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Bulletin No. 1996–4
January 22, 1996
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
wage statements with the Social Security Administration upon the termination of an employer’s operations.
Rev. Rul. 96–9, page 5.
LIFO; price indexes; department stores. The November
1995 Bureau of Labor Statistics price indexes are
accepted for use by department stores employing the
retail inventory and last-in, first-out inventory methods
for valuing inventories for tax years ended on, or with
reference to, November 30, 1995.
T.D. 8637, page 29.
IA–33–95, page 99.
Final, temporary, and proposed regulations relating to
backup withholding, statement mailing requirements,
and due diligence.
Rev. Rul. 96–10, page 27.
Basis of partner’s interest; sale between partnerships.
Partners’ bases in their partnership interests are
decreased to reflect losses on the sale of partnership
property to a related partnership that are disallowed
under section 707(b)(1) of the Internal Revenue Code.
Partners’ bases in their partnership interests are
increased to reflect gain from the sale of partnership
property that is not recognized under sections 267(d)
and 707(b)(1) of the Code.
EXCISE TAX
Rev. Rul. 96–11, page 28.
Charitable contribution by partnership. A charitable
contribution of property by a partnership reduces each
partner’s basis in the partnership by the amount of the
partner’s share of the partnership’s basis in the
property contributed.
Notice 96–4, page 69.
Partial withdrawal of proposed regulations INTL–52–86,
1988–1 C.B. 892, prescribing rules for official statements to recipients of dividends and patronage dividends paid after December 31, 1983.
Rev. Rul. 96–8, page 62.
Two COBRA premium issues. Guidance is given on two
premium issues that arise under the continuation
coverage requirements for group health plans in section
4980B of the Code.
ADMINISTRATIVE
EMPLOYMENT TAX
Rev. Proc. 96–17, page 69.
Reportin agents; Form 8655. This procedure provides
instructions for preparing and submitting Form 8655,
Reporting Agent Authorization for Magnetic Tape and
Electronic Filers. Rev. Proc. 89–19 superseded; Rev.
Procs. 94–59, 94–18, 93–46, and 89–48 superseded
in part.
T.D. 8636, page 64.
Final regulations under sections 6011, 6051, 6071,
and 6081 of the Code concerning the time for
furnishing wage statements to employees and for filing
Rev. Proc. 96–18, page 73.
Magnetic tape reporting; Forms 940, 941, and 945. This
procedure provides requirements under which a re(Continued on page 4)
T.D. 8632, page 6.
Final regulations relating to qualified cost sharing
arrangements under section 482 of the Code.
Finding Lists begin on page 104.
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Mission of the Service
The purpose of the Internal Revenue Service is to
collect the proper amount of tax revenue at the least
cost; serve the public by continually improving the
quality of our products and services; and perform in a
manner warranting the highest degree of public
confidence in our integrity, efficiency and fairness.
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to
administer the Internal Revenue Code. Tax policy
for raising revenue is determined by Congress.
With this in mind, it is the duty of the Service to
carry out that policy by correctly applying the laws
enacted by Congress; to determine the reasonable
meaning of various Code provisions in light of the
Congressional purpose in enacting them; and to
perform this work in a fair and impartial manner,
with neither a government nor a taxpayer point of
view.
At the heart of administration is interpretation of the
Code. It is the responsibility of each person in the
Service, charged with the duty of interpreting the
law, to try to find the true meaning of the statutory
provision and not to adopt a strained construction in
the belief that he or she is ‘‘protecting the revenue.’’
The revenue is properly protected only when we ascertain and apply the true meaning of the statute.
2
The Service also has the responsibility of applying
and administering the law in a reasonable,
practical manner. Issues should only be raised by
examining officers when they have merit, never
arbitrarily or for trading purposes. At the same
time, the examining officer should never hesitate
to raise a meritorious issue. It is also important
that care be exercised not to raise an issue or to
ask a court to adopt a position inconsistent with
an established Service position.
Administration should be both reasonable and
vigorous. It should be conducted with as little
delay as possible and with great courtesy and
considerateness. It should never try to overreach,
and should be reasonable within the bounds of law
and sound administration. It should, however, be
vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax
devices and fraud.
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Introduction
The Internal Revenue Bulletin is the authoritative
instrument of the Commissioner of Internal Revenue for
announcing official rulings and procedures of the
Internal Revenue Service and for publishing Treasury
Decisions, Executive Orders, Tax Conventions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription basis. Bulletin contents of a permanent nature are
consolidated semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin
all substantive rulings necessary to promote a uniform
application of the tax laws, including all rulings that
supersede, revoke, modify, or amend any of those
previously published in the Bulletin. All published
rulings apply retroactively unless otherwise indicated.
