Court Opinion

ID: 4404666
Source: CourtListenerOpinion
Date Created: 2019-06-07 17:00:27.968213+00
Date Added: 2024-06-11T09:24:44.584062
License: Public Domain

FOR PUBLICATION

         UNITED STATES COURT OF APPEALS
              FOR THE NINTH CIRCUIT

 ALTERA CORPORATION &                               Nos. 16-70496
 SUBSIDIARIES,                                           16-70497
               Petitioner-Appellee,
                                                      Tax Ct. Nos.
                      v.                                6253-12
                                                        9963-12
 COMMISSIONER OF INTERNAL
 REVENUE,                                              OPINION
            Respondent-Appellant.

                  Appeal from Decisions of the
                    United States Tax Court

           Argued and Submitted October 16, 2018
                 San Francisco, California

                           Filed June 7, 2019

   Before: Sidney R. Thomas, Chief Judge, and Susan P.
   Graber* and Kathleen M. O’Malley,** Circuit Judges.

                Opinion by Chief Judge Thomas;
                  Dissent by Judge O’Malley

    *
       The Honorable Stephen R. Reinhardt was originally assigned to this
panel. Following his death, the Honorable Susan P. Graber was drawn by
lot to replace him on the panel.
    **
      The Honorable Kathleen M. O’Malley, United States Circuit Judge
for the U.S. Court of Appeals for the Federal Circuit, sitting by
designation.
2                      ALTERA CORP. V. CIR

                            SUMMARY***

                                   Tax

    The panel reversed a decision of the Tax Court that
26 C.F.R. § 1.482-7A(d)(2), under which related entities must
share the cost of employee stock compensation in order for
their cost-sharing arrangements to be classified as qualified
cost-sharing arrangements, was invalid under the
Administrative Procedure Act.

    At issue was the validity of the Treasury regulations
implementing 26 U.S.C. § 482, which provides for the
allocation of income and deductions among related entities.
The panel first held that the Commissioner of Internal
Revenue did not exceed the authority delegated to him by
Congress under 26 U.S.C. § 482. The panel explained that
§ 482 does not speak directly to whether the Commissioner
may require parties to a QCSA to share employee stock
compensation costs in order to receive the tax benefits
associated with entering into a QCSA. The panel held that the
Treasury reasonably interpreted § 482 as an authorization to
require internal allocation methods in the QCSA context,
provided that the costs and income allocated are proportionate
to the economic activity of the related parties, and concluded
that the regulations are a reasonable method for achieving the
results required by the statute. Accordingly, the regulations
were entitled to deference under Chevron, U.S.A., Inc. v.
Natural Resources Defense Council, Inc., 467 U.S. 837
(1984).

    ***
        This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
                   ALTERA CORP. V. CIR                      3

    The panel next held that the regulations at issue were not
arbitrary and capricious under the Administrative Procedure
Act.

    Dissenting, Judge O’Malley would find, as the Tax Court
did, that 26 C.F.R. § 1.482-7A(d)(2) is invalid as arbitrary
and capricious.

                        COUNSEL

Arthur T. Catterall (argued), Richard Farber, and Gilbert S.
Rothenberg, Attorneys; Travis A. Greaves, Deputy Assistant
Attorney General; Richard E. Zuckerman, Principal Deputy
Assistant Attorney General; Tax Division, United States
Department of Justice, Washington, D.C.; for Respondent-
Appellant.

Donald M. Falk (argued), Mayer Brown LLP, Palo Alto,
California; Thomas Kittle-Kamp and William G. McGarrity,
Mayer Brown LLP, Chicago, Illinois; Brian D. Netter and
Travis Crum, Mayer Brown LLP, Washington, D.C.; A.
Duane Webber, Phillip J. Taylor, and Joseph B. Judkins,
Baker & McKenzie LLP, Washington, D.C.; for Petitioner-
Appellee.

Susan C. Morse, University of Texas School of Law, Austin,
Texas; Stephen E. Shay and Allison Bray, Certified Law
Students, Harvard Law School, Cambridge, Massachusetts;
for Amici Curiae J. Richard Harvey, Reuven Avi-Yonah, Lily
Batchelder, Joshua Blank, Noël Cunningham, Victor
Fleischer, Ari Glogower, David Kamin, Mitchell Kane,
Michael Knoll, Rebecca Kysar, Leandra Lederman, Zachary
Liscow, Ruth Mason, Susan Morse, Daniel Shaviro, Stephen
4                 ALTERA CORP. V. CIR

Shay, John Steines, David Super, Clinton Wallace, and Bret
Wells.

Jonathan E. Taylor, Gupta Wessler PLLC, Washington, D.C.;
Clint Wallace, Vanderbilt Hall, New York, New York; for
Amici Curiae Anne Alstott, Reuven Avi-Yonah, Lily
Batchelder, Joshua Blank, Noel Cunningham, Victor
Fleischer, Ari Glogower, David Kamin, Mitchell Kane, Sally
Katzen, Edward Kleinbard, Michael Knoll, Rebecca Kysar,
Zachary Liscow, Daniel Shaviro, John Steines, David Super,
Clint Wallace, and George Yin.

Larissa B. Neumann, Ronald B. Schrotenboer, and Kenneth
B. Clark, Fenwick & West LLP, Mountain View, California,
for Amicus Curiae Xilinx Inc.

Christopher J. Walker, The Ohio State University Moritz
College of Law, Columbus, Ohio; Kate Comerford Todd,
Steven P. Lehotsky, and Warren Postman, U.S. Chamber
Litigation Center, Washington, D.C.; for Amicus Curiae
Chamber of Commerce of the United States of America.

John I. Forry, San Diego, California, for Amicus Curiae
TechNet.

Alice E. Loughran, Michael C. Durst, and Charles G. Cole,
Steptoe & Johnson LLP, Washington, D.C.; Bennett Evan
Cooper, Steptoe & Johnson LLP, Phoenix, Arizona; for
Amici Curiae Software and Information Industry Association,
Financial Executives International, Information Technology
Industry Council, Silicon Valley Tax Directors Group,
Software Finance and Tax Executives Counsel, National
Association of Manufacturers, American Chemistry Council,
BSA | the Software Alliance, National Foreign Trade
                  ALTERA CORP. V. CIR                    5

Council, Biotechnology Innovation Organization, Computing
Technology Industry Association, The Tax Council, United
States Council for International Business, Semiconductor
Industry Association.

Kenneth P. Herzinger and Eric C. Wall, Orrick Herrington &
Sutcliffe LLP, San Francisco, California; Peter J. Connors,
Orrick Herrington & Sutcliffe LLP, New York, New York;
for Amici Curiae Charles W. Calomiris, Kevin H. Hassett,
and Sanjay Unni.

Roderick K. Donnelly and Neal A. Gordon, Morgan Lewis &
Bockius LLP, Palo Alto, California; Thomas M. Peterson,
Morgan Lewis & Bockius LLP, San Francisco, California; for
Amicus Curiae Cisco Systems Inc.

Christopher Bowers, David Foster, Raj Madan, and Royce
Tidwell, Skadden Arps Slate Meagher & Flom LLP,
Washington, D.C.; Nathaniel Carden, Skadden Arps Slate
Meagher & Flom LLP, Chicago, Illinois; for Amicus Curiae
Amazon.com Inc.
6                      ALTERA CORP. V. CIR

                              OPINION

THOMAS, Chief Judge:

    This appeal presents the question of the validity of
26 C.F.R. § 1.482-7A(d)(2),1 under which related business
entities must share the cost of employee stock compensation
in order for their cost-sharing arrangements to be classified as
qualified cost-sharing arrangements (“QCSA”). Although the
case appears complex, the dispute between the Department of
the Treasury and the taxpayer is relatively straightforward.
The parties agree that, under the governing tax statute, the
“arm’s length” standard applies; but they disagree about how
the standard may be met. The taxpayer argues that Treasury
must employ a specific method to meet the arm’s length
standard: a comparability analysis using comparable
transactions between unrelated business entities. Treasury
disagrees that the arm’s length standard requires the specific
comparability method in all cases. Instead, the standard
generally requires that Treasury reach an arm’s length result
of tax parity between controlled and uncontrolled business
entities. With respect to the transactions at issue here, the
governing statute allows Treasury to apply a purely internal
method of allocation, distributing the costs of employee stock
options in proportion to the income enjoyed by each related
taxpayer.

   Our task, of course, is not to assess the better tax policy,
nor the wisdom of either approach, but rather to examine

    1
      The 2003 amendments are at issue. Although they are still in effect,
the Tax Code has been reorganized, and what was § 1.482-7 in 2003 is
now numbered § 1.482-7A. To minimize confusion, our citations are to
the current version of the regulation unless otherwise specified.
                    ALTERA CORP. V. CIR                       7

whether Treasury’s regulations are permitted under the
statute. Applying the familiar tools used to examine
administrative agency regulations, we conclude that the
regulations withstand scrutiny. Therefore, we reverse the
judgment of the Tax Court.

                               I

     For many years, Congress and the Treasury have been
concerned with American businesses avoiding taxes through
the creation and use of related business entities. In the last
several decades, Congress has directed particular attention to
the potential for tax abuse by multinational corporations with
foreign subsidiaries. If, for example, the parent business
entity is in a high-tax jurisdiction, and the foreign subsidiary
is in a low-tax jurisdiction, the business enterprise can shift
costs and revenue between the related entities so that more
taxable income is allocated to the lower tax jurisdiction.
Similarly, a parent and foreign subsidiary can enter into
significant tax-avoiding cost sharing arrangements.

    This potential for tax abuse is generally not present when
similar transactions occur between unrelated business entities.
In those instances, each separate unrelated entity has the
incentive to maximize profit, and thus to allocate costs and
income consistent with economic realities. However, among
related parties, those incentives do not exist. Rather, among
related parties, after-tax maximization of profit may depend
on how costs and income are allocated between the parent
and the subsidiary regardless of economic reality, given that
after-tax profits are commonly shared.

    The concern about tax avoidance through the use of
related business entities is not new. In the Revenue Act of
8                     ALTERA CORP. V. CIR

1928, Congress granted the Secretary of the Treasury the
authority to reallocate the reported income and costs of
related businesses “in order to prevent evasion of taxes or
clearly to reflect the income of any such trades or
businesses.” Revenue Act of 1928, ch. 852, § 45, 45 Stat.
791, 806. This statute was designed to give Treasury the
flexibility it needed to prevent transaction-shuffling between
related entities for the purpose of decreasing tax liability. See
H.R. REP. NO. 70-2, at 16–17 (1927) (“[T]he Commissioner
may, in the case of two or more trades or businesses owned
or controlled by the same interests, apportion, allocate, or
distribute the income or deductions between or among them,
as may be necessary in order to prevent evasion (by the
shifting of profits, the making of fictitious sales, and other
methods frequently adopted for the purpose of ‘milking’), and
in order clearly to reflect their true tax liability.”); accord S.
REP. NO. 70-960, at 24 (1928). The purpose of the statute
was “to place a controlled taxpayer on a tax parity with an
uncontrolled taxpayer.” Comm’r v. First Sec. Bank of Utah,
405 U.S. 394, 400 (1972) (quoting 26 C.F.R. § 1.482-1(b)(1)
(1971)). In short, the primary aim of the statute was to
prevent tax evasion by related business taxpayers. 2

     In 1934, the Commissioner adopted regulations
implementing the statute and first adopted the familiar “arm’s
length” standard: “The standard to be applied in every case
is that of an uncontrolled taxpayer dealing at arm’s length
with another uncontrolled taxpayer.” Treas. Reg. 86,
art. 45-1(b) (1935). In the context of a controlled transaction,

    2
      An important, but secondary purpose was to avoid double taxation
of multi-national corporations, which the United States effected through
various tax treaties. See, e.g., Convention Concerning Double Taxation,
Fr.-U.S., art. IV, Apr. 27, 1932, 49 Stat. 3145.
                   ALTERA CORP. V. CIR                      9

the arm’s length standard is satisfied “if the results of the
transaction are consistent with the results that would have
been realized if uncontrolled taxpayers had engaged in the
same transaction under the same circumstances (arm’s length
result).” 26 C.F.R. § 1.482-1(b)(1). The relevant regulation
also noted: “However, because identical transactions can
rarely be located, whether a transaction produces an arm’s
length result generally will be determined by reference to the
results of comparable transactions under comparable
circumstances.” Id.

    Although the Secretary adopted the arm’s length standard,
courts did not hold related parties to that standard by
exclusively requiring the examination of comparable
transactions. For example, in Seminole Flavor Co. v.
Commissioner, the Tax Court rejected a strict application of
the arm’s length standard in favor of an inquiry into whether
the allocation of income between related parties was “fair and
reasonable.” 4 T.C. 1215, 1232 (1945); see also id. at 1233
(“Whether any such business agreement would have been
entered into by petitioner with total strangers is wholly
problematical.”); Grenada Indus., Inc. v. Comm’r, 17 T.C.
231, 260 (1951) (“We approve an allocation . . . to the extent
that such gross income in fact exceeded the fair value of the
services rendered . . . .”). And in 1962, we collected various
allocation standards and outright rejected the superiority of
the arm’s length bargaining analysis over all others:

       [W]e do not agree . . . that “arm’s length
       bargaining” is the sole criterion for applying
       the statutory language of [26 U.S.C. § 482] in
       determining what the “true net income” is of
       each “controlled taxpayer.” Many decisions
       have been reached under [§ 482] without
10                  ALTERA CORP. V. CIR

        reference to the phrase “arm’s length
        bargaining” and without reference to Treasury
        Department Regulations and Rulings which
        state that the talismanic combination of
        words—“arm’s length”—is the “standard to
        be applied in every case.”

Frank v. Int’l Canadian Corp., 308 F.2d 520, 528–29 (9th
Cir. 1962).

    Frank noted that “it was not any less proper . . . to use
here the ‘reasonable return’ standard than it was for other
courts to use ‘full fair value,’ ‘fair price including a
reasonable profit,’ ‘method which seems not unreasonable,’
‘fair consideration which reflects arm’s length dealing,’‘fair
and reasonable,’ ‘fair and reasonable’ or ‘fair and fairly
arrived at,’ or ‘judged as to fairness,’ all used in interpreting
[the statute].” Id. (footnotes omitted). We later limited
Frank to situations in which “it would have been difficult for
the court to hypothesize an arm’s-length transaction.” Oil
Base, Inc. v. Comm’r, 362 F.2d 212, 214 n.5 (9th Cir. 1966).
However, Frank’s central point remained: the arm’s length
standard based on comparable transactions was not the sole
basis of reallocating costs and income under the statute.

    In the 1960s, the problem of abusive transfer pricing
practices created a new adherence to a stricter arm’s length
standard. In response to concerns about the undertaxation of
multinational business entities, Congress considered
reworking the Tax Code to resolve the difficulty posed by the
application of the arm’s length standard to related party
transactions. H.R. REP. No. 87-1447, at 28–30 (1962).
However, it instead asked Treasury to “explore the possibility
of developing and promulgating regulations . . . which would
                    ALTERA CORP. V. CIR                        11

provide additional guidelines and formulas for the allocation
of income and deductions” under 26 U.S.C. § 482. H.R. REP.
NO. 87-2508, at 19 (1962) (Conf. Rep.), as reprinted in 1962
U.S.C.C.A.N. 3732, 3739. Legislators believed that § 482
authorized the Secretary to employ a profit-split allocation
method without amendment. Id.; H.R. REP. No. 87-1447, at
28–29. In 1968, following Congress’s entreaty, Treasury
finalized the first regulation tailored to the issue of intangible
property development in QCSAs. 26 C.F.R. § 1.482-2(d)
(1968).

