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July 21, 2021

US IRS memo addresses cost sharing agreements and inclusion of stock-based compensation costs

In a generic legal advice memorandum (GLAM) the Internal Revenue Service (IRS) Office of Chief Counsel (AM 2021-004) addressed its views on the treatment of stock-based compensation (SBC) costs in cost sharing agreements that include a "reverse claw-back" provision, but do not share SBC costs (non-SBC CS agreements).

The IRS asserted that it can make certain allocations to make the cost sharing transactions consistent with an arm's length result. The IRS discussed how to treat those allocations for SBC costs and the timing of the adjustments.


Under the cost sharing rules, controlled parties may enter into a cost sharing arrangement (CSA) to share the costs and risks associated with the development of intangibles in proportion to each party's share of reasonably anticipated benefits (RAB) expected to result from use of these cost-shared intangibles. The cost sharing regulations provide that the results of a CSA are consistent with the arm's length standard only if, among other requirements, each controlled participant's share of intangible development costs (IDCs), which includes SBC, is proportionate to its RAB share.

In July 2015, the US Tax Court, in a unanimous decision reviewed by the full court, held in Altera v. Commissioner (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 IDC under a CSA subject to Treas. Reg. Section 1.482-7 (see EY Global Tax Alert, US: IRS “'practice unit” sets forth examination guidance on the inclusion of stock based compensation in cost sharing arrangements, dated 8 October 2020).

IRS asserted adjustments

"Claw-back" provisions generally allow a taxpayer to remove, or "claw back," SBC included in cost pools if the 2003 SBC regulation is (1) invalidated as the result of a final decision in a court of law, (2) revised, or (3) withdrawn. "Reverse claw-back" provisions, on the other hand, generally provide that taxpayers who excluded SBC from their cost pools may later include those SBC amounts upon a certain triggering event (such as a final decision in Altera) and make a true-up payment to reflect the sum of SBC costs that should have been shared in prior years.

In the GLAM, the IRS takes the position that SBC should be included in the cost pools under the cost sharing regulations. The IRS further asserts that it can adjust the results of a cost-sharing transaction (CST) in the year in which the IDCs were incurred under Treas. Reg. Section 1.482-7(i)(2) regardless of whether there is a reverse claw-back provision. In support of this position that it can ignore the terms of reverse claw-back provisions, the IRS asserts in the GLAM that excluding SBC would result in an imbalance between IDC shares and RAB shares in any given year of exclusion.

In the GLAM, the IRS specifically addresses the following issues that may arise when the IRS makes the adjustment: (1) the correct year to include the SBC costs in the cost pool; (2) whether the adjustment affects the taxpayer's true-up obligation amount; and (3) whether the IRS can make an adjustment in a different year if it is unable to do so in the year the IDCs were incurred because the period of limitations on assessments has expired.

IRS conclusions

The IRS concludes that under Treas. Reg. Section 1.482-7(i)(2) it may make allocations to adjust the results of a CST so that each controlled taxpayer's IDC share for each tax year is equal to its RAB share. The IRS argues that the allocation must be reflected for tax purposes in the year in which the IDCs were incurred. The IRS reasons in the GLAM that its allocations should be treated as reducing the amount of the taxpayer's reverse claw-back true-up obligation by a corresponding amount in order to avoid an overpayment of the SBC costs. The IRS further asserts in the GLAM that if the adjustments cannot be made in the year the IDCs were incurred, the IRS may make other adjustments in the year of the taxpayer's triggering event to reflect the contract or ensure that the non-SBC CS agreement produces results that are consistent with an arm's length result.


This GLAM is the second significant IRS administrative guidance concerning CSAs with SBC since the conclusion of Altera (see DCN INT-T-226, discussed above). The GLAM highlights the IRS's approach to CSAs that do not share SBC costs and contain a reverse claw-back provision. The IRS's positions set forth in the GLAM suggest that the IRS will likely continue to strongly pursue SBC inclusions under the 2003 SBC regulation. In addition, the GLAM shows that the IRS intends to make SBC adjustments in the years in which the IDCs were incurred regardless of the language contained in taxpayers' reverse claw-back provisions, and will revert to enforcing the terms of a reverse claw-back provision only if a year-by-year adjustment is unavailable. The IRS's positions in the GLAM are likely to be of interest to taxpayers.

While the GLAM may be relevant in evaluating the likelihood the IRS may challenge a taxpayer's treatment of SBCs, it is not precedential authority for determining the level of comfort supporting a taxpayer's inclusion of SBC costs based on its facts and circumstances.


For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United States), International Tax and Transaction Services, Transfer Pricing, Washington, DC

Ernst & Young LLP (United States), International Tax and Transaction Services



  1. Altera v. Commissioner, 145 T.C. 91 (Tax Court 2015).
  2. Altera v. Commissioner, 926 F.3d 1061 (9th Cir. 2019).

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