Procedures relating solely to matters of internal
management are not published; however, statements of
internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the
Service on the application of the law to the pivotal facts
stated in the revenue ruling. In those based on
positions taken in rulings to taxpayers or technical
advice to Service field offices, identifying details and
information of a confidential nature are deleted to
prevent unwarranted invasions of privacy and to comply
with statutory requirements.
Rulings and procedures reported in the Bulletin do not
have the force and effect of Treasury Department
Regulations, but they may be used as precedents.
Unpublished rulings will not be relied on, used, or cited
as precedents by Service personnel in the disposition of
other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be
considered, and Service personnel and others concerned are cautioned against reaching the same
conclusions in other cases unless the facts and
circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on
provisions of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows:
Subpart A, Tax Conventions, and Subpart B, Legislation
and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellanous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and
Subparts. Also included in this part are Bank Secrecy
Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the
Treasury’s Office of the Assistant Secretary
(Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in
this part, none of these announcements are consolidated in the Cumulative Bulletins.
The first Bulletin for each month includes an index for
the matters published during the preceding month.
These monthly indexes are cumulated on a quarterly
and semiannual basis, and are published in the first
Bulletin of the succeeding quarterly and semi-annual
period, respectively.
The Bulletin Index-Digest System, a research and
reference service supplementing the Bulletin, may be
obtained from the Superintendent of Documents on a
subscription basis. It consists of four Services: Service
No. 1, Income Tax; Service No. 2, Estate and Gift
Taxes; Service No. 3, Employment Taxes; Service No.
4, Excise Taxes. Each Service consists of a basic
volume and a cumulative supplement that provides (1)
finding lists of items published in the Bulletin, (2)
digests of revenue rulings, revenue procedures, and
other published items, and (3) indexes of Public Laws,
Treasury Decisions, and Tax Conventions.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.
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HIGHLIGHTS
OF THIS ISSUE—Continued
Form 1040 series are informed of their obligations
to the Service and other participants. Rev. Proc. 95–13
superseded.
ADMINISTRATIVE—Continued
porting agent can furnish information required by the
following forms by magnetic tape: Form 940,
Employer’s Annual Federal Unemployment (FUTA) Tax
Return; Form 941, Employer’s Quarterly Federal Tax
Return; and Form 945, Annual Return of Withheld
Federal Income Tax. Rev. Procs. 93–46, 94–18, and
94–59 superseded.
Rev. Proc. 96–21, page 96.
Making the single-entity election. This procedure describes the manner and time for consolidated groups to
make the retroactive single-entity election under section 1.1221–2(g)(5)(i) of the Income Tax Regulations
for purposes of the definition of a hedging transaction.
See T.D. 8653.
Rev. Proc. 96–19, page 80.
Electronic filing; Form 941. This procedure provides
requirements under which a taxpayer, or a reporting
agent preparing Form 941, Employer’s Quarterly Federal Tax Return, for groups of taxpayers, can furnish the
required information electronically through the
Electronic Filing Program for Form 941.
T.D. 8633, page 20.
Final regulations under sections 671, 2702, 6012, and
6109 of the Code relating to grantor trust reporting
requirements.
Announcement 96–5, page 99.
This announcement identifies the Taxpayer Bill of
Rights 2 proposals that Treasury and the IRS have
already adopted administratively or will soon do so and
describes similar regulatory and guidance projects.
Rev. Proc. 96–20, page 88.
On-Line Service Electronic Filing Program; Form 1040.
Participants in the 1996 On-Line Filing Program for the
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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 170.—Charitable
Contributions and Gifts
§ 705(a)(1) to reflect that gain? See Rev. Rul.
96–10, page 27.
26 CFR 1.170A–1: Charitable Contributions
and Gifts
§ 472.—Last-in, First-out Inventories
If a partnership makes a charitable contribution of property, are the partners’ bases in their
partnership interests decreased to reflect the
contribution. See Rev. Rul. 96–11, page 28.
26 CFR 1.472–1: Last-in, first-out inventories.
Section 267.—Losses, Expenses, and
Interest with respect to Transactions
between Related Taxpayers.
LIFO; price indexes; department
stores. The November 1995 Bureau of
Labor Statistics price indexes are accepted for use by department stores
employing the retail inventory and lastin, first-out inventory methods for valuing inventories for tax years ended on, or
with reference to, November 30, 1995.
26 CFR 1.267(d)–1: Amount of gain where
loss previously disallowed.
Rev. Rul. 96–9
If gain from the sale of partnership property is
not recognized due to §§ 707(b)(1) and 267(d) of
the Internal Revenue Code, are the partners’
bases in their partnership interests incrased under
The following Department Store Inventory Price Indexes for November
1995 were issued by the Bureau of
Labor Statistics on December 14, 1995.