    The 1968 regulations “constituted a radical and
unprecedented approach to the problem they
addressed—notwithstanding their being couched in terms of
the ‘arm’s length standard,’ and notwithstanding that that
standard had been the nominal standard under the regulations
for some 30 years.” Stanley I. Langbein, The Unitary Method
and the Myth of Arm’s Length, 30 TAX NOTES 625, 644
(1986). In addition to three arm’s length pricing methods, the
1968 regulations included a “fourth method,” which was
essentially open-ended: “Where none of the three methods of
pricing . . . can reasonably be applied under the facts and
circumstances as they exist in a particular case, some
appropriate method of pricing other than those described . . . ,
or variations on such methods, can be used.” 26 C.F.R.
§ 1.482-2(e)(1)(iii) (1968).

    Following the promulgation of the 1968 regulation, courts
continued to employ a comparability analysis, but not to the
exclusion of other methodologies. Reuven S. Avi-Yonah,
The Rise & Fall of Arm’s Length: A Study in the Evolution of
U.S. International Taxation, 15 VA. TAX REV. 89, 108–29
(1995). Indeed, a study determined that direct comparable
transactions were located and applied in only 3% of the
12                 ALTERA CORP. V. CIR

Internal Revenue Service’s adjustments prior to the 1986
amendment. U.S. GEN. ACCOUNTING OFFICE., GGD-81-81,
IRS COULD BETTER PROTECT U.S. TAX INTERESTS IN
D ETERMINING THE I NCOME OF M ULTINATIONAL
CORPORATIONS (1981). The decades following the 1968
regulations involved

       a gradual realization by all parties concerned,
       but especially Congress and the IRS, that the
       [comparability method of meeting the arm’s
       length standard], firmly established . . . as the
       sole standard under section 482, did not work
       in a large number of cases, and in other cases
       its misguided application produced
       inappropriate results. The result was a
       deliberate decision to retreat from the
       standard while still paying lip service to it.

Avi-Yonah, supra, at 112; see also James P. Fuller,
Section 482: Revisited Again, 45 TAX L. REV. 421, 453
(1990) (“[T]he 1986 Act’s commensurate with income
standard is not really a new approach to § 482.”).

    Ultimately, as controlled transactions increased in
frequency and complexity, particularly with respect to
intangible property, Congress determined that legislative
action was necessary. The Tax Reform Act of 1986 reflected
Congress’s view that strict adherence to the comparability
method of meeting the arm’s length standard prevented tax
parity. Thus, the Tax Reform Act of 1986 added a sentence
to § 482 that largely forms the basis of the present dispute,
providing that:
                   ALTERA CORP. V. CIR                    13

       In the case of any transfer (or license) of
       intangible property (within the meaning of
       section 936(h)(3)(B)), the income with respect
       to such transfer or license shall be
       commensurate with the income attributable to
       the intangible.

Tax Reform Act of 1986, 26 U.S.C. § 482 (1986) (as
amended 2018).

    The House Ways and Means Committee recommended
the addition of the commensurate with income clause because
it was “concerned” that the current code and regulations “may
not be operating to assure adequate allocations to the U.S.
taxable entity of income attributable to intangibles.” H.R.
REP. NO. 99-426, at 423 (1985). The clause was intended to
correct a “recurrent problem”—“the absence of comparable
arm’s length transactions between unrelated parties, and the
inconsistent results of attempting to impose an arm’s length
concept in the absence of comparables.” Id. at 423–24.

    The House Report makes clear that the committee
intended the commensurate with income standard to displace
a comparability analysis where comparable transactions
cannot be found:

           A fundamental problem is the fact that the
       relationship between related parties is
       different from that of unrelated parties. . . .
       [M]ultinational companies operate as an
       economic unit, and not “as if” they were
       unrelated to their foreign subsidiaries. . . .

           ....
14               ALTERA CORP. V. CIR

         Certain judicial interpretations of section
     482 suggest that pricing arrangements
     between unrelated parties for items of the
     same apparent general category as those
     involved in the related party transfer may in
     some circumstances be considered a “safe
     harbor” for related party pricing
     arrangements, even though there are
     significant differences in the volume and risks
     involved, or in other factors. While the
     committee is concerned that such decisions
     may unduly emphasize the concept of
     comparables even in situations involving
     highly standardized commodities or services,
     it believes that such an approach is
     sufficiently troublesome where transfers of
     intangibles are concerned that a statutory
     modification to the intercompany pricing rules
     regarding transfers of intangibles is necessary.

         ....

         . . . There are extreme difficulties in
     determining whether the arm’s length
     transfers between unrelated parties are
     comparable. The committee thus concludes
     that it is appropriate to require that the
     payment made on a transfer of intangibles to
     a related foreign corporation . . . be
     commensurate with the income attributable to
     the intangible. . . .

         ....
                       ALTERA CORP. V. CIR                             15

             . . . [T]he committee intends to make it
         clear that industry norms or other unrelated
         party transactions do not provide a safe-harbor
         minimum payment for related party intangible
         transfers.      Where taxpayers transfer
         intangibles with a high profit potential, the
         compensation for the intangibles should be
         greater than industry averages or norms.

Id. at 424–25 (footnote and citation omitted).3

    Treasury’s first response to the Tax Reform Act was the
“White Paper,” an intensive study published in 1988. A Study
of Intercompany Pricing Under Section 482 of the Code,
I.R.S. Notice 88-123, 1988-2 C.B. 458 (“White Paper”). The
White Paper confirmed that Treasury believed the
commensurate with income standard to be consistent with the
arm’s length standard (and that Treasury understood
Congress to share that understanding). Id. at 475. Treasury
wrote that a comparability analysis must be performed where
possible, id. at 474, but it also suggested a “clear and
convincing evidence” standard for comparable transactions,
indicating that a comparability analysis would rarely be
possible. Id. at 478.

    3
        The Conference Committee suggested only one change—to broaden
the sweep of the amendment so as to encompass domestic related-party
transactions—in order to better serve the objective of the amendment,
“that the division of income between related parties reasonably reflect the
relative economic activity undertaken by each.” H.R. REP. NO. 99-841,
at II-637 (1986) (Conf. Rep.), as reprinted in 1986 U.S.C.C.A.N. 4075,
4725. The Report also clarified that cost-sharing arrangements would not
generally be subject to § 482 allocations—but only “if and to the extent
. . . the income allocated among the parties reasonably reflect the actual
economic activity undertaken by each.” Id. at II-638.
16                 ALTERA CORP. V. CIR

    The White Paper signaled a shift in the interpretation of
the arm’s length standard as it had been defined following the
1968 regulations. Treasury advanced a new allocation
method, the “basic arm’s length return method,” White Paper
at 488, that would apply only in the absence of comparable
transactions and would essentially split profits between the
related parties, id. at 490. Commentators understood that, by
attempting to synthesize the arm’s length standard and the
commensurate with income provision, Treasury was moving
away from a view that the arm’s length standard always
requires a comparability analysis. Marc M. Levey, Stanley C.
Ruchelman, & William R. Seto, Transfer Pricing of
Intangibles After the Section 482 White Paper, 71 J. TAX’N
38, 38 (1989); Josh O. Ungerman, Comment, The White
Paper: The Stealth Bomber of the Section 482 Arsenal,
42 SW. L.J. 1107, 1128–29 (1989).

    In 1994 and 1995, Treasury issued new regulations that
defined the arm’s length standard as result-oriented, meaning
that the goal is parity in taxable income rather than parity in
the method of allocation itself. 26 C.F.R. § 1.482-1(b)(1)
(1994) (“A controlled transaction meets the arm’s length
standard if the results of the transaction are consistent with
the results that would have been realized if uncontrolled
taxpayers had engaged in the same transaction under the same
circumstances (arm’s length result).”). However, the arm’s
length standard remained “the standard to be applied in every
case.” Id.

    The regulations also set forth methods by which income
could be allocated among related parties in a manner
consistent with the arm’s length standard. Id. § 1.482-
1(b)(2)(i) (1994). According to Treasury, the 1994
regulations defined the arm’s length standard in terms of “the
                    ALTERA CORP. V. CIR                      17

results that would have been realized if uncontrolled
taxpayers had engaged in the same transaction under the same
circumstances.” Compensatory Stock Options Under Section
482, 67 Fed. Reg. 48,997-01, 48,998 (proposed July 29,
2002).

    The 1995 regulation provided that “[i]ntangible
development costs” included “all of the costs incurred by [a
controlled] participant related to the intangible development
area.” 26 C.F.R. § 1.482-7(d)(1) (1995). By contrast to the
1994 regulation, the 1995 regulation—consistent with the
1986 Conference Report —“implement[ed] the
commensurate with income standard in the context of cost
sharing arrangements” by “requir[ing] that controlled
participants in a [QCSA] share all costs incurred that are
related to the development of intangibles in proportion to
their shares of the reasonably anticipated benefits attributable
to that development.” Compensatory Stock Options Under
Section 482, 67 Fed. Reg. at 48,998.

    Neither the Tax Reform Act nor the implementing
regulations specifically addressed allocation of employee
stock compensation, which is the issue in this dispute.
However, that omission was unsurprising given that the
practice did not develop on a major scale until the 1990s. Zvi
Bodie, Robert S. Kaplan, & Robert C. Merton, For the Last
Time: Stock Options Are an Expense, HARV. BUS. REV., Mar.
2003, at 62, 67. Beginning in 1997, the Secretary interpreted
the “all . . . costs” language to include stock-based
compensation, meaning that controlled taxpayers had to share
the costs (and associated deductions) of providing employee
stock compensation. Xilinx, Inc. v. Comm’r, 598 F.3d 1191,
1193–94 (9th Cir. 2010).
18                 ALTERA CORP. V. CIR

    In 2003, Treasury issued the cost-sharing regulations that
are challenged in this case. Treasury intended for the 2003
amendments to clarify, rather than to overhaul, the 1994 and
1995 regulations. The clarifications were twofold. First, the
amendments directly classified employee stock compensation
as a cost to be allocated between QCSA participants.
Compensatory Stock Options Under Section 482 (Proposed),
67 Fed. Reg. at 48,998; 26 C.F.R. § 1.482-7A(d)(2). Second,
the “coordinating amendments” clarified Treasury’s belief
that the cost-sharing regulations, including § 1.482-7A(d)(2),
operate to produce an arm’s length result. Compensatory
Stock Options Under Section 482 (Proposed), 67 Fed. Reg.
at 48,998; 26 C.F.R. § 1.482-7A(a)(3).

    Specifically, § 1.482-7A provides that costs shared by
related parties to a QCSA are not subject to IRS reallocation
for tax purposes if each entity’s share of the intangible
property development costs equals each entity’s reasonably
anticipated benefits. Section 1.482-7A(a)(3) incorporates and
coordinates with the arm’s length standard:

            A qualified cost sharing arrangement
       produces results that are consistent with an
       arm’s length result . . . if, and only if, each
       controlled participant’s share of the costs (as
       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 . . . .

Section 1.482-7A(d)(2) provides that parties to a QCSA must
allocate stock-based compensation between themselves:
                   ALTERA CORP. V. CIR                      19

            [In a QCSA], a controlled participant’s
       operating expenses include all costs
       attributable to compensation, including stock-
       based compensation. As used in this section,
       the term stock-based compensation means any
       compensation provided by a controlled
       participant to an employee or independent
       contractor in the form of equity instruments,
       options to acquire stock (stock options), or
       rights with respect to (or determined by
       reference to) equity instruments or stock
       options, including but not limited to property
       to which section 83 applies and stock options
       to which section 421 applies, regardless of
       whether ultimately settled in the form of cash,
       stock, or other property.

These regulations, and the procedure employed in adopting
them, form the basis of the present controversy.

                              II

    At issue is Altera Corporation (“Altera”) & Subsidiaries’
tax liability for the years 2004 through 2006. During the
relevant period, Altera and its subsidiaries designed,
manufactured, marketed, and sold programmable logic
devices, which are electronic components that are used to
build circuits.

    In May of 1997, Altera entered into a cost-sharing
agreement with one of its foreign subsidiaries, Altera
International, Inc., a Cayman Islands corporation (“Altera
International”), which had been incorporated earlier that year.
Altera granted to Altera International a license to use and
20                 ALTERA CORP. V. CIR

exploit Altera’s preexisting intangible property everywhere
in the world except the United States and Canada. In
exchange, Altera International paid royalties to Altera. The
parties agreed to pool their resources to share research and
development (“R&D”) costs in proportion to the benefits
anticipated from new technologies. The question in this
appeal is whether Treasury was permitted, for tax liability
purposes, to re-allocate the cost of employee stock-based
compensation.

    Altera and the IRS agreed to an Advance Pricing
Agreement covering the 1997–2003 tax years. Pursuant to
this agreement, Altera shared with Altera International stock-
based compensation costs as part of the shared R&D costs.
After the Treasury regulations were amended in 2003, Altera
and Altera International amended their cost-sharing
agreement to comply with the modified regulations,
continuing to share employee stock compensation costs.

    The agreement was amended again in 2005 following the
Tax Court’s opinion in Xilinx Inc. & Consolidated
Subsidiaries v. Commissioner, which involved a challenge to
the 1994–1995 cost-sharing regulations. 125 T.C. 37 (2005).
The parties agreed to “suspend the payment of any portion of
[a] Cost Share . . . to the extent such payment relates to the
Inclusion of Stock-Based Compensation in R&D Costs”
unless and until a court upheld the validity of the 2003 cost-
sharing regulations. The following provision explains
Altera’s reasoning:

           The Parties believe that it is more likely
       than not that (i) the Tax Court’s conclusion in
       Xilinx v. Commissioner, 125 T.C. [No.] 4
       (2005), that the arm’s length standard controls
                   ALTERA CORP. V. CIR                      21

       the determination of costs to be shared by
       controlled participants in a qualified cost
       sharing arrangement should also apply to
       Treas. Reg. § 1.482-7(d)(2) (as amended by
       T.D. 9088), and (ii) the Parties’ inclusion of
       Stock-Based Compensation in R&D Costs
       pursuant to Amendment I would be contrary
       to the arm’s length standard.

    Altera and its U.S. subsidiaries did not account for R&D-
related stock-based compensation costs on their consolidated
2004–2007 federal income tax returns. The IRS issued two
notices of deficiency to the group, applying § 1.482-7(d)(2)
to increase the group’s income by the following amounts:

                 2004         $ 24,549,315
                 2005         $ 23,015,453
                 2006         $ 17,365,388
                 2007         $ 15,463,565

    Altera timely filed petitions in the Tax Court. The parties
filed cross-motions for summary judgment, and the Tax Court
granted Altera’s motion. Sitting en banc, the Tax Court held
that § 1.482-7A(d)(2) is invalid under the Administrative
Procedure Act (“APA”), 5 U.S.C. §§ 701–706. Altera Corp.
& Subsidiaries v. Comm’r, 145 T.C. 91 (2015).

