TAX COURT OPINION

Case: Xilinx Inc. and Subsidiaries
Docket Number: 4142-01
Judge: Foley
Opinion Type: reported
Filed: 08/30/2005
Pages: 23

CA 125 T.C. No. 4 UNITED STATES TAX COURT XILINX INC. AND SUBSIDIARIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent XILINX INC. AND CONSOLIDATED SUBSIDIARIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 4142-01, 702-03. Filed August 30, 2005. P entered into a cost-sharing agreement to develop Each party research P issued to the agreement, P did not include in its foreign subsidiary. In determining the allocation of costs intangibles with S, was required to pay a percentage of the total and development costs based on its respective anticipated benefits from the intangibles. stock options to its employees performing research and development. pursuant research and development costs any amount related to the issuance of stock options to, or exercise of stock options by, deficiency, determined that pursuant to sec. 1.482-7(d), spread (i.e., date over the exercise price) or, in the alternative, the grant date value, relating to compensatory stock options, should have been included as a research and development cost. R, for cost-sharing purposes, the stock's market price on the exercise Income Tax Regs., the its employees. in his notices of SERVED AUG 3 0 2005 -2- 1. Held: R's allocation is contrary to the arm's-length standard mandated by sec. 1.482-1(b), Income Tax Regs., because uncontrolled parties would not allocate the spread or the grant date value relating to employee stock options. 2. Held, further, P's allocation satisfies the arm's- length standard mandated by sec. 1.482-1, Income Tax Regs. Kenneth B. Clark, Ronald B. Schrotenboer, William F. Colgin, Tyler A. Baker, Jaclyn J. Pampel, and Anthony D. Cipriano, petitioners. for David P. Fuller, Jeffrey A. Hatfield, Bryce A. Kranzthor, Lloyd T. Silberzweig, Kendall Williams, David N. Bowen, John E. Hinding, and Paul K. Webb, for respondent. OPINION FOLEY, Judge: Respondent determined deficiencies in the amounts of $24,653,660, $25,930,531, $27,857,516, and $27,243,975 and section 6662(a) accuracy-related penalties in the amounts of $4,935,813, $5,189,389, $5,573,412, and $5,448,795 relating to petitioners' 1996,¹ 1997, 1998, and 1999 Federal income taxes, respectively. The issues for decision are whether: (1) Petitioner and its foreign subsidiary must share the cost, if any, of stock options petitioner issued to research and development employees, (2) respondent's allocations meet the arm's-length requirement set forth in section 1.482-1(b), Income Tax Regs., and (3) petitioners are liable for section 6662(a) accuracy-related penalties. ¹ Pursuant to the parties' Apr. 4, 2002, stipulation of the 1996 taxable year is no longer in issue. settled issues, -3- Background I. Xilinx's Line of Business and Corporate Structure Xilinx Inc.,2 is in the business of researching, developing, manufacturing, marketing, and selling field programmable logic devices,3 integrated circuit devices, and other development software systems. Petitioner uses unrelated producers to (cid:16)042fabricate and assemble its wafers into integrated circuit devices. During the years in issue, petitioner was the parent of a group of affiliated subsidiaries including, but not limited to Xilinx Holding One Ltd., Xilinx Holding Two Ltd., Xilinx Development Corporation (XDC), NeoCAD Inc.,4 Xilinx Ireland (XI), and Xilinx International Corporation. XI was established in 1994 as an unlimited liability company under the laws of Ireland and was owned by Xilinx Holding One Ltd., and Xilinx Holding Two Ltd. (i.e., Irish subsidiaries of petitioner). XI was created to manufacture field programmable logic devices and to increase petitioner's European market share. It manufactured, marketed, and sold field programmable logic devices, primarily to customers 2 All references to "petitioner" are to Xilinx Inc. All references to "petitioners" are to Xilinx Inc. and its consolidated subsidiaries. 3 Field programmable logic devices are integrated circuits that can be programmed, using development software, complex functions. to perform 4 NeoCAD Inc., was liquidated in 1998. _4_ in Europe, and conducted research and development. II. The Cost-Sharing Agreement On April 2, 1995, petitioner and XI entered into a Technology Cost and Risk Sharing Agreement (cost-sharing agreement). The cost-sharing agreement provided that all "New Technology" developed by either petitioner or XI would be jointly owned. New Technology was defined as technology developed by petitioner, XI, or petitioner's consolidated subsidiaries, on or after the execution date of the cost-sharing agreement. Each party was required to pay a percentage of the total research and development costs