The indexes are accepted by the
Internal Revenue Service, under
§ 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2
C.B. 739, for appropriate application to
inventories of department stores
employing the retail inventory and lastin, first-out inventory methods for tax
years ended on, or with reference to,
November 30, 1995.
The Department Store Inventory
Price Indexes are prepared on a national basis and include (a) 23 major
groups of departments, (b) three special
combinations of the major groups—soft
goods, durable goods, and miscellaneous goods, and (c) a store total,
which covers all departments, including
some not listed separately, except for
the following: candy, foods, liquor,
tobacco, and contract departments.
BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)
Groups
Nov. 1994
Nov. 1995
Percent Change from
Nov. 1994 to Nov. 19951
1. Piece Goods. . . . . . . . . . . . . . . . . . . . . . . . . . .
2. Domestics and Draperies . . . . . . . . . . . . . . . .
3. Women’s and Children’s Shoes . . . . . . . . . .
4. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . .
5. Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . . . . .
6. Women’s Underwear . . . . . . . . . . . . . . . . . . .
7. Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . .
8. Women’s and Girls’ Accessories . . . . . . . . .
9. Women’s Outerwear and Girls’ Wear. . . . .
10. Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . .
11. Men’s Furnishings. . . . . . . . . . . . . . . . . . . . . .
12. Boys’ Clothing and Furnishings . . . . . . . . . .
13. Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15. Toilet Articles and Drugs . . . . . . . . . . . . . . .
16. Furniture and Bedding . . . . . . . . . . . . . . . . . .
17. Floor Coverings. . . . . . . . . . . . . . . . . . . . . . . .
18. Housewares . . . . . . . . . . . . . . . . . . . . . . . . . . .
19. Major Appliances . . . . . . . . . . . . . . . . . . . . . .
20. Radio and Television . . . . . . . . . . . . . . . . . . .
21. Recreation and Education2 . . . . . . . . . . . . . .
22. Home Improvements2 . . . . . . . . . . . . . . . . . . .
23. Auto Accessories2 . . . . . . . . . . . . . . . . . . . . . .
486.9
641.4
640.6
914.2
623.0
529.5
281.1
578.0
432.0
614.9
577.5
486.9
1007.9
748.5
852.9
637.5
553.8
781.1
248.4
84.3
115.3
120.8
106.3
509.3
632.0
637.8
921.8
636.8
527.8
288.2
559.8
419.3
623.7
572.7
485.5
1001.1
776.6
875.3
661.2
555.4
248.7
248.7
79.9
113.4
121.9
107.0
4.6
–1.5
–0.4
0.8
2.2
–0.3
2.5
–3.1
–2.9
1.4
–0.8
–0.3
–0.7
3.8
2.6
3.7
0.3
0.1
0.1
–5.2
–1.6
0.9
0.7
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BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)—Continued
Groups
Nov. 1994
Nov. 1995
Percent Change from
Nov. 1994 to Nov. 19951
Groups 1—15: Soft Goods. . . . . . . . . . . . . . . . . .
598.6
595.2
–0.6
Groups 16—20: Durable Goods . . . . . . . . . . . . .
464.1
465.0
0.2
Groups 21—23: Misc. Goods2. . . . . . . . . . . . . . .
114.4
113.5
–0.8
Store Total3. . . . . . . . . . . . . . . . . . . . . . . . .
552.1
550.7
–0.3
1Absence
of a minus sign before percentage change in this column signifies price increase.
on a January 1986=100 base.
3The store total index covers all departments, including some not listed separately, except for the following: candy, foods,
liquor, tobacco, and contract departments.
2Indexes
DRAFTING INFORMATION
The principal author of this revenue
ruling is Stan Michaels of the Office of
Assistant Chief Counsel (Income Tax
and Accounting). For further information regarding this revenue ruling,
contact Mr. Michaels on (202)
622-4970 (not a toll-free call).
Section 702.—Income and Credits of
Partner
26 CFR 1.702–1: Income and Credits of
Partner
If a partnership makes a charitable contribution of property, are the partners’ bases in their
partnership interests decreased to reflect the
contribution. See Rev. Rul. 96–11, page 28.
Section 482.—Allocation of Income
and Deductions Among Taxpayers
26 CFR 1.482–0: Outline of regulations under
section 482.
T.D. 8632
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 301 and 602
Section 482 Cost Sharing
Regulations
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to qualified
cost sharing arrangements under section
482 of the Internal Revenue Code.
These regulations reflect changes to
section 482 made by the Tax Reform
Act of 1986, and provide guidance to
revenue agents and taxpayers implementing the changes.
DATES: These regulations are effective
January 1, 1996.
These regulations are applicable for
taxable years beginning on or after
January 1, 1996.