    The Tax Court unanimously determined: (1) that the
Commissioner’s allocation of income and expenses between
related entities must be consistent with the arm’s length
standard; and (2) that the arm’s length standard is not met
unless the Commissioner’s allocation can be compared to an
22                 ALTERA CORP. V. CIR

actual transaction between unrelated entities. The Tax Court
reasoned that the Commissioner could not require related
parties to share stock compensation costs, because the
Commissioner had not considered any unrelated party
transactions in which the parties shared such costs. The Tax
Court held that the agency’s decisionmaking process was
fundamentally flawed because: (1) it rested on speculation
rather than on hard data and expert opinions; and (2) it failed
to respond to significant public comments, particularly those
pointing out uncontrolled cost-sharing arrangements in which
the entities did not share stock compensation costs. Id.
at 133–34.

    The Tax Court’s decision rested largely on its own
opinion in Xilinx, in which it determined that the arm’s length
standard mandates a comparability analysis. Id. at 118 (citing
Xilinx, 125 T.C. at 53–55). In its decision in this case, as
well, the Tax Court suggested that the Commissioner cannot
require related entities to share stock compensation costs
unless and until the Commissioner locates uncontrolled
transactions in which these costs are shared. Id. at 118–19.

    The Tax Court reached five holdings: (1) the 2003
amendments constitute a final legislative rule subject to the
requirements of the APA; (2) Motor Vehicle Manufacturers
Ass’n of the United States, Inc. v. State Farm Mutual
Automobile Insurance Co., 463 U.S. 29 (1983), provides the
appropriate standard of review because the standard set forth
in Chevron, U.S.A., Inc. v. Natural Resources Defense
Council, Inc., 467 U.S. 837 (1984), incorporates State Farm’s
“ reasoned decisionmaking” standard; (3) Treasury did not
support adequately its decision to allocate the costs of
employee stock compensation between related parties;
                       ALTERA CORP. V. CIR                           23

(4) Treasury’s procedural regulatory deficiencies were not
harmless;4 and (5) § 1.482-7A(d)(2) is invalid under the APA.

                                  III

    Our task in this appeal, then, is to determine whether
Treasury’s 2003 regulations are lawful. In the context of the
arguments made in this case, we evaluate the validity of the
agency’s regulations under both Chevron and State Farm,
which “provide for related but distinct standards for
reviewing rules promulgated by administrative agencies.”
Catskill Mountains Chapter of Trout Unlimited, Inc. v. EPA,
846 F.3d 492, 521 (2d Cir. 2017). “State Farm is used to
evaluate whether a rule is procedurally defective as a result of
flaws in the agency’s decisionmaking process.” Id.
“Chevron, by contrast, is generally used to evaluate whether
the conclusion reached as a result of that process—an
agency’s interpretation of a statutory provision it
administers—is reasonable.” Id.5 “A litigant challenging a
rule may challenge it under State Farm, Chevron, or both.”

    4
      On appeal, the Commissioner does not claim that any error in the
decisionmaking process, if it existed, was harmless. Thus, we decline to
address the issue.
    5
       There are circumstances when the two analyses may overlap. See,
e.g., Confederated Tribes of Grand Ronde Cmty. of Or. v. Jewell, 830 F.3d
552, 561 (D.C. Cir. 2016) (We are mindful that, “[i]n [some] situations,
what is ‘permissible’ under Chevron is also reasonable under State Farm.”
(quoting Arent v. Shalala, 70 F.3d 610, 616 n.6 (D.C. Cir. 1995))).
24                      ALTERA CORP. V. CIR

Id. Altera challenges both the procedural adequacy of the
APA process and the substance of the regulation.6

                                     A

     We first turn to Chevron analysis.

                                     1

    Under Chevron, we first apply the traditional rules of
statutory construction to determine whether “Congress has
directly spoken to the precise question at issue.” 467 U.S. at
842. We start with the plain statutory text and, “when
deciding whether the language is plain, we must read the
words ‘in their context and with a view to their place in the
overall statutory scheme.’” King v. Burwell, 135 S. Ct. 2480,
2489 (2015) (quoting FDA v. Brown & Williamson Tobacco
Corp., 529 U.S. 120, 133 (2000)).

    In addition, we examine the legislative history, the
statutory structure, and “other traditional aids of statutory
interpretation” in order to ascertain congressional intent.

     6
      We afforded the parties the opportunity to file optional supplemental
briefs on the question whether the six-year statute of limitations under
28 U.S.C. § 2401(a)—which generally applies to procedural challenges to
regulations under the APA—applies to this case. The Commissioner
responded that it had waived this non-jurisdictional defense by failing to
assert it to the Tax Court. We agree with the parties that the
Commissioner waived the defense. Day v. McDonough, 547 U.S. 198,
210 n.11 (2006) (“[S]hould a State intelligently choose to waive a statute
of limitations defense, a district court would not be at liberty to disregard
that choice.”); Whidbee v. Pierce County, 857 F.3d 1019, 1024 (9th Cir.
2017) (“[E]ven if a claim has expired under a state statute of limitations,
a defendant can still waive this affirmative defense.”). Therefore, we need
not address it.
                    ALTERA CORP. V. CIR                       25

Middlesex Cty. Sewerage Auth. v. Nat’l Sea Clammers Ass’n,
453 U.S. 1, 13 (1981). If, after conducting that Chevron step
one examination, we conclude that the statute is silent or
ambiguous on the issue, we then defer to the agency’s
interpretation so long as it “is based on a permissible
construction of the statute.” Chevron, 467 U.S. at 843. A
permissible construction is one that is not “arbitrary,
capricious, or manifestly contrary to the statute.” Id. at 844.

    Ultimately, questions of deference boil down to whether
“it appears that Congress delegated authority to the agency
generally to make rules carrying the force of law, and that the
agency interpretation claiming deference was promulgated in
the exercise of that authority.” United States v. Mead Corp.,
533 U.S. 218, 226–27 (2001). “When Congress has
‘explicitly left a gap for an agency to fill, there is an express
delegation of authority to the agency to elucidate a specific
provision of the statute by regulation,’ and any ensuing
regulation is binding in the courts unless procedurally
defective, arbitrary or capricious in substance, or manifestly
contrary to the statute.” Id. at 227 (quoting Chevron,
467 U.S. at 843–44).

    Here, the resolution of our step one Chevron examination
is straightforward. Section 482 does not speak directly to
whether the Commissioner may require parties to a QCSA to
share employee stock compensation costs in order to receive
the tax benefits associated with entering into a QCSA. Thus,
there is no question that the statute remains ambiguous
regarding the method by which Treasury is to make
allocations based on stock-based compensation.

    Altera argues that the statute, by its terms, cannot apply
to stock-based compensation. According to Altera, stock-
26                  ALTERA CORP. V. CIR

based compensation is not “transferred” between parties
because only preexisting intangibles can be transferred.
Thus, for Altera, Treasury has exceeded the delegation of
authority apparent from the plain text of the statute.

    We are not persuaded. When parties enter into a QCSA,
they are transferring future distribution rights to intangibles,
albeit intangibles that have yet to be developed. Indeed, the
present-day transfer of those rights provides the main
incentive for entering into a QCSA. The right to distribute
intangibles to be developed later is, itself, one right in the
bundle of property rights that exists at the time that parties
enter into a QCSA.

    Moreover, even assuming that the crucial transfer does
not occur contemporaneously, § 482 applies “[i]n the case of
any transfer . . . of intangible property” that produces income.
(Emphasis added.) That phrasing is as broad as possible, and
it cannot reasonably be read to exclude the transfers of
expected intangible property. See, e.g., United States v.
Gonzales, 520 U.S. 1, 5 (1997) (“Read naturally, the word
‘any’ has an expansive meaning . . . .”); see also Republic of
Iraq v. Beaty, 556 U.S. 848, 856 (2009) (“Of course the word
‘any’ (in the phrase ‘any other provision of law’) has an
‘expansive meaning, giving us no warrant to limit the class of
provisions of law [encompassed by the statutory provision].”
(citation omitted)). Additionally, the sentence necessarily is
forward-looking because the production of taxable income
always follows the transfer.

   In short, the text of the statute does not limit its
application to preexisting intangibles in the way Altera’s
argument suggests. Because parties to a QCSA transfer cost-
                   ALTERA CORP. V. CIR                      27

shared intangibles—including stock-based compensation—
they are subject to regulation under 26 U.S.C. § 482.

                              2

    Thus, we must move on to Chevron step two to consider
whether Treasury’s interpretation of § 482 as to allocation of
employee stock option costs is permissible. An agency’s
interpretation of statutory authority is examined “in light of
the statute’s text, structure and purpose.” Miguel-Miguel v.
Gonzales, 500 F.3d 941, 949 (9th Cir. 2007). The
interpretation fails if it is “unmoored from the purposes and
concerns” of the underlying statutory regime. Judulang v.
Holder, 565 U.S. 42, 64 (2011). Thus, Congress’s purpose in
enacting and amending § 482 in 1986 is key to resolution of
this issue.

     The congressional purpose in enacting § 482 was to
establish tax parity. First Sec. Bank of Utah, 405 U.S. at 400.
In the 1986 amendments, Congress called for an approach to
allocation of costs and income that would “reasonably reflect
the actual economic activity undertaken by each [party to a
QCSA],” H.R. REP. No. 99-841, at II-638 (1986) (Conf.
Rep.). Put another way, Congress’s objective in amending
§ 482 was to ensure that income follows economic activity.
Id. at II-637. Although the 1986 amendment delegates to
Treasury the choice of a specific methodology to achieve that
end, it suggested: “In the case of any transfer (or license) of
intangible property . . . , the income with respect to such
transfer or license shall be commensurate with the income
attributable to the intangible.” This standard is a purely
internal one, that is, internal to the entity being taxed, and
evidence supports Treasury’s belief that Congress intended it
to be. H.R. REP. NO. 99-426, at 423–35; H.R. REP. NO.
28                     ALTERA CORP. V. CIR

99-841, at II-637 (Conf. Rep.). In the QCSA context,
Congress did not want to interfere with controlled cost-
sharing arrangements, but only to the degree that the
allocation of costs and income “reasonably reflect[s] the
actual economic activity undertaken by each.” H.R. REP. No.
99-841, at II-638 (Conf. Rep.). In light of this history,
Treasury’s decision to adopt a methodology that followed
actual economic activity was reasonable.

    So was Treasury’s determination that uncontrolled cost-
sharing arrangements do not provide helpful guidance
regarding allocations of employee stock compensation.
When it amended § 482 in 1986, Congress bemoaned the
difficulties associated with finding and using data involving
high-profit intangibles. See H.R. REP. NO. 99-426, at 425
(“There are extreme difficulties in determining whether the
arm’s length transfers between unrelated parties are
comparable. . . . [I]t is appropriate to require that the payment
made on a transfer of intangibles to a related foreign
corporation be commensurate with the income attributable to
the intangible.”); see also Compensatory Stock Options
Under Section 482, 68 Fed. Reg. 51,171-02, 51,173 (Aug. 26,
2003) (citing H.R. REP. NO. 99-426, at 423–25) (“As
recognized in the legislative history of the Tax Reform Act of
1986, there is little, if any, public data regarding transactions
involving high-profit intangibles.”).7 It follows that Congress

     7
      Although the 2017 amendment to § 482 has no bearing on our
analysis, we note that Congress has not changed its mind:

         The transfer pricing rules of section 482 and the
         accompanying Treasury regulations are intended to
         preserve the U.S. tax base by ensuring that taxpayers do
         not shift income properly attributable to the United
         States to a related foreign company through pricing that
                      ALTERA CORP. V. CIR                             29

granted Treasury authority to develop methods that did not
rely on analysis of these problematic comparable
transactions. Indeed, Treasury echoed Congress’s rationale
for amending § 482 in the first place when it published the
final rule. Id. at 51,173 (“The uncontrolled transactions cited
by commentators do not share enough characteristics of
QCSAs involving the development of high-profit intangibles
to establish that parties at arm’s length would not take stock
options into account in the context of an arrangement similar
to a QCSA.”).

    What is more, although Altera suggests there can be only
one understanding of the methodology required by the arm’s
length standard, historically the definition of the arm’s length
standard has been a more fluid one. Indeed, as we have
discussed, for most of the twentieth century the arm’s length
standard explicitly permitted the use of flexible methodology

        does not reflect an arm’s-length result. . . . The arm’s-
        length standard is difficult to administer in situations in
        which no unrelated party market prices exist for
        transactions between related parties. . . .

             . . . For income from intangible property, section
        482 provides “in the case of any transfer (or license) of
        intangible property (within the meaning of section
        936(h)(3)(B)), the income with respect to such transfer
        or license shall be commensurate with the income
        attributable to the intangible.” By requiring inclusion
        in income of amounts commensurate with the income
        attributable to the intangible, Congress was responding
        to concerns regarding the effectiveness of the arm’s-
        length standard with respect to intangible
        property—including, in particular, high-profit-potential
        intangibles.

H. REP. NO. 115-466, at 574–75 (2017).
30                 ALTERA CORP. V. CIR

in order to achieve an arm’s length result. See also H.R. REP.
NO. 87-2508, at 18–19 (1962) (Conf. Rep.) (noting that, in
1962, Congress stated that Treasury should “provide
additional guidelines and formulas” to achieve arm’s length
results). It is true that, more recently, an understanding that
the primary means of reaching an arm’s length result
suggested the analysis of comparable transactions. But, in the
lead-up to the 1986 amendments, Congress voiced numerous
concerns regarding reliance on this methodology. Further, as
we have discussed, courts for more than half a century have
held that a comparable transaction analysis was not the
exclusive methodology to be employed under the statute. In
light of the historic versatility of methodology, it is
reasonable that Treasury would understand that Congress
intended for it to depart from analysis of comparable
transactions as the exclusive means of achieving an arm’s
length result.

    In addition, Treasury reasonably concluded that doing
away with analysis of comparable transactions was an
efficient means of ensuring that § 482 would “operat[e] to
assure adequate allocations to the U.S. taxable entity of
income attributable to intangibles in [QCSAs].” H.R. REP.
NO. 99-426, at 423. Congress expressed numerous concerns
that pre-1986 allocation methods permitted entities to
undervalue their tax liability by placing undue emphasis on
“the concept of comparables” and basing allocations on
industry norms, rather than on actual economic activity. Id.
at 424–25. Doing away with analysis of comparable
transactions, and instead requiring an internal method of
allocation, proves a reasonable method of alleviating these
concerns.
                    ALTERA CORP. V. CIR                       31

    In sum, Treasury reasonably understood § 482 as an
authorization to require internal allocation methods in the
QCSA context, provided that the costs and income allocated
are proportionate to the economic activity of the related
parties. These internal allocation methods are reasonable
methods for reaching the arm’s length results required by
statute. While interpreting the statute to do away with
reliance on comparables may not have been “the only
possible interpretation” of Congress’s intent, it proves a
reasonable one. Entergy Corp. v. Riverkeeper, Inc., 556 U.S.
208, 218 (2009). Thus, Treasury’s interpretation is not
“arbitrary, capricious, or manifestly contrary to the statute,”
and it is therefore permissible under Chevron. 467 U.S.
at 844.

                               3

    Altera contends that the Commissioner misreads § 482
and its history, arguing that the addition of the commensurate
with income standard to § 482 did nothing to change the
meaning and operation of the arm’s length standard, thus
rendering Treasury’s interpretation unreasonable. Altera
supports its argument with a canon of construction:
“Amendments by implication, like repeals by implication, are
not favored.” United States v. Welden, 377 U.S. 95, 103 n.12
(1964). That canon does not apply here. It operates to
prevent courts from attributing unspoken motives to
legislators, not to force courts to ignore legislative action and
express legislative history. In addition, cases invoking the
maxim typically refer to a later-enacted, separate statute or
provision amending a previous statute or provision; most
cases do not involve changes to the same statute or
32                     ALTERA CORP. V. CIR

provision.8 It is illogical to argue that amending a singular
statute does not alter its meaning.

