                    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,
            Respondent-Appellant.                    ORDER


                   Filed November 12, 2019

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

                           Order;
             Dissent by Judge Milan D. Smith, Jr.




    *
      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 denied a petition for rehearing en banc on
behalf of the court in a case in which the panel reversed the
decision of the Tax Court.

    Judge M. Smith, joined by Judges Callahan and Bade,
dissented from the denial of rehearing en banc. Title 26 of
United States Code § 482 authorizes the Department of
Treasury to re-allocate reported income and costs between
related entities where necessary to prevent them from
improperly avoiding taxes. Judge M. Smith agreed with the
Tax Court’s unanimous conclusion that the Treasury’s
implementing regulation § 1.482-7(d)(2) constituted
arbitrary and capricious rulemaking in violation of the
Administrative Procedure Act. Judge M. Smith observed
that, in addition to being wrongly decided, the majority’s
decision engenders deleterious practical consequences,
threatens the uniform enforcement of the Tax Code, invites
an effective circuit split, ignores the reasonable reliance of
businesses on the well-settled arm’s length standard and
subjects those businesses to double taxation, lowers the bar
for compliance with the Administrative Procedure Act, and
sends a signal that executive agencies can bypass proper
notice-and-comment         procedures     through    post-hoc
rationalization.




    **
       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

                       COUNSEL

Arthur T. Catterall (argued), Richard Farber, Gilbert S.
Rothenberg, and Francesca Ugolini, 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,
Travis Crum, and Nicole A. Saharsky, Mayer Brown LLP,
Washington, D.C.; A. Duane Webber, Phillip J. Taylor, and
Joseph B. Judkins, Baker & McKenzie LLP, Washington,
D.C.; Ginger D. Anders, Munger Tolles & Olson LLP,
Washington, D.C.; Mark R. Yohalem, Munger Tolles &
Olson LLP, Los Angeles, California; for Petitioner-
Appellee.

Susan C. Morse, University of Texas Law School, Austin,
Texas; Stephen E. Shay and Allison Bray, Certified Law
Students, Harvard Law School, Cambridge, Massachusetts;
Clinton G. Wallace, Columbia, South Carolina; and Leandra
Lederman, Bloomington, Indiana; for Amici Curiae Law
Academics and Professors.

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.
4                 ALTERA CORP. V. CIR

Larissa B. Neumann, Ronald B. Schrotenboer, Kenneth B.
Clark, Adam R. Gahtan, and Michael D. Knobler, 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.

Charles G. Cole, Alice E. Loughran, Michael C. Durst,
Gregory N. Kidder, and Mark C. Savignac, Steptoe &
Johnson LLP, Washington, D.C.; Bennett Evan Cooper,
Steptoe & Johnson LLP, Phoenix, Arizona; Alexander
Volokh, Emory University School of Law, Atlanta, Georgia;
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 Council, Biotechnology Innovation
Organization, Computing Technology Industry Association,
The Tax Council, United States Council for International
Business, and 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.
                  ALTERA CORP. V. CIR                    5

Roderick K. Donnelly and Neal A. Gordon, Morgan Lewis
& Bockius LLP, Palo Alto, California; Thomas M. Peterson,
Morgan Lewis & Bockius LLP, San Francisco, California;
Michelle L. Andrighetto, Morgan Lewis & Bockius LLP,
Boston, Massachusetts; Justin McGough, 3M Company,
Saint Paul, Minnesota; Karen Robinson, Vice President,
Legal, Adobe Inc., San Jose, California; Theodore J.
Boutrous Jr. and Christopher Chorba, Gibson Dunn &
Crutcher LLP (for Apple Inc.), Los Angeles, California;
Armin D. Eberhard, Director, International Tax Planning
and M&A, Applied Materials, Santa Clara, California;
Desiree Ralls-Morrison, SVP, General Counsel & Corporate
Secretary, Boston Scientific Corporation, Marlborough,
Massachusetts; Thomas J. Vallone, Senior Vice President,
Global Tax, Dell Technologies Inc., Round Rock, Texas;
Andy Sherman, Dolby Laboratories Inc., San Francisco,
California; Aaron Johnson, VP Legal, eBay, San Jose,
California; Jacob Schatz, EVP, General Counsel and
Corporate Secretary, Electronic Arts Inc., Redwood City,
California; Katie Lodato, Vice President – Global Tax, Eli
Lilly and Company, Indianapolis, Indiana; Dana L. Lasley,
Emerson Electric Co., St. Louis, Missouri; Paul S. Grewal,
VP & Deputy General Counsel, Facebook Inc., Menlo Park,
California; John Whittle, Executive Vice President, General
Counsel, Fortinet, Sunnyvale, California; Christine
Henninger, General Mills Inc., Golden Valley, Minnesota;
Nora Puckett, Google LLC, Mountain View, California;
Kyle Bonacum, GoPro Inc., San Mateo, California; Joshua
Mishoe, Vice President, Hewlett Packard Enterprise
Company, Plano, Texas; Barbara Beckerman, International
Paper Company, Memphis, Tennessee; Michael R. Peterson,
President and Corporate Secretary, Johnson Controls Inc.;
Mark Casper, Vice President and Deputy General Counsel,
Maxim Integrated, San Jose, California; Matthew Fawcett,
General Counsel, NetApp Inc., Sunnyvale, California;
6                 ALTERA CORP. V. CIR