FOR FURTHER INFORMATION
CONTACT: Lisa Sams of the Office of
Associate Chief Counsel (International), IRS (202) 622–3840 (not a tollfree number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations have
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545–1364. Responses
to these collections of information are
required to determine whether an intangible development arrangement is a
qualified cost sharing arrangement and
who are the participants in such
arrangement.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number.
6
The estimated average annual burden
per recordkeeper is 8 hours. The
estimated average annual burden per
respondent is 0.5 hour.
Comments concerning the accuracy
of this burden estimate and suggestions
for reducing this burden should be sent
to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, T:FP,
Washington, DC 20224, and to the
Office of Management and Budget,
Attn: Desk Officer for the Department
of the Treasury, Office of Information
and Regulatory Affairs, Washington,
DC 20503.
Books and records relating to these
collections of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
Section 482 was amended by the Tax
Reform Act of 1986, Public Law 99–
514, 100 Stat. 2085, 2561, et. seq.
(1986–3 C.B. (Vol. 1) 1, 478). On
January 30, 1992, a notice of proposed
rulemaking concerning the section 482
amendment in the context of cost
sharing was published in the Federal
Register (INTL–0372–88, 57 FR 3571
[1992–1 C.B. 1164]).
Written comments were received
with respect to the notice of proposed
rulemaking, and a public hearing was
held on August 31, 1992. After consideration of all the comments, the proposed regulations under section 482 are
adopted as revised by this Treasury
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decision, and the corresponding temporary regulations (which contain the cost
sharing regulations as in effect since
1968) are removed.
Explanation of Provisions
Introduction
The Tax Reform Act of 1986 (the
Act) amended section 482 to require
that consideration for intangible property transferred in a controlled transaction be commensurate with the income
attributable to the intangible. The Conference Committee report to the Act
indicated that in revising section 482,
Congress did not intend to preclude the
use of bona fide research and development cost sharing arrangements as an
appropriate method of allocating income attributable to intangibles among
related parties. The Conference Committee report stated, however, that in
order for cost sharing arrangements to
produce results consistent with the
commensurate-with-income standard,
(a) a cost sharer should 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 should be
shared, (b) the allocation of costs
generally should be proportionate to
profit as determined before deduction
for research and development, and (c)
to the extent that one party contributes
funds toward research and development
at a significantly earlier point in time
than another (or is otherwise putting its
funds at risk to a greater extent than
the other) that party should receive an
appropriate return on its investment.
See H.R. Rep. 99–281, 99th Cong., 2d
Sess. (1986) at II–638.
The Conference Committee report to
the Act recommended that the IRS
conduct a comprehensive study and
consider whether the regulations under
section 482 (issued in 1968) should be
modified in any respect.
The White Paper
In response to the Conference Committee’s directive, the IRS and the
Treasury Department issued a study of
intercompany pricing [Notice 88–123
(1988–2 C.B. 458)] on October 18,
1988 (the White Paper). The White
Paper suggested that most bona fide
cost sharing arrangements should have
certain provisions. For example, the
White Paper stated that most product
areas covered by cost sharing arrangements should be within three-digit
Standard Industrial Classification
codes, that most participants should be
assigned exclusive geographic rights in
developed intangibles (and should predict benefits and divide costs accordingly) and that marketing intangibles
should be excluded from bona fide cost
sharing arrangements.
Comments on the White Paper indicated that, in practice, there was a great
deal of variety in the terms of bona
fide cost sharing arrangements, and that
if the White Paper’s suggestions were
incorporated in regulations, the regulations would unduly restrict the availability of cost sharing.
The 1992 proposed regulations
The IRS issued proposed cost sharing regulations on January 30, 1992
(INTL–0372–88, 57 FR 3571). In general, the proposed regulations allowed
more flexibility than anticipated by the
White Paper, relying on anti-abuse tests
rather than requiring standard cost
sharing provisions.
The proposed regulations stated that
in order to be qualified, a cost sharing
arrangement had to meet the following
five requirements: (1) the arrangement
had to have two or more eligible
participants, (2) the arrangement had to
be recorded in writing contemporaneously with the formation of the
cost sharing arrangement, (3) the
eligible participants had to share the
costs and risks of intangible development in return for a specified interest
in any intangible produced, (4) the
arrangement had to reflect a reasonable
effort by each eligible participant to
share costs and risks in proportion to
anticipated benefits from using developed intangibles, and (5) the arrangement had to meet certain administrative
requirements. The key requirements
were that participants had to be eligible
and that costs and risks had to be
proportionate to benefits.
Under the proposed regulations, only
a controlled taxpayer that would use
developed intangibles in the active
conduct of its trade or business was
eligible to participate in a cost sharing
arrangement. This requirement was
considered necessary to ensure that
controlled foreign entities were not
7
established simply to participate in cost
sharing arrangements without performing any other meaningful function, and
to ensure that each participant’s share
of anticipated benefits was measurable.