    Altera’s interpretation of the 1986 amendment would
render the commensurate with income clause meaningless
except in two circumstances: (1) to allow the Commissioner
periodically to adjust prices initially assigned following a
comparability analysis; and (2) to reflect a party’s
contribution of existing intangible property or “buy-in” to a
cost-sharing arrangement. This narrow reading of § 482 is
not supported by the text or history of the 1986 amendment.

    The Commissioner’s allocation of employee stock
compensation costs between related parties is necessary for
Treasury to fulfill its obligation under § 482. Congress did
not intend to interfere with qualified cost-sharing
arrangements when those arrangements provided for the
allocation of income consistent with the commensurate with
income provision. H.R. REP. NO. 99-841, at II-638 (Conf.
Rep.).

                                     4

    Altera makes much of the United States’s treaty
obligations with other countries, asserting that a purely
internal standard is inconsistent with the standards agreed to

     8
      See, e.g., Nat’l Ass’n of Home Builders v. Defs. of Wildlife, 551 U.S.
644, 650–52, 664 n.8 (2007) (considering whether a later-enacted
provision of the Endangered Species Act could amend a provision of the
Clean Water Act); Blanchette v. Conn. Gen. Ins. Corps., 419 U.S. 102,
134 (1974) (considering whether the Rail Act amended a remedy provided
by the Tucker Act); United States v. Dahl, 314 F.3d 976, 977–78 (9th Cir.
2002) (considering whether a provision codified as a separate note to an
existing statute amended the statute).
                   ALTERA CORP. V. CIR                      33

therein and is therefore unreasonable. However, there is no
evidence that our treaty obligations bind us to the analysis of
comparable transactions. As demonstrated by nearly a
century of interpreting § 482 and its precursor, the arm’s
length standard is not necessarily confined to one
methodology. It reflects neither how related parties behave
nor how they are taxed. Moreover, our most recent treaties
incorporate not only the arm’s length standard, but also the
2003 regulations. See, e.g., U.S. DEP’T OF TREASURY,
TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN
THE UNITED STATES AND POLAND FOR THE AVOIDANCE OF
DOUBLE TAXATION 31 (2013) (“It is understood that the Code
section 482 ‘commensurate with income’ standard for
determining appropriate transfer prices for intangibles
operates consistently with the arm’s-length standard. The
implementation of this standard in the regulations under Code
section 482 is in accordance with the general principles of
paragraph 1 of Article 9 of the Convention . . . .”).

                              B

    Though Treasury’s interpretation of its statutory grant of
authority was reasonable, we also must examine whether the
procedures used in its promulgation prove defective under the
APA. Catskill Mountains, 846 F.3d at 522 (“[I]f an
interpretive rule was promulgated in a procedurally defective
manner, it will be set aside regardless of whether its
interpretation of the statute is reasonable.”). After reviewing
the administrative record, we conclude that Treasury
complied with the procedural requirements of the APA and,
therefore, the regulations survive State Farm scrutiny.

    Section 706 of the APA directs courts to “decide all
relevant questions of law, interpret constitutional and
34                  ALTERA CORP. V. CIR

statutory provisions, and determine the meaning or
applicability of the terms of an agency action.” 5 U.S.C.
§ 706 (flush language). Agencies may not act in ways that
are “arbitrary, capricious, an abuse of discretion, or otherwise
not in accordance with law.” Id. § 706(2)(A).

    The APA “sets forth the full extent of judicial authority to
review executive agency action for procedural correctness.”
FCC v. Fox Television Stations, Inc., 556 U.S. 502, 513
(2009). It “prescribes a three-step procedure for so-called
‘notice-and-comment rulemaking.’” Perez v. Mortg. Bankers
Ass’n, 135 S. Ct. 1199, 1203 (2015) (citing 5 U.S.C. § 553).
First, a “[g]eneral notice of proposed rule making” must
ordinarily be published in the Federal Register. 5 U.S.C.
§ 553(b). Second, provided that “notice [is] required,” the
agency must “give interested persons an opportunity to
participate in the rule making through submission of written
data, views, or arguments.” Id. § 553(c). “An agency must
consider and respond to significant comments received during
the period for public comment.” Perez, 135 S. Ct. at 1203.
Third, the agency must incorporate in the final rule “a concise
general statement of [its] basis and purpose.” 5 U.S.C.
§ 553(c).

     Altera does not dispute that Treasury satisfied the first
step by giving notice of the 2003 regulations. Id. Nor does
there appear to be a controversy as to whether Treasury
included in the final rule “a concise general statement of [its]
basis and purpose.” Id.; 5 U.S.C. § 553. Rather, Altera
argues that the regulations fail on the second step, asserting
that: (1) Treasury improperly rejected comments submitted
in opposition to the proposed rule, (2) Treasury’s current
litigation position is inconsistent with statements made during
the rulemaking process, (3) Treasury did not adequately
                   ALTERA CORP. V. CIR                      35

support its position that employee stock compensation is a
cost, and (4) a more searching review is required under Fox,
because the agency altered its position. We address each in
turn.

                              1

    Under State Farm, the touchstone of “arbitrary and
capricious” review under the APA is “reasoned
decisionmaking.” State Farm, 463 U.S. at 52. “[T]he agency
must examine the relevant data and articulate a satisfactory
explanation for its action including a ‘rational connection
between the facts found and the choice made.’” Id. at 43
(quoting Burlington Truck Lines, Inc. v. United States,
371 U.S. 156, 168 (1962)). “[A]gency action is lawful only
if it rests ‘on a consideration of the relevant factors.’”
Michigan v. EPA, 135 S. Ct. 2699, 2706 (2015) (quoting State
Farm, 463 U.S. at 43). However, we may not set aside
agency action simply because the rulemaking process could
have been improved; rather, we must determine whether the
agency’s “path may reasonably be discerned.” State Farm,
463 U.S. at 43 (quoting Bowman Transp., Inc. v. Ark.-Best
Freight Sys., Inc., 419 U.S. 281, 286 (1974)).

    In considering and responding to comments, “the agency
must examine the relevant data and articulate a satisfactory
explanation for its action including a ‘rational connection
between the facts found and the choice made.’” Id. (quoting
Burlington Truck Lines, 371 U.S. at 168). “[A]n agency need
only respond to ‘significant’ comments, i.e., those which raise
relevant points and which, if adopted, would require a change
in the agency’s proposed rule.” Am. Mining Congress v.
EPA, 965 F.2d 759, 771 (9th Cir. 1992) (quoting Home Box
Office v. FCC, 567 F.2d 9, 35 & n.58 (D.C. Cir. 1977) (per
36                 ALTERA CORP. V. CIR

curiam)). If the comments ignored by the agency would not
bear on the agency’s “consideration of the relevant factors,”
we may not reverse the agency’s decision. Id.

    Treasury published its notice of proposed rulemaking in
2002.     Compensatory Stock Options Under Section
482 (Proposed), 67 Fed. Reg. 48,997-01. In its notice,
Treasury made clear that it was relying on the commensurate
with income provision. Id. at 48,998. To support its position,
Treasury drew from the legislative history of the 1986
amendment, explaining that Congress intended a party to a
QCSA to “bear its portion of all research and development
costs.” Id. (quoting H.R. REP. NO. 99-841, at II-638 (Conf.
Rep.). It also informed interested parties of its intent to
coordinate the new regulations with the arm’s length
standard, suggesting that it was attempting to synthesize the
potentially disparate standards found within § 482 itself. Id.
at 48,998, 49,000–01.

    Commenters responded by attacking the proposed
regulations as inconsistent with the traditional arm’s length
standard because the methodology did not involve analysis of
comparable transactions. To support their position, they
primarily discussed arm’s length agreements in which
unrelated parties did not mention employee stock options.
They explained that unrelated parties do not share stock
compensation costs because it is difficult to value stock-based
compensation, and there can be a great deal of expense and
risk involved.

    In the preamble to the final rule, Treasury dismissed the
comments (and, relatedly, the behavior of controlled
taxpayers):
           ALTERA CORP. V. CIR                    37

     Treasury and the IRS continue to believe
that requiring stock-based compensation to be
taken into account for purposes of QCSAs is
consistent with the legislative intent
underlying section 482 and with the arm’s
length standard (and therefore with the
obligations of the United States under its
income tax treaties . . .). The legislative
history of the Tax Reform Act of 1986
expressed Congress’s intent to respect cost
sharing arrangements as consistent with the
commensurate with income standard, and
therefore consistent with the arm’s length
standard, if and to the extent that the
participants’ shares of income “reasonably
reflect the actual economic activity
undertaken by each.” See H.R. CONF. REP.
NO. 99-481, at II-638 (1986). . . . [I]n order
for a QCSA to reach an arm’s length result
consistent with legislative intent, the QCSA
must reflect all relevant costs, including such
critical elements of cost as the cost of
compensating employees for providing
services related to the development of the
intangibles pursuant to the QCSA. Treasury
and the IRS do not believe that there is any
basis for distinguishing between stock-based
compensation and other forms of
compensation in this context.

    Treasury and the IRS do not agree with
the comments that assert that taking stock-
based compensation into account in the QCSA
context would be inconsistent with the arm’s
38                 ALTERA CORP. V. CIR

        length standard in the absence of evidence
        that parties at arm’s length take stock-based
        compensation into account in similar
        circumstances. . . . The uncontrolled
        transactions cited by commentators do not
        share enough characteristics of QCSAs
        involving the development of high-profit
        intangibles to establish that parties at arm’s
        length would not take stock options into
        account in the context of an arrangement
        similar to a QCSA.

Compensatory Stock Options under Section 482 (Preamble to
Final Rule), 68 Fed. Reg. 51,171-02, 51,172–73 (Aug. 26,
2003).

     Treasury added:

        Treasury and the IRS believe that if a
        significant element of [the costs shared by
        unrelated parties] consists of stock-based
        compensation, the party committing
        employees to the arrangement generally
        would not agree to do so on terms that ignore
        the stock-based compensation.

Id. at 51,173.

    By submitting the cited transactions between unrelated
parties, the commentators apparently assumed that Treasury
would employ analysis of comparable transactions. This
assumption, however, overlooks Treasury’s decision to do
away with analysis of comparable transactions in the first
place—a decision that was made clear enough by citations to
                    ALTERA CORP. V. CIR                      39

legislative history in the notice of proposed rulemaking and
in the preamble to the final rule. As discussed in our Chevron
analysis, Treasury’s conclusion that it could require parties to
a QCSA to share all costs was a reasonable one. Thus,
“significant” comments that required a response would have
spoken to why this interpretation was not, in fact, reasonable,
so that adopting the comments would require Treasury to
change the regulation. Am. Mining Congress, 965 F.2d at
771. As an example, Treasury would have been required to
respond to comments demonstrating that doing away with
analysis of comparables did not, in fact, serve the purposes of
parity set out in the statute.

     Indeed, the cited transactions actually reinforced the
original justification for adopting a purely internal
methodology—the lack of transactions comparable to those
occurring between parties to a QCSA. Specifically, as
Treasury remarked, the submitted transactions did not “share
enough characteristics of QCSAs involving the development
of high-profit intangibles” to provide grounds for accurate
comparison. Because of this lack of similar transactions,
Treasury justifiably chose to employ methodology that did
not depend on non-existent comparables to satisfy the
commensurate with income test and achieve tax parity. In
this way, the comments reinforced Treasury’s premise for
adopting the purely internal methodology, but were irrelevant
to the underlying choice of methodology. Treasury did not
err in refusing to examine them more rigorously.

    In sum, we cannot find a failure in Treasury’s refusal to
consider comments that proved irrelevant to its
decisionmaking process. Here, Treasury gave sufficient
notice of what it intended to do and why, and the submitted
comments were irrelevant to the issues Treasury was
40                 ALTERA CORP. V. CIR

considering. Because the comments had no bearing on
“relevant factors” to the rulemaking, nor any bearing on the
final rule, there was no APA violation. Am. Mining
Congress, 965 F.2d at 771.

                              2

    Treasury’s current litigation position is not inconsistent
with the statements it made to support the 2003 regulations at
the time of the rulemaking. Altera argues that its position is
justified by SEC v. Chenery Corp., 332 U.S. 194 (1947).
“[A] reviewing court . . . must judge the propriety of [agency]
action solely by the grounds invoked by the agency.” Id. at
196. “If those grounds are inadequate or improper, the court
is powerless to affirm the administrative action by
substituting what it considers to be a more adequate or proper
basis.” Id.

    Altera argues that the Commissioner cannot now claim
that “Treasury reasonably determined that it was statutorily
authorized to dispense with comparability analysis” because
“[n]owhere in the regulatory history did the Secretary suggest
that he ‘was statutorily authorized to dispense with
comparability analysis.’” But these arguments misunderstand
the rulemaking requirements imposed by Chenery. Chenery
does not require us to adopt Altera’s position as to how the
arm’s length standard operates. Instead, we must “defer to an
interpretation which was a necessary presupposition of [the
agency’s] decision,” if reasonable, even when alternative
interpretations are available. Nat’l R.R. Passenger Corp. v.
Boston & Maine Corp., 503 U.S. 407, 419–20 (1992).

    Treasury reasonably interpreted congressional intent in
the 1986 amendments as permitting it to dispense with a
                      ALTERA CORP. V. CIR                           41

comparable transaction analysis in the absence of actual
comparable transactions. Its interpretation was all the more
reasonable given, as we have discussed, that the arm’s length
standard has historically been understood as more fluid than
Altera suggests. Because Chenery does not require agencies
to provide “exhaustive, contemporaneous legal arguments to
preemptively defend its action,” its references to the 1986
amendments provide an adequate ground for its
determination. Nat’l Elec. Mfrs. Ass’n v. U.S. Dep’t of
Energy, 654 F.3d 496, 515 (4th Cir. 2011).

    Altera contends further that the Commissioner’s position
is incompatible with Treasury’s statements during the
rulemaking process, when the Secretary claimed that the cost-
sharing regulations were consistent with the arm’s length
standard (as well as the commensurate with income standard).
This argument misinterprets Treasury’s position. Treasury
asserted then, and still asserts in this litigation, that using an
internal method of reallocation is consistent with the arm’s
length standard because it attempts to bring parity to the tax
treatment of controlled and uncontrolled taxpayers, as does
comparison of comparable transactions when they exist.
Treasury’s position was also consistent with its White Paper,9
and Treasury’s interpretation in the 1994 regulation of the
arm’s length standard as result-oriented, rather than method-
oriented, with the goal of achieving tax parity. 26 C.F.R.
§ 1.482-1(b)(1) (1994).

    9
     Altera argues that a passage in the White Paper, in which Treasury
wrote that “intangible income must be allocated on the basis of
comparable transactions if comparables exist,” demonstrates
inconsistency. However, that statement is entirely consistent with
Treasury’s view that a different methodology must be applied when
comparable transactions do not exist.
42                 ALTERA CORP. V. CIR

    Altera’s argument is founded on its belief that an arm’s
length analysis always must be method-oriented, and rooted
in actual transactional analysis. But the question before us is
not which view is superior; it is whether Treasury’s position
in 2003 was incompatible with its prior position in
promulgating the 1994 and 1995 regulations. As we have
discussed, it was clear in 1994 and 1995 that, in
implementing the commensurate with income amendment,
Treasury was moving away from a purely method-based,
comparable-transaction view of the arm’s length standard in
attempting to achieve tax parity. Treasury’s citation to the
amendment, and its legislative history, demonstrates that its
position was not inconsistent, and there is no basis under
Chenery to invalidate it.