Margaret C. Wilson, Wilson Law Group LLC (for Oracle
Corporation), Princeton, New Jersey; Maryanne Bifulco,
Vice President, Transfer Pricing Counsel, PepsiCo Inc.,
Purchase, New York; Markus Green, Assistant GC,
Government Relations/Litigation, Pfizer Inc., New York,
New York; Lowell Yoder, McDermott Will & Emery (for
Procter and Gamble Company), Chicago, Illinois; Beth
Wapner, VP Tax, Qualcomm Incorporated, San Diego,
California; Tanya Guazzo, S&P Global Inc., New York,
New York; Russell Elmer, ServiceNow Inc., Santa Clara,
California; Lora Blum, General Counsel, SurveyMonkey,
San Mateo, California; Scott C. Taylor, EVP, General
Counsel & Secretary, Symantec Corporation, Mountain
View, California; Donald P. Lancaster, United Parcel
Service Inc., Atlanta, Georgia; Lisa McFall, VP & Deputy
General Counsel, Workday Inc., Pleasanton, California; for
Amicus Curiae Cisco Systems Inc. and Thirty-Two Other
Affected Companies.

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.

Miriam L. Fisher, Melissa Arbus Sherry, and Eric J.
Konopka, Latham & Watkins LLP, Washington, D.C., for
Amici Curiae PricewaterhouseCoopers LLP, Deloitte Tax
LLP, and KPMG LLP.
                    ALTERA CORP. V. CIR                       7

                           ORDER

    The full court has been advised of the petition for
rehearing en banc. A judge requested a vote on whether to
rehear the matter en banc. The matter failed to receive a
majority of the votes of the nonrecused active judges in favor
of en banc consideration. Fed. R. App. P. 35. Judges
McKeown, Wardlaw, Bybee, Bea, Watford, Owens,
Friedland, Miller, Collins, and Lee were recused and did not
participate in the vote.

    The petition for rehearing en banc is denied. Attached is
the dissent from and statements respecting the denial of
rehearing en banc.



M. SMITH, Circuit Judge, with whom CALLAHAN and
BADE, Circuit Judges, join, dissenting from the denial of
rehearing en banc:

    Neither the laudable goal of preventing tax evasion nor
the prospect of adding billions of dollars to the public coffers
excuses the Department of the Treasury from complying
with the Administrative Procedure Act. In 2003, Treasury
promulgated a tax rule with no reasoned basis for its
decision, pursuant to an explanation that ran contrary to the
evidence before it. In 2019, a divided panel of our court
upheld that rule based on a novel interpretation of the
relevant statute, which Treasury developed only as an
appellate litigating position, and which was never subject to
notice and comment. As recognized by the unanimous en
banc Tax Court, Treasury’s actions in this case are the
epitome of arbitrary and capricious rulemaking. The panel
majority’s decision tramples on the reliance interests of
American businesses, threatens the uniform enforcement of
8                     ALTERA CORP. V. CIR

the Tax Code, and drastically lowers the bar for compliance
with the Administrative Procedure Act.

    I respectfully dissent from our court’s denial of rehearing
en banc. 1

                                  I.

    For almost a century, Congress has authorized Treasury
to recalculate the taxes of related entities based on what their
taxes would look like if they were unrelated entities. For the
past fifty years, Treasury has made this determination by
analyzing whether the results of a transaction between
related entities are consistent with the results of a
comparable transaction between entities operating at arm’s
length. When a transaction does not meet this arm’s length
standard, Treasury adjusts it for tax purposes by re-
allocating the related entities’ costs and income.

    In the late-1990s, Treasury decided that stock-based
compensation—then a new phenomenon—was a type of
cost it wanted to re-allocate under these calculations. The
problem was, and remains, that unrelated entities do not
share stock-based compensation costs. Treasury’s first
attempt at such a re-allocation was therefore thrown out by
the Tax Court and by this court because it was contrary to
Treasury’s own regulations calling for application of the
arm’s length standard. Perhaps preemptively recognizing
this defect on the very face of its rules, Treasury attempted a
mid-litigation cure of simply adding a cross reference to its



    1
       Judges McKeown, Wardlaw, Bybee, Bea, Watford, Owens,
Friedland, Miller, Collins, and Lee were recused from consideration of
en banc rehearing in this matter.
                        ALTERA CORP. V. CIR                                 9

arm’s length standard provision. That attempted cure is the
2003 rulemaking challenged here.

                                     A.

    In 1928, Congress enacted 26 U.S.C. (“I.R.C.”) § 482 to
authorize Treasury to re-allocate reported income and costs
between related entities where necessary to prevent them
from improperly avoiding taxes by, for instance, shifting
income to lower tax foreign jurisdictions. See H.R. Rep. No.
70-2, at 16–17 (1927); Comm’r v. First Sec. Bank of Utah,
N.A., 405 U.S. 394, 400 (1972). Treasury soon promulgated
regulations specifying that “[t]he 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). 2

    In 1968, Treasury promulgated regulations specific to
“qualified cost-sharing arrangements” (QCSAs) 3, such as
the research and development agreement at issue in this case.
See 33 Fed. Reg. 5848 (April 16, 1968). Treasury 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
    2
      An “uncontrolled” taxpayer is distinguished from a “controlled”
taxpayer, defined as “any one of two or more taxpayers owned or
controlled directly or indirectly by the same interests, . . . includ[ing] the
taxpayer that owns or controls the other taxpayers.” Treas. Reg.
§ 1.482–1(i)(5).

