ALTERA CORPORATION AND SUBSIDIARIES, PETITIONER v.
 COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
 Docket Nos. 6253–12, 9963–12.               Filed July 27, 2015.

    In Xilinx Inc. v. Commissioner, 

 (2005), aff ’d,
 

 (9th Cir. 2010), we held that, under the 1995
 cost-sharing regulations, controlled entities entering into
 qualified cost-sharing agreements (QCSAs) need not share
 stock-based compensation (SBC) costs because parties oper-
 ating at arm’s length would not do so. In 2003 Treasury
 issued sec. 1.482–7(d)(2), Income Tax Regs. (final rule). The
 final rule requires controlled parties entering into QCSAs to
 share SBC costs. P is an affiliated group of corporations that
 filed consolidated returns for the years in issue. A–US, the
 parent company, is a Delaware corporation, and A–I, a sub-
 sidiary of A–US, is a Cayman Islands corporation. A–US and
 A–I entered into a QCSA. During its 2004–07 taxable years
 A–US granted SBC to its employees. A–US did not share the
 SBC costs with A–I. R determined deficiencies based on I.R.C.
 sec. 482 allocations R made pursuant to the final rule. P and
 R have filed cross-motions for partial summary judgment. P
 contends that the final rule is arbitrary and capricious under
 5 U.S.C. sec. 706(2)(A) and Motor Vehicle Mfrs. Ass’n of the
 U.S. v. State Farm Mut. Auto Ins. Co., 

 (1983). R
 contends that the final rule is valid under Chevron, U.S.A.,
 Inc. v. Natural Res. Def. Council, Inc., 

 (1984), or
 alternatively, under State Farm. Held: The final rule is a
 legislative rule—i.e., it is not an interpretive rule under 5
 U.S.C. sec. 553(b)—because it has the force of law. See Am.
 Mining Cong. v. Mine Safety & Health Admin., 

,
 1109 (D.C. Cir. 1993). The final rule has the force of law
 because in I.R.C. sec. 7805(a) ‘‘Congress has delegated legisla-
 tive power to’’ Treasury, id., and Treasury ‘‘intended to exer-
 cise that power’’ when it issued the final rule, id. Held, fur-
 ther, whether State Farm or Chevron supplies the standard of
 review is immaterial because Chevron step 2 incorporates the
 reasoned decisionmaking standard of State Farm, see
 Judulang v. Holder, 565 U.S. ll, ll, 

, 483
 n.7 (2011), and we are being asked to decide whether
 Treasury reasonably concluded that the final rule is con-
 sistent with the arm’s-length standard. Held, further,
 Treasury failed to support its belief that unrelated parties
 would share SBC costs with any evidence in the administra-
 tive record, see State Farm, 463 U.S. at 43; failed to articulate
 why all QCSAs should be treated identically, see id.; and
 failed to respond to significant comments, see Home Box
 Office, Inc. v. FCC, 

, 35 (D.C. Cir. 1977). Addition-
 ally, Treasury’s ‘‘explanation for its decision * * * runs

                                                                     91
92            145 UNITED STATES TAX COURT REPORTS                        (91)

      counter to the evidence before’’ it. State Farm, 463 U.S. at 43.
      Held, further, the harmless error rule of 5 U.S.C. sec. 706 is
      inapplicable because it is not clear that Treasury would have
      adopted the final rule if it had been determined to be incon-
      sistent with the arm’s-length standard. Held, further, the final
      rule fails to satisfy State Farm’s reasoned decisionmaking
      standard and is therefore invalid. See 5 U.S.C. sec. 706(2)(A);
      State Farm, 463 U.S. at 43.

  Andrew P. Crousore, Donald M. Falk, Joseph B. Judkins,
Thomas Lee Kittle-Kamp, William G. McGarrity, Kristyn A.
Medina, Brian D. Netter, Phillip J. Taylor, and Allen Duane
Webber, for petitioner.
  Farhad Asghar, Kevin G. Croke, Anne O’Brien
Hintermeister, Allan Lang, Aaron T. Vaughan, and Mary E.
Wynne, for respondent.

                                OPINION

   MARVEL, Judge: These consolidated cases are before the
Court on the parties’ cross-motions for partial summary judg-
ment under Rule 121. 1 The issue presented by the parties’
cross-motions is whether section 1.482–7(d)(2), Income Tax
Regs. (final rule)—which the Department of the Treasury
(Treasury) issued in 2003 and which requires participants in
qualified cost-sharing arrangements (QCSAs) to share stock-
based compensation costs to achieve an arm’s-length result—
is arbitrary and capricious and therefore invalid.

                              Background
  Petitioner is an affiliated group of corporations that filed
consolidated Federal income tax returns for the years at
issue. During all relevant years, Altera Corp. (Altera U.S.),
the parent company, was a Delaware corporation, and Altera
International, a subsidiary of Altera U.S., was a Cayman
Islands corporation. When petitioner filed its petitions with
this Court, the principal place of business of Altera U.S. was
in California.
  1 Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect at all relevant times, and all Rule references
are to the Tax Court Rules of Practice and Procedure. All APA section ref-
erences are to the Administrative Procedure Act (APA), 5 U.S.C. secs. 551–
559, 701–706 (2012).
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER             93


I. Petitioner’s R&D Cost-Sharing Agreement
   Petitioner develops, manufactures, markets, and sells
programmable logic devices (PLDs) and related hardware,
software, and pre-defined design building blocks for use in
programming the PLDs (programming tools). Altera U.S. and
Altera International entered into concurrent agreements that
became effective May 23, 1997: a master technology license
agreement (technology license agreement) and a technology
research and development cost-sharing agreement (R&D
cost-sharing agreement).
   Under the technology license agreement, Altera U.S.
licensed to Altera International the right to use and exploit,
everywhere except the United States and Canada, all of
Altera U.S.’ intangible property relating to PLDs and
programming tools that existed before the R&D cost-sharing
agreement (pre-cost-sharing intangible property). In
exchange for the rights granted under the technology license
agreement, Altera International paid royalties to Altera U.S.
in each year from 1997 through 2003. As of December 31,
2003, Altera International owned a fully paid-up license to
use the pre-cost-sharing intangible property in its territory.
   Under the R&D cost-sharing agreement, Altera U.S. and
Altera International agreed to pool their respective resources
to conduct research and development using the pre-cost-
sharing intangible property. Under the R&D cost-sharing
agreement, Altera U.S. and Altera International agreed to
share the risks and costs of research and development activi-
ties they performed on or after May 23, 1997. The R&D cost-
sharing agreement was in effect from May 23, 1997, through
2007.
   During each of petitioner’s taxable years ending December
31, 2004, December 30, 2005, December 29, 2006, and
December 28, 2007 (2004–07 taxable years), Altera U.S.
granted stock options and other stock-based compensation to
certain of its employees. Certain of the employees of Altera
U.S. who performed research and development activities sub-
ject to the R&D cost-sharing agreement received stock
options or other stock-based compensation. The employees’
cash compensation was included in the cost pool under the
R&D cost-sharing agreement. Their stock-based compensa-
tion was not included.
94           145 UNITED STATES TAX COURT REPORTS                            (91)


  Pursuant to the R&D cost-sharing agreement, Altera Inter-
national made the following cost-sharing payments to Altera
U.S. for its 2004–07 taxable years:
             Year                                    Cost-sharing payment

             2004   ..............................       $129,469,233
             2005   ..............................        160,722,953
             2006   ..............................        164,836,577
             2007   ..............................        192,755,438

II. Petitioner’s Tax Reporting and Respondent’s Section 482
    Allocations

  Petitioner timely filed its Forms 1120, U.S. Corporation
Income Tax Return, for its 2004–07 taxable years.
Respondent timely mailed notices of deficiency to petitioner
with respect to its 2004–07 taxable years. The notices of defi-
ciency allocated, pursuant to section 482, income from Altera
International to Altera U.S. by increasing Altera Inter-
national’s cost-sharing payments for 2004–07 by the fol-
lowing amounts:
                                                        Cost-sharing
             Year                                    payment adjustment

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

Bringing petitioner into compliance with the final rule was
the sole purpose of the cost-sharing adjustments in the notice
of deficiency.
III. Section 482
     A. Arm’s-Length Standard
  Section 482 authorizes the Commissioner to allocate
income and expenses among related entities to prevent tax
evasion and to ensure that taxpayers clearly reflect income
relating to transactions between related entities. The first
sentence of section 482 provides, in relevant part, as follows:
   In any case of two or more organizations, trades, or businesses * * *
 owned or controlled directly or indirectly by the same interests, the Sec-
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                       95


  retary[2] may distribute, apportion, or allocate gross income, deductions,
  credits, or allowances between or among such organizations, trades, or
  businesses, 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.
  * * *
  Section 1.482–1(a)(1), Income Tax Regs., explains the pur-
pose of section 482 as follows:
  The purpose of section 482 is to ensure that taxpayers clearly reflect
  income attributable to controlled transactions and to prevent the avoid-
  ance of taxes with respect to such transactions. Section 482 places a con-
  trolled taxpayer[3] on a tax parity with an uncontrolled taxpayer by
  determining the true taxable income of the controlled taxpayer. * * *

Section 1.482–1(b)(1), Income Tax Regs., provides 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. A controlled transaction
  meets the arm’s length standard if the results of the transaction are con-
  sistent with the results that would have been realized if uncontrolled
  taxpayers had engaged in the same transaction under the same cir-
  cumstances (arm’s length result). However, because identical trans-
  actions 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. * * *

  The arm’s-length standard is also incorporated into
numerous income tax treaties between the United States and
foreign countries. See, e.g., Convention for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion With
Respect to Taxes on Income and on Capital Gains, U.S.-U.K.
(2001 U.S.-U.K. Income Tax Convention), art. 9, July 24,
2001, Tax Treaties (CCH) para. 10,901.09, at 201,019; U.S.
Model Income Tax Convention of Nov. 15, 2006 (2006 U.S.
Model Income Tax Convention), art. 9, Tax Treaties (CCH)
para. 209.09, at 10,559; Treasury Department Technical
Explanation of the 2001 U.S.-U.K. Income Tax Convention,
art. 9, Tax Treaties (CCH) para. 10,911, at 201,306 (‘‘This
Article incorporates in the Convention the arm’s-length prin-
  2 The term ‘‘Secretary’’ means the Secretary of the Treasury or his dele-

gate. Sec. 7701(a)(11)(B).
  3 The term ‘‘controlled taxpayer’’ means ‘‘any one of two or more tax-

payers owned or controlled directly or indirectly by the same interests, and
includes the taxpayer that owns or controls the other taxpayers.’’ Sec.
1.482–1(i)(5), Income Tax Regs.
96           145 UNITED STATES TAX COURT REPORTS                        (91)


ciple reflected in the U.S. domestic transfer pricing provi-
sions, particularly Code section 482.’’); Treasury Department
Technical Explanation of the 2006 U.S. Model Income Tax
Convention, art. 9, Tax Treaties (CCH) para. 215, at 10,640
(same).
     B. Commensurate-With-Income Standard
  In 1986 Congress amended section 482 by adding, in rel-
evant part, the following sentence: ‘‘In the case of any
transfer (or license) of intangible property * * *, the income
with respect to such transfer or license shall be commensu-
rate with the income attributable to the intangible.’’ Tax
Reform Act of 1986, Pub. L. No. 99–514, sec. 1231(e)(1), 100
Stat. at 2562.
  The House report that accompanied the House version of
the 1986 amendment to section 482 states, in relevant part,
as follows:
   Many observers have questioned the effectiveness of the ‘‘arm’s length’’
 approach of the regulations under section 482. A recurrent problem is
 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.