                              3

    Altera also argues that Treasury did not adequately
support its position that employee stock compensation is a
cost, asserting that Treasury wrongfully ignored evidence that
companies do not factor stock-based compensation into their
pricing decisions. As an accounting matter in the past, this
issue may have been disputed. Indeed, at one point, “[t]he
debate on accounting for stock-based compensation . . .
became so divisive that it threatened the [Financial
Accounting Standards] Board’s future working relationship
with some of its constituents.” FINANCIAL ACCOUNTING
STANDARDS BOARD, FINANCIAL ACCOUNTING FOUNDATION,
A CCOUNTING FOR S TOCK -B ASED C OMPENSATION :
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO.
123, at 25 (1995). However, as we will discuss, it is
uncontroversial today. Since 1995, the Financial Accounting
Standards Board has supported treating stock options as costs.
Id.
                    ALTERA CORP. V. CIR                      43

    Treasury’s rulemaking process was sufficient. Treasury
articulated why treating stock-based compensation as a cost
led to arm’s length results. It first noted that stock-based
compensation is a “critical element” of R&D costs for parties
to a QCSA and noted that such compensation is “clearly
related to the intangible development area.” Compensatory
Stock Options Under Section 482 (Preamble to Final Rule),
68 Fed. Reg. at 51,173. Logic supports these conclusions.
Parties dealing at arm’s length, as Treasury explained, would
not “ignore” stock-based compensation if such compensation
were a “significant element” of the compensation costs one
party incurs and another party agrees to reimburse when
developing high-profit intangibles. Id. Rather, “through
bargaining,” each party would ensure that the cost-sharing
agreement is in its best interest, meaning that the parties will
consider the internal costs of stock compensation without
requiring the other party to recognize those costs. Id.

    Though commentators presented evidence of some
transactions in which stock-based compensation was not a
cost, this evidence provided little guidance because it did not
concern parties to a QCSA developing high-profit intangibles.
This out-of-context data did not require a different decision.
In the absence of applicable evidence, Treasury’s analysis
provides a logical explanation of how treating stock-based
compensation as a cost leads to arm’s length results.

    In addition, as we have noted, generally accepted
accounting principles supported Treasury’s conclusion, and
Treasury cited generally to “tax and other accounting
principles” for its determination that there is a “cost
associated with stock-based compensation.” Compensatory
Stock Options Under Section 482 (Proposed), 67 Fed. Reg. at
48,999. One such principle is that a distinction exists
44                    ALTERA CORP. V. CIR

between the economic costs of stock compensation—which
are debatable—versus the accounting costs—which are not.
Because entities account for the cost of providing employee
stock options, it is reasonable for Treasury to allocate that
cost.    In light of these fundamental understandings,
Treasury’s reference to “tax and other accounting principles”
provides a solid foundation for the Commissioner’s
interpretation.10

     Most notably, the Tax Code classifies stock-based
compensation as a trade or business “expense.” 26 U.S.C.
§ 162(a). And the challenged regulation cites the provision
providing that this expense is a deductible expense.
26 C.F.R. § 1.482-7A(d)(2)(iii)(A) (“[T]he operating expense
attributable to stock-based compensation is equal to the
amount allowable . . . as a deduction for Federal income tax
purposes . . . (for example, under [26 U.S.C. § 83(h)]).”).
The reference to the Tax Code’s classifications in the
regulation itself serves as yet another articulation of
Treasury’s reasoning, the reasonableness of which is made
clear by the Tax Code’s treatment of stock-based
compensation as a cost.

    Though it could have been more specific, Treasury
“articulated a rational connection” between its decision and
these industry standards. County of Amador v. U.S. Dep’t of
Interior, 872 F.3d 1012, 1027 (9th Cir. 2017) (internal

     10
      See, e.g., Andrew Barry, How Much Do Silicon Valley Firms Really
Earn?, BARRON’S (June 27, 2015), http://www.barrons.com/articles/how-
much-do-silicon-valley-firms-really-earn-1435372718)) (noting that
numerous companies, including Google and Qualcomm, reported stock
compensation “total[ling] five percent or more of revenue in recent
years”).
                   ALTERA CORP. V. CIR                      45

quotation marks omitted), cert. denied, 139 S. Ct. 64 (2018).
Presuming that Treasury was authorized to dispense with a
comparability analysis, making the economic behavior of
uncontrolled taxpayers irrelevant, Altera does not offer any
compelling argument against the reasonableness of
Treasury’s determination.

                              4

    Finally, in addition to its general State Farm argument,
Altera asks for a more searching review under Fox. Altera
claims that the cost-sharing amendments present a major shift
in administrative policy such that Treasury could not issue the
regulations without carefully considering and broadcasting its
decision. Altera argues that “[t]he assertion that the
commensurate with income clause supplants the arm’s-length
standard with a ‘purely internal’ analysis is a sharp—but
unacknowledged—reversal from Treasury’s long-standing
prior policy.”

    “Agencies are free to change their existing policies as
long as they provide a reasoned explanation for the change.”
Encino Motorcars, LLC v. Navarro, 136 S. Ct. 2117, 2125
(2016). Indeed, “[w]hen an agency changes its existing
position, it ‘need not always provide a more detailed
justification than what would suffice for a new policy created
on a blank slate.’” Id. at 2125–26 (quoting Fox, 556 U.S. at
515). However, an agency may not “depart from a prior
policy sub silentio or simply disregard rules that are still on
the books.” Fox, 556 U.S. at 515.

       [A] policy change complies with the APA if
       the agency
46                 ALTERA CORP. V. CIR

       (1) displays “awareness that it is changing
       position,”

       (2) shows that “the new policy is permissible
       under the statute,”

       (3) “believes” the new policy is better, and

       (4) provides “good reasons” for the new
       policy, which, if the “new policy rests upon
       factual findings that contradict those which
       underlay its prior policy,” must include “a
       reasoned explanation . . . for disregarding
       facts and circumstances that underlay or were
       engendered by the prior policy.”

Organized Vill. of Kake v. U.S. Dep’t of Agric., 795 F.3d 956,
966 (9th Cir. 2015) (en banc) (format altered) (quoting Fox,
556 U.S. at 515–16).

    At its core, this argument is not meaningfully different
from Altera’s general APA argument. If the arm’s length
standard allows the Commissioner to allocate costs between
related parties without a comparability analysis, there is no
policy change, merely a clarification of the same policy.
Further, as we have discussed, the policy change was
occasioned by the congressional addition of the
“commensurate with income” sentence in the Tax Reform
Act of 1984 and the 1994 and 1995 implementing regulations.
Those changes occurred well before 2003. The 2003
regulations clarified, rather than altered, prior policy. And
the enactment of a statutory amendment obviously makes a
concomitant regulatory amendment appropriate.
                   ALTERA CORP. V. CIR                     47

                              5

    Thus, the 2003 regulations are not arbitrary and
capricious under the standard of review imposed by the APA.
Treasury’s regulatory path may be reasonably discerned.
Treasury understood § 482 to authorize it to employ a purely
internal, commensurate with income approach in dealing with
related companies. It provided adequate notice of its intent
and adequately considered the objections. Its conclusion that
stock based compensation should be treated as a cost was
adequately supported in the record, and its position did not
represent a policy change under Fox.

                              C

    Altera also argues that the outcome of this case is
controlled by our court’s decision in Xilinx. We disagree.
Although the Xilinx panel could have reached a holding that
would foreclose the Commissioner’s current position, it did
not.

    In Xilinx, we considered the 1994 and 1995 cost-sharing
regulations. The case involved a matter of regulatory
interpretation, not executive authority. Xilinx, Inc., another
maker of programmable logic devices, challenged the
Commissioner’s allocation of employee stock options
between Xilinx and its Irish subsidiary. 598 F.3d at 1192. As
framed by the panel, the issue was whether § 1.482-1
(1994)—which sets forth the arm’s length standard—could be
reconciled with § 1.482-7(d)(1) (1995)—under which parties
to a QCSA were required to share “all . . . costs” incurred in
developing intangibles. Id. at 1195.
48                  ALTERA CORP. V. CIR

     Xilinx does not govern here. First, the parties in Xilinx
were not debating administrative authority, and we did not
consider the “commensurate with income” standard, which
Congress itself did not see as inconsistent with the arm’s
length standard. Second, and more significantly, the Xilinx
panel was faced with a conflict between two rules. If the
rules were conceptually distinguishable, they were also in
direct conflict. The arm’s length rule, § 1.482-1(b)(1) (1994),
listed specific methods for calculating an arm’s length result.
The all-costs provision was not one of those methods, as the
first Xilinx majority noted. 567 F.3d at 491. Treasury issued
the coordinating amendment in 2003, after the tax years at
issue in Xilinx, and the arm’s length regulation now expressly
references the cost-sharing provision that Altera challenges.
The Xilinx panel did not address the “open question” of
whether the 2003 regulations remedied the error identified in
that decision. 598 F.3d at 1198 n.4 (Fisher, J., concurring).
Today, there is no conflict in the regulations, and Altera does
not challenge the regulations on the ground that a conflict
exists.

    Xilinx did not involve the question of statutory
interpretation, the Commissioner’s authority, or the
regulation at issue in this appeal:             26 C.F.R.
§ 1.482-7A(d)(2). Accordingly, it does not assist Altera.

                               IV

    The 1986 amendment focused specifically on intangibles,
and it gave Treasury the ability to respond to rapid changes
in the high tech industry. “The broad language of [§ 482]
reflects an intentional effort to confer the flexibility necessary
to forestall . . . obsolescence.” Massachusetts v. EPA,
549 U.S. 497, 532 (2007). In the modern economy, employee
                    ALTERA CORP. V. CIR                      49

stock options are integral to R&D arrangements. In fact, in
Altera’s 2015 annual report, its stock-based compensation
cost equaled nearly five percent of total revenue. ALTERA
CORP., ANNUAL REPORT FOR THE FISCAL YEAR ENDED DEC.
31, 2014 (FORM 10-K). Simply speaking, the rise in
employee stock compensation is an economic development
that Treasury cannot ignore without rejecting its obligations
under § 482.

    In sum, we disagree with the Tax Court that the 2003
regulations are arbitrary and capricious under the standard of
review imposed by the APA. While the rulemaking process
was less than ideal, the APA does not require perfection. We
are able to reasonably discern Treasury’s path—Treasury
understood § 482 to authorize it to employ a purely internal,
commensurate with income approach where comparable
transactions are not comparable.

    In light of the statute’s plain text and the legislative
history, Treasury also reasonably concluded that Congress
intended to hone the definition of the arm’s length standard
so that it could work to achieve an arm’s length result, instead
of forcing application of a particular comparability method.
Given the long history of the application of other methods,
and the text and legislative history of the Tax Reform Act of
1984, Treasury’s understanding of its power to use
methodologies other than a pure transactional comparability
analysis was reasonable, and we defer to its interpretation
under Chevron. The Commissioner did not exceed the
authority delegated to him by Congress in issuing the
regulations.

    REVERSED.
50                  ALTERA CORP. V. CIR

O’MALLEY, Circuit Judge, dissenting:

    “[T]he foundational principle of administrative law [is]
that a court may uphold agency action only on the grounds
that the agency invoked when it took the action.” Michigan
v. EPA, 135 S. Ct. 2699, 2710 (2015) (citing SEC v. Chenery
Corp. (“Chenery I”), 318 U.S. 80, 87 (1943)). Prior to
promulgating Treas. Reg. § 1.482-7A(d)(2), whose validity
we consider here, Treasury repeatedly recognized that
26 U.S.C. § 482 requires application of an arm’s length
standard when determining the true taxable income of a
controlled taxpayer—i.e., it requires Treasury to assess what
a taxpayer dealing with an uncontrolled taxpayer would do in
the same circumstances. And, Treasury just as consistently
asserted that a comparability analysis is the only way to
determine the arm’s length standard; indeed, Treasury made
clear that a comparability analysis is the cornerstone of the
arm’s length standard. Despite these consistent practices and
declarations, in its preamble to § 1.482-7A(d)(2), Treasury
stated, for the first time and with no explanation, that it may,
instead, employ the “commensurate with income” standard to
reach the required arm’s length result.

    Today, the majority justifies Treasury’s about-face in
three steps: (1) it finds that, by citing to the legislative
history surrounding the enactment of the Tax Reform Act of
1986 in the preamble to § 1.482-7A(d)(2), Treasury implicitly
communicated its understanding that Congress “permitt[ed]
it to dispense with a comparable transaction analysis,”
Op. 40–41; (2) it finds that, by including that same cryptic
citation to legislative history in its proposed notice of
rulemaking, Treasury made it “clear enough” to interested
parties that Treasury was changing its longstanding practice
of applying a comparability analysis, Op. 38–39; and (3) it
                   ALTERA CORP. V. CIR                      51

justifies Treasury’s resort to the commensurate with income
standard by invoking the second sentence of § 482 to
conclude that Treasury may jettison the arm’s length standard
altogether—a justification Treasury never provided and one
which does not withstand careful scrutiny.

    The majority, thus, “suppl[ies] a reasoned basis for the
agency’s action that the agency itself has not given,” Motor
Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins.
Co., 463 U.S. 29, 43 (1983) (citing SEC v. Chenery Corp.
(“Chenery II”), 332 U.S. 194, 196 (1947)), encourages
“executive agencies’ penchant for changing their views about
the law’s meaning almost as often as they change
administrations,” BNSF Ry. Co. v. Loos, 586 U.S. ___, No.
17-1042, slip op. at 9 (2019) (Gorsuch, J., dissenting), and
endorses a practice of requiring interested parties to engage
in a scavenger hunt to understand an agency’s rulemaking
proposals. That practice is inconsistent with another
fundamental Administrative Procedure Act (“APA”)
principle: that a notice of proposed rulemaking “should be
sufficiently descriptive of the ‘subjects and issues involved’
so that interested parties may offer informed criticism and
comments.” Am. Mining Cong. v. U.S. EPA, 965 F.2d 759,
770 (9th Cir. 1992) (quoting Ethyl Corp. v. EPA, 541 F.2d 1,
48 (D.C. Cir. 1976) (en banc)). In so doing, the majority
stretches “highly deferential” review, Providence Yakima
Med. Ctr. v. Sebelius, 611 F.3d 1181, 1190 (9th Cir. 2010)
(quoting J & G Sales Ltd. v. Truscott, 473 F.3d 1043, 1051
(9th Cir. 2007)), beyond its breaking point.

    I would instead find, as the Tax Court did, that Treasury’s
explanation of its rule (to the extent any was provided) failed
to satisfy the State Farm standard, that Treasury did not
provide adequate notice of its intent to change its
52                  ALTERA CORP. V. CIR

longstanding practice of employing the arm’s length standard
and using a comparability analysis to get there, and that its
new rule is invalid as arbitrary and capricious. I would also
hold that this court’s previous decision in Xilinx, Inc. v.
Commissioner of Internal Revenue (“Xilinx II”), 598 F.3d
1191 (9th Cir. 2010), controls and mandates an order
affirming the Tax Court’s decision. I therefore would affirm
the judgment of the Tax Court that expenses related to stock-
based compensation are not among the costs to be shared in
qualified cost sharing arrangements (“QCSAs”) under Treas.
Reg. § 1.482-7(d)(1) (as amended in 2013). See Altera Corp.
v. Comm’r, 145 T.C. 91, 92 (2015). For these reasons, I
respectfully dissent.