     3
       Designation of a cost-sharing agreement as a QCSA allows
participating entities to share the costs of developing intangible property
without incurring partnership taxation, and without any foreign
participants incurring taxes for doing business in the United States.
Treas. Reg. § 1.482-7A(a)(1).
10                     ALTERA CORP. V. CIR

been adopted by unrelated parties similarly situated had they
entered into such an arrangement.” Id. at 5854. The arm’s
length standard thus requires an “essentially and intensely
factual” inquiry that looks to comparable transactions
between non-related entities to ensure tax parity. Procacci
v. Comm’r, 94 T.C. 397, 412 (1990).

    In 1986, Congress amended § 482 to address the
valuation of transfers of intangible property, 4 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.” I.R.C. § 482. This amendment appeared
to introduce a new standard for allocating costs—a
“commensurate with income” standard—which might have
constituted a departure from the traditional arm’s length
analysis. But soon after, in 1988, Treasury dispelled such
notions by publishing what came to be known as the “White
Paper.” See A Study of Intercompany Pricing Under Section
482 of the Code, I.R.S. Notice 88-123, 1988-2 C.B. 458. The
phrase “arm’s length standard” appears throughout the
White Paper, which reiterated that “intangible income must
be allocated on the basis of comparable transactions if
comparables exist.” Id. at 474 (emphasis added). In short,
although the amended § 482 referenced a seemingly
unfamiliar “commensurate with income” standard, the

     4
      At the time the regulation challenged in this case was promulgated,
“intangible property” was defined by a list of items that included any
“patent, invention, formula, process, design, pattern, or know-how,”
“copyright,” “trademark,” “license,” and so forth. I.R.C. § 936(h)(3)(B)
(1996). In 2017, Congress amended the definition to include “goodwill,
going concern value, . . . workforce in place,” and other items whose
value is “not attributable to tangible property or the services of any
individual.” I.R.C. § 367(d)(4).
                      ALTERA CORP. V. CIR                           11

White Paper emphasized that “Congress intended no
departure from the arm’s length standard”—which is to say,
an analysis based on comparability. Id. at 475. 5

                                  B.

    In 1995, Treasury promulgated a regulation requiring
participants in a QCSA to share “all of the costs” of
developing intangibles. Treas. Reg. § 1.482-7(d)(1) (1995).
Beginning in 1997, Treasury interpreted stock-based
compensation to be such a cost. See Xilinx, Inc. v. Comm’r,
598 F.3d 1191, 1193–94 (9th Cir. 2010).

    Xilinx, Inc. challenged this interpretation, and the Tax
Court ruled in Xilinx’s favor. Xilinx, Inc. v. Comm’r,
125 T.C. 37, 62 (2005). The Tax Court found as a factual
matter that “two unrelated parties in a cost sharing
agreement would not share any costs related to [stock-based
compensation].” Xilinx, 598 F.3d at 1194. At the same time,
it found that Treas. Reg. § 1.482-1(b)(1)—i.e., the arm’s
length standard—still controlled over Treasury’s new all
costs regulation. Id. It therefore found Treasury’s re-


    5
      Significantly, Congress prompted the creation of the White Paper
at the same time it added the “commensurate with income” standard to
§ 482. See H.R. Rep. No. 99-841, at 637–38 (1986) (Conf. Rep.), as
reprinted in 1986 U.S.C.C.A.N. 4075, 4725–26. Specifically, Congress
“believe[d] that a comprehensive study of intercompany pricing rules by
the Internal Revenue Service should be conducted and that careful
consideration should be given to whether the existing regulations could
be modified in any respect.” Id. at 638, as reprinted in 1986
U.S.C.C.A.N. at 4726. The resulting study—the White Paper—clearly
stated that “the commensurate with income standard is fully consistent
with the arm’s length principle,” and that “intangible income must be
allocated on the basis of comparable transactions if comparables exist.”
1988-2 C.B. at 458, 474.
12                     ALTERA CORP. V. CIR

allocation of Xilinx’s stock-based compensation costs to be
arbitrary and capricious. Id.

    Our court affirmed the Tax Court, noting that the
“purpose of the regulations is parity between taxpayers in
uncontrolled transactions and taxpayers in controlled
transactions,” which is determined “based on how parties
operating at arm’s length would behave.” Id. at 1196.
Because Treasury “d[id] not dispute” that “unrelated parties
would not share [stock-based compensation],” we concluded
that Treasury could not require related parties to share it. Id.
at 1194, 1196. We therefore found the all costs provision
inoperative.