                       *   *    *   *    *   *    *
   The problems are particularly acute in the case of transfers of high-
 profit potential intangibles. Taxpayers may transfer such intangibles to
 foreign related corporations or to possession corporations at an early
 stage, for a relatively low royalty, and take the position that it was not
 possible at the time of the transfers to predict the subsequent success
 of the product. Even in the case of a proven high-profit intangible, tax-
 payers frequently take the position that intercompany royalty rates may
 appropriately be set on the basis of industry norms for transfers of much
 less profitable items.
   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.* * *
   In many cases firms that develop high profit-potential intangibles tend
 to retain their rights or transfer them to related parties in which they
 retain an equity interest in order to maximize their profits. * * *
 Industry norms for transfers to unrelated parties of less profitable intan-
 gibles frequently are not realistic comparables in these cases.
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                          97


  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 or possessions cor-
  poration be commensurate with the income attributable to the intan-
  gible. * * *

                         *   *    *   *    *   *    *
    The basic requirement of the bill is that payments with respect to
  intangibles that a U.S. person transfers to a related foreign corporation
  or possessions corporation must be commensurate with the income
  attributable to the intangible. * * *
    In making this change, the 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 intangibles transfers.
  Where taxpayers transfer intangibles with a high profit potential, the
  compensation for the intangibles should be greater than industry aver-
  ages or norms. * * *

                         *   *    *   *    *   *    *
    In requiring that payments be commensurate with the income stream,
  the bill does not intend to mandate the use of the ‘‘contract manufac-
  turer’’ or ‘‘cost-plus’’ methods of allocating income or any other particular
  method. As under present law, all the facts and circumstances are to be
  considered in determining what pricing methods are appropriate in cases
  involving intangible property, including the extent to which the trans-
  feree bears real risks with respect to its ability to make a profit from
  the intangible or, instead, sells products produced with the intangible
  largely to related parties (which may involve little sales risk or activity)
  and has a market essentially dependent on, or assured by, such related
  parties’ marketing efforts. However, the profit or income stream gen-
  erated by or associated with intangible property is to be given primary
  weight.
    [H.R. Rept. No. 99–426, at 423–426 (1985), 1986–3 C.B. (Vol. 2) 1,
  423–426.]

 The conference report that accompanied the 1986 amend-
ment to section 482 states, in relevant part, as follows:
  In view of the fact that the objective of these provisions—that the divi-
  sion of income between related parties reasonably reflect the relative
  economic activity undertaken by each—applies equally to inbound trans-
  fers, the conferees concluded that it would be appropriate for these prin-
  ciples to apply to transfers between related parties generally if income
  must otherwise be taken into account.

                         *   *    *   *    *   *    *
    The conferees are also aware that many important and difficult issues
  under section 482 are left unresolved by this legislation. The conferees
98           145 UNITED STATES TAX COURT REPORTS                        (91)


 believe that a comprehensive study of intercompany pricing rules by the
 Internal Revenue Service should be conducted and that careful consider-
 ation should be given to whether the existing regulations could be modi-
 fied in any respect.
    In revising section 482, the conferees do not intend to preclude the use
 of certain bona fide research and development cost-sharing arrange-
 ments as an appropriate method of allocating income attributable to
 intangibles among related parties, if and to the extent such agreements
 are consistent with the purposes of this provision that the income allo-
 cated among the parties reasonably reflect the actual economic activity
 undertaken by each. Under such a bona fide cost-sharing arrangement,
 the cost-sharer would be expected to bear its portion of all research and
 development costs, on unsuccessful as well as successful products within
 an appropriate product area, and the costs of research and development
 at all relevant development stages would be included. In order for cost-
 sharing arrangements to produce results consistent with the changes
 made by the Act to royalty arrangements, it is envisioned that the
 allocation of R&D cost-sharing arrangements generally should be propor-
 tionate to profit as determined before deduction for research and
 development. In addition, to the extent, if any, that one party is actually
 contributing funds toward research and development at a significantly
 earlier point in time than the other, or is otherwise effectively putting
 its funds at risk to a greater extent than the other, it would be expected
 that an appropriate return would be required to such party to reflect its
 investment.
    [H.R. Conf. Rept. No. 99–841 (Vol. II), at II–637 through II–638
 (1986), 1986–3 C.B. (Vol. 4) 1, 637–638.]

     C. Treasury’s Position That the Commensurate-With-
        Income Standard Was Intended To Work Consistently
        With the Arm’s-Length Standard
   As the conference report suggested, Treasury and the
Internal Revenue Service (IRS) conducted a comprehensive
study of the regulations under section 482, the results of
which they published in Notice 88–123, 1988–2 C.B. 458
(1988 White Paper).
   The 1988 White Paper concluded that the arm’s-length
standard is the international norm for making transfer
pricing adjustments. Id., 1988–2 C.B. at 475 (‘‘The arm’s
length standard is embodied in all U.S. tax treaties; it is in
each major model treaty, including the U.S. Model Conven-
tion; it is incorporated into most tax treaties to which the
United States is not a party; it has been explicitly adopted
by international organizations that have addressed them-
selves to transfer pricing issues; and virtually every major
industrial nation takes the arm’s length standard as its
(91)         ALTERA CORP. & SUBS. v. COMMISSIONER                    99


frame of reference in transfer pricing cases.’’ (Fn. ref.
omitted.)). The 1988 White Paper further concluded that
Congress intended for the commensurate-with-income
standard to work consistently with the arm’s-length
standard. See id. (‘‘To allay fears that Congress intended the
commensurate with income standard to be implemented in a
manner inconsistent with international transfer pricing
norms and U.S. treaty obligations, Treasury officials publicly
stated that Congress intended no departure from the arm’s
length standard, and that the Treasury Department would so
interpret the new law.’’).
  The 1988 White Paper explained that the commensurate-
with-income standard is consistent with the arm’s-length
standard because
  [l]ooking at the income related to the intangible and splitting it
  according to relative economic contributions is consistent with what
  unrelated parties do. The general goal of the commensurate with income
  standard is, therefore, to ensure that each party earns the income or
  return from the intangible that an unrelated party would earn in an
  arm’s length transfer of the intangible. [Id., 1988–2 C.B. at 472.]

Accordingly, in technical explanations to numerous income
tax treaties that the United States has entered into since
then, Treasury has repeatedly affirmed that Congress
intended for the commensurate-with-income standard to
work consistently with the arm’s-length standard. See, e.g.,
Treasury Department Technical Explanation of the 2001
U.S.-U.K. Income Tax Convention, art. 9, Tax Treaties (CCH)
para. 10,911, at 201,307 (‘‘It is understood that the ‘commen-
surate with income’ standard for determining appropriate
transfer prices for intangibles, added to Code section 482 by
the Tax Reform Act of 1986, was designed to operate consist-
ently with the arm’s-length standard.’’); Treasury Depart-
ment Technical Explanation of the 2006 U.S. Model Income
Tax Convention, art. 9, Tax Treaties (CCH) para. 215, at
10,640–10,641 (same).
IV. 1995 Cost-Sharing Regulations
  We have previously considered whether controlled tax-
payers must include stock-based compensation in the pool of
costs to be shared. Most recently, in Xilinx Inc. v. Commis-
sioner, 

 (2005), aff ’d, 

 (9th Cir.
2010), we addressed the treatment of stock-based compensa-
100        145 UNITED STATES TAX COURT REPORTS              (91)


tion with respect to taxable years subject to cost-sharing
regulations that Treasury finalized in 1995 (1995 cost-
sharing regulations). Because our findings and conclusions,
and the conclusions of the U.S. Court of Appeals for the
Ninth Circuit, in Xilinx are relevant in these cases, we
briefly review the 1995 cost-sharing regulations, our Opinion
in Xilinx, and the opinions of the U.S. Court of Appeals for
the Ninth Circuit in that case.
  A. Regulatory Provisions
  The 1995 cost-sharing regulations prohibited the District
Director from making allocations under section 482 ‘‘except
to the extent necessary to make each controlled participant’s
share of the costs * * * of intangible development under the
qualified cost-sharing arrangement equal to its share of
reasonably anticipated benefits attributable to such develop-
ment’’. T.D. 8632, 1996–1 C.B. 85, 90. The 1995 cost-sharing
regulations further provided that ‘‘a controlled participant’s
costs of developing intangibles * * * [include] all of the costs
incurred by that participant related to the intangible
development area’’. Id., 1996–1 C.B. at 92.
  B. Our Opinion in Xilinx
   In Xilinx Inc. v. Commissioner, 

, the taxpayer
challenged deficiencies determined under the 1995 cost-
sharing regulations on the basis of the Commissioner’s deter-
mination that the taxpayer should have included the value
of stock-based compensation in the intangible development
cost pool. Assuming arguendo that the value of stock-based
compensation is a cost under the 1995 cost-sharing regula-
tions, we held that the Commissioner’s allocations failed to
satisfy the arm’s-length standard of section 1.482–1(b)(1),
Income Tax Regs. See id. at 53.
   In reaching this holding we concluded that, consistent with
the 1995 cost-sharing regulations, (1) in determining the true
taxable income of a controlled taxpayer, the arm’s-length
standard applies in all cases, see id. at 54–55; (2) the arm’s-
length standard requires an analysis of what unrelated enti-
ties would do, see id. at 53–54; (3) the commensurate-with-
income standard was never intended to supplant the arm’s-
length standard, see id. at 56–58; and (4) unrelated parties
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                      101


would not share the exercise spread or grant date value 4 of
stock-based compensation, see id. at 58–62.
    In concluding that unrelated parties would not share either
the exercise spread or grant date value of stock-based com-
pensation, (1) we observed that the Commissioner’s expert
agreed that unrelated parties would not explicitly share the
exercise spread or grant date value of stock-based compensa-
tion because unrelated parties would find it hard to agree
how to measure such value and because doing so would leave
them open to potential disputes, see id. at 58; (2) we found
that the taxpayers proved that companies do not take into
account either the exercise spread or grant date value of
stock-based compensation for product pricing purposes, see
id. at 59; (3) we observed that the Commissioner produced no
credible evidence showing that unrelated parties implicitly
share the exercise spread or grant date value of stock-based
compensation, see id.; (4) we credited the testimony of the
taxpayers’ numerous fact witnesses who testified that unre-
lated parties do not share either the exercise spread or grant
date value of stock-based compensation in cost-sharing agree-
ments, see id.; (5) we found that the taxpayers proved that
‘‘if unrelated parties believed that the spread and grant date
value were costs’’, they ‘‘would be very explicit about their
treatment’’, id.; (6) we credited the testimony of the tax-
payers’ expert who testified that unrelated parties would not
agree to share spread-based cost because doing so would
create perverse incentives for each party to diminish the
stock price of the other, see id. at 61; and (7) we observed
that during the years in issue the grant value of stock-based
compensation was generally not treated as an expense for tax
and financial accounting purposes, see id. at 61–62.
  C. The Ninth Circuit Opinions in Xilinx
  The U.S. Court of Appeals for the Ninth Circuit initially
reversed our Opinion in Xilinx. The majority opinion by
Judge Fisher reasoned that ‘‘[b]ecause the all costs require-
ment [of the 1995 cost-sharing regulations] is irreconcilable
  4 The exercise spread value is the spread between the option strike price

and the price of the underlying stock when the option is exercised. See
Xilinx Inc. v. Commissioner, 

, 47 (2005), aff ’d, 

(9th Cir. 2010). The grant date value is the fair market value of the option
on its grant date. See id. at 50.
102         145 UNITED STATES TAX COURT REPORTS               (91)


with the arm’s length standard,’’ the more specific all costs
requirement controls. Xilinx Inc. v. Commissioner, 