                      I. BACKGROUND

              A. The Arm’s Length Standard

                       1. Before 1986

    “The purpose of section 482 is to place a controlled
taxpayer on a tax parity with an uncontrolled taxpayer, by
determining according to the standard of an uncontrolled
taxpayer, the true taxable income from the property and
business of a controlled taxpayer.” Comm’r v. First Sec.
Bank of Utah, 405 U.S. 394, 400 (1972) (quoting Treas. Reg.
§ 1.482-1(b)(1) (1971)). The “touchstone” of this tax parity
inquiry is the arm’s length standard. Xilinx II, 598 F.3d at
1198 n.1 (Fisher, J., concurring). Indeed, the first sentence of
§ 482 states that, “[i]n any case of two or more organizations,
trades, or businesses . . . owned or controlled directly or
indirectly by the same interests, the Secretary
may . . . allocate gross income . . . if he determines that
such . . . allocation is necessary in order to prevent evasion of
                   ALTERA CORP. V. CIR                      53

taxes or clearly to reflect the income of any of such
organizations, trades, or businesses.” This sentence has
always been viewed as requiring an arm’s length standard.
See First Sec. Bank of Utah, 405 U.S. at 400; Barclays Bank
PLC v. Franchise Tax Bd. of Cal., 512 U.S. 298, 305 (1994).

    Since the 1930s, Treasury regulations consistently have
explained that, “[i]n determining the true taxable income of
a controlled taxpayer, the standard to be applied in every case
is that of a taxpayer dealing at arm’s length with an
uncontrolled taxpayer.” Treas. Reg. § 1.482-1(b)(1) (2003)
(emphasis added). That is, income and deductions are to be
allocated among related companies in the same way that
unrelated companies negotiating at arm’s length would
allocate income and deductions. As far back as 1968,
Treasury’s regulations also required that, “[i]n order for the
sharing of costs and risks to be considered on an arm’s length
basis, the terms and conditions must be comparable to those
which would have been adopted by unrelated parties similarly
situated had they entered into such an arrangement.”
Allocation of Income and Deductions Among Taxpayers,
33 Fed. Reg. 5848, 5854 (April 16, 1968) (emphasis added).
That same regulation provided that Treasury may not allocate
income with respect to QCSAs involving the development of
intangible property unless doing so would be consistent with
the arm’s length standard. Id. (providing that, in “a bona fide
cost sharing arrangement with respect to the development of
intangible property, the district director shall not make
allocations with respect to such acquisition except as may be
appropriate to reflect each participant’s arm’s length share of
the costs and risks of developing the property.”). Therefore,
at the time Congress enacted the 1986 amendment,
Treasury’s own regulations explicitly required a
determination of what an arm’s length result would show and
54                  ALTERA CORP. V. CIR

required a comparability analysis to reach that result where
comparable transactions exist.

    The majority attempts to water down the text of
Treasury’s own regulations at the time. It contends that,
“[a]lthough the Secretary adopted the arm’s length standard,
courts did not hold related parties to the standard by
exclusively requiring the examination of comparable
transactions.” Op. 9. To support its position, the majority
cites this court’s decision in Frank v. Int’l Canadian Corp.,
308 F.2d 520, 528–29 (9th Cir. 1962), which disagreed that
“‘arm’s length bargaining’ is the sole criterion for applying
the statutory language of [§ 482] in determining what the
‘true net income’ is of each ‘controlled taxpayer.’” But, in
Oil Base, Inc. v. Commissioner of Internal Revenue, 362 F.2d
212, 214 n.5 (9th Cir. 1966), this court clarified that the
holding in Frank was an outlier, limited only to the peculiar
facts of that case. Frank’s departure from the arm’s length
analysis, the court held, was justified, in part, because “there
was no evidence that arm’s-length bargaining upon the
specific commodities sold had produced a higher return” and
because “the complexity of the circumstances surrounding the
services rendered by the subsidiary” made it “difficult for the
court to hypothesize an arm’s-length transaction.” Id.
Significantly, the parties in Frank had stipulated to applying
a standard other than the arm’s length standard. Id.

    There really can be no doubt that, prior to the 1986
amendment, this Circuit believed that an arm’s length
standard based on comparable transactions was the sole basis
for allocating costs and income under the statute in all but the
narrow circumstances outlined in Frank—including the
presence of the stipulation therein. The majority’s attempt to
breathe life back into Frank is, simply, unpersuasive.
                    ALTERA CORP. V. CIR                      55

                 2. The 1986 Amendment

    The 1986 amendment passed against the backdrop of
Treasury’s own longstanding practices did not change the
obligation to employ an arm’s length standard. Indeed,
Congress left the first sentence of § 482—the sentence that
undisputedly incorporates the arm’s length standard—intact.
It merely added a second sentence providing that, “[i]n the
case of any transfer (or license) of intangible property . . . ,
the income with respect to such transfer or license shall be
commensurate with the income attributable to the intangible.”
Tax Reform Act of 1986, Pub. L. No. 99-514, § 1231(e)(1),
100 Stat. 2085, 2562 (1986) (codified as amended at
26 U.S.C. § 482). The plain text of the statute limits the
application of the commensurate with income standard to
only transfers or licenses of intangible property.

    This is consistent with the underlying purpose of the 1986
amendment. Congress explained in the committee report that
it was introducing the commensurate with income standard to
address a “recurrent problem” with transfers of highly
valuable intangible property: “the absence of comparable
arm’s length transactions between unrelated parties, and the
inconsistent results of attempting to impose an arm’s length
concept in the absence of comparables.” H.R. REP. NO.
99-426, at 423–24 (1985). Congress noted that “[i]ndustry
norms for transfers to unrelated parties of less profitable
intangibles frequently are not realistic comparables in these
cases,” and that “[t]here are extreme difficulties in
determining whether the arm’s length transfers between
unrelated parties are comparable.” Id. at 424–25. To address
this specific gap, Congress found it “appropriate to require
that the payment made on a transfer of intangibles to a related
foreign corporation . . . be commensurate with the income
56                  ALTERA CORP. V. CIR

attributable to the intangible.” Id. at 425. Congress did not
make any other findings regarding the use of the
commensurate with income standard for any transactions
other than transfers or licenses of intangible property. Thus,
the statute—read in light of this legislative history—did not
grant Treasury the flexibility to depart from a comparability
analysis whenever it sees fit; rather, it permitted a departure
in the limited context of “any transfer (or license) of
intangible property” because it had found that comparable
transactions in such cases are frequently unrealistic.

     Treasury reiterated the limited circumstances in which the
commensurate with income standard applies in its 1988
“White Paper.” It stated there that, even in the context of
transfers or licenses of intangible property, the “intangible
income must be allocated on the basis of comparable
transactions if comparables exist.” A Study of Intercompany
Pricing under Section 482 of the Code (“White Paper”),
I.R.S. Notice 88-123, 1988-1 C.B. 458, 474; see also id. at
473 (noting that, where “there is a true comparable for” the
licensing of a “high profit potential intangible,” the royalty
rate for the license “must be set on the basis of the
comparable because that remains the best measure of how
third parties would allocate intangible income”). Only “in
situations in which comparables do not exist” for transfers of
intangible property would the commensurate with income
standard apply. Id. at 474. Indeed, the United States
continued to insist in tax treaties, and in documents that
Treasury issued to explain these treaties, that § 482 mandated
the arm’s length principle, in all but this narrow category of
intangible transfers. See Xilinx II, 598 F.3d at 1196–97
(citing tax treaty explanations); see also id. at 1198 n.1
(Fisher, J., concurring) (noting that “the 1997 United
States–Ireland Tax Treaty, . . . and others like it, reinforce the
                      ALTERA CORP. V. CIR                           57

arm’s length standard as Congress’ intended touchstone for
§ 482”).1

        B. Treatment of Stock-Based Compensation

    In the early 1990s, related companies began to
compensate certain employees who performed research and
development activities pursuant to QCSAs by granting stock
options and other stock-based compensation. See id. at
1192–93. This manner of compensation allowed companies
to avoid the income reallocation mechanisms available under
§ 482 by including only the employees’ cash compensation
in the cost pool under the agreement, but not their stock-
based compensation.

    To address this loophole, Treasury promulgated new
regulations governing the tax treatment of controlled
transactions in 1994 and 1995. These regulations affirmed
that “the standard to be applied in every case” was the arm’s
length standard and that “an arm’s length result generally will
be determined by reference to the results of comparable
transactions” because “identical transactions can rarely be
located.” Treas. Reg. § 1.482-1(b)(1) (as amended in 1994).
They also provided that intangible development costs
included “all of the costs incurred by . . . [an uncontrolled]
participant related to the intangible development area.”

    1
      As the majority observes, more recent tax treaty explanations have
also cited the alternative commensurate with income standard. Op. 32–33
(citing Technical Explanation of the US-Poland Tax Treaty, at 31 (Feb.
13, 2013)). Even these explanations, however, emphasize the primacy of
the arm’s length standard, and they assure the reader that the
commensurate with income standard “operates consistently with the
arm’s-length standard.” Technical Explanation of the US-Poland Tax
Treaty, at 30–31 (Feb. 13, 2013).
58                  ALTERA CORP. V. CIR

Treas. Reg. § 1.482-7(d)(1) (as amended in 1995). The IRS
interpreted this latter “all costs” provision to include stock-
based compensation, so that related companies in cost-sharing
agreements would have to share costs of providing such
compensation. Xilinx II, 598 F.3d at 1193–94.

    When Xilinx, Inc. (“Xilinx”) challenged the IRS’s
interpretation, the Tax Court decided that the agency’s
interpretation was inconsistent with Treas. Reg. § 1.482-1
because the IRS had not adduced evidence sufficient to show
that unrelated parties transacting at arm’s length would, in
fact, share expenses related to stock-based compensation.
Xilinx v. Commissioner (“Xilinx I”), 125 T.C. 37, 53 (2005).
The Commissioner did not appeal this underlying factual
finding and, instead, argued on appeal to this court that Treas.
Reg. § 1.482-7 superseded the arm’s length requirement of
Treas. Reg. § 1.482-1. All three members of the divided
panel therefore assumed that sharing expenses related to
stock-based compensation would be inconsistent with the
arm’s length standard. Xilinx II, 598 F.3d at 1194 (“The
Commissioner does not dispute the tax court’s factual finding
that unrelated parties would not share [employee stock
options] as a cost.”); id. at 1199 (Reinhardt, J., dissenting)
(assuming that the Tax Court “correctly resolved” the issue
of whether sharing stock-based compensation costs would
constitute an arm’s length result). The panel also assumed
that Treas. Reg. § 1.482-7 required stock-based compensation
expenses to be shared. Id. at 1196 (majority opinion) (noting
that the “all costs” provision “does not permit any exceptions,
even for costs that unrelated parties would not share”); id.
at 1199 (Reinhardt, J., dissenting) (assuming that the “all
costs” provision includes “employee stock option costs”).
But a majority of the panel ultimately held that the arm’s
length standard, which it described as the fundamental
                    ALTERA CORP. V. CIR                       59

“purpose” of the regulations, trumped Treas. Reg. § 1.482-7,
and that stock-based compensation expenses could not be
shared in the absence of evidence that unrelated parties would
share such costs. Id. at 1196 (majority opinion); see also id.
at 1198 n.1 (Fisher, J., concurring) (finding “the arm’s length
standard” to be “Congress’ intended touchstone for § 482”).
On that ground, this court affirmed the Tax Court’s judgment
in favor of Xilinx. Id. at 1196 (majority opinion).

                C. The Regulations at Issue

     While Xilinx II was pending before this court, Treasury
promulgated the regulations at issue here. Compensatory
Stock Options Under Section 482, 68 Fed. Reg. 51,171,
51,172 (Aug. 26, 2003) (codified at 26 C.F.R. pts. 1 and 602).
The amended regulations sought to reconcile the apparent
contradiction between the arm’s length standard in Treas.
Reg. § 1.482-1 and the requirement that stock-based
compensation expenses be shared under Treas. Reg.
§ 1.482-7. The former provision now specifies that § 1.482-7
“provides the specific methods to be used to evaluate whether
a [QCSA] produces results consistent with an arm’s length
result.” Treas. Reg. § 1.482-1(b)(2)(i) (2003). And
§ 1.482-7, in turn, now provides that a QCSA produces an
arm’s length result “if, and only if,” the participants share all
of the costs of intangible development—explicitly including
costs associated with stock-based compensation—in
proportion to their shares of reasonably anticipated benefits
attributable to such development. Treas. Reg. § 1.482-7(d)(2)
(2003).

    Altera Corp. (“Altera U.S.”), a Delaware corporation, and
its subsidiary Altera International, a Cayman Islands
corporation, (collectively “Altera”) entered into a technology
60                 ALTERA CORP. V. CIR

research and development cost-sharing agreement under
which the related participants “agreed to pool their respective
resources to conduct research and development using the pre-
cost-sharing intangible property” and “to share the risks and
costs of research and development activities they performed
on or after May 23, 1997.” Altera, 145 T.C. at 93. This
agreement was effective from May 23, 1997 through 2007.
Id. During the 2004–2007 taxable years, Altera U.S. granted
stock options and other stock-based compensation to certain
employees who performed research and development
activities pursuant to the agreement. Id. The employees’
cash compensation was included in the cost pool under the
agreement, but their stock-based compensation was not. Id.

     Altera timely filed an income tax return for its 2004–2007
taxable years. Id. at 94. Treasury responded by mailing
notices of deficiency for those years, allocating income from
Altera International to Altera U.S. by increasing Altera
International’s cost-sharing payments. Id. Treasury claimed
its cost-sharing adjustments were for the purpose of bringing
Altera in compliance with § 1.482-7(d)(2), now
§ 1.482-7A(d)(2). Id. Altera challenged the validity of
§ 1.482-7A(d)(2) in Tax Court, arguing that the new rule is
arbitrary and capricious. Id. at 92. The Tax Court
unanimously held, as discussed in more detail below, that the
explanation Treasury offered in the preamble accompanying
the new regulations was insufficient to justify those
regulations under State Farm. Id. at 120–33. The
Commissioner appeals that decision.

                       II. Discussion

    The Tax Court considered and rejected Treasury’s plainly
stated explanation for its regulation—that Treasury applied
                    ALTERA CORP. V. CIR                        61

the commensurate with income test because it could find no
transactions comparable to the QCSAs at issue and that
Treasury’s analysis was actually consistent with the arm’s
length standard. The Commissioner now argues on appeal,
however—and the majority accepts its new claim—that what
Treasury was actually saying is that § 482 no longer requires
a comparability analysis when Treasury concludes that any
comparable transactions are imperfect and that the
methodology for arriving at an arm’s length result is, and
always has been, fluid. I disagree. Specifically, as explained
below, I believe that: (1) Treasury’s rule is procedurally
invalid and the majority’s attempt to recreate the record
surrounding its adoption cannot cure that flaw; (2) Treasury’s
purported interpretation of § 482 is wrong; and (3) related
companies may not be required to share the cost of stock-
based compensation under current law because comparable
uncontrolled taxpayers would not do so.