     In his concurrence, Judge Fisher noted that Treasury’s
defense of the all costs provision relied on a rationale “not
clearly articulated . . . until” the commencement of
litigation. Id. at 1198 (Fisher, J., concurring). Judge Fisher
was “troubled by the complex, theoretical nature of many of
[Treasury’s] arguments . . . . Not only does this make it
difficult for the court to navigate the regulatory framework,
it shows that taxpayers have not been given clear, fair notice
of how the regulations will affect them.” Id. 6

     6
        Judge Reinhardt dissented, finding instead that the paramount
purpose of the regulations is preventing tax avoidance, and noting that
tax law is not always fair or reasonable to businesses. Id. at 1199–1200
(Reinhardt, J., dissenting). Judge Reinhardt would have resolved the
case in favor of Treasury by holding that the specific all costs provision
(i.e. specifically addressing QCSAs) takes precedence over the general
arm’s length standard. Id. at 1199.

    Judge Reinhardt also sat on the original panel in this case. See
Altera Corp. v. Comm’r, No. 16-70496, 2018 WL 3542989 (9th Cir. July
24, 2018), withdrawn, 898 F.3d 1266 (9th Cir. 2018). There he
concurred with the majority, again in favor of Treasury, but on the
                        ALTERA CORP. V. CIR                               13

                                     C.

    In 2003, while the Xilinx litigation concerning the 1995
regulation was pending, Treasury published a rule codifying
its decision that QCSA parties should share stock-based
compensation costs. To achieve this, Treasury updated the
arm’s length standard provision, Treas. Reg. § 1.482-1, with
a cross-reference to its 1995 “all of the costs” provision, id.
§ 1.482-7, 7 and specifically defined “operating expenses”
thereunder to include stock-based compensation, id.
§ 1.482-7(d)(2).    Compensatory Stock Options Under
Section 482, 68 Fed. Reg. 51,171, 51,178 (Aug. 26, 2003).
Treasury purported 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,” because
“unrelated parties entering into QCSAs would generally
share stock-based compensation costs.” Id. at 51,173.

                                     II.

    During the 2004–2007 taxable years, Appellee Altera
Corporation (Altera) shared certain costs with one of its
foreign subsidiaries, Altera International, pursuant to a
research and development cost-sharing agreement. Relying

ground that the meaning of the arm’s length standard is so fluid as to
permissibly encompass the all costs method. That opinion, published
four months after Judge Reinhardt passed away, was ultimately
withdrawn. Yovino v. Rizo, 139 S. Ct. 706, 707 n.* (2019) (per curiam);
see id. at 710 (“[F]ederal judges are appointed for life, not for eternity.”).
The majority opinion of the reconstituted panel essentially adopted the
reasoning of the original panel.
    7
      Subsequent to the 2003 amendments at issue, the Treasury
Regulations have been re-organized and Treas. Reg. § 1.482-7 is now
§ 1.482-7A.
14                 ALTERA CORP. V. CIR

on the Tax Court’s 2005 decision in Xilinx, the companies
did not share the costs of stock-based compensation. After
Altera filed consolidated income tax returns for these years,
Treasury issued notices of deficiency on the grounds that it
had to re-allocate over $100 million in income from Altera
International to Altera to account for the unshared costs of
stock-based compensation. Treasury asserted that this re-
allocation was necessary under Treas. Reg. § 1.482-7(d)(2).
Altera timely filed petitions in the Tax Court.

                             A.

     In a unanimous 15–0 decision, the Tax Court agreed with
Altera and concluded that the regulation is arbitrary and
capricious. Altera Corp. v. Comm’r, 145 T.C. 91, 133–34
(2015). The Tax Court determined that, during the
rulemaking process, Treasury specifically justified its new
stock-based compensation rule on the ground that it “was
required by—or was at least consistent with—the arm’s-
length standard.” Id. at 121 & n.17 (citing 68 Fed. Reg.
at 51,173 (“The 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.”)). By contrast, the Tax Court found that
Treasury did not rely on § 482’s “commensurate with
income” language, nor could this language sustain an
inconsistent rule in any event given Congress’s intent for it
to work “consistently with the arm’s-length standard.” Id.
(citing White Paper at 472, 475).

    The Tax Court therefore proceeded to analyze whether
Treasury had articulated a reasoned basis for its conclusion
that “unrelated parties entering into QCSAs would generally
share stock-based compensation costs.” Id. at 123 (citing
68 Fed. Reg. at 51,173). It found that the administrative
record contained no empirical data supporting such a
                    ALTERA CORP. V. CIR                      15

conclusion, that Treasury had made no attempt to search for
evidence supporting such a conclusion, and that Treasury
was unaware of any actual transaction illustrating such a
result. Id. at 122–23. To the contrary, the Tax Court noted
that Treasury “seemed to accept the commentators’
economic analyses, which concluded that . . . unrelated
parties to a QCSA would be unwilling to share the exercise
spread or grant date value of stock-based compensation.” Id.
at 131. The Tax Court therefore found that “Treasury’s
‘explanation for its decision . . . runs counter to the evidence
before’ it.” Id. (alteration in original) (quoting Motor
Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto.
Ins. Co., 463 U.S. 29, 43 (1983)). It further concluded that
“Treasury’s ‘ipse dixit conclusion, coupled with its failure to
respond to contrary arguments resting on solid data,
epitomizes arbitrary and capricious decisionmaking.’” Id.
at 134 (quoting Ill. Pub. Telecomms. Ass’n v. FCC, 117 F.3d
555, 564 (D.C. Cir. 1997)).

                              B.