, 489 (9th Cir. 2009), rev’g and remanding 

,
withdrawn, 

 (9th Cir. 2010). The dissenting
opinion by Judge Noonan agreed that the regulations were
irreconcilable, see id. at 497 (Noonan, J., dissenting), but con-
cluded that the all costs requirement should be construed as
not applying to stock-based compensation because (1) the
regulations should be interpreted in the light of the domi-
nant purpose of the statute—‘‘parity between taxpayers in
uncontrolled transactions and taxpayers in controlled trans-
actions’’, id. at 498; (2) any inconsistencies in the regulations
should be construed against the Government, see id.; and (3)
Treasury’s technical explanation of the income tax conven-
tion between the United States and Ireland confirms that the
commensurate-with-income standard is meant to work
consistently with the arm’s-length standard, see id. at
 498–500 (‘‘This article incorporates in the Convention the
arm’s[-]length principle reflected in the U.S. domestic
transfer pricing provision, particularly Code section 482.
* * * It is understood that the ‘commensurate with income’
standard for determining appropriate transfer prices for
intangibles, added to Code section 482 by the Tax Reform Act
of 1986, was designed to operate consistently with the arm’s-
length standard.’’ (quoting Treasury Department Technical
Explanation of the Convention for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect
to Taxes on Income and Capital Gains Signed at Dublin on
July 28, 1997, and the Protocol Signed at Dublin on July 28,
1997 (1997 U.S.-Ir. Income Tax Convention and Protocol),
U.S.-Ir., Tax Treaties (CCH) para. 4435, at 103,223)).
   The Court of Appeals subsequently withdrew its opinion in
Xilinx and issued a new opinion affirming our Opinion in
Xilinx. The new opinion by Judge Noonan was in substance
similar to his original dissenting opinion, with the exception
that the new opinion did not rest its reasoning on the notion
that inconsistencies in the regulations should be resolved
against the Government. See Xilinx Inc. v. Commissioner,
598 F.3d at 1191–1197 (Noonan, J.).
   Judge Fisher’s concurring opinion first explained the par-
ties’ ‘‘dueling interpretations of the ‘arm’s length standard’ ’’.
Id. at 1197 (Fisher, J., concurring). According to Judge
(91)         ALTERA CORP. & SUBS. v. COMMISSIONER                       103


Fisher, Xilinx contended that the arm’s-length standard
required ‘‘controlled parties * * * [to] share only those costs
uncontrolled parties share.’’ Id. By contrast, the Commis-
sioner contended that
  analyzing comparable transactions is unhelpful in situations where
  related and unrelated parties always occupy materially different cir-
  cumstances. As applied to sharing * * * [employee-stock-option (ESO)]
  costs, the Commissioner argues (consistent with the tax court’s findings)
  that the reason unrelated parties do not, and would not, share ESO costs
  is that they are unwilling to expose themselves to an obligation that will
  vary with an unrelated company’s stock price. Related companies are
  less prone to this concern precisely because they are related—i.e.,
  because XI is wholly owned by Xilinx, it is already exposed to variations
  in Xilinx’s overall stock price, at least in some respects. * * * [Id.]

Judge Fisher concluded ‘‘that Xilinx’s understanding of the
regulations is the more reasonable even if the Commis-
sioner’s current interpretation may be theoretically plau-
sible.’’ Id. at 1198. He further explained that ‘‘we need not
defer to * * * [the Commissioner’s interpretation of the
arm’s-length standard] because he has not clearly articulated
his rationale until now.’’ Id. (citing United States v. Thomp-
son/Ctr. Arms Co., 

, 518–519 & n.9 (1992)). In
a footnote Judge Fisher added: ‘‘It is an open question
whether these flaws have been addressed in the new
regulations Treasury issued after the tax years at issue
in this case.’’ Id. n.4. Notwithstanding Judge Fisher’s con-
cerns, Judge Reinhardt, dissenting, would have continued to
adhere to the panel’s original opinion. See id. at 1199–1200
(Reinhardt, J., dissenting).
V. 2003 Cost-Sharing Regulations
  A. Notice of Proposed Rulemaking
   In July 2002 Treasury issued a notice of proposed rule-
making and notice of a public hearing (NPRM) with respect
to proposed amendments to the 1995 cost-sharing regula-
tions. The NPRM set a public hearing on the proposed
amendments for November 20, 2002. See 67 Fed. Reg. 48997
(July 29, 2002). The preamble to the NPRM states that the
proposed amendments to the 1995 cost-sharing regulations
sought to clarify
104          145 UNITED STATES TAX COURT REPORTS                        (91)

  that stock-based compensation must be taken into account in deter-
  mining operating expenses under § 1.482–7(d)(1)[, Income Tax Regs.,]
  and to provide rules for measuring stock-based compensation costs * * *
  [, and] to include express provisions to coordinate the cost sharing rules
  of § 1.482–7[, Income Tax Regs.,] with the arm’s length standard as set
  forth in § 1.482–1[, Income Tax Regs.]. [Id. at 48998.]

  B. Comments Submitted in Response to the Proposed Regu-
     lations
  In response to the NPRM the following persons and
organizations submitted written comments to Treasury: (1)
American Electronics Association (AeA); (2) Baker &
McKenzie, LLP, on behalf of the Software Finance and Tax
Executives Council (SoFTEC); (3) Deloitte & Touche, LLP; (4)
Ernst & Young LLP, on behalf of the Global Competitiveness
Coalition (Global); (5) Fenwick & West, LLP (Fenwick); (6)
Financial Executives International (FEI); (7) Information
Technology Association of America; (8) Information Tech-
nology Industry Council; (9) KPMG, LLP; (10) Pricewater-
houseCoopers, LLP (PwC); (11) Irish Office of the Revenue
Commissioners; (12) Joseph A. Grundfest, W.A. Franke Pro-
fessor of Law and Business, Stanford Law School; (13) Xilinx
Inc. Additionally, the following four persons spoke at the
November 20, 2002, public hearing: (1) Eric D. Ryan, of PwC;
(2) Ron Schrotenboer, of Fenwick; (3) John M. Peterson, Jr.,
of Baker & McKenzie, LLP and on behalf of SoFTEC; and (4)
Caroline Graves Hurley, of AeA. 5
  Several of the commentators informed Treasury that they
knew of no transactions between unrelated parties, including
any cost-sharing arrangement, service agreement, or other
contract, that required one party to pay or reimburse the
other party for amounts attributable to stock-based com-
pensation.
  AeA provided to Treasury the results of a survey of its
members. AeA member companies reviewed their arm’s-
length codevelopment and joint venture agreements and
found none in which the parties shared stock-based com-
pensation. For those agreements that did not explicitly
address the treatment of stock-based compensation, the
  5 Tax Analysts prepared a written transcript of the November 20, 2002,

hearing. Treasury did not request or pay for the transcript and did not
identify it as an ‘‘official’’ transcript.
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                       105


companies reviewed their accounting records and found none
in which any costs associated with stock-based compensation
were shared.
   AeA and PwC represented to Treasury that they conducted
multiple searches of the Electronic Data Gathering, Analysis,
and Retrieval (EDGAR) system 6 and found no cost-sharing
agreements between unrelated parties in which the parties
agreed to share either the exercise spread or grant date
value of stock-based compensation.
   Several commentators identified arm’s-length agreements
in which stock-based compensation was not shared or
reimbursed. For example, (1) AeA identified, and PwC pro-
vided, a 1997 collaboration agreement between Amylin
Pharmaceuticals, Inc., and Hoechst Marion Roussel, Inc.
(Amylin-HMR collaboration agreement), that did not include
stock options in the pool of costs to be shared; (2) PwC identi-
fied a joint development agreement between the bio-
technology company AgraQuest, Inc., and Rohm & Haas
under which only ‘‘out-of-pocket costs’’ would be shared; (3)
PwC identified a 1999 cost-sharing agreement between soft-
ware companies Healtheon Corp. and Beech Street Corp.
that expressly excluded stock options from the pool of
expenses to be shared. Additionally, in written comments,
and again at the November 20, 2002, hearing, Ms. Hurley
offered to provide Treasury with more detailed information
regarding several agreements involving AeA member compa-
nies, provided that the companies received adequate assur-
ances that their proprietary information would not be dis-
closed. 7
   FEI submitted model accounting procedures from the
Council of Petroleum Accountant Societies (COPAS) for
sharing costs among joint operating agreement partners in
the petroleum industry. FEI noted that COPAS recommends
that joint operating agreements should not allow stock
  6 EDGAR    is maintained by the Securities and Exchange Commission
(SEC) and is a public and searchable database that provides users with
free access to registration statements, periodic reports, and other forms
filed by companies, including ‘‘material contracts’’ that are required by law
to be attached as exhibits to certain SEC forms.
   7 Respondent admits that Treasury never had any discussions with the

AeA member companies regarding the arm’s-length cost-sharing agree-
ments that the AeA member companies offered to discuss.
106          145 UNITED STATES TAX COURT REPORTS                      (91)


options to be charged against the joint account because they
are difficult to accurately value.
  AeA, SoFTEC, KPMG, and PwC cited the practice of the
Federal Government, which regularly enters into cost-
reimbursement contracts at arm’s length. They noted that
Federal acquisition regulations prohibit reimbursement of
amounts attributable to stock-based compensation. 8
  AeA, Global, and PwC explained that, from an economic
perspective, unrelated parties would not agree to share or
reimburse amounts related to stock-based compensation
because the value of stock-based compensation is speculative,
potentially large, and completely outside the control of the
parties. SoFTEC provided a detailed economic analysis from
economists William Baumol and Burton Malkiel reaching the
same conclusion.
  Finally, the Baumol and Malkiel analysis concluded that
there is no net economic cost to a corporation or its share-
holders from the issuance of stock-based compensation. Simi-
larly, Mr. Grundfest asserted that a company’s ‘‘decision to
grant options to employees * * * does not change its oper-
ating expenses’’ and does not factor into its pricing decisions.
  C. Final Rule
  1. Regulatory Provisions
  In August 2003 Treasury issued the final rule. The final
rule explicitly required parties to QCSAs to share stock-
based compensation costs. See sec. 1.482–7(d)(2), Income Tax
Regs. The final rule also added sections 1.482–1(b)(2)(i)
through 1.482–7(a)(3), Income Tax Regs., to provide that a
QCSA produces an arm’s-length result only if the parties’
costs are determined in accordance with the final rule. See
T.D. 9088, 2003–2 C.B. 841, 847–848.
  The final rule provides two methods for measuring the
value of stock-based compensation: a default method and an
elective method. Under the default method, ‘‘the costs attrib-
utable to stock-based compensation generally are included as
intangible development costs upon the exercise of the option
and measured by the spread between the option strike price
  8 Federal acquisition regulations prohibit contractors from charging the

Government for stock-based compensation. See 48 C.F.R. sec. 31.205–6(i)
(2013).
(91)         ALTERA CORP. & SUBS. v. COMMISSIONER                    107


and the price of the underlying stock.’’ Id., 2003–2 C.B. at
844. Under the elective method, ‘‘the costs attributable to
stock options are taken into account in certain cases in
accordance with the ‘fair value’ of the option, as reported for
financial accounting purposes either as a charge against
income or in footnoted disclosures.’’ Id. The elective method,
however, is available only with respect to options on stock
that is publicly traded ‘‘on an established United States secu-
rities market and is issued by a company whose financial
statements are prepared in accordance with United States
generally accepted accounting principles for the taxable
year.’’ Sec. 1.482–7(d)(3)(iii)(B)(2), Income Tax Regs.
  2. Lack of Evidence From Uncontrolled Transactions
   When it issued the final rule, the files maintained by
Treasury relating to the final rule did not contain any expert
opinions, empirical data, or published or unpublished arti-
cles, papers, surveys, or reports supporting a determination
that the amounts attributable to stock-based compensation
must be included in the cost pool of QCSAs to achieve an
arm’s-length result. Those files also did not contain any
record that Treasury searched any database that could have
contained agreements between unrelated parties relating to
joint undertakings or the provision of services. Additionally,
Treasury was unaware of any written contract between unre-
lated parties, whether in a cost-sharing arrangement or
otherwise, that required one party to pay or reimburse the
other party for amounts attributable to stock-based com-
pensation; or any evidence of any actual transaction between
unrelated parties, whether in a cost-sharing arrangement or
otherwise, in which one party paid or reimbursed the other
party for amounts attributable to stock-based compensation.
  3. Response to Comments
  The preamble to the final rule responded to comments that
asserted that the proposed amendments to the 1995 cost-
sharing regulations were inconsistent with the arm’s-length
standard, in relevant part, as follows:
    Treasury and the IRS continue to believe that requiring stock-based
  compensation to be taken into account for purposes of QCSAs is con-
  sistent with the legislative intent underlying section 482 and with the
  arm’s length standard (and therefore with the obligations of the United
108          145 UNITED STATES TAX COURT REPORTS                         (91)