based on the respective anticipated benefits from New Technology. The cost-sharing agreement further provided that each year the parties would review and, when appropriate, adjust such percentages to ensure that costs continued to be based on the anticipated benefits to each party. Petitioner and XI were required to share direct costs, indirect costs, and acquired intellectual property rights costs. Direct costs were defined in the agreement as those costs directly related to the research and development of New Technology including, but not limited to, salaries, bonuses, and other payroll costs and benefits. Indirect costs were defined as those costs, incurred by other departments, that generally benefit all research and development including, but not limited to, administrative, legal, accounting, and insurance costs. -5- Acquired intellectual property rights costs were defined as costs incurred in connection with the acquisition of products or intellectual property rights. In determining the allocation of costs pursuant to the cost-sharing agreement, petitioner did not include in research and development costs any amount related to the issuance of employee stock options (ESOs). Cost-sharing percentages for petitioner and XI relating to 1997, 1998, and 1999 were as follows: Year 1997 1998 1999 Petitioner XI 73.61% 73.35 65.09 26.39% 26.65 34.91 In 1997, 1998, and 1999, the following number of petitioner's and XI's employees engaged in research and development: Year 1997 1998 1999 Petitioner 338 343 394 XI 6 10 16 III. Petitioner's Stock Option Plans ESOs are offers to sell stock at a stated price (i.e., the exercise price) for a stated period of time. They are used by many companies to attract, retain, and motivate employees and align employee and employer goals. There are basically three types of ESOs: statutory or incentive stock options (ISOs), nonstatutory stock options (NSOs), and purchase rights issued pursuant to an employee stock purchase plan (ESPP purchase -6- rights). ISOs and NSOs allow employees to purchase stock at a fixed price for a specified period of time. ESPP purchase rights allow employees to purchase stock at a discount through the use of payroll deductions. ISOs and ESPP purchase rights receive special tax treatment and are typically not subject to tax when they are granted or exercised, but the stock acquired pursuant to the exercise of these options is subject to tax when such stock is sold.5 NSOs, however, are, pursuant to section 83,6 Property Transferred in Connection with the Performance of Services, subject to tax upon exercise unless the option has a readily ascertainable fair market value.7 Sec. 83(a). If an NSO has a 5 Pursuant to secs. 422 and 423, respectively, ISOs and ESPP purchase rights are subject to a holding period requirement. This period begins on the exercise date and ends on the date that is the later of 2 years after the grant date or 1 year after the transfer of the share of stock. If the employee disposes of expires, disposition". to recognize ordinary income (i.e., equal price on the exercise date over the exercise price) taxable year in which the disposition occurred. Secs. 422(a)(1) and 423(a)(1). the stock before the holding period this disposition will be considered a "disqualifying A disqualifying disposition requires the employee to the stock's market Sec. 421(b). in the 6 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. An option has a readily ascertainable fair market value if it is actively traded on an established market or the taxpayer can establish all of (1) The option is transferable by the optionee; immediately in full by the optionee; subject fair market value of to any restriction which has a significant effect on.the the option is exercisable the following conditions: the option; and (4) the option is not (2) (3) the fair market value of (continued...) -7- readily ascertainable fair market value, income is recognized on the grant date, and the issuer is entitled to a deduction. Sec. 83(h); sec. 1.83-7(a), Income Tax Regs. NSOs, when granted, may be "in-the-money", "out-of-the- money", or "at-the-money". ISOs, however, may only be "at-the- money" or "out-of-the-money".8 An option is deemed in-the-money when the exercise price on the grant date is below the stock's market price. Conversely, an option is out-of-the-money when the exercise price on the grant date is above the stock's market price. An option that has an exercise price equal to the stock's market price on the grant date is considered at-the-money. An employee typically cannot exercise options, until the employee has a vested right (i.e., a legal right that is not contingent on the performance of additional services) in the option pursuant to the stock option plan's terms. Some companies permit immediate vesting upon issuance of an option, while others delay vesting several years or allow incremental vesting over a period of years. 