T.C. Memo. 2000-388
UNITED STATES TAX COURT
SEAGATE TECHNOLOGY, INC., SUCCESSOR IN INTEREST TO SEAGATE
PERIPHERALS, INC., f.k.a. CONNER PERIPHERALS, INC., Petitioner
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15086-98. Filed December 22, 2000.
P, a domestic corporation, entered into a cost-
sharing agreement with its foreign subsidiaries in
connection with certain intangibles that were
transferred to the subsidiaries. R determined that P
should have included in the cost-sharing pool the cost
of stock options for P’s employees who performed the
research and development regarding the intangibles.
Where there is a bona fide cost-sharing arrangement, R
may make allocations only “to reflect each
participant’s arm’s-length share of the cost of the
risks of developing the property.” Sec. 1.482-2(d)(4),
Income Tax Regs. P contends that R is limited to
making allocations only where R is aware of actual
arm’s-length circumstances where the cost of stock
options is shared. P also contends that for purposes
of summary judgment, R’s reliance on an expert’s
opinion is not a “fact” for purposes of deciding
whether the parties have a genuine dispute about a
material fact.
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Held: Under the regulations, R is not required
to be aware of arm’s-length circumstances as a
prerequisite to the making of a determination
allocating a cost in connection with a sharing
agreement. Held further: Petitioner has not shown
that there is no genuine issue of material fact.
Mark A. Oates, Thomas V.M. Linguanti, John M. Peterson, Jr.,
Mary E. Wynn, and Andrew P. Crousore, for petitioner.
Debra K. Estrem, Jeffrey A. Hatfield, Michael J. Cooper,
Bryce A. Kranzthor, Ewan D. Purkiss, and Mark S. Heroux, for
respondent.
MEMORANDUM OPINION
GERBER, Judge: Petitioner moved for partial summary
judgment1 concerning what has been denominated the “section 4822
stock option cost-sharing issue”. In particular, petitioner
questions whether respondent may employ section 482 to make an
1
Petitioner has filed two motions for partial summary
judgment. This opinion addresses the issue that the parties have
denominated the “section 482 stock option cost-sharing issue”.
The other summary judgment motion involves what has been
denominated the “Read-Rite issue”, addressing whether the
“relation back doctrine” established in Arrowsmith v.
Commissioner, 344 U.S. 6 (1952), applies in characterizing
petitioner’s gain on the sale of stock for purposes of sec. 954.
See Seagate Technology, Inc. v. Commissioner, T.C. Memo. 2000-
361.
2
All section references are to the Internal Revenue Code in
effect for the 1990, 1991, and 1992 tax years, and all Rule
references are to the Tax Court Rules of Practice and Procedure,
unless otherwise indicated.
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allocation to include petitioner’s cost, if any, of employee
stock options in the cost-sharing pool for purposes of a cost-
sharing agreement between petitioner and its foreign
subsidiaries.
In support of its motion, petitioner argues that, as a
matter of law, respondent is prohibited from making an allocation
with respect to the cost-sharing arrangement for the following
reasons: (1) Respondent is not aware of specific arm’s-length
dealings where stock option costs were shared; (2) respondent
relies on opinion as opposed to factual support for inclusion of
the “at-the-money” stock options3 in the pool of costs; (3)
section 1.482-2(b)(5)(ii), Income Tax Regs., excludes “expenses
associated with the issuance of stock”; and (4) petitioner
allocated and apportioned the costs of nonintegral support
services consistently using a reasonable method in keeping with
sound accounting practices within the meaning of section 1.482-
2(b)(6)(i), Income Tax Regs.
3
An “at-the-money” stock option is issued at an exercise
price pegged to the market value on the issue date. Accordingly,
if the market value of the stock remains at the option issue
price or lower, the option will not be exercised. Conversely, if
the market price exceeds the option issue price, the option would
more likely be exercised.
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Respondent counters that: (1) Section 1.482-2(d)(4)4 and
(b)(4), Income Tax Regs., requires that “all costs” be included
in cost-sharing arrangements, and “all costs” include employee
stock options; and (2) there are disputed material facts
concerning whether arm’s-length parties would share the cost of
stock options granted to employees who performed the research and
development for the transferred intangible.