 States under its income tax treaties and with the OECD transfer pricing
 guidelines). The legislative history of the Tax Reform Act of 1986
 expressed Congress’s intent to respect cost sharing arrangements as con-
 sistent with the commensurate with income standard, and therefore con-
 sistent 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[t]. No. 99–481 [Vol. II],
 at II–638 (1986). * * * In order for the costs incurred by a participant
 to reasonably reflect its actual economic activity, the costs must be
 determined on a comprehensive basis. Therefore, in 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 con-
 text.
    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 length standard in the absence of
 evidence that parties at arm’s length take stock-based compensation into
 account in similar circumstances. Section 1.482–1(b)(1)[, Income Tax
 Regs.,] provides that 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.’’ * * * While the
 results actually realized in similar transactions under similar cir-
 cumstances 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 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. H.R.
 Rep[t]. No. 99–426, at 423-[4]25 (1985). 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. Government contractors
 that are entitled to reimbursement for services on a cost-plus basis
 under government procurement law assume substantially less entrepre-
 neurial risk than that assumed by service providers that participate in
 QCSAs, and therefore the economic relationship between the parties to
 such an arrangement is very different from the economic relationship
 between participants in a QCSA. The other agreements highlighted by
 commentators establish arrangements that differ significantly from
 QCSAs in that they provide for the payment of markups on cost or of
 non-cost-based service fees to service providers within the arrangement
 or for the payment of royalties among participants in the arrangement.
 Such terms, which may have the effect of mitigating the impact of using
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                        109


  a cost base to be shared or reimbursed that is less than comprehensive,
  would not be permitted by the QCSA regulations. * * *
     The 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. These final regulations reflect that at arm’s length the
  parties to an arrangement that is based on the sharing of costs to
  develop intangibles in order to obtain the benefit of an independent right
  to exploit such intangibles would ensure through bargaining that the
  arrangement reflected all relevant costs, including all costs of compen-
  sating employees for providing services related to the arrangement. Par-
  ties dealing at arm’s length in such an arrangement based on the
  sharing of costs and benefits generally would not distinguish between
  stock-based compensation and other forms of compensation.
     For example, assume that two parties are negotiating an arrangement
  similar to a QCSA in order to attempt to develop patentable pharma-
  ceutical products, and that they anticipate that they will benefit equally
  from their exploitation of such patents in their respective geographic
  markets. Assume further that one party is considering the commitment
  of several employees to perform research with respect to the arrange-
  ment. That party would not agree to commit employees to an arrange-
  ment that is based on the sharing of costs in order to obtain the benefit
  of independent exploitation rights unless the other party agrees to
  reimburse its share of the compensation costs of the employees. Treasury
  and the IRS believe that if a significant element of that compensation
  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.
     [T.D. 9088, 2003–2 C.B. at 842–843.]

  The preamble to the final rule responded to comments that
asserted that stock-based compensation does not constitute
an economic cost, or relevant economic cost, as follows:
  Treasury and the IRS continue to believe that requiring stock-based
  compensation to be taken into account in the context of QCSAs is appro-
  priate. 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. Treasury and the IRS agree
  that the disposition of financial reporting issues does not mandate a par-
  ticular result under these regulations. [Id., 2003–2 C.B. at 843.]

  The preamble to the final rule responded to comments that
asserted that parties at arm’s length would not share either
the exercise spread or grant date value of stock-based com-
pensation because they would produce results that are too
speculative or not sufficiently related to the employee serv-
ices that are compensated, as follows:
110           145 UNITED STATES TAX COURT REPORTS                       (91)

  Treasury and the IRS believe that it is appropriate for regulations to
  prescribe guidance in this context that is consistent with the arm’s
  length standard and that also is objective and administrable. As long as
  the measurement method is determined at or before grant date, either
  of the prescribed measurement methods can be expected to result in an
  appropriate allocation of costs among QCSA participants and therefore
  would be consistent with the arm’s length standard. [Id., 2003–2 C.B. at
  844.]

  Finally, the preamble to the final rule states that ‘‘[i]t has
also been determined that [APA] section 553(b) * * * does
not apply to these regulations.’’ Id., 2003–2 C.B. at 847.

                               Discussion
I. Summary Judgment
  Rule 121(a) provides that either party may move for sum-
mary judgment upon all or any part of the legal issues in
controversy. Full or partial summary judgment may be
granted only if it is demonstrated that there is no genuine
dispute as to any material fact and that a decision may be
rendered as a matter of law. See Rule 121(b); Sundstrand
Corp. v. Commissioner, 

, 520 (1992), aff ’d, 

 (7th Cir. 1994). We conclude that there is no gen-
uine dispute as to any material fact relating to the issue pre-
sented by the parties’ cross-motions for partial summary
judgment and that the issue may be decided as a matter of
law.
II. Applicable Principles of Administrative Law
  A. Notice and Comment Rulemaking
  Pursuant to APA sec. 553, in promulgating regulations
through informal rulemaking an agency must (1) publish a
notice of proposed rulemaking in the Federal Register, 9 see
APA sec. 553(b); (2) provide ‘‘interested persons an oppor-
tunity to participate in the rule making through submission
of written data, views, or arguments with or without oppor-
tunity for oral presentation’’, id. subsec. (c); and (3) ‘‘[a]fter
  9 The notice of proposed rulemaking must include ‘‘(1) a statement of the
time, place, and nature of public rule making proceedings; (2) reference to
the legal authority under which the rule is proposed; and (3) either the
terms or substance of the proposed rule or a description of the subjects and
issues involved.’’ APA sec. 553(b).
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                         111


consideration of the relevant matter presented, * * * incor-
porate in the rules adopted a concise general statement of
their basis and purpose’’, id. These requirements do not
apply to interpretive rules, 10 see id. subsec. (b)(A), or when
an agency for good cause finds—and incorporates its findings
in the rules issued—that ‘‘notice and public procedure
thereon are impracticable, unnecessary, or contrary to the
public interest’’, id. para. (B).
   Generally, interpretive rules merely explain preexisting
substantive law. See Hemp Indus. Ass’n v. DEA, 

, 1087 (9th Cir. 2003). Substantive (or legislative) rules
by contrast, ‘‘create rights, impose obligations, or effect a
change in existing law’’. Id. Stated simply, ‘‘legislative rules,
unlike interpretive rules, have the ‘force of law.’ ’’ Id. (quoting
Am. Mining Cong. v. Mine Safety & Health Admin., 

, 1109 (D.C. Cir. 1993)); see also Chrysler Corp. v.
Brown, 

, 301–302 (1979).
   A rule has the force of law ‘‘only if Congress has delegated
legislative power to the agency and if the agency intended to
exercise that power in promulgating the rule.’’ Am. Mining
Cong., 995 F.2d at 1109 (citing Am. Postal Workers Union v.
USPS, 

, 558 (D.C. Cir. 1983)). The U.S. Court
of Appeals for the Ninth Circuit, to which an appeal in these
cases appears to lie absent a stipulation to the contrary, see
sec. 7482(b)(1)(B), (2), has held that we can infer that an
agency intends for a rule to have the force of law in any of
the following circumstances: ‘‘(1) when, in the absence of the
rule, there would not be an adequate legislative basis for
enforcement action; (2) when the agency has explicitly
invoked its general legislative authority; or (3) when the rule
effectively amends a prior legislative rule,’’ Hemp Indus., 333
  10 We have previously referred to regulations issued pursuant to specific

grants of rulemaking authority as legislative regulations and regulations
issued pursuant to Treasury’s general rulemaking authority, under sec.
7805(a), as interpretive regulations. See, e.g., Tutor-Saliba Corp. v. Com-
missioner, 

, 7 (2000). Because the terms ‘‘legislative’’ and ‘‘inter-
pretive’’ have different meanings in the administrative law context, see
Hemp Indus. Ass’n v. DEA, 

, 1087 (9th Cir. 2003), we will
refer to regulations issued pursuant to specific grants of rulemaking au-
thority as specific authority regulations and regulations issued pursuant to
Treasury’s general rulemaking authority, under sec. 7805(a), as general
authority regulations.
112             145 UNITED STATES TAX COURT REPORTS                    (91)


F.3d at 1087 (citing Am. Mining Cong., 

), or
‘‘effect[s] a change in existing law or policy’’, D.H. Blattner &
Sons, Inc. v. Sec’y of Labor, Mine Safety & Health Admin.,

, 1109 (9th Cir. 1998) (alteration in original)
(quoting Powderly v. Schweiker, 

, 1098 (9th
Cir. 1983)). In determining whether a rule is interpretive or
legislative we ‘‘need not accept the agency characterization at
face value.’’ Hemp Indus., 333 F.3d at 1087 (citing Gunderson
v. Hood, 

, 1154 n.27 (9th Cir. 2001)).
   The notice and comment requirements of APA sec. 553 ‘‘are
intended to assist judicial review as well as to provide fair
treatment for persons affected by a rule.’’ Home Box Office,
Inc. v. FCC, 

, 35 (D.C. Cir. 1977). Accordingly,
‘‘there must be an exchange of views, information, and criti-
cism between interested persons and the agency.’’ Id.
Additionally, because ‘‘the opportunity to comment is mean-
ingless unless the agency responds to significant points
raised by the public’’, an agency is required to respond to
significant comments. 11 Id. at 35–36. However, ‘‘[t]he failure
to respond to comments is significant only insofar as it dem-
onstrates that the agency’s decision was not based on a
consideration of the relevant factors.’’ Sherley v. Sebelius, 

, 784 (D.C. Cir. 2012) (quoting Covad Commc’ns v.
FCC, 

, 550 (D.C. Cir. 2006)).
  B. Judicial Review of Agency Decisionmaking—State Farm
     Review
  Pursuant to APA sec. 706(2)(A), a court must ‘‘hold unlaw-
ful and set aside agency action, findings, and conclusions’’
that the court finds to be ‘‘arbitrary, capricious, an abuse of
discretion, or otherwise not in accordance with law’’. A
court’s review under this ‘‘standard is narrow and a court is
not to substitute its judgment for that of the agency.’’ Motor
Vehicle Mfrs. Ass’n of the U.S. v. State Farm Mut. Auto. Ins.
  11 ‘‘[O]nlycomments which, if true, raise points relevant to the agency’s
decision and which, if adopted, would require a change in an agency’s pro-
posed rule cast doubt on the reasonableness of a position taken by the
agency. Moreover, comments which themselves are purely speculative and
do not disclose the factual or policy basis on which they rest require no
response.’’ Home Box Office, Inc. v. FCC, 

, 35 n.58 (D.C. Cir.
1977); see also Am. Mining Cong. v. EPA, 

, 771 (9th Cir. 1992)
(citing Home Box Office, 567 F.2d at 35 & n.58).
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER             113


Co., 

, 43 (1983); see also Judulang v. Holder, 565
U.S. ll, ll, 

, 483 (2011); Citizens to Pres.
Overton Park, Inc. v. Volpe, 

, 416 (1971), abro-
gated on other grounds by Califano v. Sanders, 

(1977). However, a reviewing court must ensure that the
agency ‘‘engaged in reasoned decisionmaking.’’ Judulang, 565
U.S. at ll, 132 S. Ct. at 484. To engage in reasoned
decisionmaking, ‘‘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.’ ’’ State Farm, 463 U.S. at 43 (quoting Bur-
lington Truck Lines v. United States, 