7(...continued) Income Tax Regs. the option privilege is readily ascertainable. and (2), right to benefit property subject Sec. 1.83-7(b)(3), Income Tax Regs. "Option privilege" is the value of the from any future increase in the value of to the option, without risking any capital. Sec. 1.83-7(b)(1) the Pursuant to sec. 422, the exercise price relating to ISOs may not be less than the stock's market price on the grant date. Sec. 422(b) (4). -8- Petitioner, pursuant to broad-based.plans (i.e., plans that offer ESOs to 20 percent or more of a company's employees), offered three types of stock option compensation: ISOs, NSOs, and ESPP purchase rights. All ISOs and NSOs issued by petitioner were at-the-money. All ESPP purchase rights were issued with an exercise price equal to 85 percent of the stock's market price. Prior to and during the 1997 taxable year, the options were generally subject to a 5-year vesting period. After 1997, petitioner decreased the vesting period from 5 to 4 years. Pursuant to the stock option plan, employees could exercise options by delivering to petitioner's broker a notice of exercise with irrevocable instructions and consideration equal to the exercise price. The broker would then deliver the instructions and consideration to petitioner. Employees could elect to exercise their options in either a "same-day-sale" or "buy-and- hold" transaction. In a same-day-sale, the employee does not make a payment for the stock relating to the option. Instead, simultaneous execution of the option and sale of the stock results in the excess of the stock's market price on the grant date over the exercise price going to the employee and the amount of the exercise price going to petitioner. In a buy-and-hold transaction, the employee pays the exercise price by presenting a check or other form of consideration to petitioner's broker and in exchange receives the shares of stock. A. 1988 Stock Option Plan _9_ In 1988, petitioner established the Xilinx 1988 Stock Option Plan (1988 Stock Option Plan). The 1988 Stock Option Plan provided for the grant of ISOs and NSOs. Under the 1988 Stock Option Plan, petitioner granted options as part of the employee hiring process and retention program. Petitioner also granted merit and discretionary stock options. Merit options were based on job performance and granted after an employee's annual review. Discretionary stock options were a separate pool of options made available to petitioner's vice presidents to reward their subordinates for significant project achievements. Under the 1988 Stock Option Plan, former employees generally could exercise options if the exercise occurred within 30 days after the -cessation of the employee's tenure at the company. In April of 1998, the 1988 Stock Option Plan was replaced by the Xilinx, Inc. 1997 Stock Plan (1997 Stock Option Plan). The 1997 Stock Option Plan provided for the grant of ESPP purchase rights in addition to ISOs and NSOs. B. 1990 Employee Qualified Stock Purchase Plan The Xilinx, Inc. 1990 Employee Qualified Stock Purchase Plan (ESPP) allowed full-time employees to purchase petitioner's stock at a discount. Beginning January 1, 1990, the ESPP provided 24- month offering periods which commenced during the beginning of -10- January and July. Eligible employees could participate in the ESPP by completing a Subscription Agreement authorizing payroll deductions. During a 24-month offering period, employees could contribute to the plan through payroll deductions in any amount between 2 and 15 percent of their total compensation. Upon exercise, petitioner woüld deduct the exercise price from the employee's accumulated payroll deductions. The exercise price was equal to the lower of 85 percent of the stock's market price on the offering date (i.e., the first day of each offering period), or 85 percent of the stock's market price on the exercise date. Stock could be purchased twice a year (i.e., on June 30 and December 31). Petitioner also maintained a stock buy-back program. Pursuant to the program, petitioner, during 1997, 1998, and 1999, purchased stock from stockholde.rs and transferred such stock (i.e., treasury shares) to employees who had exercised options or purchased stock pursuant to petitioner's ESPP. IV. Petitioner's Stock Option Intercompany Agreements With XI On March 31, 1996, petitioner and XI entered into The Xilinx Ireland/Xilinx, Inc. Stock Option Intercompany Agreement. The purpose of the Stock Option Intercompany Agreement was to allow XI employees to acquire stock in petitioner. The Stock Option Intercompany Agreement provided that