
“all costs” requirement is consistent with § 1.482-1(b)(1)’s
arm’s length standard and controls. In particular, the Commis-
sioner argues that, because there are material differences in
the economic circumstances of related and unrelated compa-
nies in relation to cost-sharing agreements like the one in this
case, it was proper for the IRS to require that in this narrow
context the arm’s length result should be defined by the “all
costs” requirement.
Having thoroughly considered not only the plain language
of the regulations but also the various interpretive tools the
parties and amici have brought before us, including the legis-
lative history of § 482, the drafting history of the regulations,
persuasive authority from international tax treaties1 and what
1I agree that the 1997 United States-Ireland Tax Treaty, along with
Treasury’s Technical Explanation, although not addressing the specific
regulatory conflict at issue here, is evidence that Xilinx’s understanding
of the arm’s length standard was and is quite reasonable. The treaty, and
others like it, reinforce the arm’s length standard as Congress’ intended
touchstone for § 482.
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appears to have been the understanding of corporate taxpayers
in similar circumstances and of others,2 I conclude that
Xilinx’s understanding of the regulations is the more reason-
able even if the Commissioner’s current interpretation may be
theoretically plausible. Traditional tools of statutory construc-
tion do not resolve the apparent conflict in these regulations
as applied to Xilinx, and the Commissioner’s attempts to
square the “all costs” regulation with the arm’s length stan-
dard have only succeeded in demonstrating that the regula-
tions are at best ambiguous.3
Although I would not go so far as Xilinx in characterizing
the Commissioner’s interpretation as merely a “convenient lit-
igating position,” Bowen v. Georgetown Univ. Hosp., 488
U.S. 204, 213 (1988), we need not defer to it because he has
not clearly articulated his rationale until now. See United
States v. Thompson/Ctr. Arms Co., 504 U.S. 505, 518-19 &
n.9 (1992) (declining to defer to an agency interpretation of
a tax statute where no prior guidance went directly “to the
narrow question presented”). Indeed, I am troubled by the
complex, theoretical nature of many of the Commissioner’s
arguments trying to reconcile the two regulations. Not only
2Apparently Xilinx’s understanding was widely shared in the business
community and tax profession. See Brief of PricewaterhouseCoopers LLP,
Deloitte Tax LLP and KMPG LLM as Amici Curiae on the Petition for
Rehearing at 5-6 (describing a “global consensus”); Brief of Cisco Sys-
tems, Inc. and Thirty-Two Other Affected Companies as Amici Curiae on
the Petition for Rehearing at 3 (describing “settled business expecta-
tions”); cf. Brief of Former U.S. Treasury and Internal Revenue Service
Officials at 3-5.
3The dissent invokes the prior, withdrawn majority opinion. Dissent at
4613-14; see Xilinx, Inc. v. CIR, 567 F.3d 482 (9th Cir. 2009), withdrawn
January 13, 2010. In writing that opinion, I was persuaded that the arm’s
length standard and the all costs regulation were in conflict, and that the
more specific of the two should control. See 567 F.3d at 486. I no longer
share Judge Reinhardt’s confidence in that resolution because the Com-
missioner’s response to Xilinx’s petition for rehearing declined to fully
endorse its reasoning. Instead, the thrust of the Commissioner’s response
was that our result was correct, even though our reasoning was not.
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does this make it difficult for the court to navigate the regula-
tory framework, it shows that taxpayers have not been given
clear, fair notice of how the regulations will affect them.4
Accordingly, I join Judge Noonan in affirming the tax
court. These regulations are hopelessly ambiguous and the
ambiguity should be resolved in favor of what appears to have
been the commonly held understanding of the meaning and
purpose of the arm’s length standard prior to this litigation.
REINHARDT, Circuit Judge, dissenting:
I have considerable doubt as to whether Xilinx, Inc.
(“Xilinx”) and Xilinx Ireland allocated the costs associated
with employee stock options in a manner that can be charac-
terized as an arm’s length result. I will assume, however, that
the tax court correctly resolved that issue. If so, there is
clearly a conflict between the arm’s length regulation codified
at 26 C.F.R. § 1.482-1(b)(1), which applies to all transactions
between controlled parties, and the “all costs” regulation codi-
fied at § 1.482-7(d)(1), which applies only to cost-sharing
arrangements between controlled parties.1 I continue to
believe that, as a matter of law, the “all costs” regulation, as
the specific of the two provisions, the one designed to deal
specifically with the type of question before us, controls. I
would therefore reverse the tax court’s ruling that the Com-
missioner’s proposed allocation was arbitrary and capricious
for the reasons explained in our opinion, Xilinx Inc. v. CIR,
4It is an open question whether these flaws have been addressed in the
new regulations Treasury issued after the tax years at issue in this case.
See 26 C.F.R. § 1.482-7T(a) & (d)(1)(iii) (2009) (stating explicitly that
ESOs are costs that must be shared and that the all costs requirement is
an arm’s length result).
1To be clear, I refer here only to the regulations in effect during tax
years 1997, 1998, and 1999. I express no view as to whether subsequent
regulations resolved this conflict.
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567 F.3d 482 (9th Cir. 2009), withdrawn on January 13, 2010
in anticipation of the issuance of Judge Noonan’s and Judge
Fisher’s new opinions, supra.