, 168
(1962)).
   In reviewing an agency action a court must determine
‘‘whether the decision was based on a consideration of the
relevant factors and whether there has been a clear error of
judgment.’’ Id. (quoting Bowman Transp., Inc. v. Arkansas-
Best Freight Sys., Inc., 

, 285 (1974)); see also
Judulang, 565 U.S. at ll, 132 S. Ct. at 484. ‘‘Normally, an
agency rule would be arbitrary and capricious if the agency
has relied on factors which Congress has not intended it to
consider, entirely failed to consider an important aspect of
the problem, offered an explanation for its decision that runs
counter to the evidence before the agency, or is so implau-
sible that it could not be ascribed to a difference in view or
the product of agency expertise.’’ State Farm, 463 U.S. at 43.
   In providing a reasoned explanation for agency action that
departs from an agency’s prior position the agency must ‘‘dis-
play awareness that it is changing position.’’ FCC v. Fox
Television Stations, Inc., 

, 515 (2009) (citing
United States v. Nixon, 

, 696 (1974)). However,
the agency need not demonstrate ‘‘that the reasons for the
new policy are better than the reasons for the old one’’. Id.
   In examining an agency’s explanation for issuing a rule a
reviewing court ‘‘ ‘may not supply a reasoned basis for the
agency’s action that the agency itself has not given.’ ’’ State
Farm, 463 U.S. at 43 (quoting SEC v. Chenery Corp., 

, 196 (1947)); see also Carpenter Family Invs., LLC
v. Commissioner, 

, 380, 396 n.30 (2011). Simi-
larly, when an agency ‘‘relie[s] on multiple rationales (and
has not done so in the alternative), and * * * [a reviewing
court] conclude[s] that at least one of the rationales is defi-
114           145 UNITED STATES TAX COURT REPORTS                       (91)


cient,’’ Nat’l Fuel Gas Supply Corp. v. FERC, 

,
839 (D.C. Cir. 2006) (citing Allied-Signal, Inc. v. U.S.
Nuclear Regulatory Comm’n, 

, 150–151 (D.C.
Cir. 1993), and Consol. Edison Co. of N.Y. v. FERC, 

, 641–642 (D.C. Cir. 1987)), the court cannot sustain the
agency action on the basis of the sufficient rationale unless
the court is certain that the agency would have taken the
same action ‘‘even absent the flawed rationale’’, id. However,
the reviewing court must ‘‘uphold a decision of less than
ideal clarity if the agency’s path may reasonably be dis-
cerned.’’ State Farm, 463 U.S. at 43 (quoting Bowman
Transp., 419 U.S. at 286).
  C. Judicial Review of Agency Statutory Construction—
     Chevron Review
  A court reviews an agency’s authoritative construction of a
statute under the two-step test first articulated in Chevron,
U.S.A., Inc. v. Natural Res. Def. Council, Inc., 

,
842 (1984). See Mayo Found. for Med. Educ. & Research v.
United States, 

, 55–58 (2011). In Mayo Found.,
the Supreme Court clarified that both specific authority regu-
lations and general authority regulations are to be accorded
Chevron deference. 12 See id.
  Under Chevron step 1, ‘‘applying the ordinary tools of
statutory construction,’’ City of Arlington v. FCC, 569 U.S.
ll, ll, 

, 1868 (2013), a court must deter-
mine ‘‘whether Congress has directly spoken to the precise
question at issue. If the intent of Congress is clear, that is
the end of the matter; for the court, as well as the agency,
must give effect to the unambiguously expressed intent of
Congress.’’ Chevron, 467 U.S. at 842–843. Under Chevron
step 2, a court must defer to the agency’s authoritative
  12 The Supreme Court explained that ‘‘Chevron deference is appropriate

‘when 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.’ ’’
Mayo Found. for Med. Educ. & Research v. United States, 

, 57
(2011) (quoting United States v. Mead Corp., 

, 226–227
(2001)). The Supreme Court concluded that when Treasury issues general
authority regulations after full notice and comment procedures, these con-
ditions are met and those regulations are therefore entitled to Chevron def-
erence. See id. at 56–57.
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER              115


interpretation of an ambiguous statute ‘‘unless it is ‘arbitrary
or capricious in substance, or manifestly contrary to the
statute.’ ’’ Mayo Found., 562 U.S. at 53 (quoting Household
Credit Servs., Inc. v. Pfennig, 

, 242 (2004)); see
also Judulang, 565 U.S. at ll, 132 S. Ct. at 483 n.7.
  Chevron deference applies even where an agency adopts a
construction that conflicts with a prior judicial construction
of the statute. See Nat’l Cable & Telecomms. Ass’n v. Brand
X Internet Servs., 

, 982–983 (2005). However, if
a precedential case holds that a statute unambiguously
expresses a congressional intent that is contrary to the
agency’s construction of the statute, the prior judicial
construction controls. See id.; see also United States v. Home
Concrete & Supply, LLC, 566 U.S. ll, ll, 

, 1844 (2012).
  D. Harmless Error
  APA sec. 706 instructs reviewing courts to take ‘‘due
account * * * of the rule of prejudicial error.’’ See also Nat’l
Ass’n of Home Builders v. Defenders of Wildlife, 

,
659–660 (2007) (‘‘In administrative law, as in federal civil
and criminal litigation, there is a harmless error rule[.]’’
(quoting PDK Labs. Inc. v. DEA, 

, 799 (D.C. Cir.
2004))). This rule reflects the notion that ‘‘[i]f the agency’s
mistake did not affect the outcome, if it did not prejudice the
petitioner, it would be senseless to vacate’’ the agency action.
PDK Labs., 362 F.3d at 799.
III. Preliminary Administrative Law Issues
   The parties disagree whether the final rule is a legislative
rule or an interpretive rule. The parties also disagree
regarding the standard of review that we should apply. We
therefore address these issues before considering the validity
of the final rule.
  A. APA Sec. 553 Applies to the Final Rule.
   Petitioner contends that the final rule is a legislative rule
under APA sec. 553(b) and is therefore subject to the notice
and comment requirements of APA sec. 553 because, if valid,
it would have the force of law. Alternatively, petitioner con-
tends that if the final rule were an interpretive rule, it would
‘‘not have the force and effect of law’’, Shalala v. Guernsey
116          145 UNITED STATES TAX COURT REPORTS                   (91)


Mem’l Hosp., 

, 99 (1995), and therefore the final
rule would not be binding on this Court. Respondent agrees
that the final rule has the force of law but disagrees with
petitioner’s contention that it is a legislative rule. However,
respondent declined to argue this issue on brief or at oral
argument.
   Instead, respondent contends that we need not decide this
issue because Treasury complied with the notice and com-
ment requirements. However, petitioner contends that
Treasury failed to adequately explain the basis of the final
rule, and Treasury’s obligation to explain the basis of the
final rule depends, at least in part, on its being a legislative
rule subject to the notice and comment requirements of APA
sec. 553. See APA sec. 553(c); cf. Internal Revenue Manual
pt. 32.1.5.4.7.5.1(2) (Sept. 30, 2011) (‘‘[M]ost IRS/Treasury
regulations will be interpretative regulations because they
fill gaps in legislation or have a prior existence in the law.’’);
id. pt. 32.1.5.4.7.3(1) (‘‘In the Explanation of Provisions sec-
tion, the drafting team should describe the substantive provi-
sions of the regulation in clear, concise, plain language
* * *. It is not necessary to justify the rules that are being
proposed or adopted or alternatives that were consid-
ered.’’). 13 Petitioner also contends that Treasury failed to
respond to significant comments, and Treasury’s obligation to
respond to significant comments is derived, at least in part,
from the notice and comment requirements of APA sec. 553.
See Home Box Office, 567 F.2d at 35–36. Moreover, we
cannot avoid this issue because petitioner alternatively con-
tends that the final rule would not bind this Court if it were
an interpretive rule. Consequently, we will decide this issue.
   Pursuant to section 7805(a) the Secretary is authorized to
‘‘prescribe all needful rules and regulations for the enforce-
ment of ’’ the Code. Such regulations carry the force of law,
and the Code imposes penalties for failing to follow them.
See, e.g., sec. 6662(b)(1). We therefore conclude that ‘‘Con-
gress has delegated legislative power to’’ Treasury. Am.
Mining Cong., 995 F.2d at 1109.
   We further conclude that Treasury intended for the final
rule to have the force of law for the following reasons: (1) the
  13 The current version of Internal Revenue Manual pt. 32.1.5.4.7.3(1)

(Oct. 20, 2014) omits the second sentence.
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER            117


parties stipulated—and we agree, see Xilinx Inc. v. Commis-
sioner, 

—that the adjustments to petitioner’s
income can be sustained only on the basis of the final rule,
see Hemp Indus., 333 F.3d at 1087, and (2) in promulgating
the final rule Treasury invoked its general legislative rule-
making authority under section 7805(a), see id. The final rule
is therefore a legislative rule. See Am. Mining Cong., 995
F.2d at 1109.
  Because it is a legislative rule and Treasury did not find
for good cause that notice and comment were impracticable,
unnecessary, or contrary to the public interest, see APA sec.
553(b)(A) and (B), APA sec. 553 applies to the final rule. We
must therefore also consider whether Treasury satisfied its
obligations under APA sec. 553(b) and (c) in issuing the final
rule.
  B. The Final Rule Must Satisfy State Farm’s Reasoned
     Decisionmaking Standard.
   Petitioner contends that we should review the final rule
under State Farm. Respondent contends that we should
review the final rule under Chevron. For the reasons that fol-
low, we conclude that—regardless of the ultimate standard of
review—the final rule must satisfy State Farm’s reasoned
decisionmaking standard.
   Respondent contends that State Farm review is not appro-
priate because the interpretation and implementation of sec-
tion 482 do not require empirical analysis. Similarly,
respondent repeatedly argues that section 482 does not
require allocations to be made with reference to uncontrolled
party conduct. But ‘‘[t]he 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. * * * The
standard to be applied in every case is that of an uncon-
trolled taxpayer dealing at arm’s length with another uncon-
trolled taxpayer.’’ Commissioner v. First Sec. Bank of Utah,

, 400 (1972) (quoting section 1.482–1(b)(1),
Income Tax Regs. (1971)); accord sec. 1.482–1(a)(1), (b)(1),
Income Tax Regs.; Treasury Department Technical Expla-
nation of the 2001 U.S.-U.K. Income Tax Convention, art. 9;
Treasury Department Technical Explanation of the 1997
118           145 UNITED STATES TAX COURT REPORTS                        (91)


U.S.-Ir. Income Tax Convention and Protocol, art. 9, Tax
Treaties (CCH) para. 4435, at 103,223; Treasury Department
Technical Explanation of the 2006 U.S. Model Income Tax
Convention, art. 9. For these reasons we have previously
stated that ‘‘the determination under section 482 is essen-
tially and intensely factual’’. Procacci v. Commissioner, 