The proposed regulations allowed
costs to be divided based on any
measurement that would reasonably
predict cost sharing benefits (e.g.,
anticipated units of production or anticipated sales). However, the basis for
measuring anticipated benefits and dividing costs was checked by a cost-tooperating-income ratio. The method for
dividing costs was presumed to be
unreasonable if a U.S. participant’s
ratio of shared costs to operating
income attributable to developed intangibles was grossly disproportionate to
the cost-to-operating-income ratio of
the other participants.
If a U.S. participant’s cost-tooperating-income ratio was not grossly
disproportionate, a section 482 allocation could still be made under three
circumstances: (a) if the cost-tooperating-income ratio was disproportionate (allocation of costs), (b) if the
pool of costs shared was too broad or
too narrow, so that the U.S. participant
was paying for research that it would
not use (allocation of costs), or (c) if
the cost-to-operating-income ratio was
substantially disproportionate, such that
a transfer of an intangible could be
deemed to have occurred (allocation of
income).
Under the proposed regulations, the
IRS could also make an allocation of
income to reflect a buy-in or buy-out
event, that is, a transfer of an intangible that could occur, for example,
when a participant joined or left a cost
sharing arrangement.
Comments on the 1992 proposed
regulations
The 1992 proposed cost sharing
regulations were generally well received. However, there were five areas
of particular concern to commenters.
The first was the mechanical use of
cost-to-operating-income ratios as a
standard for measuring the reasonableness of an effort to share costs in
proportion to anticipated benefits.
Commenters noted that operating income attributable to developed intangibles was difficult to measure, and that
other bases for measuring benefits
might produce more reliable results.
Commenters also believed that the
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ratios might be overused, leading to
adjustments to costs in every year, and
to many deemed transfers of intangibles. In addition, commenters stated
that the ratios did not provide any
certainty that a cost sharing arrangement would not be disregarded, since a
‘‘grossly disproportionate’’ ratio was
not numerically defined.
The second area of concern was the
eligible participant requirement. Commenters argued that separate research
entities (with no separate active trade
or business) should be allowed to
participate in cost sharing arrangements, as should marketing affiliates.
Commenters also argued that transfers
of intangibles to unrelated entities
should not disqualify a participant, and
that foreign-to-foreign transfers should
not necessarily be monitored. Some
comments also stated that controlled
entities should be able to participate
even if their cost sharing payments
would be characterized differently for
purposes of foreign law.
The third area of concern was the
regulations’ requirement that every participant be able to benefit from every
intangible developed under a cost sharing arrangement. Commenters stated
that the regulations should allow both
single-product cost sharing arrangements and umbrella cost sharing arrangements (i.e., cost sharing arrangements under which a broad category of
a controlled group’s research and development would be covered).
The fourth area of concern was the
buy-in and buy-out rules. There were
some suggestions for clarifying and
simplifying the rules. For example,
comments urged that the regulations
provide that one participant’s abandonment of its rights would not necessarily
confer benefits on the other participants, and that a new participant need
not always make a buy-in payment
when joining a cost sharing arrangement. Suggestions for simplifying the
rules generally consisted of proposed
safe harbors for valuing intangibles.
The final general area of concern
was the administrative requirements.
Several commenters suggested that annual adjustments to the method used to
share costs should not be required.
Commenters also suggested that taxpayers not be required to attach their
cost sharing arrangements to their
returns, and that the time period for
producing records be increased.
In addition to these general areas of
concern, commenters noted that there
should be more guidance about when
the IRS would deem a cost sharing
arrangement to exist. Commenters also
argued that existing cost sharing arrangements should be grandfathered, or
that there should be a longer transition
period. Commenters suggested that financial accounting rules be used to
calculate costs to be shared, and that
the IRS address the impact of currency
fluctuations on the cost-to-operatingincome ratios. Finally, commenters
asked that the regulations clarify that a
cost sharing arrangement would not be
deemed to create a partnership or a
U.S. trade or business.
The final regulations
Without fundamentally altering the
policies of the 1992 proposed regulations, the final regulations reflect numerous modifications in response to the
comments described above. They also
reflect the approach of the final section
482 regulations relating to transfers of
tangible and intangible property.