I agree with the majority that the canons of construction
“are not mandatory rules,” and that their interpretive force can
be overcome by other circumstances evidencing legislative
intent. Maj. op. at 4608-09 (quoting Chickasaw Nation v.
United States, 534 U.S. 84, 94 (2001)). Such circumstances,
however, are not present here. Contrary to the majority’s
assertions, the conflict between the arm’s length provision
and the “all costs” requirement cannot be resolved by looking
to the purpose of the regulations or to Treasury’s Technical
Explanation of the 1997 United States-Ireland Tax Treaty.
Judge Fisher also looks to the understanding of the multina-
tional corporations and their business and tax advisors, a dubi-
ous practice for which he cites no legal authority.
The stated purpose of the regulatory scheme is “to ensure
that taxpayers clearly reflect income attributable to controlled
transactions and to prevent the avoidance of taxes with
respect to such transactions.” 26 C.F.R. § 1.482-1(1)(a). In the
context of this case, neither regulation more clearly imple-
ments that purpose than the other. Controlled and uncon-
trolled parties always operate under materially different
circumstances with regard to employee stock option costs.
Accordingly, the “all costs” regulation may simply reflect the
conclusion that, whatever uncontrolled parties might do,
requiring controlled parties to share such costs “ensure[s] that
taxpayers clearly reflect [the] income attributable to [the] con-
trolled transaction[ ]” as a whole. Nor is it clear that excluding
those costs would better achieve tax parity. It is not the iden-
tity of treatment with respect to a single item that controls
with respect to this general goal, but the overall manner in
which the transaction is treated. The Commissioner has deter-
mined that including “all costs” is the best manner of achiev-
ing this general objective, and his decision does not appear to
be unreasonable.
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Similarly, Treasury’s Technical Explanation of the 1997
United States-Ireland Tax Treaty does not justify disregarding
the “all costs” requirement when determining deductible
costs. A Technical Explanation is not subject to the APA’s
notice and comment requirement and does not carry the force
of law. See 5 U.S.C. § 553(a)(1) (exempting “foreign affairs
function[s] of the United States” from the APA); see, e.g.,
Explanation of Convention with Ireland (1997) (“The Techni-
cal Explanation is an official guide to the Convention and
Protocol.” (emphasis added)). Certainly, it cannot trump the
plain language of the duly enacted “all costs” regulation,
which does have the force of law and is entitled to this court’s
deference. United States v. Mead Corp., 533 U.S. 218, 226-27
(2001); cf. Cent. Laborers’ Pension Fund v. Heinz, 541 U.S.
739, 748 (2004) (“[N]either an unreasoned statement in the
manual nor allegedly longstanding agency practice can trump
a formal regulation with . . . the force of law.”).
I recognize that Xilinx and amici have raised serious doubts
as to whether the result that I believe to be legally required is,
from both a practical and an equitable standpoint, the proper
one. I am particularly troubled by the international tax conse-
quences that such a result would apparently create. Tax law,
however, involves the resolution by Congress of complex
political and economic issues that sometimes may affect busi-
ness or individual interests in unforeseen ways, and some-
times in ways that benefit one political or economic interest
at the expense of another. These resolutions are not always
arrived at in an open, objective, or non-political manner. To
put it plainly, fairness is not always Congress’s ultimate
objective in enacting tax legislation. Accordingly, some pro-
visions of tax law may appear to some businesses, individu-
als, or even judges to be in conflict with reasonable or
sensible tax or national policy. Yet they may reflect the intent
of Congress when it enacted the statute. Tax regulations are
frequently even more complex than the legislation they imple-
ment, and it is often difficult for judges to clearly resolve their
meaning. Still, it is the job of the courts to make the necessary
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determinations and in doing so to apply established legal rules
and principles. By contrast, it is the business of Congress and
the Treasury, not the courts, to correct any errors in those stat-
utes or regulations, especially as they can be readily corrected
once they are called to their attention.
For the reasons I have explained, it is particularly inappro-
priate for courts to resolve tax cases on a practical or equita-
ble basis or to interpret tax statutes and regulations other than
strictly in accordance with settled legal principles. The canon
of construction under which the specific controls the general
is one such settled legal principle, and one that is especially
pertinent here. Indeed, it is controlling. I adhere to the previ-
ous majority opinion of this court.2
For these reasons, I respectfully dissent.
2I, like Judge Fisher, am less than enthusiastic about the Commission-
er’s explanation of how he believes we should resolve this case. His pref-
erence is that we find somehow that the arm’s length standard is met by
way of the all costs requirement. I must confess that I have difficulty fol-
lowing his reasoning and, like Judge Fisher, am not persuaded by that
argument. However, the Commissioner then says that if we still believe
that the two provisions are in conflict, we must apply the rule on which
Judge Fisher originally relied and on which I continue to rely. I guess I
am just not as sensitive as Judge Fisher. Simply because the Commis-
sioner advanced an argument that we reject, but then argued that if we
reject it, we should apply the rule that we held applicable in our opinion
is hardly a reason for abandoning the rule that we believed to be correct.
We can’t expect anyone, let alone the Commissioner of Internal Revenue,
to agree completely with everything we say. Rejecting the Commission-
er’s first argument leaves us exactly where we were before he advanced
it: The two regulations are in conflict, and (as Judge Fisher and I once
agreed) that conflict must be resolved by applying the specific regulation
rather than the general one.
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