the cost incurred by petitioner for the grant or.exercise of options by XI employees -11- would be borne by XI. The cost equaled the stock's market price on the exercise date over the exercise price. Upon receipt of petitioner's notice specifying the appropriate amount, XI was required to pay petitioner. On March 31, 1996, petitioner and XI also entered into the Xilinx, Inc./Xilinx Ireland Employee Stock Purchase Plan Reimbursement Agreement (ESPP Reimbursement Agreement), which allowed XI employees to purchase, with payroll deductions, petitioner's stock. XI was required to pay petitioner the cost associated with the exercise of the options. Pursuant to the agreement, the cost equaled the stock's market price on the exercise date over the exercise price. Upon receipt of petitioner's notice specifying the appropriate amount, XI was required to pay petitioner. (cid:16)042V. Financial Accounting Disclosure Rules A. Background The Financial Accounting Standards Board (FASB) is the professional organization primarily responsible for establishing financial reporting standards in the United States. FASB's standards are known as Generally Accepted Accounting Principles (GAAP). For more than 30 years, FASB has recognized certain ESOs as an expense to the issuing corporation. -12- B. Accounting Principles Board Opinion No. 25, for Stock Issued to Employees" (APB 25) "Accounting In 1972, FASB authorized APB 25, which required ESOs tô be valued using the "intrinsic value method" (IVM). From 1972 to December 15, 1995, the IVM was the only authorized financial accounting method for valuing ESOs. Under the IVM, the value of ESOs is the excess of the stock's market price on the grant date over the exercise price. This value is reported directly on the employer's income statement relating. to the year in which the ESOs are granted. ESOs granted at-the-money have no intrinsic value because the stock's market price on the grant date is equal to the exercise price. C. Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" (SFAS 123) In October of 1995, FASB issued SFAS 123, which is effective for fiscal years ending after December 15, 1995. SFAS 123.added the "fair value method" (FVM) as the preferred method for valuing ESOs. Pursuant to SFAS 123, companies continuing to use the IVM were required to "make pro forma disclosures of net income and, if presented, earnings per share, as if the * * * [FVM] had been applied." The value of an ESO is composed of two components: the intrinsic value and the call premium. While the intrinsic value is equal to the stock's market price on the grant date over the -13- exercise price, the call premium is the amount, in excess of an ESO's intrinsic value, that a purchaser would be willing to pay for the ESO. An ESO's call premium is difficult to measure because it, unlike the call premium of a publicly traded option, cannot be valued daily based on market transactions. FASB readily recognized that the IVM fails to measure adequately the call premium relating to ESOs.9 Nevertheless, the IVM remained a permissible accounting method during the years in issue. Although the EVM was added as the preferred method in 1996, most companies continued to use the IVM during the years in issue. Pursuant to the FVM, a corporation must measure the amount of the expense as equal to the fair value of the ESO on the grant date and amortize such expense over the vesting period. Under SFAS 123, fair value is measured using option pricing models that (cid:16)042consider the following six attributes of equity-based instruments: (1) The exercise price, (2) the expected life of· the option, (3) the current price of the underlying stock, (4) the expected price volatility of the underlying stock, (5) expected dividends, and (6) the risk-free interest rate for the expected life of the option. The FVM utilizes option pricing models, such as the Black 9 FASB, in SFAS 123, stated: "Zero is not within the range of reasonable estimates of the date they are granted, before they expire." the value of employee stock options at the date they vest, or at other dates -14- Scholes model (BS model), for purposes of measuring the value of ESOs. The BS model was originally designed to measure publicly traded options and, as a result, fails to adequately take into account numerous differences between ESOs and publicly traded options. For example, ESOs are nontransferable and have terms to maturity that are usually longer than those of publicly traded options. The extended term of an ESO complicates the task of estimating the volatility of the stock price, which is an essential input in the pricing of any option. Furthermore, ESOs cannot be traded, so they must be discounted to account for the difference in value between tradeable