        A. The New Rule is Procedurally Invalid

    Under the Administrative Procedure Act, we must “hold
unlawful and set aside agency action . . . found to be . . .
arbitrary, capricious, an abuse of discretion, or otherwise not
in accordance with law.” 5 U.S.C. § 706(2)(A). Our review
of an agency regulation is “highly deferential, presuming the
agency action to be valid and affirming the agency action if
a reasonable basis exists for its decision.” Crickon v.
Thomas, 579 F.3d 978, 982 (9th Cir. 2009) (quoting Nw.
Ecosystem All. v. U.S. Fish & Wildlife Serv., 475 F.3d 1136,
1140 (9th Cir. 2007)). But “an agency’s action must be
upheld, if at all, on the basis articulated by the agency itself.”
State Farm, 463 U.S. at 50 (citing Burlington Truck Lines v.
United States, 371 U.S. 156, 168 (1962)). For that reason,
“[w]e may not supply a reasoned basis for the agency’s action
62                  ALTERA CORP. V. CIR

that the agency itself has not given.” Id. at 43 (quoting
Chenery II, 332 U.S. at 196).

    I start, therefore, with what Treasury said when it
promulgated the regulation at issue. In Treasury’s notice of
proposed rulemaking, the agency explained the origins of the
commensurate with income standard and discussed the White
Paper. Compensatory Stock Options Under Section 482, 67
Fed. Reg. 48,997, 48,998 (proposed July 29, 2002) (to be
codified at 26 C.F.R. pt. 1). Treasury noted, in particular, the
White Paper’s observation “that Congress intended that
Treasury and the IRS apply and interpret the commensurate
with income standard consistently with the arm’s length
standard.” Id. (citing White Paper, 1988-1 C.B. at 458, 477).

     Treasury then detailed how the proposed rules would
function, including that the new rules required stock-based
compensation costs to be included among the costs shared in
a QCSA to produce “results consistent with an arm’s length
result.” Id. at 49,000–01. It acknowledged that “[t]he Tax
Reform Act of 1986 . . . amended section 482 to require that
consideration for intangible property transferred in a
controlled transaction be commensurate with the income
attributable to the intangible” property. Id. at 48,998
(emphasis added). But it then conclusively stated, based on
a vague reference to the “legislative history of the Act,” that
parties may continue to enter into bona fide research and
development cost sharing arrangements so long as “the
income allocated among the parties reasonably reflect actual
economic activity undertaken by each”—i.e., so long as these
agreements to develop intangible property survive the
commensurate with income standard. Id. (emphasis added).
Not once did Treasury justify its application of the
commensurate with income standard by stating that QCSAs
                    ALTERA CORP. V. CIR                      63

of this kind constitute “transfers” of intangible property under
the Tax Reform Act. And, while it generally cited to the
legislative history of the 1986 amendments to § 482—a fact
on which the majority places great weight—it did not explain
what portions of the legislative history it found pertinent or
how any of that history factored into its thinking.

    Treasury expanded on its reasoning in the preamble to the
final rule. It explained that the tax treatment of stock-based
compensation in QCSAs would have to be consistent “with
the arm’s length standard (and therefore with the obligations
of the United States under its income tax treaties and with the
OECD transfer pricing guidelines).” 68 Fed. Reg. at 51,172.
Treasury observed, however, that the legislative history of the
1986 amendment to § 482 “expressed Congress’s intent to
respect cost sharing arrangements as consistent with the
commensurate with income standard, and therefore consistent
with the arm’s length standard, if and to the extent that
participants’ shares of income ‘reasonably reflect the actual
economic activity undertaken by each.’” Id. (quoting H.R.
REP. NO. 99-481, at II-638 (1986) (Conf. Rep.)). Again,
Treasury never explained why QCSAs in which controlled
parties share costs to develop intangibles would constitute
“transfers” of intangibles sufficient to trigger the
commensurate with income standard in the first place.
Instead, it simply declared that, “in order for a QCSA to reach
an arm’s length result consistent with legislative intent,” the
QCSA must include stock-based compensation among the
costs shared. Id.

    Throughout the preamble, Treasury repeatedly
emphasized that it was continuing to apply the arm’s length
standard. Treasury explained, for example, that “[t]he
regulations relating to QCSAs have as their focus reaching
64                 ALTERA CORP. V. CIR

results consistent with what parties at arm’s length generally
would do if they entered into cost sharing arrangements for
the development of high-profit intangibles.” Id. (emphasis
added). Treasury determined that “[p]arties dealing at arm’s
length in [a cost-sharing] arrangement based on the sharing
of costs and benefits generally would not distinguish between
stock-based compensation and other forms of compensation.”
Id. (emphasis added). And Treasury concluded that “[t]he
final regulations provide that stock-based compensation must
be taken into account in the context of QCSAs because such
a result is consistent with the arm’s length standard.” Id.
(emphasis added).

    Yet, Treasury failed to consider comparable transactions
submitted by commentators demonstrating that unrelated
companies would never share the cost of stock-based
compensation. Treasury responded to these comments
invoking the arm’s length standard. See id. (rejecting
“comments that assert that taking stock-based compensation
into account in the QCSA context would be inconsistent with
the arm’s length standard in the absence of evidence that
parties at arm’s length take stock-based compensation into
account in similar circumstances”). Treasury acknowledged
that these comparable arm’s-length transactions are typically
relevant, but it determined that there were no comparable
transactions available for QCSAs for the development of
high-profit intangibles:

       While the results actually realized in similar
       transactions under similar circumstances
       ordinarily provide significant evidence in
       determining whether a controlled transaction
       meets the arm’s length standard, in the case of
       QCSAs such data may not be available. As
                    ALTERA CORP. V. CIR                       65

        recognized in the legislative history of the Tax
        Reform Act of 1986, there is little, if any,
        public data regarding transactions involving
        high-profit intangibles. The uncontrolled
        transactions cited by commentators do not
        share enough characteristics of QCSAs
        involving the development of high-profit
        intangibles to establish that parties at arm’s
        length would not take stock options into
        account in the context of an arrangement
        similar to a QCSA.

Id. at 51,172–73 (internal citation omitted).

    The Tax Court held that Treasury’s explanation for its
regulation was insufficient under State Farm. Altera,
145 T.C. at 120–33. It found that Treasury “failed to provide
a reasoned basis” for its “belief that unrelated parties entering
into QCSAs would generally share stock-based compensation
costs.” Id. at 123. The court acknowledged that agencies
need not gather empirical evidence for some policy-based
propositions, but it held that “the belief that unrelated parties
would share stock-based compensation costs in the context of
a QCSA” was not such a proposition. Id. In reaching this
conclusion, the court observed that commentators submitted
significant evidence during the rulemaking process indicating
that unrelated parties would not share stock-based
compensation costs in QCSAs; that the Tax Court itself had
made a factual determination on that issue in Xilinx
I—concluding they would not; and, that Treasury was
required at least to attempt to gather empirical evidence
before declaring that no such evidence was available. Id.
at 123–24.
66                 ALTERA CORP. V. CIR

     The Tax Court then detailed why Treasury’s explanation
for the regulations was insufficient. The court noted that only
some QCSAs involved high-profit intangibles or included
stock-based compensation as a significant element of
compensation, yet Treasury failed to distinguish between
QCSAs with and without those characteristics. Id. at 125–27.
And the court found that Treasury responded only in
conclusory fashion to a number of comments identifying
comparable transactions or explaining why unrelated parties
would not share stock-based compensation costs in QCSAs.
Id. at 127–30. On these grounds, the Tax Court struck down
the regulation. Id. at 133–34.

    On appeal, the Commissioner does not meaningfully
dispute the Tax Court’s determination that Treasury’s
analysis under the arm’s length standard was inadequate and
unsupported. In its opening brief, it contends, instead, “that,
in the context of a QCSA, the arm’s-length standard does not
require an analysis of what unrelated entities do under
comparable circumstances.” Appellant’s Br. 57 (internal
quotation marks omitted). In the Commissioner’s view,
Treasury’s detailed explanations regarding its comparability
analysis were merely “extraneous observations”—“since
Treasury reasonably determined that it was statutorily
authorized to dispense with comparability analysis in this
narrow context, there was no need for it to establish that the
uncontrolled transactions cited by commentators were
insufficiently comparable.” Appellant’s Br. 64.

    In its supplemental brief, the Commissioner reiterates
that—despite its own earlier machinations to the contrary—
one should not conflate comparability analysis with the arm’s
length standard. Appellant’s Suppl. Br. 29–31. It also argues
for the first time that Treasury’s passing reference to the
                    ALTERA CORP. V. CIR                      67

legislative history of § 482 not only justified its departure
from a comparability analysis, but also explained that QCSAs
to develop intangibles constitute transfers of intangibles
under the second sentence of § 482.

    The majority accepts the latest of the Commissioner’s
ever-evolving post-hoc rationalizations and then, amazingly,
goes even further to justify what Treasury did here. First, it
accepts the Commissioner’s new explanation that the
taxpayer’s agreement to “divide beneficial ownership of any
Developed Technology” constitutes a transfer of intangibles.
E.R. 145. Second, it holds that Treasury’s reference to the
legislative history communicated its understanding that, when
Congress enacted the 1986 amendment, it “delegate[d] to
Treasury the choice of a specific methodology to” “ensure
that income follows economic activity.” Op. 27. The
majority finds that Treasury implicitly communicated its
understanding that Congress called upon it to move away
from a comparability analysis and “to develop methods that
[d]o not rely on analysis of” what it deems “problematic
comparable transactions” when it sees fit. Op. 28–29. The
majority finds that Treasury was therefore entitled to ignore
the comparable transactions submitted by commentators
because they purportedly did not “bear[] on ‘relevant factors’
to the rulemaking.” Op. 39–40 (quoting Am. Mining Cong.,
965 F.2d at 771). As to Altera’s rejoinder that Treasury never
suggested that it had the authority to “dispense with” the
comparability analysis entirely, Appellee’s Br. 43, the
majority dismisses this argument, stating that, “historically[,]
the definition of the arm’s length standard has been a more
fluid one.” Op. 29. Finally, the majority concludes that the
second sentence of § 482 not only allowed Treasury to
dispense with a comparability analysis but also allowed it to
ignore the arm’s length test altogether.
68                    ALTERA CORP. V. CIR

     I do not share the majority’s views. Treasury may well
have thought—incorrectly, I believe—that QCSAs involving
the development of high-profit intangibles constitute transfers
of intellectual property under the second sentence of § 482.
It may also have believed that, given the fundamental
characteristics of stock-based compensation in QCSAs and
what the majority here calls the “fluid” definition of the arm’s
length standard, it could dispense with a comparability
analysis entirely, regardless of whether QCSAs constitute
transfers. Cf. Xilinx II, 598 F.3d at 1197 (Fisher, J.,
concurring) (hypothesizing why unrelated companies may not
share stock-based compensation costs). It may—despite
never taking this position before rehearing in this
appeal—have even believed that the arm’s length standard
was not required at all in these circumstances by virtue of the
second sentence of § 482. But the APA required Treasury to
say that it was taking these positions, which depart starkly
from Treasury’s previous regulations. See FCC v. Fox
Television Stations, Inc., 556 U.S. 502, 515 (2009) (“[T]he
requirement that an agency provide reasoned explanation for
its action would ordinarily demand that it display awareness
that it is changing position.”).

    The APA’s safeguards ensure that those regulated do not
have to guess at the regulator’s reasoning; just as importantly,
they afford regulated parties a meaningful opportunity to
respond to that reasoning. Treasury’s notice of proposed
rulemaking ran afoul of these safeguards by failing to put the
relevant public on notice of its intention to depart from a
traditional arm’s length analysis.2 See CSX Transp., Inc. v.

     2
       The majority also glosses over the Tax Court’s criticism that the
final rule applied to all QCSAs but was based only on Treasury’s beliefs
about the subset of QCSAs involving “high-profit intangibles” where
                      ALTERA CORP. V. CIR                            69

Surface Transp. Bd., 584 F.3d 1076, 1080 (D.C. Cir. 2009)
(holding that a final rule “violates the APA’s notice
requirement where ‘interested parties would have had to
divine [the agency’s] unspoken thoughts’” (alteration in
original) (quoting Int’l Union, United Mine Workers of Am.
v. Mine Safety & Health Admin., 407 F.3d 1250, 1259–60
(D.C. Cir. 2005))). Asking Treasury to show its work in the
preamble to its final rule—that is, to set forth when and why
the agency believed that a comparability analysis is not
required or even why an arm’s length analysis can be
eschewed—does not, as the majority states, “require agencies
to provide ‘exhaustive, contemporaneous legal arguments to
preemptively defend its action.’” Op. 41 (quoting Nat’l Elec.
Mfrs. Ass’n v. U.S. Dep’t of Energy, 654 F.3d 496, 515 (4th
Cir. 2011)). It is the essence of the review that the APA
demands.

    When the Tax Court conducted that review, it considered
the explanation that Treasury offered, and it found that
Treasury “failed to provide a reasoned basis” for its “belief
that unrelated parties entering into QCSAs would generally
share stock-based compensation costs.” Altera, 145 T.C.
at 123. The Tax Court set forth in detail why Treasury’s
explanation for the regulations was insufficient. Id.
at 125–30. Treasury offers no response to these findings; it
simply invites this court to recreate the record and interpret
§ 482 in a way it never asked the Tax Court to do in order to
supply a post-hoc justification for its decisionmaking. I

stock-based compensation is a “significant element” of compensation.
Altera, 145 T.C. at 125–26 (quoting Compensatory Stock Options Under
Section 482, 68 Fed. Reg. at 51,173). Treasury’s failure to explain this
leap and the Commissioner’s failure to defend it provide another reason
that Treasury failed to comply with the APA.
70                  ALTERA CORP. V. CIR

would hold, as the Tax Court did, that Treasury’s belated
arguments are insufficient to justify the 2003 regulations and
that those regulations are, thus, are procedurally invalid.

     B. Chevron Does Not Save Treasury’s Flawed
            Interpretation of Section 482

    Even if Treasury did not err procedurally, I would still
find that the regulations are impermissible under Chevron.
The Commissioner does not argue that its interpretation of
§ 482 is compelled by the unambiguous text of the statute at
step one of Chevron. Rather, he contends that § 482 does not
directly resolve the question of whether Treasury may
allocate the cost of stock-based compensation between related
parties. The majority similarly reasons that “[§] 482 does not
speak directly to whether the Commissioner may require
parties to a QCSA to share employee stock compensation
costs in order to receive the tax benefits associated with
entering into a QSCA.” Op. 25. It thus concludes that “there
is no question that the statute remains ambiguous regarding
the method by which Treasury is to make allocations based
on stock-based compensation.” Op. 25.

    While I agree with the majority and the Commissioner
that the statute is silent as to the precise question of whether
the Commissioner may require parties to a QCSA to share the
cost of stock-based compensation, I believe that the statute
unambiguously communicates the types of cases in which
each methodology applies. Specifically, § 482 dictates that
the status quo—i.e, the arm’s length standard—controls in
“any case of two or more organizations, trades, or businesses
owned or controlled directly or indirectly by the same
interests.”     It also allows Treasury to employ the
commensurate with income standard, but only “[i]n the case
                    ALTERA CORP. V. CIR                        71

of any transfer (or license) of intangible property.”
Accordingly, the precise gap left by Congress in this case is
the question of whether QCSAs constitute a “transfer” of
“intangible property” under the second sentence of the
statute. If yes, then Treasury may employ the commensurate
with income standard to determine if related parties to a
QCSAs would share the cost of stock-based compensation.
If no, then Treasury must make that determination by
employing a comparability analysis to reach an arm’s length
result. Because the statute does not expressly state that
QCSAs for the development intangibles constitute “transfers”
of intangibles, I would proceed to step two of Chevron.