Section 1.482–7(a)(1) defines a cost
sharing arrangement as an agreement
for sharing costs in proportion to
reasonably anticipated benefits from the
individual exploitation of interests in
the intangibles that are developed. In
order to claim the benefits of the safe
harbor, a taxpayer must also satisfy
certain formal requirements (enumerated in §1.482–7(b)). The district
director may apply the cost sharing
rules to any arrangement that in substance constitutes a cost sharing arrangement, notwithstanding any failure
to satisfy particular requirements of the
safe harbor. It is further provided that a
qualified cost sharing arrangement, or
an arrangement treated in substance as
such, will not be treated as a partnership. (A corresponding provision is
added to §301.7701–3 pertaining to the
definition of a partnership.) Neither
will a foreign participant be treated as
engaged in a trade or business within
the United States solely by virtue of its
participation in such an arrangement.
Section 1.482–7(a)(2) restates the
general rule of cost sharing in a
manner intended to emphasize its limitation on allocations: no section 482
allocation will be made with respect to
a qualified cost sharing arrangement,
except to make each controlled participant’s share of the intangible development costs equal to its share of
reasonably anticipated benefits.
8
Section 1.482–7(b) contains the requirements for a qualified cost sharing
arrangement. This provision substantially tracks the proposed regulations. A
modification was made in the second requirement which now directs that the arrangement provide a method to calculate
each controlled participant’s share of
intangible development costs, based on
factors that can reasonably be expected
to reflect anticipated benefits. The new
standard is intended to ensure that cost
sharing arrangements will not be disregarded by the IRS as long as the
factors upon which an estimate of benefits was based were reasonable, even if
the estimate proved to be inaccurate.
Section 1.482–7(b)(4) requires that a
cost sharing arrangement be set forth in
writing and contain a number of
specified provisions, including the interest that each controlled participant
will receive in any intangibles developed pursuant to the arrangement. The
intangibles developed under a cost
sharing arrangement are referred to as
the ‘‘covered intangibles.’’ It is possible that the research activity undertaken
may result in development of intangible
property that was not foreseen at the
inception of the cost sharing arrangement; any such property is also included within the definition of the term
covered intangibles. The prescriptive
rules in relation to the scope of the
intangible development area under the
proposed regulations are eliminated in
favor of a flexible definition that
encompasses any research and development actually undertaken under the cost
sharing arrangement.
Section 1.482–7(c) provides rules for
being a participant in a qualified cost
sharing arrangement. Unlike the proposed regulations, the final regulations
permit participation by unrelated persons, which are referred to as ‘‘uncontrolled participants.’’ Controlled taxpayers may be participants, referred to
as ‘‘controlled participants,’’ if they
satisfy the conditions set forth in these
rules. These qualification rules replace
the proposed regulations’ concept of
‘‘eligible participant.’’ The tax treatment of controlled taxpayers that do
not qualify as controlled participants
provided in §1.482–7(c)(4) essentially
tracks the treatment provided for ineligible participants under the proposed
regulations.
The requirements for being a controlled participant are basically the
same as in the proposed regulations. In
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particular, a controlled participant must
use or reasonably expect to use covered
intangibles in the active conduct of a
trade or business. Thus, an entity that
chiefly provides services (e.g., as a
contract researcher) may not be a
controlled participant. These provisions
are necessary for the reason that they
are necessary to the proposed regulations: to prevent foreign controlled
entities from being established simply
to participate in cost sharing arrangements. In accordance with §1.482–
7(c)(4) mentioned above, service entities (such as contract researchers) may
furnish research and development services to the members of a qualified cost
sharing arrangement, with the appropriate consideration for such assistance in
the research and development undertaken in the intangible development
area being governed by the rules in
§1.482–4(f)(3)(iii) (Allocations with respect to assistance provided to the
owner). In the case of a controlled
research entity, the appropriate arm’s
length compensation would generally
be determined under the principles of
§1.482–2(b) (Performance of services
for another). Each controlled participant would be deemed to incur as part
of its intangible development costs a
share of such compensation equal to its
share of reasonably anticipated
benefits.
As under the proposed regulations,
the activity of another person may be
attributed to a controlled taxpayer for
purposes of meeting the active conduct
requirement. However, modified language is adopted to be more precise
concerning the intended requirements
for attribution. These requirements
were phrased in the proposed regulations as bearing the risk and receiving
the benefits of the attributed activity.
Under the final regulations, the attribution will be made only in cases in
which the controlled taxpayer exercises
substantial managerial and operational
control over the attributed activities.
As under the proposed regulations, a
principal purpose to use cost sharing to
accomplish a transfer or license of
covered intangibles to uncontrolled or
controlled taxpayers will defeat satisfaction of the active conduct requirement. However, a principal purpose
will not be implied where there are
legitimate business reasons for subsequently licensing covered intangibles.
The subgroup rules of the proposed
regulations are eliminated. Their major
purpose is accomplished by a simpler
provision (see the discussion of
§1.482–7(h)). In addition, the final
regulations treat all members of a
consolidated group as a single
participant.