and nontradeable options (i.e., tradeable options are worth more than nontradeable options). Yet, the appropriate discount is difficult to determine with reasonable accuracy because the discount is based on the value of the ESO to an employee. Moreover, an ESO's value is affected by whether an employee forfeits the option by failing to exercise it or exercises the option prior to the expiration of the ESO's maximum life. These employee decisions cannot be reliably modeled. Thus, FAS 123 requires companies to make certain adjustments to take into account the differences between ESOs and publicly traded options. For example, to account for op.tion forfeiture, SFAS 123 requires that an ESO's value be discounted to reflect the amount of forfeitures expected annually. With respect to early exercise, thé expected life of -15- the option is used instead of the ESO's actual or maximum life. During the years in issue, petitioners, on their Securities and Exchange Commission Forms 10-K, elected to use the IVM, as prescribed in APB 25, to measure expenses attributable to ESOs. As required by SFAS 123, petitioners disclosed net income and earnings per share as if the FVM had been applied. In determining the fair value of ESOs, petitioners used an adjusted BS model. VI. Procedural History A. Petitioners' Federal Income Tax Returns Petitioners are accrual basis taxpayers and timely filed consolidated Federal income tax returns for their taxable years ended March 29, 1996, March 29, 1997, March 28, 1998, and April 3, 1999. During the years in issue, GAAP, pursuant to APB 25, provided that the issuing company did not incur an expense related to options granted at-the-money. In accordance with APB 25, petitioner did not, for purposes of its cost-sharing agreement with XI, include any costs related to ESOs issued to employees. On December 28, 2000, and October 17, 2002, respondent issued notices of deficiency relating to 1996 through 1998 and 1999, respectively. In his notices of deficiency, respondent determined that petitioners were required, pursuant to its cost- -16- sharing agreement, to share with XI the costs of certain ESOs. Respondent determined that the cost required to be taken into account equaled the spread (i.e., the stock's market price on the exercise date over the exercise price) relating to ESOs exercised by petitioner's employees (spread theory). Respondent defined the spread as the amount of petitioners' section 83 deduction relating to the exercise of NSOs and disqualifying dispositions of ISOs and ESPP purchase rights.1°· Respondent's determination resulted in the following deficiencies and penalties:¹¹ Year 1996 1997 1998 1999 Deficiency $24,653,660 25,930,531 27,857,516 27,243,975 Penalty Sec. 6662(a) $4,935,813 5,189,389 5,573,412 5,448,795 On March 26, 2001, and January 14, 2003, respectively, petitioners timely filed their petitions with the Court seeking.a redetermination of the deficiencies set forth in the December 28, 2000, and October 17, 2002, notices. Petitioner's principal place of business was San Jose, California, at the time the ¹° ISOs and ESPP purchase rights meeting the requirements of secs. 422 and 423, however, were not definition because they are not subject supra note 5). included in respondent's to tax under sec. 83 (see ¹¹ Respondent's reallocation of petitioner's expenses, reduced petitioner's deductible business expenses and turn, increased petitioner's taxable income. in -17- petitions were filed. On April 4, 2002, the parties stipulated that no amount relating to ESOs would be included in petitioner's 1996 cost-sharing pool. B. Summary Judgment Motions The Court filed petitioners' motion for partial summary (cid:16)042judgment on February 4, 2002, and on March 6, 2002, filed respondent's cross-motion for partial summary judgment. On October 28, 2003, we denied both parties' motions, addressed whether the spread is a cost pursuant to section 1.482-7(d)(1), Income Tax Regs., and concluded: respondent has not established that indeed a cost or that appropriate time to determine and measure such cost. * sufficiently established that it did not expense upon the employee's exercise of issue. the exercise date is the * petitioner has not the spread is In addition, incur an the options at * * * * The Court also addressed whether respondent's lack of knowledge of comparable transactions (i.e., where unrelated parties agree to share the spread), or a finding that uncontrolled parties would not share the spread, would have any effect on respondent's authority to make allocations pursuant to section 1.482-1(a)(2), Income Tax Regs. We concluded: Income Tax Regs., does not to have actual knowledge of an Section 1.482-1(b)(2), require respondent arm's-length transaction as a prerequisite