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Abbott Laboratories has petitioned the Tax Court to redetermine deficiencies of almost $417 million, which the IRS assessed for the 2019 tax year (Abbott Laboratories v. Commissioner, No. 20227-23 (Dec. 22, 2023)). Abbott is asking the Tax Court to find, among other things, that the IRS erred in (1) adjusting Abbott's royalty income for IP licensing transactions; (2) including stock-based compensation (SBC) in the taxpayer's cost-sharing arrangement or the cost base of controlled services transactions; and (3) disallowing amortization deductions authorized under IRC Section 197 when computing Abbott's global intangible low-taxed income (GILTI) under IRC Section 951A.

Royalty income

In the petition, Abbott disputes the IRS's adjustment of its royalty income for the 2019 tax year from licenses for nutritional and diabetes care products, asserting that the payments it received from its affiliates were negotiated at arm's length. Further, Abbott asserts that the government had previously signed an agreement during the 2011 exam that a 2% royalty for the intercompany license of Abbott nutritional products to its affiliates would be considered arm's length so long as there were no "substantial changes in the Nutrition business segment." As no substantial change had occurred since the 2012 agreement, Abbott argued, the IRS should not have adjusted Abbott's income.

Stock-based compensation

Abbott also disputes the IRS adjusting its income by adding stock-based compensation to (1) intercompany service fees that Abbott and certain US affiliates charged to certain foreign affiliates, and (2) a shared cost pool under a qualified cost-sharing arrangement between two group entities.

Abbott asserts that the intercompany service fees were arm's length. Abbott also argues that the IRS misapplied Treas. Reg. Section 1.482-9, which only requires SBC to be included in cost bases for intercompany service charges when the taxpayer (1) elects to apply the services cost method (SCM) for eligible services under Treas. Reg. Section 1.482-9(b) and Revenue Procedure 2007-13, or (2) applies the comparable profits method using a return on "total services cost profit level indicator" under Treas. Reg. Section 1.482-9(f)(2)(ii). Abbott asserts that most of the IRS's adjustment was attributable to services transactions that did not fall into either of these categories. Further, interpreting Treas. Reg. Section 1.482-9 as requiring taxpayers to include SBC in all intercompany services cost bases is inconsistent with IRC Section 482's arm's-length standard and violates the Administrative Procedure Act.

GILTI income

Abbott disputes the IRS increasing its income by disallowing amortization deductions allowed under IRC Section 197 when computing Abbott's GILTI under IRC Section 951A based on Treas. Reg. Section 1.951A-2(c)(5). This regulation generally disallows amortization arising from basis created in a transfer from January 1, 2018, through the effective date of the GILTI provisions for fiscal-year taxpayers (or calendar-year taxpayers with fiscal-year controlled foreign corporations (CFCs). Abbott asserts that the regulation is invalid because it is contrary to the plain text of IRC Section 951A, and Treasury violated the Administrative Procedures Act in promulgating it. See Tax Alert 2019-1132 for more information on IRC Section 951A.

Altera

The last case litigated on including SBC in CSAs was Altera v. Commissioner (Altera). In July 2015, the US Tax Court, in a unanimous decision reviewed by the full court, held in Altera that the 2003 regulation requiring participants in CSAs to share SBC costs was invalid.¹ In June 2019, a divided panel of the US Court of Appeals for the Ninth Circuit reversed the Tax Court and upheld the 2003 regulation requiring controlled participants to include the cost of SBC in a CSA.² In June 2020, the US Supreme Court denied Altera's petition for a writ of certiorari.

In September 2020, the IRS released a new practice unit titled "Cost Sharing Arrangements with Stock Based Compensation" (DCN INT-T-226), focusing on the inclusion of SBC as an intangible development cost (IDC) under a CSA subject to Treas. Reg. Section 1.482-7 (see Tax Alert 2020-2413). In July 2021, the IRS Office of Chief Counsel (AM 2021-004) released a generic legal advice memorandum, in the context of SBC costs in CSAs that include a "reverse claw-back" provision, but do not share SBC costs, asserting that the IRS can make certain allocations to make the cost-sharing transactions consistent with an arm's-length result (see Tax Alert 2021-1389).

Implications

In Altera, the US Court of Appeals for the Ninth Circuit ruled in favor of the IRS and upheld the 2003 regulation requiring controlled participants to include the cost of SBC in a CSA. An appeal from the Tax Court in Abbott would lie in the US Court of Appeals for the Seventh Circuit, which ultimately could hold in favor of Abbott and lead to a split of authority on the SBC issue between the two circuits. Such a circuit split may result in the US Supreme Court taking the case on appeal and finally settling the long-standing SBC issue.