    Treasury appealed, and a divided panel of this court
reversed. Altera Corp. v. Commissioner, 926 F.3d 1061,
1087 (9th Cir. 2019). On appeal, Treasury adopted a new
position: that its 2003 rule was justified not because
unrelated parties would actually share costs in the manner
the rule now specifies, but because Treasury no longer needs
to consider the behavior of unrelated parties at all.
Treasury’s new theory is that it can allocate costs under a
QCSA based on a standard purely internal to the participants,
with no analysis of comparable transactions between
unrelated entities, and call this an arm’s length result. The
majority, applying Chevron, U.S.A., Inc. v. Natural
Resources Defense Council, Inc., 467 U.S. 837 (1984),
found that this revised interpretation of § 482 is permissible.
16                 ALTERA CORP. V. CIR

Altera, 926 F.3d at 1075–78. It further concluded that
“Treasury’s decision to do away with analysis of comparable
transactions” was neither arbitrary nor capricious, because it
“was made clear enough by citations to legislative history in
the notice of proposed rulemaking and in the preamble to the
final rule.” Id. at 1082. Because Treasury abandoned the
comparability standard, the majority explained, it was not
required to address public comments that emphasized the
absence of stock-based compensation cost-sharing in
comparable transactions. Id.

    Judge O’Malley dissented, noting that “Treasury
repeatedly recognized that I.R.C. § 482 requires application
of an arm’s length standard when determining the true
taxable income of a controlled taxpayer,” and “just as
consistently asserted that a comparability analysis is the only
way to determine the arm’s length standard.” Id. at 1087
(O’Malley, J., dissenting). She concluded that Treasury
could not depart from this well-settled rule using only “a
justification Treasury never provided [during the rulemaking
process] and one which does not withstand careful scrutiny.”
Id. Judge O’Malley further concluded that the regulation is
arbitrary and capricious; that the regulation would be
impermissible under Chevron even if Treasury had not erred
procedurally; and that, because the regulation is invalid, our
decision in Xilinx controls. Id. at 1092–1101.

                             III.

    Under the APA, we must “hold unlawful and set aside
agency action” that is “arbitrary, capricious, an abuse of
discretion, or otherwise not in accordance with law.”
5 U.S.C. § 706(2)(A). An agency’s rule is arbitrary and
capricious when it “offer[s] an explanation for its decision
that runs counter to the evidence before” it. State Farm,
463 U.S. at 43. “The reviewing court should not attempt
                   ALTERA CORP. V. CIR                      17

itself to make up for such deficiencies: ‘We may not supply
a reasoned basis for the agency’s action that the agency itself
has not given.’” Id. (quoting SEC v. Chenery Corp.,
332 U.S. 194, 196 (1947)). As recently emphasized by the
Supreme Court, “[w]e cannot ignore [a] disconnect between
the decision made and the explanation given. Our review is
deferential, but we are ‘not required to exhibit a naiveté from
which ordinary citizens are free.’” Dep’t of Commerce v.
New York, 139 S. Ct. 2551, 2575 (2019) (quoting United
States v. Stanchich, 550 F.2d 1294, 1300 (2d Cir. 1977)
(Friendly, J.)).

                              A.

    By its own account, Treasury’s 2003 rulemaking was an
attempted application of the traditional arm’s length
standard. Reviewing the 2003 rule on this basis, as we must,
Treasury acted arbitrarily and capriciously because its
“explanation for its decision [ran] counter to the evidence
before” it. State Farm, 463 U.S. at 43.

    Treasury’s explanation for its decision during the
rulemaking process was that allocating stock-based
compensation costs was justified because “unrelated parties
entering into QCSAs would generally share stock-based
compensation costs.” 68 Fed. Reg. at 51,173. Treasury
considered this relevant because “[t]he regulations relating
to QCSAs have as their focus reaching 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. Treasury asserted that
“[p]arties dealing at arm’s length in [a QCSA] based on the
sharing of costs and benefits generally would not distinguish
between stock-based compensation and other forms of
compensation.” Id. In conclusion, Treasury emphasized
that “[t]he final regulations provide that stock-based
18                 ALTERA CORP. V. CIR

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).

    As the unanimous Tax Court rightly concluded,
Treasury’s stated reasons for concluding that the sharing of
stock-based compensation costs was required by the arm’s
length standard were belied by the evidence. Altera,
145 T.C. at 131. Treasury “fail[ed] to cite any evidence
supporting its belief that unrelated parties to QCSAs would
share stock-based compensation costs,” commentators
submitted “significant evidence . . . showing that unrelated
parties to QCSAs would not share stock-based compensation
costs,” and Treasury “fail[ed] to respond to much of the
submitted evidence.” Id. As a result, the administrative
record contained no empirical data supporting Treasury’s
conclusion. Id. at 122–23. Indeed, Treasury had made no
attempt to search for evidence supporting its conclusion, and
was unaware of any actual transaction in which unrelated
parties had shared stock-based compensation costs. Id.

    This “disconnect between the decision made and the
explanation given” requires that we vacate Treasury’s rule
as arbitrary and capricious. Dep’t of Commerce, 139 S. Ct.
at 2575. This should be the end of our analysis.

                             B.