Background
Petitioner is the successor in interest to Conner
Peripherals, Inc. (Conner Domestic), which developed and
manufactured hard disk drives for sale to personal computer
manufacturers and others. Effective January 1, 1988, Conner
Domestic and its wholly owned foreign manufacturing subsidiary,
Conner Peripherals Singapore, Ltd. (Conner Foreign 1), entered
into a cost-sharing agreement. Effective July 1, 1990, Conner
Domestic, Conner Foreign 1, and Conner Domestic’s wholly owned
Singapore corporation, Conner Peripherals Pte., Ltd., entered
into a new cost-sharing agreement for sharing research and
development (R&D) costs, and the 1988 cost-sharing agreement was
4
Sec. 1.482-2(d), Income Tax Regs., was amended in 1993,
and respondent refers to the amended version (sec. 1.482-2A(d),
Income Tax Regs.) in his materials. Petitioner, on the other
hand, refers to the unamended version. While the years we
consider predate the amendment, the amended version, to the
extent pertinent here, has not been changed. Accordingly, the
references used by the parties are interchangeable.
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terminated. Pursuant to the new agreement, the three
corporations shared $62.9 million, $85 million, and $94.7 million
of R&D costs for the development of a new generation of disk
drives for 1990, 1991, and 1992, respectively.
In connection with an audit, respondent challenged certain
of the allocations under the cost-sharing agreement. Agreement
was reached with respect to all determined allocations with the
exception of respondent’s determination that the value or cost of
stock options granted to Conner Domestic’s employees had to be
included in the cost-sharing pool. Petitioner contended that
arm’s-length parties would not share the cost, if any, of
employee stock options, and respondent was not aware of any
arm’s-length cost-sharing arrangement where the parties shared
the cost incurred with respect to the grant of an at-the-money
stock option to the employees of one of the parties.
Discussion
Summary judgment is an appropriate means by which to decide
a legal issue if the pleadings, admissions, and other materials,
including affidavits, demonstrate that no genuine issue exists as
to any material fact and a decision may be rendered as a matter
of law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98
T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994). Summary
judgment is a device used to expedite litigation, but it is not a
substitute for a trial in that disputes over factual issues are
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not to be resolved in such proceedings. See Espinoza v.
Commissioner, 78 T.C. 412, 415-416 (1982); Shiosaki v.
Commissioner, 61 T.C. 861 (1974). The party moving for summary
judgment has the burden of showing the absence of a genuine issue
as to any material fact. See Shiosaki v. Commissioner, supra.
The dispute here concerns a cross-border transfer of
intangibles by a domestic parent to its foreign subsidiaries.
Under the regulations in effect for the years under
consideration, if a group of controlled entities participated in
a “bona fide cost-sharing arrangement” as to the development of
intangibles, then the district director is limited in his
approach to reallocation. Sec. 1.482-2(d)(4), Income Tax Regs.
In particular, the regulation provides that if there is a “bona
fide cost-sharing arrangement”, then “the district director shall
not make allocations with respect to such acquisition [of
intangibles] except as may be appropriate to reflect each
participant’s arm’s length share of the costs and risks of
developing the property.” Id.
The regulation goes on to direct that cost-sharing
arrangements will be considered “arm’s length” where the “terms
and conditions * * * [are] comparable to those which would have
been adopted by unrelated parties similarly situated had they
entered into such an arrangement.” Id. There is no disagreement
about the bona fides of the cost-sharing agreements between the
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controlled entities in this case. Respondent and petitioner have
also resolved their differences regarding several other
reallocations determined by respondent. The only question
presented is whether the controlled entities must share the cost,
if any, of the domestic parent’s stock options given to the
parent’s employees who performed research and development
regarding particular intangibles.
Petitioner argues that where a bona fide cost-sharing
arrangement exists, section 1.482-2(d)(4), Income Tax Regs.,
requires respondent to have a factual predicate in order to make
any allocations. Petitioner also points out that respondent has
admitted that he does not have evidence or knowledge of an actual
arm’s-length transaction where stock option costs were shared.