Section 1.482–7(d) defines intangible
development costs as operating expenses other than depreciation and
amortization expense, plus an arm’s
length charge for tangible property
made available to the cost sharing
arrangement. Costs to be shared include
all costs relating to the intangible
development area, which, as noted,
comprises any research actually undertaken under the cost sharing arrangement. As under the proposed regulations, the district director may adjust
the pool of costs shared in order to
properly reflect costs that relate to the
intangible development area.
Section 1.482–7(e) defines anticipated benefits as additional income
generated or costs saved by the use of
covered intangibles. The pool of benefits may also be adjusted in order to
properly reflect benefits that relate to
the intangible development area.
Section 1.482–7(f) governs cost allocations by the district director in
order to make a controlled participant’s
share of costs equal to its share of
reasonably anticipated benefits. Anticipated benefits of uncontrolled participants will be excluded from anticipated
benefits in calculating the benefits
shares of controlled participants. A
share of reasonably anticipated benefits
will be determined using the most
reliable estimate of benefits. This rule
echoes the best method rule for determining the most reliable measure of an
arm’s length result under §1.482–1(c).
The reliability of an estimate of
benefits principally depends on two
factors: the reliability of the basis for
measuring benefits used and the reliability of the projections used. The
cost-to-operating-income ratio used in
the proposed regulations to check the
reasonableness of an effort to share
costs in proportion to anticipated benefits has not been included in the final
regulations. Rather, the final regulations provide that an allocation of costs
or income may be made if the taxpayer
did not use the most reliable estimate
of benefits, which depends on the facts
and circumstances of each case.
Section 1.482–7(f)(3)(ii) provides
that in estimating a controlled participant’s share of benefits, the most
reliable basis for measuring anticipated
9
benefits must be used, taking into account the factors set forth in §1.482–
1(c)(2)(ii). The measurement basis used
must be consistent for all controlled
participants. The regulations provide
that benefits may be measured directly
or indirectly. In addition, regardless of
whether a direct or indirect basis of
measurement is employed, it may be
necessary to make adjustments to account for material differences in the
activities that controlled participants
perform in connection with exploitation
of covered intangibles, such as between
wholesale and retail distribution.
Section 1.482–7(f)(3)(iii) describes
the scope of various indirect bases for
measuring benefits, such as units, sales,
and operating profit. Indirect bases
other than those enumerated may be
employed as long as they bear a
relationship to benefits.
Section 1.482–7(f)(3)(iv) discusses
projections used to estimate benefits.
Projections required for this purpose
generally include a determination of the
time period between the inception of
the research and development and the
receipt of benefits, a projection of the
time over which benefits will be
received, and a projection of the
benefits anticipated for each year in
which it is anticipated that the intangible will generate benefits. However,
the regulations note that in certain
circumstances, current annual benefit
shares may be used in lieu of
projections.
Section 1.482–7(f)(3)(iv)(B) states
that a significant divergence between
projected and actual benefit shares may
indicate that the projections were not
reliable. A significant divergence is
defined as divergence in excess of 20%
between projected and actual benefit
shares. If there is a significant divergence, which is not due to an unforeseeable event, then the district
director may use actual benefits as the
most reliable basis for measuring benefits. Conversely, no allocation will be
made based on a divergence that is not
considered significant as long as the
estimate is made using the most reliable basis for measuring benefits.
For purposes of the 20% test, all
non-U.S. controlled participants are
treated as a single controlled participant
in order that a divergence by a foreign
controlled participant with a very small
share of the total costs will not necessarily trigger an allocation (section
1.482–7(f)(3)(iv)(D), Example 8, il-
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lustrates this rule). Section 1.482–7(f)(3)(iv)(B) and (C) notes that adjustments among foreign controlled
participants will only be made if the
adjustment will have a substantial U.S.
tax impact, for example, under subpart
F.
Section 1.482–7(f)(4) states that cost
allocations must be reflected for tax
purposes in the year in which costs
were incurred. This reflects a change
from the rule in the 1992 proposed
regulations, which stated that cost
allocations would be included in income in the taxable year under review,
even if the costs to be allocated were
incurred in a prior taxable year. The
purpose of the change was to match up
cost adjustments with the year to which
they relate in accordance with the clear
reflection of income principle of section 482.
Section 1.482–7(g) provides buy-in
and buy-out rules that are similar to the
rules in the proposed regulations. However, some of the clarifications suggested by commenters have been
incorporated in these rules. A ‘‘substantially disproportionate’’ cost-tooperating-income ratio will no longer
trigger an adjustment to income under
these rules. However, if, after any cost
allocations authorized by §1.482–
7(a)(2), the economic substance of the
arrangement is inconsistent with the
terms of the arrangement over a period
of years (for example, through a consistent pattern of one controlled participant bearing an inappropriately high or
low share of the cost of intangible
development), then the district director
may impute an agreement consistent
with the course of conduct. In that
case, one or more of the participants
would be deemed to own a greater
interest in covered intangibles than
provided under the arrangement, and
must receive buy-in payments from the
other participants.
