Xilinx, stock option pricing, and the meaning of arm's length

In this paper, we examine the controversy surrounding the Xilinx case and explore what the case means for the future of transfer pricing. Although the IRS acquiesced in the Xilinx result, it expressly disagreed with the reasoning and asserted that the issue is now moot due to the application of the 2009 regulations. In sharp contrast, multiple commentators have expressed the view that the Xilinx result might in fact render the 2009 regulations invalid. For this reason, it is apparent that significant uncertainty continues to surround the central issues in Xilinx, namely, the way that stock option costs should be treated in cost sharing arrangements. In this paper, we explore what happened in Xilinx and why it matters. We then examine the implications of these developments for the future of transfer pricing, suggesting that this is potentially a watershed moment in the history of transfer pricing and the meaning of arm's length. We conclude that the Supreme Court's decision in Mayo means that the 2009 regulations are likely to stand. However, we also suggest that the IRS may have erred in not appealing the Xilinx decision because of the fundamental importance of establishing a true understanding of arm's length. The current interpretation, as articulated by the Ninth Circuit, leaves lingering uncertainty and appears to place the U.S. at odds with the position of the Organisation for Economic Co-operation and Development (OECD).