, 412 (1990).
   Section 1.482–1(b)(1), Income Tax Regs., provides 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.’’ In
Xilinx Inc. v. Commissioner, 125 T.C. at 53–55, we held that
the arm’s-length standard always requires an analysis of
what unrelated entities do under comparable circumstances.
Similarly, in promulgating the final rule Treasury explicitly
considered whether unrelated parties would share stock-
based compensation costs in the context of a QCSA. See T.D.
9088, 2003–2 C.B. at 843 (‘‘Treasury and the IRS believe that
if a significant element of that compensation 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.’’). Treasury
necessarily decided an empirical question when it concluded
that the final rule was consistent with the arm’s-length
standard.
   Respondent counters that Treasury should be permitted to
issue regulations modifying—or even abandoning—the arm’s-
length standard. But the preamble to the final rule does not
justify the final rule on the basis of any modification or
abandonment of the arm’s-length standard, 14 and respondent
concedes that the purpose of section 482 is to achieve tax
parity. 15 The preamble also did not dismiss any of the evi-
  14 For example, the preamble does not say that controlled transactions

can never be comparable to uncontrolled transactions because related and
unrelated parties always occupy materially different circumstances. Cf.
Xilinx Inc. v. Commissioner, 598 F.3d at 1197 (Fisher, J., concurring) (‘‘The
Commissioner * * * contends that analyzing comparable transactions is
unhelpful in situations where related and unrelated parties always occupy
materially different circumstances.’’).
  15 The preamble states that ‘‘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 length standard
(91)         ALTERA CORP. & SUBS. v. COMMISSIONER                     119


dence submitted by commentators regarding unrelated party
conduct as addressing an irrelevant or inconsequential factor.
See id., 2003–2 C.B. at 842–843. We therefore need not
decide whether, under Brand X, 545 U.S. at 982–983,
Treasury would be free to modify or abandon the arm’s-
length standard because it has not done so here. See Chenery
Corp., 332 U.S. at 196; Carpenter Family Invs., LLC v.
Commissioner, 136 T.C. at 380, 396 n.30.
   The validity of the final rule therefore turns on whether
Treasury reasonably concluded, see State Farm, 463 U.S. at
43, that it is consistent with the arm’s-length standard, and
that is necessarily an empirical determination. The reason-
ableness of Treasury’s conclusion in no way depends on its
interpretation of section 482 or any other statute. As the
Supreme Court recently articulated, State Farm review is
‘‘the more apt analytic framework’’ where the challenged
regulation does not rely on an agency’s interpretation of a
statute. Judulang, 565 U.S. at ll n.7, 132 S. Ct. at 483.
   Nevertheless, respondent contends that we should not
review the final rule under State Farm because the Supreme
Court has never, and this Court has rarely, reviewed
Treasury regulations under State Farm. However,
respondent concedes that Treasury is subject to the APA, and
respondent has not advanced any justification for exempting
Treasury regulations from State Farm review. The Supreme
Court has stated that ‘‘[i]n the absence of such justification,
we are not inclined to carve out an approach to administra-
tive review good for tax law only. To the contrary, we have
expressly ‘[r]ecogniz[ed] the importance of maintaining a uni-
form approach to judicial review of administrative action.’ ’’
Mayo Found., 562 U.S. at 55 (quoting Dickinson v. Zurko,

, 154 (1999) (alteration in original)); see also
Dominion Res., Inc. v. United States, 

, 1319
(Fed. Cir. 2012) (invalidating the associated-property rule in
section 1.263A–11(e)(1)(ii)(B), Income Tax Regs., under State
Farm).
in the absence of evidence that parties at arm’s length take stock-based
compensation into account in similar circumstances.’’ T.D. 9088, 2003–2
C.B. 841, 842. However, the preamble never suggests that the final rule
could be consistent with the arm’s-length standard if evidence showed that
unrelated parties would not share stock-based compensation costs or that
an evidentiary inquiry was unnecessary. See id., 2003–2 C.B. at 842–843.
120          145 UNITED STATES TAX COURT REPORTS                       (91)


  Ultimately, however, whether State Farm or Chevron sup-
plies the standard of review is immaterial because Chevron
step 2 16 incorporates the reasoned decisionmaking standard
of State Farm. See Judulang, 565 U.S. at ll n.7, 132 S. Ct.
at 483 (stating that, under either standard, the ‘‘analysis
would be the same, because under Chevron step two, we ask
whether an agency interpretation is ‘arbitrary or capricious
in substance’ ’’ (quoting Mayo Found., 562 U.S. at 53));
Torres-Valdivias v. Holder, 

, 1114 n.5 (9th Cir.
2014) (citing Judulang, 565 U.S. at ll n.7, 132 S. Ct. at
483); Agape Church, Inc. v. FCC, 

, 410 (D.C. Cir.
2013) (citing Judulang, 565 U.S. at ll n.7, 132 S. Ct. at
483). Because the validity of the final rule turns on whether
Treasury reasonably concluded that it is consistent with the
arm’s-length standard, the final rule must—in any event—
satisfy State Farm’s reasoned decisionmaking standard.
Accordingly, we will examine whether the final rule satisfies
that standard without deciding whether Chevron or State
Farm provides the ultimate standard of review.
IV. Whether the Final Rule Satisfies State Farm’s Reasoned
    Decisionmaking Standard
  Petitioner contends that the final rule is invalid because
(A) it lacks a basis in fact, (B) Treasury failed to rationally
connect the choice it made with the facts it found, (C)
Treasury failed to respond to significant comments, and (D)
the final rule is contrary to the evidence before Treasury.
Respondent disagrees.
  A. The Final Rule Lacks a Basis in Fact.
  Petitioner contends that the final rule lacks a basis in fact
because Treasury issued the final rule without any evidence
that unrelated parties would ever agree to share stock-based
compensation costs. Respondent contends that (1) Treasury
did not rely solely on its belief that unrelated parties
entering into QCSAs would generally share stock-based com-
pensation costs but also on the commensurate-with-income
standard and (2) Treasury was sufficiently experienced with
cost-sharing agreements to conclude that unrelated parties
  16 The parties agree that sec. 482 is ambiguous. These cases would there-

fore be resolved at Chevron step 2.
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                        121


entering into QCSAs would generally share stock-based com-
pensation costs.
  1. The Commensurate-With-Income Standard Cannot Jus-
     tify the Final Rule.
  Although Treasury referred to the commensurate-with-
income standard in the preamble to the final rule, it relied
on its belief that the final rule was required by—or was at
least consistent with—the arm’s-length standard. 17 In Xilinx
Inc. v. Commissioner, 125 T.C. at 56–58, we concluded that
Congress never intended for the commensurate-with-income
standard to supplant the arm’s-length standard. In the 1988
White Paper, Treasury and the IRS similarly concluded that
Congress intended for the commensurate-with-income
standard to work consistently with the arm’s-length
standard. See Notice 88–123, 1988–2 C.B. 458, 472, 475.
Treasury has since repeatedly reinforced this conclusion in
technical explanations to numerous income tax treaties. 18
See, e.g., Treasury Department Technical Explanation of the
2001 U.S.-U.K. Income Tax Convention, art. 9, Tax Treaties
(CCH) para. 10,911, at 201,306–201,307; Treasury Depart-
ment Technical Explanation of the 1997 U.S.-Ir. Income Tax
Convention and Protocol, Tax Treaties (CCH) para. 4435, at
103,223; Treasury Department Technical Explanation of the
2006 U.S. Model Income Tax Convention, art. 9, Tax Treaties
   17 In its response to comments asserting that stock-based compensation

does not constitute an economic cost to the issuing corporation, Treasury
appears to have relied exclusively on the arm’s-length standard. See T.D.
9088, 2003–2 C.B. at 843 (‘‘Treasury and the IRS continue to believe that
requiring stock-based compensation to be taken into account in the context
of QCSAs is appropriate. 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.’’).
   18 ‘‘A tax treaty is negotiated by the United States with the active par-

ticipation of the Treasury. The Treasury’s reading of the treaty is ‘entitled
to great weight.’ ’’ Xilinx Inc. v. Commissioner, 598 F.3d at 1196–1197
(Noonan, J.) (quoting United States v. Stuart, 

, 369 (1989)),
aff ’g 

 (2005). Therefore, ‘‘[e]ven if the treaty and the Technical
Explanation should be held not to operate as law trumping the hapless
* * * [final rule], treaty and explanation act as guides. They tell us what
the Treasury * * * had in mind’’, Xilinx Inc. v. Commissioner, 

, 500–501 (9th Cir. 2009) (Noonan, J., dissenting), rev’g and remanding

, withdrawn, 

 (9th Cir. 2010), in issuing the final
rule.
122          145 UNITED STATES TAX COURT REPORTS                      (91)


(CCH) para. 215, at 10,640–10,641. The preamble to the final
rule does not indicate that Treasury intended to abandon
this conclusion and we conclude that it did not. 19
   Moreover, because Treasury did not rely exclusively on the
commensurate-with-income standard, we cannot sustain the
final rule solely on that basis if we decide that Treasury’s
reliance on the arm’s-length standard in issuing the final
rule was unreasonable. See Chenery Corp., 332 U.S. at 196;
Nat’l Fuel Gas Supply, 468 F.3d at 839 (citing Allied-Signal,
988 F.2d at 150–151, and Consol. Edison, 823 F.2d at 641–
642). Accordingly, the commensurate-with-income standard,
as interpreted by Treasury, cannot provide a sufficient basis
for the final rule.
  2. Treasury’s Unsupported Assertion Cannot Justify the
     Final Rule.
   A court will generally not override an agency’s ‘‘reasoned
judgment about what conclusions to draw from technical evi-
dence or how to adjudicate between rival scientific [or eco-
nomic] theories’’. Tripoli Rocketry Ass’n v. Bureau of Alcohol,
Tobacco, Firearms & Explosives, 

, 83 (D.C. Cir.
2006). However, ‘‘where an agency has articulated no rea-
soned basis for its decision—where its action is founded on
unsupported assertions or unstated inferences—* * * [a
court] will not ‘abdicate the judicial duty carefully to ‘‘review
the record to ascertain that the agency has made a reasoned
decision based on reasonable extrapolations from some reli-
able evidence.’’ ’ ’’ Id. (quoting Am. Mining Cong. v. EPA, 

, 1187 (D.C. Cir. 1990)).
   Respondent concedes that (1) in adopting the final rule,
Treasury took the position that it was not obligated to
engage in fact finding or to follow evidence gathering proce-
dures; (2) the files maintained by Treasury relating to the
final rule did not contain any empirical or other evidence
supporting Treasury’s belief that unrelated parties entering
into QCSAs would generally share stock-based compensation
  19 Even were we to conclude that Treasury intended to adopt a more ex-

pansive understanding of the commensurate-with-income standard, we
would be unable to sustain the final rule on that basis because Treasury
never acknowledged that it was changing its position. See FCC v. Fox Tele-
vision Stations, Inc., 

, 515 (2009) (citing United States v.
Nixon, 

, 696 (1974)).
(91)          ALTERA CORP. & SUBS. v. COMMISSIONER                      123


costs; (3) the files maintained by Treasury relating to the
final rule did not have any record that Treasury searched
any database that could have contained agreements between
unrelated parties; and (4) Treasury was unaware of any writ-
ten agreement—or of any transaction—between unrelated
parties that required one party to pay or reimburse the other
party for amounts attributable to stock-based compensa-
tion. 20
   The preamble to the final rule offered only Treasury’s
belief that unrelated parties entering into QCSAs would gen-
erally share stock-based compensation costs. Specifically, the
preamble to the final rule states that, in the context of a
hypothetical QCSA between unrelated parties to develop
patentable pharmaceutical products, ‘‘Treasury and the IRS
believe that if a significant element of that compensation
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.’’
T.D. 9088, 2003–2 C.B. at 843. Treasury, however, failed to
provide a reasoned basis for reaching this conclusion from
any evidence in the administrative record. See Tripoli Rock-
etry, 437 F.3d at 83. Indeed, ‘‘every indication in the record
points the other way’’. State Farm, 463 U.S. at 57 (internal
quotation omitted); see infra part IV.C.
   Respondent defends Treasury’s failure to provide a rea-
soned basis for its conclusion from any evidence in the
administrative record on the notion that ‘‘[t]here are some
propositions for which scant empirical evidence can be mar-
shaled’’. See Fox Television, 556 U.S. at 519. This may be
true regarding certain propositions, see id. (‘‘the harmful
effect of broadcast profanity on children is one of them’’), but
we do not agree that the belief that unrelated parties would
share stock-based compensation costs in the context of a
QCSA is one of them. First, commentators submitted signifi-
cant evidence regarding this proposition. See infra part IV.C.
  20 Treasury’s failure to conduct any factfinding before issuing the final

rule is also evident in the preamble to the final rule. See T.D. 9088, 2003–
2 C.B. at 842 (‘‘While the results actually realized in similar transactions
under similar circumstances ordinarily provide significant evidence in de-
termining whether a controlled transaction meets the arm’s length stand-
ard, in the case of QCSAs such data may not be available.’’ (Emphasis
added.)).
124        145 UNITED STATES TAX COURT REPORTS              (91)