Respondent, instead, relies on an affidavit containing an
expert’s opinion that options are part of the costs that would be
shared between arm’s-length parties. Where a bona fide cost-
sharing arrangement exists, petitioner contends that respondent
may not rely solely on an expert’s opinion as a basis for a stock
option cost-sharing allocation. Petitioner also argues that
respondent’s expert’s opinion is unreliable under the standard
set forth in Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579
(1993), and related cases. Additionally, petitioner contends
that even if the expert’s opinion was acceptable and/or
admissible, it is “opinion” and not “fact” and, therefore, could
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not be the basis for a genuine issue as to a material fact so as
to preclude the use of summary judgment.
Petitioner contends that it has shown that stock option
costs would not be shared in an arm’s-length transaction.
Petitioner’s proof on this point consists of the experiences of
its officers and employees, some of whom have worked for or with
unrelated third parties. Petitioner also relies on the fact that
the Federal Acquisition Regulations System (FARS) classifies
qualifying employee stock purchase plans as “noncompensatory.”
That classification precludes payment by the Federal Government
for costs of qualified employee stock options in connection with
contracts governed by FARS. Because FARS governs all civil and
military Federal executive branch contracts with private business
for goods and services, petitioner reasons that a large number of
“arm’s-length transactions” do not include the cost-sharing of
employee stock options.
Respondent counters that the regulations provide that all
costs should be included and that stock option costs are “costs”
that may be allocated. In addition, respondent relies on an
expert’s opinion that stock option costs would be accounted for
in an arm’s-length business relationship. Respondent also relies
on what he believes are analogous court opinions in which the
stock options have been treated as compensation or as part of the
consideration for a transaction. Finally, respondent contends
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that the FARS contracts are not comparable to the circumstances
in this case.
The parties’ disagreement raises several questions about the
regulations. Firstly, we must consider whether the Commissioner
must be aware of an actual arm’s-length transaction before
allocating costs between controlled entities that have a bona
fide cost-sharing arrangement. Secondly, if an actual arm’s-
length example is not required, then we must decide whether the
Commissioner must possess facts and/or admissible evidence before
making such an allocation.5
We do not agree with petitioner’s perception that respondent
would have to be aware of an actual arm’s-length transaction as a
prerequisite to making any allocations. Section 1.482-2(d)(4),
Income Tax Regs., limits the Commissioner’s ability to make an
allocation, in the case of a bona fide cost-sharing arrangement,
to the appropriate reflection of each participant’s arm’s-length
share of the costs and risks of developing the property. The
regulation goes on to direct that cost-sharing arrangements will
be considered “arm’s length” where the “terms and conditions
[are] comparable to those which would have been adopted by
unrelated parties similarly situated had they entered into such
5
The parties have raised several other factual and/or legal
questions that need not be addressed in the setting of this
summary judgment motion because of our conclusion that there is a
genuine issue as to a material fact.
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an arrangement.” (Emphasis added.) Accordingly, there is no
requirement that the Commissioner have actual knowledge of an
arm’s-length situation as a prerequisite to the determination of
an allocation in the case of a cost-sharing arrangement.
In addition, the regulatory standard does not require that
the Commissioner rely on fact, as opposed to opinion, before
making an allocation where there is a bona fide cost-sharing
arrangement. There is no specific minimum standard prerequisite
to the Commissioner’s determination that an allocation should be
made. Such a determination, however, may ultimately be found to
be arbitrary, capricious, or unreasonable, but that standard is
not the threshold enabling the Commissioner’s determination that
an allocation should be made.
We do not conclude that respondent’s determination is or is
not well founded. Likewise, we do not, in the context of this
opinion, accept, agree with, or disagree with respondent’s
expert’s opinion. We must however, observe that for better or
for worse, expert witnesses have become the prognosticators and
the bane of transfer pricing cases. Both parties may rely on
expert advice/opinions in reaching their conclusions and/or
defending their positions.