    The panel majority’s opinion impermissibly upholds the
2003 rule based on a host of rationales and interpretive
maneuvers amounting to “a [purportedly] reasoned basis for
the agency’s action that the agency itself has not given.”
State Farm, 463 U.S. at 43 (quoting Chenery, 332 U.S.
at 196).
                   ALTERA CORP. V. CIR                     19

    At no point in Treasury’s 2003 rulemaking did it make a
finding, let alone one subject to notice and comment, that
comparable transactions are per se unavailable for QCSAs,
such that other methods must be employed in the first
instance. See Altera, 926 F.3d at 1077–78, 1083 n.9
(majority opinion) (using legislative history and Treasury’s
one-sentence rejection of comparables submitted by
commenters to draw this conclusion). At no point in
Treasury’s 2003 rulemaking did it announce that it was
returning to a pre-1968 interpretation of § 482 subjecting
taxpayers to an unpredictable “fair and reasonable” standard.
See id. at 1068–69, 1078 (using caselaw from “most of the
twentieth century,” i.e., before Treasury promulgated more
specific regulations in 1968, to justify this return). At no
point in Treasury’s 2003 rulemaking did it interpret the
commensurate-with-income standard to provide an
independent justification for its treatment of stock-based
compensation. See id. at 1077 (using legislative history
alone to infer this justification). And at no point in
Treasury’s 2003 rulemaking did it reverse its longstanding
interpretation of the commensurate-with-income standard as
consistent with the traditional arm’s length standard. See id.
at 1077, 1081 (deriving a disparate interpretation of the
commensurate-with-income standard from whole cloth and
relying on Treasury’s insertion of a cross-reference to
conclude that these newly disparate standards were
appropriately “synthesize[d]”).

    The panel majority ignores Treasury’s clear statements
in the preamble to its 2003 rule expressly justifying its
treatment of stock-based compensation based on a
traditional    arm’s     length     analysis    employing
(unsubstantiated) comparable transactions. See 68 Fed. Reg.
at 51,173. The panel upholds the rule only by accepting
Treasury’s convenient litigating position on appeal that it
20                 ALTERA CORP. V. CIR

permissibly jettisoned the traditional arm’s length standard
altogether. See Altera, 926 F.3d at 1077. By re-writing the
reasoning supporting the rule, the majority renders extensive
comments irrelevant, and is strangely untroubled by the idea
that no member of the tax community noticed this alternative
reasoning or submitted a relevant comment. See id. at 1081–
82; cf. Chisom v. Roemer, 501 U.S. 380, 396 n.23 (1991) (“I
think judges as well as detectives may take into
consideration the fact that a watchdog did not bark in the
night.”) (quoting Harrison v. PPG Industries, Inc., 446 U.S.
578, 602 (1980) (Rehnquist, J., dissenting)).

    The APA does not allow an agency to reclassify the
reasoning it articulated to the public as “extraneous
observations,” Appellant’s Br. at 64, ignore public
comments pointing out the failures in such reasoning, and
then defend its rule in litigation using reasoning the public
never had notice of. Yet that is precisely what the majority’s
opinion allows Treasury to do.

                             C.

    Even if an agency could force the public to engage in a
“scavenger hunt” for “cryptic” references in order to
understand its reasoning in the ordinary rulemaking case,
Altera, 926 F.3d at 1087–88 (O’Malley, J., dissenting), the
APA would prohibit Treasury from doing so here:

       When 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.”
       But the agency must at least “display
       awareness that it is changing position” and
       “show that there are good reasons for the new
       policy.” In explaining its changed position,
                   ALTERA CORP. V. CIR                     21

       an agency must also be cognizant that
       longstanding policies may have “engendered
       serious reliance interests that must be taken
       into account.”

Encino Motorcars, LLC v. Navarro, 136 S. Ct. 2117, 2125–
26 (2016) (citations omitted) (quoting FCC v. Fox Television
Stations, Inc., 556 U.S. 502, 515 (2009)).

    In contrast to its statements during the 2003 rulemaking
and before the Tax Court, Treasury no longer disputes that
stock-based compensation costs cannot be re-allocated
under the traditional arm’s length standard. A legitimate rule
requiring the sharing of stock-based compensation costs
would therefore have necessitated a change in position
regarding the type of standard permissibly employed under
§ 482. The relevant Supreme Court precedents call us to be
particularly vigilant in ensuring that Treasury provided fair
notice of this change in position. See id. It did not.

    The majority opinion assumes away this problem by
relying on legislative history from the 1986 amendment,
making it seem as though the necessary interpretation of
§ 482 had been on the books for nearly twenty years before
the 2003 rule. See Altera, 926 F.3d at 1085–86 (majority
opinion). But Treasury expressly disclaimed the majority’s
interpretation of the 1986 amendment in the 1988 White
Paper. White Paper at 472. The interpretation of § 482 on
the books in 2003 was the traditional arm’s length standard.
Therefore, even if Treasury had articulated a permissible re-
interpretation of § 482 in its 2003 rule, its failure to
acknowledge the newness of this interpretation, let alone to
consider the “serious reliance interests” engendered by the
previous interpretation, would supply an independent reason
22                  ALTERA CORP. V. CIR

to vacate the rule. Encino Motorcars, 136 S. Ct. at 2126
(quoting Fox, 556 U.S. at 515).

                              IV.

    The majority opinion additionally errs by accepting the
interpretation of § 482’s commensurate-with-income
provision that Treasury now advocates.            Treasury’s
interpretation is not entitled to deference, and it conflicts
with the plain language of the statute.

