In a recent determination overturning an assessment by the Irish Revenue Commissioners (59TACD2024 — Corporation Tax (taxappeals.ie)), Ireland's Tax Appeals Commission (Commission) ruled that the cost of stock-based awards (SBAs) should be borne by the US parent company, not its Irish subsidiary; as such, the Irish subsidiary did not need to include the SBAs in its cost base for the transfer pricing calculation.

This is the first transfer pricing case decided by the Commission after Ireland's formal adoption of transfer pricing legislation in 2011.¹

Ireland

The case concerns tax assessments stemming from transfer pricing adjustments made by the Revenue Commissioners to the Irish subsidiary's cost base for intercompany services provided to its US parent. The adjustments relate to SBAs granted by the US parent company to the employees of the Irish subsidiary.

Facts

Under a services agreement, the Irish subsidiary performed sales and marketing and contract research and development services for its US parent and charged a fee based on the subsidiary's costs plus a mark-up. The intercompany agreement specifically excluded any SBAs awarded by the parent company to the subsidiary's employees, and the Irish subsidiary did not include the SBAs when calculating the fee under the services agreement.

The parent and subsidiary did not enter into a recharge agreement for tax purposes, so the US parent incurred the tax cost of the SBAs, not the subsidiary. Moreover, the subsidiary did not deduct any SBAs awarded by the parent company to its employees.

The Irish subsidiary's financial statements included a line item for the SBAs that the US parent awarded to the subsidiary's employees. The cost recorded in the subsidiary's financial statements reflected the SBA's fair value, which the subsidiary's financial reporting standards required, according to the ruling. The ruling also indicated that the subsidiary's financial reporting standards do not consider the tax treatment of SBAs, whether a tax recharged agreement is executed, or whether the SBAs are deducted for tax purposes.

Parties' assertions

The Revenue Commissioners alleged that the Irish subsidiary did not demonstrate that the intercompany service fees it received from the US parent for the relevant years were arm's length because the SBAs should have been included in the Irish subsidiary's costs for purposes of calculating the fee under the services agreement.

The Irish subsidiary asserted that the SBAs did not have to be included because they created an economic cost for the parent company. As that cost was not charged to the subsidiary for tax purposes, the subsidiary never incurred an economic cost.

Commission analysis

The Irish transfer pricing legislation (Part 35A TCA 1997), introduced in 2011, later incorporated the OECD's 2022 transfer pricing guidelines. The Commission said the Irish transfer pricing legislation should be construed to ensure, as far as practicable, consistency with the OECD guidelines, which have the arm's-length principle as their fundamental principle. The Commission indicated the Transactional Net Margin Method (TNMM) was the most appropriate method to test the Irish subsidiary's profits during the relevant years.

The central disagreement between the parties related to whether the Irish subsidiary should have included the accounting expense for the SBAs in the cost base when calculating the transfer price on intercompany services. The Revenue Commissioners asserted that, at arm's length, the Irish subsidiary would earn a profit mark-up, not only on the operating costs but also on the SBAs' accounting expense, effectively relying on the financial reporting standards' definition of cost.

The Commission said the SBAs were not a cost that burdens the services that the Irish subsidiary provided to the US parent. The US parent was the sole decision maker and risk taker in relation to an SBA award.

The Commission concluded that, "at arm's length, there was no economic basis for the [Irish subsidiary] to receive service fees or operating profits associated with the SBAs accounting expense and thus, the arm's length principle requires that the SBAs accounting expense should be excluded from the [Irish subsidiary]'s cost base in computing its mark-up on costs, on the basis that the SBAs are notional costs, which are included in the financial statements for accounting purposes only, but not actual costs that are incurred by the [Irish subsidiary]. The arm's length principle dictates that if the parent company bears the economic cost of the SBAs, it is the parent company that should earn any arm's length profit associated with incurring that cost."

United States

Stock-based compensation (SBC) has been an issue in the United States for some time. The most recent case, Abbott Labs v. Commissioner, is currently before the Tax Court. Abbott disputes the IRS adjusting its income by adding SBC 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 (CSA) between two group entities (see Tax Alert 2024-0221). Additionally, in Altera v. Commissioner, the US Court of Appeals for the Ninth Circuit upheld the 2003 regulation requiring controlled participants to include the cost of SBC in a CSA.²

Implications

This is an important case as it illustrates the different treatment of SBAs under financial reporting standards and Ireland's interpretation of the OECD guidelines. While the financial reporting rules recognize SBAs as a cost that gets reflected in a company's financial statements, the Tax Appeals Commission concluded SBAs were a notional (or fictional) cost to the Irish subsidiary and a true economic cost (and risk) to the parent. To support the economic risk of issuing SBAs, taxpayers should confirm the economic substance of their specific facts is consistently reflected in intercompany service agreements, stock award agreements, board minutes, global transfer pricing policies, and transfer pricing documentation.

Other countries may interpret the OECD guidelines differently and reach a different conclusion on this issue. Taxpayers are therefore encouraged to examine their specific facts and internal documentation, including transfer pricing policies, in relation to the treatment of SBAs. Taxpayers also may consider seeking an advance pricing agreement (or invoking mutual agreement procedure) for tax certainty on this issue.