Second, we were able to reach a definitive factual determina-
tion on the basis of significant evidence regarding this very
proposition in Xilinx. See Xilinx Inc. v. Commissioner, 125
T.C. at 58–62. Third, Treasury could not have rationally con-
cluded that this is a proposition ‘‘for which scant empirical
evidence can be marshaled’’, see Fox Television, 556 U.S. at
519, without attempting to marshal empirical evidence in the
first instance, which respondent concedes it did not do.
     Relying on Peck v. Thomas, 

 (9th Cir. 2012),
respondent further contends that we must defer to Treas-
ury’s expertise with respect to whether the parties operating
at arm’s length would share stock-based compensation. At
issue in Peck was a regulation issued by the Bureau of
Prisons that denied early release to inmates with a felony
conviction for certain enumerated offenses. In issuing the
regulation the Bureau of Prisons expressly relied on its
‘‘ ‘correctional experience’ ’’ in determining which offenses
warrant preclusion from early release but did not disclose
any statistical studies to support its conclusions. See id. at
773 (quoting 74 Fed. Reg. 1895 (Jan. 14, 2009)). The U.S.
Court of Appeals for the Ninth Circuit rejected an inmate’s
argument that the Bureau of Prisons violated the APA in
issuing this regulation because it did not develop statistical
evidence to support its conclusions. See id. at 775–776. The
Court of Appeals reasoned that the Bureau of Prisons was
entitled to rely on its experience and the APA did not require
it to develop statistical evidence to support its conclusions.
See id. (citing Sacora v. Thomas, 

, 1067, 1069
(9th Cir. 2010)).
     Respondent’s reliance on Peck is misplaced. First, in Peck,
the Bureau of Prisons relied on its extensive correctional
experience in determining which offenses warrant preclusion
from early release. Here, by contrast, Treasury admits that
it had no knowledge of any transactions in which parties
operating at arm’s length shared stock-based compensation.
     Second, the preamble to the regulation at issue in Peck
expressly relied on the Bureau of Prisons’ extensive, hands-
on correctional experience. Here, by contrast, the preamble to
the final rule does not rely on Treasury’s experience as a
party to arm’s-length cost-sharing agreements—or even on
any experience Treasury may have had in examining the
arm’s-length cost-sharing agreements of taxpayers it regu-
(91)        ALTERA CORP. & SUBS. v. COMMISSIONER             125


lates. Indeed, the preamble to the final rule all but dis-
claimed Treasury’s reliance on any such experience.
   Third, the administrative record for the regulation at issue
in Peck contained no evidence contradicting the Bureau of
Prisons’ correctional experience. Here, by contrast, com-
mentators introduced significant evidence showing that par-
ties operating at arm’s length would not share stock-based
compensation. See infra part IV.C. Peck does not support the
contention that an agency can rely on unsupported assertions
in the face of significant contrary evidence in the administra-
tive record.
   We conclude that (1) by failing to engage in any fact
finding, Treasury failed to ‘‘examine the relevant data’’, State
Farm, 463 U.S. at 43, and (2) Treasury failed to support its
belief that unrelated parties would share stock-based com-
pensation costs in the context of a QCSA with any evidence
in the record. Accordingly, the final rule lacks a basis in fact.
  B. Treasury Failed To Rationally Connect the Choice It
     Made With the Facts It Found.
   Petitioner contends that the preamble to the final rule fails
to rationally connect the choice that Treasury made in
issuing a uniform final rule with the facts on which it pur-
ported to rely. See id. The preamble to the final rule
indicates that Treasury relied on its belief that unrelated
parties entering into QCSAs to develop ‘‘high-profit intangi-
bles’’ would share stock-based compensation if the stock-
based compensation was a ‘‘significant element’’ of the com-
pensation. T.D. 9088, 2003–2 C.B. at 842–843. However, peti-
tioner alleges, and respondent does not dispute, that (1)
many QCSAs do not deal with ‘‘high-profit intangibles’’ and
(2) stock-based compensation is often not a ‘‘significant ele-
ment’’ of the compensation of the employees of taxpayers that
enter into QCSAs. Yet the final rule does not distinguish
between QCSAs to develop ‘‘high-profit intangibles’’ in which
stock-based compensation was a ‘‘significant element’’ of the
compensation and QCSAs in which these elements are not
present. Petitioner contends—and we agree—that the pre-
amble’s explanation for Treasury’s decision is therefore inad-
equate. See State Farm, 463 U.S. at 43.
   Indeed, respondent does not directly refute petitioner’s
contention. Instead, respondent defends the final rule’s
126           145 UNITED STATES TAX COURT REPORTS                        (91)


inflexibility by arguing that the final rule is reasonable
because it eases administrative burdens. 21
   Improving administrability can be a reasonable basis for
agency action. See Mayo Found., 562 U.S. at 59 (‘‘[Treasury]
reasonably concluded that its full-time employee rule would
‘improve administrability[.]’ ’’ (quoting T.D. 9167, 2005–1 C.B.
261, 262)). However, Treasury failed to give this—or any
other—explanation for treating all QCSAs identically in the
preamble to the final rule, 22 cf. id., and we cannot reason-
ably discern, see State Farm, 463 U.S. at 43, that this was
Treasury’s rationale for adopting a uniform final rule
because the administrative benefits of a uniform final rule
are entirely speculative. 23
   Moreover, even if we could discern that this was Treasury’s
intent, we would be unable to sustain the final rule on that
basis because Treasury did not disclose its factual findings
and we would therefore be unable to evaluate whether
Treasury reasonably concluded that the purported adminis-
trative benefits of a uniform final rule can justify erroneously
allocating income in some of those cases. We therefore con-
clude that, by treating all QCSAs identically, Treasury failed
to articulate a ‘‘rational connection between the facts found
   21 Respondent also argues that petitioner cannot complain if the final

rule sometimes produces results that are inconsistent with the arm’s-
length standard because the QCSA regime provides an ‘‘elective assured
treatment’’. However, Treasury rejected commentators’ suggestion to issue
the final rule as a safe harbor, see T.D. 9088, 2003–2 C.B. at 843–844, and
we conclude that petitioner has not forfeited its right to challenge the va-
lidity of the final rule because it chose to structure the R&D cost-sharing
agreement as a QCSA.
   22 The preamble to the final rule discusses administrability only with re-

spect to Treasury’s selection of the exercise spread method and the elective
grant date method as the only available valuation methods. See T.D. 9088,
2003–2 C.B. at 844.
   23 We also note that unlike the statutory provision at issue in Mayo

Found., sec. 482 purports only to empower the Secretary to allocate income
among controlled entities but not to directly govern taxpayer conduct. See
sec. 1.482–1(a)(3), Income Tax Regs. (‘‘If necessary to reflect an arm’s
length result, a controlled taxpayer may report * * * the results of its con-
trolled transactions based upon prices different from those actually
charged.’’ (Emphasis added.)). It is accordingly unclear whether admin-
istrability concerns are relevant in the context of sec. 482. However, be-
cause we cannot reasonably discern that Treasury relied on administra-
bility concerns here, we need not resolve this question.
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER            127


and the choice made.’’ State Farm, 463 U.S. at 43 (quoting
Burlington Truck Lines, 371 U.S. at 168).
  C. Treasury Failed To Respond to Significant Comments.
   Petitioner contends that Treasury failed to respond to
significant    comments      submitted    by    commentators.
Respondent contends that Treasury was not persuaded by
the submitted comments.
   Several commentators informed Treasury that they knew
of no evidence of any transaction between unrelated parties
that required one party to reimburse the other party for
amounts attributable to stock-based compensation. Addition-
ally, AeA informed Treasury that a survey of its member
companies’ arm’s-length codevelopment and joint venture
agreements found none in which the parties agreed to share
stock-based compensation costs. We found similar evidence to
be relevant in Xilinx. See Xilinx Inc. v. Commissioner, 125
T.C. at 59. Treasury never directly responded to this evi-
dence. Instead, Treasury reasoned that the final rule would
not be inconsistent with the arm’s-length standard in the
absence of evidence that unrelated parties share stock-based
compensation costs because relevant data may not be avail-
able. See T.D. 9088, 2003–2 C.B. at 842. Treasury’s response,
however, in no way refutes the commentators’ evidence that
unrelated parties never share such compensation.
   AeA and PwC further represented to Treasury that they
conducted multiple searches of the EDGAR system and found
no cost-sharing agreements between unrelated parties in
which the parties agreed to share either the exercise spread
or grant date value of stock-based compensation. Treasury
never responded to this evidence.
   Several commentators identified arm’s-length agreements
in which stock-based compensation was not shared or
reimbursed. Treasury responded to these comments by
stating that ‘‘[t]he uncontrolled transactions cited by com-
mentators do not share enough characteristics of QCSAs
involving the development of high-profit intangibles to estab-
lish that parties at arm’s length would not take stock options
into account in the context of an arrangement similar to a
QCSA.’’ Id. In particular, Treasury stated that
128          145 UNITED STATES TAX COURT REPORTS                       (91)

  [t]he other agreements highlighted by commentators establish arrange-
  ments that differ significantly from QCSAs in that they provide for the
  payment of markups on cost or of non-cost-based service fees to service
  providers within the arrangement or for the payment of royalties among
  participants in the arrangement. Such terms, which may have the effect
  of mitigating the impact of using a cost base to be shared or reimbursed
  that is less than comprehensive, would not be permitted by the QCSA
  regulations. * * * [Id.]

However, the Amylin-HMR collaboration agreement that AeA
identified and PwC submitted did not ‘‘provide for the pay-
ment of markups on cost or of non-cost-based service fees to
service providers within the arrangement or for the payment
of royalties among participants in the arrangement.’’ Id.
Respondent contends that the Amylin-HMR collaboration
agreement is not comparable to a QCSA for other reasons,
but Treasury failed to identify those reasons in the preamble
to the final rule. 24 See Chenery Corp., 332 U.S. at 196; Car-
penter Family Invs., LLC v. Commissioner, 136 T.C. at 380,
396 n.30. More significantly, Treasury did not explain why
identical transactions are necessary to prove whether unre-
lated parties would share stock-based compensation costs in
the context of a QCSA. In Xilinx Inc. v. Commissioner, 125
T.C. at 58–62, we found that unrelated parties would not
share the exercise spread or grant date value of stock-based
compensation, and in doing so we did not rely on trans-
actions that were identical or substantially similar to QCSAs.
Rather, we relied on the behavior of uncontrolled parties in
comparable business transactions as well as on other evi-
dence. See id. 25
  FEI provided model accounting procedures from COPAS
that recommended against sharing stock-based compensation
because it is difficult to value. Treasury never responded to
this evidence.
  24 The Amylin-HMR collaboration agreement also would permit the shar-
ing of stock-based compensation based on the intrinsic value method,
under which options issued in-the-money would be recognized as an ex-
pense. However, the treatment of in-the-money stock options is not at
issue here, and the final rule explicitly rejected the use of the intrinsic
value method. See T.D. 9088, 2003–2 C.B. at 844.
  25 Treasury appears to require a similar approach in analyzing com-

parability under the sec. 482 regulations. See sec. 1.482–1(d), Income Tax
Regs.
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER             129