to determining that an allocation should be made. Seagate Technology, 2000-388. See Inc. v. Commissioner, T.C. Memo. it is established that If, however, -18- uncontrolled parties would not share the spread, we may conclude that respondent's determination is arbitrary, capricious, or unreasonable. evidence or established facts adequately addressing whether the arm's-length standard has been met. * neither party has presented 'sufficient * * C. Promulgation of Regulations Addressing Cost Sharing of Stock-Based Compensation On July 29, 2002, the U.S. Department of the Treasury (Treasury) issued proposed regulations regarding the treatment of ESOs for cost-sharing purposes. In the preamble accompanying these proposed regulations, Treasury stated: The proposed regulations provide that in determining a controlled participant's operating expenses within the meaning of § 1.482-7(d)(1), all compensation, stock-based compensation, account. * must be taken into including * * 67 Fed. Reg. 48999 (July 29, 2002). As a result of this change (i.e., the inclusion of stock-based compensation) to section 1.482-7(d)(1), Income Tax Regs., Treasury stated that it was adding: New § 1.482-7(a)(3) clarifies that express provlsions coordinating the cost sharing rules of § 1.482-7 with the arm's length standard as set forth in § 1.482-1. in order for a qualified cost sharing arrangement produce results consistent with an arm's length result within the meaning of § 1.482-1(b)(1), all requirements of § 1.482-7 must be met, that each controlled participant's share of development costs equal anticipated benefits attributable to the development of intangibles. amendments to § 1.482-1 to clarify that § 1.482-7 provides the specific method to be used to evaluate whether a qualified cost sharing arrangement produces The proposed regulations also make including the requirement its share of reasonably intangible to -19- results consistent with an arm's length result, and to clarify that under the best method rule, of § 1.482-7 set respect to qualified cost sharing arrangements. forth the applicable method with the provisions Id. at 49000. Sections 1.482-1 and 1.482-7, Income Tax Regs., were modified as follows: SEC. 1.482-1. Allocation of Taxpayers. Income and Deductions Among * * * * * * * * * * Section 1.482-7 provides the specific method (2) to be used to evaluate whether a qualified cost sharing arrangement produces results consistent with an arm's length result. * * SEC. 1.482-7. Sharing of Costs. * * * * * * * * * * * * (3) Coordination with § 1.482-1.--A qualified cost sharing arrangement produces results that are consistent with an arm's length result within the meaning of § 1.482-1(b)(1) controlled participant's share of determined under paragraph (d) of this section) of intangible development under the qualified cost sharing arrangement equals its share of reasonably anticipated benefits attributable to such development (as required by paragraph (a)(2) of this section) and all other requirements of this section are satisfied. if, and only if, each the costs (as * * * * * * * * * a controlled including stock-based * (2) Stock-based compensation.--(i)* * participant's operating expenses include all costs attributable to compensation, * stock-based compensation means any compensation. compensation provided by a controlled participant to an employee * options to acquire stock (stock options), or rights with respect instruments or stock options, to property to which section 83 applies and stock options to which section 421 applies, whether ultimately settled in the form of cash, stock, or other property. to (or determined by reference to) equity in the form of equity instruments, including but not regardless of limited * * -20- * intangibles * * * * *. In general.-Except as the qualified cost sharing * all stock-based compensation that is granted (ii) * during the term of arrangement and is related at date of grant to.the development of is included as an intangible development cost * (iii) Measurement and timing of stock-based compensation expense.--(A) otherwise provided in this paragraph (d)(2)(iii), the operating expense attributable to stock-based compensation is equal controlled participant as a deduction for federal income tax purposes with respect compensation (for example, under section 83(h)) and is taken into account as an operating expense under this section for the taxable year for which the deduction is allowable. (1) Transfers to which section 421 applies.