-38-
to be cost-shared, the cost sharing partner has a
perverse incentive to diminish (or at least help
contain) the stock price of the other firm because the
lower this price, the less the spread-based cost that
the partner has to bear.
Unrelated parties would not be inclined to enter into a contract
which contains terms that could encourage such counterproductive
conduct. Accordingly, respondent’s allocation relating to the
spread theory fails to meet the arm’s-length standard mandated by
section 1.482-1(b), Income Tax Regs.14
2. Grant Date Value
Respondent, who had the burden of proof with respect to the
grant date theory, presented no evidence that unrelated parties
would, pursuant to the FVM, make a cost-sharing allocation of at-
the-money options or ESPP purchase rights. To the contrary,
petitioners’ uncontradicted evidence established that in
determining cost allocations unrelated parties would not include
any cost related to the issuance of ESOs. In essence, respondent
contends that petitioner was required to allocate, and thereby
sustain tangible economic consequences relating to, an amount
that unrelated parties do not treat as an expense for tax or
14 Petitioners’ treatment of the spread as a reimbursable
expense for purposes of its intercompany agreement with XI has no
bearing on our conclusion. Sec. 482 looks to transactions
between unrelated, not related, parties to determine whether the
arm’s-length standard in sec. 1.482-1, Income Tax Regs., has been
satisfied.
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