A US appelate court overturned a lower court’s decision today, securing a big victory for the Internal Revenue Service and setting a new precedent for the manner in which multinational corporations handle transfer pricing regulations in the United States.  From the Wall Street Journal:

The case involves so-called transfer pricing, the complex arrangements companies use to allocate costs and revenue between operations in different tax jurisdictions. Transfer-pricing disputes between multinational companies and the IRS are drawing attention as companies do more business overseas and develop more sophisticated methods for cutting their taxes, particularly in the technology and pharmaceutical industries.

In Xilinx’s case, the San Jose, Calif., company allocated a portion of its research and development costs to an Irish subsidiary. However, when it came to stock options granted to the company’s research employees, Xilinx kept in the U.S. the entire value of the tax deductions related to those options. None of the deductions were allocated to the subsidiary in Ireland, where corporate income-tax rates are significantly lower than in the U.S., thus lowering Xilinx’s global tax burden.

U.S. Treasury Department regulations dictate that all deductions and income in transfer pricing arrangements are allocated according to an “arm’s length” standard — how unrelated companies would share those costs. Xilinx argued that unrelated companies wouldn’t have shared the costs of the stock options.

By a vote of 2-1, a panel of the appellate court ruled that the costs related to the options had to be shared, which would increase Xilinx’s taxable income in the U.S.

It will be very interesting to see what the fallout is from this decision.  Xilinx hasn’t decided whether or not they will appeal to the Supreme Court yet, so we’ll keep our eyes on this case.

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