   AeA, SoFTEC, KPMG, and PwC cited regulations that pro-
hibit contractors from charging the Federal Government for
stock-based compensation. Treasury responded to this evi-
dence by stating that ‘‘[g]overnment contractors that are
entitled to reimbursement for services on a cost-plus basis
under government procurement law assume substantially
less entrepreneurial risk than that assumed by service pro-
viders that participate in QCSAs’’. See T.D. 9088, 2003–2
C.B. at 842. However, this distinction rings hollow in the face
of other evidence submitted by commentators that showed
that even parties to agreements in which the parties assume
considerable entrepreneurial risk do not share stock-based
compensation costs.
   AeA, Global, and PwC explained that, from an economic
perspective, unrelated parties would be unwilling to share
stock-based compensation costs because the value of stock-
based compensation is speculative, potentially large, and
completely outside the control of the parties. SoFTEC sub-
mitted Baumol and Malkiel’s detailed economic analysis
reaching the same conclusion. We found similar evidence to
be relevant in Xilinx. See Xilinx Inc. v. Commissioner, 125
T.C. at 61. Treasury never directly responded to this evi-
dence. Instead, Treasury construed these comments as objec-
tions to Treasury’s selection of the exercise spread method
and the grant date method as the only available valuation
methods. See T.D. 9088, 2003–2 C.B. at 844. Treasury
responded that these methods are consistent with the arm’s-
length standard and are administrable. See id. Treasury,
however, never explained how these methods could be con-
sistent with the arm’s-length standard if unrelated parties
would not share them or why unrelated parties would share
stock-based compensation costs in any other way.
   The Baumol and Malkiel analysis also concluded that there
is no net economic cost to a corporation or its shareholders
from the issuance of stock-based compensation. Treasury
identified this evidence in the preamble to the final rule but
did not directly respond to it. See id., 2003–2 C.B. at 843.
Instead, the preamble states that ‘‘[t]he final regulations pro-
vide that stock-based compensation must be taken into
account in the context of QCSAs because such a result is con-
sistent with the arm’s length standard.’’ Id. Treasury, how-
ever, never explained why unrelated parties would share
130           145 UNITED STATES TAX COURT REPORTS                       (91)


stock-based compensation costs—or how the commensurate-
with-income standard could justify the final rule—if stock-
based compensation is not an economic cost to the issuing
corporation or its shareholders. 26
   Mr. Grundfest informed Treasury that companies do not
factor stock-based compensation into their pricing decisions.
We found similar evidence to be relevant in Xilinx. See Xilinx
Inc. v. Commissioner, 125 T.C. at 59. Treasury never
responded to this evidence.
   Indeed, Treasury failed to respond directly to any of the
evidence that unrelated parties would not share stock-based
compensation costs, other than by asserting that the trans-
actions cited by the commentators did not ‘‘share enough
characteristics of QCSAs involving the development of high-
profit intangibles’’ to be relevant. T.D. 9088, 2003–2 C.B. at
842. This was a mere assertion; Treasury offered no analysis
addressing the extent of the supposed differences or
explaining why any differences make the cited transactions
irrelevant or unpersuasive. By contrast, in Xilinx we exam-
ined a broad array of evidence to determine whether unre-
lated parties would share such costs. See Xilinx Inc. v.
Commissioner, 125 T.C. at 58–62. Tellingly, respondent does
not even attempt to explain why Treasury failed to address
similar evidence in the preamble to the final rule.
   Although Treasury’s failure to respond to an isolated com-
ment or two would probably not be fatal to the final rule,
Treasury’s failure to meaningfully respond to numerous rel-
evant and significant comments certainly is. See Home Box
Office, 567 F.2d at 35–36. Meaningful judicial review and fair
treatment of affected persons require ‘‘an exchange of views,
information, and criticism between interested persons and
the agency.’’ Id. at 35. Treasury’s failure to adequately
respond to commentators frustrates our review of the final
rule and was prejudicial to affected entities.
  26 Respondent contends that the final rule is consistent with the com-

mensurate-with-income standard because stock-based compensation is eco-
nomic activity even if it is not an economic cost. However, Treasury never
made this distinction in the preamble to the final rule, see SEC v. Chenery
Corp., 

, 196 (1947); Carpenter Family Invs., LLC v. Commis-
sioner, 

, 380, 396 n.30 (2011), and it did not explain why unre-
lated parties would share items that are not economic costs.
(91)       ALTERA CORP. & SUBS. v. COMMISSIONER              131


  D. The Final Rule Is Contrary to the Evidence Before
     Treasury.
   Petitioner contends that the final rule is contrary to the
evidence before Treasury when it issued the final rule. We
agree.
   We have already discussed Treasury’s failure to cite any
evidence supporting its belief that unrelated parties to
QCSAs would share stock-based compensation costs, see
supra part IV.A; the significant evidence submitted by com-
mentators showing that unrelated parties to QCSAs would
not share stock-based compensation costs, see supra part
IV.C; and Treasury’s failure to respond to much of the sub-
mitted evidence, see id.
   Significantly, Treasury never said that it found any of the
submitted evidence incredible. Treasury also seemed to
accept the commentators’ economic analyses, which con-
cluded that—and explained why—unrelated parties to a
QCSA would be unwilling to share the exercise spread or
grant date value of stock-based compensation. Finally,
respondent has not identified any evidence in the administra-
tive record that supports Treasury’s belief that unrelated
parties to QCSAs would generally share stock-based com-
pensation costs.
   Although we are mindful that ‘‘a court is not to substitute
its judgment for that of the agency’’, State Farm, 463 U.S. at
43, we conclude that Treasury’s ‘‘explanation for its decision
* * * runs counter to the evidence before’’ it, see id.
V. Harmless Error
  Respondent contends that, pursuant to the harmless error
rule of APA sec. 706, any deficiencies in Treasury’s reasoning
should not invalidate the final rule because (1) Treasury had
sufficient alternative reasons for adopting the final rule and
(2) in the years following Treasury’s adoption of the final rule
the Financial Accounting Standards Board (FASB), the Inter-
national Accounting Standards Board (IASB), and the
Organisation for Economic Cooperation and Development
132          145 UNITED STATES TAX COURT REPORTS                       (91)


(OECD) 27 have adopted policy positions that concur with
Treasury’s. 28
  A. Alternative Reasons for Adopting the Final Rule
   Although the preamble refers to the commensurate-with-
income standard, we have already concluded that Treasury
never indicated that it was prepared to independently rely on
the commensurate-with-income standard—or any other rea-
son—as a basis for adopting the final rule. See supra parts
III.B and IV.A.1. Moreover, because the arm’s-length
standard is incorporated into numerous income tax treaties,
see, e.g., 2001 U.S.-U.K. Income Tax Convention, art. 9; 2006
U.S. Model Income Tax Convention, art. 9; Treasury Depart-
ment Technical Explanation of the 2001 U.S.-U.K. Income
Tax Convention, art. 9, Tax Treaties (CCH) para. 10,911, at
201,306–201,307; Treasury Department Technical Expla-
nation of the 2006 U.S. Model Income Tax Convention, art.
9; Tax Treaties (CCH) para. 215, at 10,640–10,641,
respondent cannot reasonably contend that Treasury would
have clearly adopted the final rule had it concluded that the
final rule conflicted with that standard. See PDK Labs., 362
F.3d at 799.


  27 In 2004 the OECD published a report on the impact of employee stock
options on transfer pricing that ‘‘start[ed] with the premise that employee
stock options are remuneration.’’ OECD, Employee Stock Option Plans: Im-
pact on Transfer Pricing 1. In 2005, however, the OECD published a policy
study that again started with the same premise but recognized that the
arm’s-length standard required more analysis. See OECD, The Taxation of
Employee Stock Options, Tax Policy Studies No. 11, at 165 (‘‘Of course,
whether in-kind remuneration, including stock options, should be taken
into account in any particular case depends on a determination of what
independent parties acting at arm’s length would do in the facts and cir-
cumstances of that case.’’).
  28 Each of the policy positions that respondent now contends support the

2003 final rule was published after Treasury promulgated the final rule.
See, e.g., Statement of Financial Accounting Standards No. 123, Account-
ing for Stock-Based Compensation (revised 2004), Share-Based Payment;
International Financial Reporting Standard No. 2, Share-based Payment,
February 2004; OECD, Employee Stock Option Plans: Impact on Transfer
Pricing; see also OECD, the Taxation of Employee Stock Options, OECD
Tax Policy Studies No. 11.
(91)           ALTERA CORP. & SUBS. v. COMMISSIONER                      133


  B. Settled Policy
   Respondent’s argument that the policy debate underlying
the final rule has long been settled is irrelevant and mis-
apprehends the role of this Court under State Farm. It is
irrelevant because Treasury expressly disavowed reliance on
financial reporting standards when it issued the final rule,
see T.D. 9088, 2003–2 C.B. at 843 (‘‘Treasury and the IRS
agree that the disposition of financial reporting issues does
not mandate a particular result under these regulations.’’),
and the policy positions to which respondent refers did not
exist and were therefore unavailable to Treasury when it
issued the final rule, see Chenery Corp., 332 U.S. at 196; Car-
penter Family Invs., LLC v. Commissioner, 136 T.C. at 380,
396 n.30. Respondent’s argument misapprehends the role of
this Court because, under State Farm, our role is not to
decide whether the final rule is good policy—it is simply to
‘‘ensur[e] that * * * [Treasury] engaged in reasoned decision-
making.’’ Judulang, 565 U.S. at ll, 132 S. Ct. at 483–484.
   Because it is not clear that Treasury would have adopted
the final rule had it concluded that the final rule is incon-
sistent with the arm’s-length standard, the harmless error
rule is inapplicable.
VI. Conclusion
  Because the final rule lacks a basis in fact, Treasury failed
to rationally connect the choice it made with the facts found,
Treasury failed to respond to significant comments when it
issued the final rule, and Treasury’s conclusion that the final
rule is consistent with the arm’s-length standard is contrary
to all of the evidence before it, we conclude that the final rule
fails to satisfy State Farm’s reasoned decisionmaking
standard and therefore is invalid. 29 See APA sec. 706(2)(A);
  29 Because  we conclude that the final rule fails to satisfy State Farm’s
reasoned decisionmaking standard, the final rule would be invalid even if
we were to conclude that Chevron supplies the ultimate standard of re-
view. See supra part III.B. The analysis under Chevron would proceed as
follows: The parties agree that sec. 482 is ambiguous. We would therefore
proceed to Chevron step 2. Under Chevron step 2, we would conclude the
final rule is invalid because it is ‘‘arbitrary or capricious in substance’’,
Judulang v. Holder, 565 U.S. ll, ll n.7, 

, 483 (2011)
(quoting Mayo Found., 562 U.S. at 53), and therefore cannot be justified
                                                Continued
134           145 UNITED STATES TAX COURT REPORTS                 (91)


State Farm, 463 U.S. at 43. Indeed, Treasury’s ‘‘ipse dixit
conclusion, coupled with its failure to respond to contrary
arguments resting on solid data, epitomizes arbitrary and
capricious decisionmaking.’’ Ill. Pub. Telecomms. Ass’n v.
FCC, 

, 564 (D.C. Cir. 1997).
   By reason of the above respondent erred in making the sec-
tion 482 allocations at issue, and petitioner is therefore enti-
tled to partial summary judgment. We will grant petitioner’s
motion and deny respondent’s motion.
   We have considered the parties’ remaining arguments, and
to the extent not discussed above, conclude those arguments
are irrelevant, moot, or without merit.
   To reflect the foregoing,
                         An appropriate order will be issued.
  Reviewed by the Court.
  THORNTON, COLVIN, HALPERN, FOLEY, VASQUEZ, GALE,
GOEKE, HOLMES, PARIS, KERRIGAN, BUCH, LAUBER, NEGA,
and ASHFORD, JJ., agree with this opinion of the Court.
  MORRISON and PUGH, JJ., did not participate in the consid-
eration of this opinion.

                             f




as being a reasonable interpretation of what sec. 482 requires.