The Irish Tax Appeals Commission recently made a controversial decision regarding the transfer pricing treatment of employee stock options issued by a foreign parent, which is problematic due to flawed analysis. The dispute involved an Irish subsidiary of a U.S.-based software development multinational, and while both parties agreed on the use of the transactional net margin method (TNMM), they disagreed on the composition of the services cost base. The revenue commissioners argued that the stock options should be charged to the U.S. parent with a 10 percent markup, while the taxpayer contended that the costs should be attributed to the foreign parent.
The case draws comparisons to similar cases in the U.S., such as Abbott Laboratories and Altera Corp., where the issuers of stock options were also the employers. However, the better international comparable is Kontera Technologies Ltd. v. Assessing Officer Tel Aviv and Finisar Israel Ltd. v. Assessing Officer Rehovot, in which the issue was decided differently. They held that the stock option grants by a publicly traded U.S. parent should be included in the costs of employee compensation.
The decision in case 59TACD2024 carries significant implications for Ireland, as a host for U.S. multinational subsidiaries that heavily rely on employee stock options. If the U.S. parent’s stock option costs are attributed to the Irish subsidiary, it could result in increased taxable income for the subsidiary. Despite the commendable effort by Tax Appeals Commissioner Claire Millrine to address such a complex issue, the flawed analysis and incorrect result show that the Irish judiciary is now 0-1 in transfer pricing cases.
The analysis of the case erroneously discredited the revenue commissioners’ reliance on accounting standards for reporting the stock option expense in the subsidiary’s financial statements. Millrine’s decision failed to properly apply the OECD guidelines on the treatment of stock options in transfer pricing, thereby leading to an incorrect conclusion. By overlooking key principles in transfer pricing, the judgment perpetuates flawed arguments that could have negative repercussions in the future.
The decision also rejected the Xilinx-Altera theory, which argues that controlled parties should not share stock-based compensation costs, despite failing to question the premise of stock-based compensation representing real economic costs. By emphasizing the economic value of stock options and their significance as a form of employee compensation, the judgment positioned them as legitimate costs that should be included in transfer pricing calculations, contrary to the flawed arguments presented by the taxpayer. Moving forward, it is essential for Irish judges to explicitly reject such erroneous theories to uphold the integrity of transfer pricing principles.