    At step two, we consider whether Treasury’s
interpretation is “arbitrary or capricious in substance, or
manifestly contrary to the statute.” Mayo Found. for Med.
Educ. & Research v. United States, 562 U.S. 44, 53 (2011)
(internal citations omitted). The agency’s interpretation is not
arbitrary and capricious if it is “rationally related to the goals
of the Act.” AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366,
388 (1999). “If the [agency]’s interpretation is permissible in
light of the statute’s text, structure and purpose, we must
defer under Chevron.” Miguel-Miguel v. Gonzales, 500 F.3d
941, 949 (9th Cir. 2007). Accordingly, I begin with the text
of the statute.

    The statutory text provides in relevant part:

        In any case of two or more organizations,
        trades, or businesses . . . owned or controlled
        directly or indirectly by the same interests, the
        Secretary may distribute, apportion, or
        allocate gross income, deductions, credits, or
        allowances between or among such
72                 ALTERA CORP. V. CIR

       organizations . . . if he determines that such
       distribution, apportionment, or allocation is
       necessary in order to prevent evasion of taxes
       or clearly to reflect the income of any of such
       organizations, trades, or businesses. In the
       case of any transfer (or license) of intangible
       property (within the meaning of section
       367(d)(4)), the income with respect to such
       transfer or license shall be commensurate with
       the income attributable to the intangible.

Section 482 (emphases added). It is undisputed that the first
sentence of the statute requires an arm’s length analysis; even
the majority agrees with that longstanding principle. As
previously explained, moreover, at the time Congress
amended § 482, the arm’s length standard was understood to
require a comparability analysis. But, because transfers of
intangible property oftentimes lacked comparable
transactions, Congress added a second sentence to the statute.
This sentence allows the Secretary to apply the commensurate
with income standard to reach an arm’s length result in the
case of any transfer of intangible property.

    The Commissioner contends, based on Treasury’s
purported belief that QCSAs are transfers of intangible
property, that Treasury correctly interpreted § 482 to require
that controlled companies share the cost of stock-based
compensation. But, as noted above, Treasury never made,
much less supported, a finding that QCSAs constitute
transfers of intangible property. We cannot and should not
conclude that the Commissioner’s post-hoc interpretation
would be permissible when Treasury never articulated such
an interpretation.     Even if it had, Treasury’s own
characterization of QCSAs as arrangements “for the
                   ALTERA CORP. V. CIR                      73

development of high-profit intangibles” contradicts any
conclusion that QCSAs constitute transfers of already
existing intangible property. 68 Fed. Reg. at 51,173
(emphasis added). No rights are transferred when parties
enter into an agreement to develop intangibles; this is because
the rights to later-developed intangible property would spring
ab initio to the parties who shared the development costs
without any need to transfer the property. And, there is no
guarantee when the cost-sharing arrangements are entered
into that any intangible will, in fact, be developed. In such
circumstances, Treasury should not have employed the
commensurate with income standard.

    The majority attempts to justify Treasury’s departure
from the comparability analysis in these circumstances by
stating it was reasonable for Treasury to “determin[e] that
uncontrolled cost-sharing arrangements,” such as those
submitted by the commentators, “do not provide helpful
guidance regarding allocations of employee stock
compensation.” Op. 28. According to the majority, the
legislative history “makes clear” that Congress “intended the
commensurate with income standard to displace a
comparability analysis where comparable transactions cannot
be found.” Op. 13. This reasoning fails for several reasons.

    As noted, the text of the statute provides that Treasury
may employ the commensurate with income standard only in
the case of a transfer or license of intangible property—not
whenever Treasury finds that uncontrolled transactions fail to
provide helpful guidance. Congress did not leave a gap in the
statute allowing Treasury to choose when one methodology
displaces the other. Rather, it made its own findings
regarding the relative helpfulness of comparable uncontrolled
transactions in the case of a transfer or license of intangible
74                  ALTERA CORP. V. CIR

property. It then amended § 482 to allow for the use of the
commensurate with income methodology in those specific
cases, but not in others. Congress’s findings in the legislative
history do not invite Treasury to make its own determinations
regarding the helpfulness of other uncontrolled transactions.
Nor do they allow Treasury to expand the category of cases
in which the commensurate with income standard would
apply when the statutory text states otherwise. Here,
Treasury’s only justification for eschewing the comparability
analysis was its insistence that the legislative history allows
it to disregard comparable transactions that it deems
imperfect. This rationale is inconsistent with the plain text of
the statute and thus, is impermissible under Chevron.

    Even if Treasury could dispense with a comparability
analysis whenever it believed no comparables exist, that
interpretation would still fail step two of Chevron because
uncontrolled comparable transactions do exist here. Even the
majority acknowledges Treasury’s view that a different
methodology may only be applied “when comparable
transactions do not exist.” Op. 41 n.9 (emphasis added).
Treasury itself explained, in effect, that a precondition for the
applicability of the commensurate with income standard is
the lack of real-world comparable transactions with which to
make an arm’s length comparison. Such transactions, as
Treasury admitted, would “ordinarily provide significant
evidence in determining whether a controlled transaction
meets the arm’s length standard.” 68 Fed. Reg. at 51,173.
According to the majority, however, imperfect comparables
are tantamount to the absence of comparables.

    But the arm’s length standard of § 482 does not require
perfectly identical transactions—only comparable ones. As
Altera notes, the Commissioner cannot “avoid the statutory
                   ALTERA CORP. V. CIR                      75

limits on his ability to reallocate income by asserting that a
related-party transaction is fundamentally different from all
similar transactions between unrelated parties by virtue of the
very fact that the parties are related.” Appellee’s Suppl.
Br. 33. Such an interpretation would allow Treasury to
dispense with the comparability analysis altogether because
related parties, by virtue of common ownership, are always
positioned differently than unrelated parties. Legislative
history can only do so much—if any—work, and it certainly
cannot set out an exception that swallows a rule codified by
statute.

    Even if Treasury were correct that no comparable
transactions exist, Treasury’s reasoning would still fail.
Treasury concluded that it could allocate costs because there
were no transactions in which parties at arm’s length would
even consider taking stock options into account in the context
of an arrangement similar to a QCSA. See 68 Fed. Reg.
at 51,173. But the absence of evidence is not evidence of
absence. Indeed, the absence of any comparable transactions
could itself mean that uncontrolled taxpayers would not share
the costs of stock-based compensation. Treasury believes,
however, that uncontrolled taxpayers would not enter into
such transactions, and, rather than find the absence of such
transactions meaningful to a comparison, believes it is
justified in using different methodologies to assess income.
But the fact that evidence of the absence of comparable
transactions might support more favorable tax treatment does
not mean that no comparison can be made.

    Finally, while Treasury’s interpretation of § 482 is
“entitled to no less deference . . . simply because it has
changed over time, . . . the agency must nevertheless engage
in reasoned analysis sufficient to command our deference.”
76                  ALTERA CORP. V. CIR

Good Fortune Shipping SA v. Comm’r of Internal Rev. Serv.,
897 F.3d 256, 263 (D.C. Cir. 2018) (internal quotations and
citations omitted); Judalang v. Holder, 132 S. Ct. 476, 483
n.7 (2011) (clarifying that the court’s analysis of whether an
agency provided a reasoned explanation under State Farm
and its analysis of whether an agency’s interpretation is
permissible under Chevron step two is “the same, because
under Chevron step two, we ask whether an agency
interpretation is ‘arbitrary or capricious in substance’”). Such
a reasoned explanation, at a minimum, requires Treasury to
“display awareness that it is changing position.” Good
Fortune Shipping, 897 F.3d at 263 (quoting Fox, 556 U.S.
at 515). “An agency may not, for example, depart from a
prior policy sub silentio or simply disregard rules that are still
on the books.” Fox, 556 U.S. at 515. And an agency may
need to “provide a more detailed justification than what
would suffice for a new policy created on a blank slate . . .
when, for example, . . . its prior policy has engendered serious
reliance interests that must be taken into account.” Id. (citing
Smiley v. Citibank (S.D.), N.A., 517 U.S. 736, 742 (1996)).
“‘Unexplained inconsistency’ between agency actions is ‘a
reason for holding an interpretation to be an arbitrary and
capricious change.’” Organized Vill. of Kake v. USDA,
795 F.3d 956, 966 (9th Cir. 2015) (en banc) (quoting Nat’l
Cable & Telecomms. Ass’n v. Brand X Internet Servs.,
545 U.S. 967, 981 (2005)).

    As this court held in Xilinx II, the previous regulations
preserved the primacy of the arm’s length standard and its
requirement of comparability analysis. See Xilinx II,
598 F.3d at 1195–96 (explaining the then-operative version
of Treas. Reg. § 1.482-1). In amending those regulations,
however, Treasury never indicated—either in the notice of
proposed rulemaking or in the preamble accompanying the
                    ALTERA CORP. V. CIR                      77

final rule—any awareness that it was changing course.
Treasury instead repeated its previous policy that it need not
conduct a comparability analysis where no comparable
transactions can be found. See 68 Fed. Reg. at 51,172–73. It
then ignored existing comparable transactions to reach what
it claimed was “an arm’s length result.” Id.

    The majority contends that this does not constitute a
change because, “historically[,] the definition of the arm’s
length standard has been a more fluid one.” Op. 29. But, as
explained above, the comparability analysis has always been
a defining aspect of the arm’s length standard. The mere fact
that Treasury may have been inconsistent in the way it has
applied the arm’s length standard, as the majority contends,
does not mean that the statute permits a fluid definition of the
standard. City of Arlington v. FCC, 569 U.S. 290, 327 (2013)
(Roberts, C.J., dissenting) (“We do not leave it to the agency
to decide when it is in charge.”). Because Treasury departed
from the comparability analysis and failed to provide a
reasoned explanation for why the commensurate with income
standard is permissible under the statute, I would find that
Treasury’s regulations constitute an impermissible
interpretation of the statute at Chevron step two.

  C. Stock-based Compensation Is Not a Shared Cost
                 Under Section 482

     Because I would find that Treasury’s regulations are
procedurally and substantively defective, I would interpret the
statute in the first instance, without deference. Encino
Motorcars, LLC v. Navarro, 136 S. Ct. 2117, 2125 (2016)
(“Chevron deference is not warranted where the regulation is
procedurally defective—that is, where the agency errs by
failing to follow the correct procedures in issuing the
78                  ALTERA CORP. V. CIR

regulation.” (internal quotations and citations omitted)); Util.
Air Regulatory Grp. v. EPA, 573 U.S. 302, 321 (2014) (“[A]n
agency interpretation that is inconsistent with the design and
structure of the statute as a whole does not merit deference.”
(internal citations and quotations omitted)).

    Because I would find the 2003 regulations were invalid,
I believe that this court’s decision in Xilinx II controls, and
that the Tax Court properly entered judgment in favor of
Altera. Altera, 145 T.C. at 134. Even if Xilinx II did not
control, I would hold that related parties in QCSAs need not
share costs associated with stock-based compensation.

    I agree with the majority that § 482 does not address this
issue expressly. But I agree with amicus curiae Cisco
Systems, Inc. (“Cisco”), that, under the best reading of § 482,
QCSAs are not subject to the commensurate with income
standard. As Cisco points out, the commensurate with
income standard applies only to a “transfer (or license) of
intangible property,” § 482, which is distinct from a cost
sharing agreement for the joint development of intangibles,
see White Paper, 1988-1 C.B. at 474 (noting that “bona fide
research and development cost sharing arrangements” provide
a way to “avoid[] section 482 transfer pricing issues related
to the licensing or other transfer of intangibles”). The plain
meaning of “transfer” indicates shifting ownership of an
existing right from one party to another. But under a cost-
sharing arrangement, parties agree to develop intangibles
together. Because the intangible does not exist at the time the
cost sharing arrangement is entered into, there can be no
transfer either.

   The majority contends that Congress’s choice to use the
word “any” is significant. It reasons that, because “§ 482
                   ALTERA CORP. V. CIR                     79

applies ‘[i]n the case of any transfer . . . of intangible
property,’” the statute “cannot reasonably be read to exclude
the transfers of expected intangible property.” Op. 26. But,
while “any” can be a broadening modifier, it must be read in
the context of its surrounding text. Cf. United States v.
Gonzales, 520 U.S. 1, 5 (1997) (finding that use of “any”
modifies the term it precedes.); see Ali v. Fed. Bureau of
Prisons, 552 U.S. 214, 226 (2008) (narrowing the effect of
“any” based on the context in which it appears because “a
word is known by the company it keeps.” (internal citations
and quotations omitted)).

    Here, “any” does not modify “intangible property.”
Rather, it precedes and thus, applies only to “transfer.” This
indicates that, while the statutory text may cover any kind of
transfer, including expected transfers, it does not cover any
kind of intangible property—say, for example, intangible
property that does not yet exist. Indeed, § 482 expressly
defines the term “intangible property” by referencing the
definition provided in § 367(d)(4). See § 482 (“. . . any
transfer (or license) of intangible property (within the
meaning of section 367(d)(4)).” (emphasis added)). We need
not guess at whether Congress intended a broad reading of the
term because § 367(d)(4) enumerates specific categories of
intangible property covered under the statute, and none of
those categories contemplates the mere possibility that
intangible property may someday exist.

    While “any” may modify “transfer,” moreover, QCSAs
do not provide for future transfers; rather, as noted above,
rights to later-developed intangible property—if ever
developed—would spring ab initio to the parties who shared
the development costs and would thereby dispense with any
need to transfer those rights at some time in the future. I
80                 ALTERA CORP. V. CIR

would conclude, absent additional evidence to conclude
otherwise, that QCSAs are not transfers subject to the
commensurate with income standard under § 482.

     Rather, I would find that QCSAs are governed under the
first sentence of § 482 and that Treasury may only allocate
the cost of stock-based compensation among related
companies if unrelated companies dealing at arm’s length
would do so under comparable circumstances. The evidence
of comparable transactions submitted by commentators
demonstrates that unrelated companies do not and would not
share such costs. Thus, I would hold that an arm’s length
result is one in which related parties in QCSAs do not share
costs associated with stock-based compensation.

     The Commissioner contends that the backdrop against
which Congress enacted the 1986 amendment demonstrates
that Congress intended § 482 to require related companies to
share stock-based compensation. But, as the majority admits,
“[n]either the Tax Reform Act nor the implementing
regulations specifically addressed allocation of employee
stock compensation.” Op. 17. This is because the practice of
providing stock-based compensation did not develop on a
major scale until the 1990s—after Congress passed the 1986
amendment. Therefore, Congress could not have been
legislating against the backdrop of this particular type of tax
avoidance. While it may choose to address this practice now,
it cannot be deemed to have done so then.

     Not all forms of tax avoidance amount to illegal tax
evasion. The very definition of a loophole is a gap in the law
or a set of rules. While Treasury may promulgate regulations
to close such gaps, it must do so in a manner consistent with
its statutory authority under the Tax Reform Act and with the
                   ALTERA CORP. V. CIR                      81

procedures outlined in the APA. When it fails to comply with
those requirements, its actions cannot be justified by the mere
existence of the loophole. In other words, an arm’s length
result is not simply any result that maximizes one’s tax
obligations. For these reasons, I dissent.