                              A.

     “[A] court must make an independent inquiry into
whether the character and context of the agency
interpretation entitles it to controlling weight.” Kisor v.
Wilkie, 139 S. Ct. 2400, 2416 (2019) (citing United States v.
Mead Corp., 533 U.S. 218, 229–31, 236–37 (2001)). For
example, “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 regulation.” Encino Motorcars, 136 S. Ct.
at 2125. As demonstrated above, Treasury’s 2003 rule was
procedurally defective because its “explanation for its
decision [ran] counter to the evidence before” it. State Farm,
463 U.S. at 43. Even had it articulated a reasoned basis for
its rule, it failed to “display awareness that it [was] changing
position.” Fox, 556 U.S. at 515. “An arbitrary and
capricious regulation of this sort is itself unlawful and
receives no Chevron deference.” Encino Motorcars, 136 S.
Ct. at 2126.

    Moreover, Treasury did not articulate a reasoned basis
for its rule during notice-and-comment rulemaking, but
rather attempts to do so now in its briefing on appeal.
“Deference to what appears to be nothing more than an
                    ALTERA CORP. V. CIR                      23

agency’s convenient litigating position would be entirely
inappropriate.” Bowen v. Georgetown Univ. Hosp., 488 U.S.
204, 213 (1988); cf. Kisor, 139 S. Ct. at 2417–18 (“[A] court
should decline to defer to a merely ‘convenient litigating
position’ or ‘post hoc rationalizatio[n] advanced’ to ‘defend
past agency action against attack.’ And a court may not defer
to a new interpretation, whether or not introduced in
litigation, that creates ‘unfair surprise’ to regulated parties.
That disruption of expectations may occur when an agency
substitutes one view of a rule for another.” (citations and
footnote omitted) (first quoting Christopher v. SmithKline
Beecham Corp., 567 U.S. 142, 155 (2012), then quoting
Long Island Care at Home, Ltd. v. Coke, 551 U.S. 158, 170
(2007))). A litigating position is not “promulgated in the
exercise of [Congressionally delegated] authority,” Mead,
533 U.S. at 227, because it is not adopted “through any
‘relatively formal administrative procedure,’” Price v.
Stevedoring Servs. of Am., Inc., 697 F.3d 820, 827 (9th Cir.
2012) (en banc) (quoting Mead, 533 U.S. at 230). Rather,
an agency’s litigating position can “ordinarily [be]
change[d] . . . from one case to another” via “internal
decisionmaking not open to public comment or
determination.” Id. at 827, 830; cf. Xilinx, 598 F.3d at 1198
(Fisher, J., concurring) (“Not only do[]” Treasury’s
“complex, theoretical” litigating arguments “make it
difficult for the court to navigate the regulatory framework,
it shows that taxpayers have not been given clear, fair notice
of how the regulations will affect them.”). Nor is there any
indication that Treasury’s litigating position here “is one of
long standing” or the product of “careful consideration . . .
over a long period of time,” Barnhart v. Walton, 535 U.S.
212, 221–22 (2002), seeing as how Treasury did not even
make the same argument to the Tax Court in this matter.
24                ALTERA CORP. V. CIR

    Though some amici suggest it could, Treasury does not
ask for Auer deference to its interpretation of Treas. Reg.
§ 1.482-1 (the arm’s length standard). See Auer v. Robbins,
519 U.S. 452 (1997). Given the very detailed limitations on
Auer deference spelled out in Kisor, virtually none of which
Treasury’s actions satisfy, it is clear that such deference
would not be available even if not disclaimed. See 139 S.
Ct. at 2415–18 (e.g., generally does not apply to “an agency
construction ‘conflict[ing] with a prior’ one,” id. at 2418
(quoting Thomas Jefferson Univ. v. Shalala, 512 U.S. 504,
515 (1994))).

    Even Skidmore deference is likely inappropriate here,
where “billions of dollars” are at stake. King v. Burwell,
135 S. Ct. 2480, 2488–89 (2015) (finding Chevron
inapplicable and making no mention of Skidmore v. Swift &
Co., 323 U.S. 134 (1944)).

                            B.

    Setting aside whether Treasury’s new interpretation of
the commensurate-with-income standard obeys Treasury’s
own determination that Congress intended it to work
“consistently with the arm’s length standard,” White Paper
at 472, 475, the commensurate-with-income provision
simply does not apply to QCSAs.

    By its terms, the provision is applicable only if QCSAs
constitute “transfers of intangible property.” I.R.C. § 482.
They do not. The majority opinion focuses on the breadth of
the word “transfers,” modified by “any,” to conclude that
transfers of future distribution rights fall within the
provision’s ambit. Altera, 926 F.3d at 1076. This reasoning
suffers from two defects. First, QCSAs do not involve a
transfer of future distribution rights. Treasury itself
characterized QCSAs as “cost sharing arrangements for the
                       ALTERA CORP. V. CIR                           25

development of high-profit intangibles.” 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.”     Altera, 926 F.3d at 1098 (O’Malley, J.
dissenting). Second, the statutory definition of “intangible
property” comprises a list of property types that currently
exist, none of which resembles future distribution rights. See
supra, note 4; I.R.C. § 936(h)(3)(B) (1996). 8

     The panel majority’s application of the commensurate-
with-income standard to Altera’s QCSA was therefore
incorrect. Even “under Chevron, the agency’s reading must
fall ‘within the bounds of reasonable interpretation.’ And let
there be no mistake: That is a requirement an agency can
fail.” Kisor, 139 S. Ct. at 2416 (citation omitted) (quoting
Arlington v. FCC, 569 U.S. 290, 296 (2013)).