Here we will be engaged in deciding whether the sharing of
stock option costs is a circumstance “comparable to those which
would have been adopted by unrelated parties”. Sec. 1.482-
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2(d)(4), Income Tax Regs. Petitioner, from a limited universe of
information, has attempted to show that it is not aware of an
arm’s-length transaction where the costs of stock options were
shared; i.e., that its officers and employees are not aware of
any circumstances where costs of stock options have been shared
in petitioner’s experiences and in those of employees who have
experience with other companies. Through Government FARS
contract standards, petitioner has attempted to show that some
portion of the potential universe of unrelated (arm’s-length)
research and development transactions did not involve the sharing
of the cost of employee stock options.
In the context of a partial summary judgment motion, we
should not undertake the role of a fact finder. In such a
setting, a judge should not engage in credibility determinations,
weighing the evidence, or drawing inferences from the “facts”
that the moving and nonmoving parties present. See Anderson v.
Liberty Lobby, Inc., 477 U.S. 242, 255 (1985); Naftel v.
Commissioner, 85 T.C. 527, 529 (1985). As significantly, “The
evidence of the non-movant is to be believed, and all justifiable
inferences are to be drawn in his favor.” Anderson v. Liberty
Lobby, Inc., supra at 255; see also Adickes v. S.H. Kress & Co.,
398 U.S. 144, 158-159 (1970); Blanton v. Commissioner, 94 T.C.
491, 494 (1990).
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Neither party has advanced evidence or affidavits completely
resolving, as a factual matter, the question of whether arm’s-
length parties to a similar transaction would share the cost of
employee stock options. There are also questions about whether
the options had any cost to petitioner at the time of issuance
and/or the appropriate time to measure the cost of the stock
options. Under these circumstances, we are compelled to hold
that there is a genuine dispute about material facts. We cannot
say that either party has presented or had the opportunity to
fully present facts or other evidence adequately addressing, for
the benefit of a fact finder, whether the regulatory standard has
been met. Accordingly, this matter is not ripe for summary
adjudication, and further development and/or a trial may be
necessary to resolve the disputed factual aspects of this case.
As to petitioner’s argument that there is no genuine dispute
about a material fact because respondent relies solely on opinion
evidence, we disagree with petitioner’s perspective. Petitioner
chooses to focus on the means by which respondent may attempt to
convince the Court that his determination is well founded and/or
that his determination is based on conditions that are comparable
to those that would have been adopted by unrelated parties
similarly situated had they entered into such an arrangement.
Even though an expert’s opinion may be hearsay (i.e., not based
on the expert’s personal knowledge but on his perception of the
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operative facts of a case), courts may rely on the expert’s
affidavits in denying motions for summary judgment. See Cabrales
v. County of Los Angeles, 864 F.2d 1454, 1460 (9th Cir. 1988),
vacated and remanded 490 U.S. 1087 (1989); see also Newhouse
Broad. Corp. v. Commissioner, T.C. Memo. 2000-270.
As explained above, under the regulations, respondent is not
required to present an actual example of an arm’s-length
transaction where the costs of employee stock options were
shared.6 Petitioner, if it follows its present approach, will
try to show that such costs are not shared by proving a negative;
i.e., no transactions where there was cost sharing. Respondent,
on the other hand, if he follows his present approach, will
attempt to show by means of expert opinion that such costs would
or should be shared within the meaning of the regulations.
Obviously, an expert’s opinion and/or testimony is generally not
admissible as fact because he or she generally renders opinions
after the fact. Nevertheless, experts’ opinions are received for
the purpose of assisting the trier of fact in reaching a factual
conclusion.
Our conclusion that there remains a genuine dispute about a
material fact does not presume that respondent’s expert(s) is
qualified or that the opinion(s) is necessarily helpful or
6
We note, however, that such a showing would be preferred
to opinion evidence.
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admissible, but that such questions cannot be decided in the
context of this summary judgment motion. Likewise, petitioner’s
proposed evidence of the nonexistence of such an arm’s-length
sharing of stock option costs is not being “judged” at this time.
To reflect the foregoing,
An order will be issued
denying petitioner’s motion for
partial summary judgment regarding
the “section 482 stock-option cost-
sharing issue”.