--Solely for purposes of this paragraph (d)(2)(iii) (A), section 421 does not apply to the transfer of stock pursuant exercise of an option that meets the requirements of section 422(a) or 423(a). to the amount allowable to the to that stock-based to the Id. at 49001. On August 26, 2003, Treasury finalized its proposed regulations without modifying the above-referenced provisions. The final regulations are applicable to stock-based compensation provided to employees in taxable years beginning on or after August 26, 2003. D. Respondent's Amendments to Answer In the December 28, 2000, notice of deficiency, respondent determined that the cost-sharing pool included ESOs granted to petitioner's research and development employees prior to and after April 2, 1995 (i.e., the cost-sharing agreement's execution date), and exercised during 1997 and 1998. On August 4, 2003, the Court filed respondent's motion for leave to file an -21- amendment to the answer in docket No. 4142-01 (i.e., relating to 1997 and 1998). On October 21, 2003, the Court granted the motion and filed respondent's amendment to answer which asserted that the only ESOs at issue were those granted on or after April 2, 1995, and exercised during 1997 and 1998. As a result of this amendment, respondent's adjustments to petitioner's cost-sharing pool, relating to ESOs exercised in 1997 and 1998, decreased from $4,504,781 to $389,037 and $5,195,104 to $1,263,006, respectively. On November 25, 2003, the Court granted the parties' joint motion to consolidate docket No. 4142-01 and docket No. 702-03 (i.e., relating to 1999) for purposes of trial, briefing, and opinion. The Court, on February 6, 2004, filed respondent's motion for leave to file a second amendment to the answer in docket No. 4142-01 and an amendment to the amended answer in docket No. 702- 03. In this motion, respondent sought permission to contend that ESOs provided to petitioner's research and development employees be valued as of the date those options were granted (grant date theory). On April 8, 2004, the Court denied respondent's motion because the motion failed to provide sufficient information (i.e., the number of options at issue or the amounts of the revised deficiencies) relating to respondent's grant date theory. The Court, on May 11, 2004, filed respondent's motion for -22- leave to file a second amendment to the answer in docket No. 4142-01 and an amendment to the amended answer in docket No. 702- 03. In this motion, respondent included the number of options at issue and the amounts of the revised deficiencies. Pursuant to his grant date theory, the amounts of the revised deficiencies relating to 1997, 1998, and 1999 are $25,121,951, $27,854,698, and $24,784,465, respectively. On June 3, 2004, the Court granted respondent's motion but concluded that respondent's amendment raised a new matter because "the grant date theory requires different evidence (i.e., includes additional options and utilizes a different method of valuation)" and alters the original deficiency. On July 14, 2004, the trial commenced. Discussion I. Applicable Statute and Regulations A. Purpose and Scope of Section 482 Section 482 was enacted to prevent tax evasion and ensure that taxpayers clearly reflect income relating to transactions between controlled entities. It accomplishes this purpose by authorizing respondent:· [to] distribute, apportion, or allocate gross income, deductions,. credits, or allowances between or among if he determines that such * distribution, apportionment, or allocation is necessary * taxes or clearly to reflect the income of [controlled entities], to prevent evasion of [such entities]. * * * * * * * -23- Section 482 places a controlled taxpayer on a tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer. Sec. 1.482-1(a)(1), Income Tax Regs. In determining true taxable income, "the standard to be applied in every case is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer." See United States Steel (cid:16)042Corp. v. Commissioner, 617 F.2d 942, 947 (2d Cir. 1980) (stating the "'arm's length' standard is * * * meant to be an objective standard that does not depend on the absence or presence of any intent on the part of the taxpayer to distort his income."), revg. T.C. Memo. 1977-140; sec. 1.482-1(b)(1), Income Tax Regs. Because identical transactions are rare, the arm's-length result will "generally * * * be determined by reference to the results of comparable transactions under comparable circumstances." Sec. 1.482-1(b) (1), Income Tax Regs. B. Application of Section 482 to Qualified Cost-Sharing Agreements Section 482 provides that "In the case of any transfer * * * of intangible property * * * the income with respect to such transfer * * * shall be commensurate with the income attributable to the intangible." Participants in a qualified cost-sharing agreement (QCSA) relinquish exclusive ownership of all exploitation rights in new intangibles they individually develop and agree to share ownership of, and costs associated with, such