                                  V.

    In addition to being wrongly decided, the panel
majority’s decision engenders particularly deleterious
practical consequences.


     8
       The majority’s discussion of future commodities, Altera, 926 F.3d
at 1076 (majority opinion), is particularly off the mark given that such
futures are excluded from the definition of intangible property as having
value “attributable to tangible property.” I.R.C. § 367(d)(4)(G). The
majority’s assertion that stock-based compensation is a transferred
intangible under a QCSA only further confuses the point. See id.
Treasury is attempting to re-allocate Altera’s income in this case
precisely because the parties did not transfer any stock-based
compensation costs.
26                 ALTERA CORP. V. CIR

    First, the majority opinion will likely upset the uniform
application of the challenged regulation in the Tax Court,
producing a situation akin to a circuit split. Although the
Tax Court “will follow the clearly established position of a
Court of Appeals to which a case is appealable,” it “will give
effect to [its] own views in cases appealable to courts that
have not yet decided the issue.” Mitchell v. Comm’r,
106 T.C.M. (CCH) 215, 220 n.7 (2013); cf. Fehlhaber v.
Comm’r, 94 T.C. 863, 867 (1990) (disagreeing with a
reversal by the Ninth Circuit and adhering to its position in
cases outside the Ninth Circuit). The Tax Court determined
unanimously, in a 15–0 decision, that Treasury’s 2003
rulemaking “epitomize[d] arbitrary and capricious
decisionmaking.’” 145 T.C. at 134 (quoting Ill. Pub.
Telecomms. Ass’n v. FCC, 117 F.3d 555, 564 (D.C. Cir.
1997)). This uncommon unanimity and severity of censure
strongly suggest that the Tax Court will continue to be
persuaded by its original reasoning. If so, the tax treatment
of stock-based compensation costs will turn on the
happenstance of where a business is located and create
incentives to locate or incorporate elsewhere. Such a
possibility is particularly problematic in the context of
federal taxation, given that “[a] cardinal principle of
Congress in its tax scheme is uniformity.” United States v.
Gilbert Assocs., Inc., 345 U.S. 361, 364 (1953). In the
meantime, businesses lack certainty regarding the meaning
of the arm’s length standard outside the Ninth Circuit.

    Second, the panel majority’s opinion tramples on the
longstanding reliance interests of American businesses. See
Appellee’s Petition for Rehearing En Banc at 1–2, App’x C
1–4 (listing 56 companies that “noted the Altera issue in their
annual reports (Forms 10-K) to the SEC,” ranging from
Alphabet Inc., reporting $4.4 billion at stake, to Groupon,
Inc., reporting $14 million at stake). “Courts properly have
                   ALTERA CORP. V. CIR                     27

been reluctant to depart from an interpretation of tax law
which has been generally accepted when the departure could
have potentially far-reaching consequences.” Comm’r v.
Greenspun, 670 F.2d 123, 126 (9th Cir. 1982) (quoting
United States v. Byrum, 408 U.S. 125, 135 (1972)).

    Finally, as numerous amici observe, the panel majority
opinion upsets not only domestic tax law, but international
tax law as well. The allocation of income between related
entities operating in different countries is a problem that
must be addressed not only by Treasury and the IRS, but also
by the relevant foreign tax agencies. In order to avoid double
taxation, and pursuant to tax treaties negotiated by the
United States, the arm’s length method is “used by all major
developed nations.” Barclays Bank PLC v. Franchise Tax
Bd., 512 U.S. 298, 305 (1994). The panel majority’s
interpretation of § 482 as allowing for the use of a purely
internal standard to make cost and income allocations, i.e.,
without ever inquiring as to the behavior of parties operating
at arm’s length, greatly upsets this international uniformity.

                            ***

    Treasury justified its 2003 rule as an application of the
traditional arm’s length standard. Without searching for any
evidence, it assumed it knew what comparable transactions
would look like. Without any real analysis, it dismissed
comments providing contrary examples. The en banc Tax
Court unanimously, and rightly, invalidated the rule as
arbitrary and capricious because Treasury’s explanation for
its decision ran counter to the evidence before it. Only
before this court did Treasury conjure a new justification for
the rule, not only newly applying the commensurate-with-
income provision of the statute, but also newly interpreting
that provision to bypass the traditional arm’s length
standard.
28                 ALTERA CORP. V. CIR

    The panel majority was wrong to accept this
justification, both procedurally and substantively. Its
decision invites an effective circuit split, ignores the
reasonable reliance of businesses on the well-settled arm’s
length standard, subjects those businesses to double taxation,
and sows uncertainty over the fate of billions of dollars.
Moreover, its endorsement of Treasury’s arbitrary and
capricious rulemaking sends a signal that executive agencies
can bypass proper notice-and-comment procedures as long
as they come up with a clever post-hoc rationalization by the
time their rules are litigated.

   I respectfully dissent from the denial of rehearing en
banc.