The rules do not provide safe harbor
methods for valuing intangibles, but
rely on the intangible valuation rules of
§§1.482–1 and 1.482–4 through 1.482–
6. To the extent some participants
furnish a disproportionately greater
amount of existing intangibles to the
arrangement, they must be compensated
by royalties by the participants who
furnish a disproportionately lesser
amount of existing intangibles to the
arrangement. Buy-in payments owed
are netted against payments owing, and
only the net payment is treated as a
royalty. No implication is intended that
netting of cross royalties is permissible
outside of the qualified cost sharing
safe harbor rules.
Section 1.482–7(h) provides rules
regarding the character of payments
made pursuant to a qualified cost
sharing arrangement. Cost sharing payments received are generally treated as
reductions of research and development
expense. A net approach is applied to
foster simplicity and generally preserve
the character of items actually incurred
by a participant to the extent not
reimbursed. In addition, for purposes of
the research credit determined under
section 41, cost sharing payments
among controlled participants will be
treated as provided for intra-group
transactions in §1.41–8(e). Finally, any
payment that in substance constitutes a
cost sharing payment will be treated as
such, regardless of its characterization
under foreign law. This rule is intended
to enable foreign entities to participate
in cost sharing arrangements with U.S.
controlled participants even if foreign
law does not recognize cost sharing.
This rule obviated the main reason for
the subgroup rules which, as noted,
have accordingly been eliminated.
Section 1.482–7(i) requires that controlled participants must use a consistent accounting method for measuring
costs and benefits, and must translate
foreign currencies on a consistent basis.
To the extent that the accounting
method materially differs from U.S.
generally accepted accounting principles, any such material differences
must be documented, as provided in
§1.482–7(j)(2)(iv).
Section 1.482–7(j) provides simplified recordkeeping and reporting
requirements. It is anticipated that
many of the background documents
necessary for purposes of this section
will be kept pursuant to section 6662(e)
and the regulations thereunder.
Section 1.482–7(k) provides that this
regulation is effective for taxable years
beginning on or after January 1, 1996.
Section 1.482–7(l) allows a one-year
transition period for taxpayers to conform their cost sharing arrangements
with the requirements of the final
regulations. A longer period was not
considered necessary, given the increased flexibility and the reduced
number of administrative requirements
of the final regulations.
Special Analyses
It has been determined that this
Treasury decision is not a significant
10
regulatory action as defined in EO
12866. Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not
apply to these regulations, and, therefore, a Regulatory Flexibility Analysis
is not required. Pursuant to section
7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking
preceding these regulations was submitted to the Small Business Administration for comment on its impact on
small business.
Drafting Information
The principal author of these regulations is Lisa Sams, Office of Associate
Chief Counsel (International), IRS.
However, other personnel from the IRS
and Treasury Department participated
in their development.
*
*
*
*
*
*
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1, 301
and 602 are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority for part 1
is amended by adding an entry for
section 1.482–7 to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.482–7 is also issued under 26
U.S.C. 482. * * *
Par. 2. Section 1.482–0 is amended
by:
1. Removing the entry for §1.482–
7T.
2. Adding the entry for §1.482–7 to
read as follows:
§1.482–0 Outline of regulations under
482.
*
*
*
*
*
*
§1.482–7 Sharing of costs.
(a) In general.
(1) Scope and application of the
rules in this section.
(2) Limitation on allocations.
(3) Cross references.
(b) Qualified cost sharing arrangement.
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(c) Participant.
(1) In general.
(2) Active conduct of a trade or
business.
(i) Trade or business.
(ii) Active conduct.
(iii) Examples.
(3) Use of covered intangibles
in the active conduct of a
trade or business.
(i) In general.
(ii) Example.
(4) Treatment of a controlled
taxpayer that is not a controlled participant.
(i) In general.
(ii) Example.
(5) Treatment of consolidated
group.
(d) Costs.
(1) Intangible development costs.
(2) Examples.
(e) Anticipated benefits.
(1) Benefits.
(2) Reasonably anticipated benefits.
(f) Cost allocations.
(1) In general.
(2) Share of intangible development costs.
(i) In general.
(ii) Example.
(3) Share of reasonably anticipated benefits.
(i) In general.
(ii) Measure of benefits.
(iii) Indirect bases for measuring anticipated benefits.
(A) Units used, produced or sold.
(B) Sales.
(C) Operating profit.
(D) Other bases for
measuring anticipated benefits.
(E) Examples.
(iv) Projections used to estimate anticipated benefits.
(A) In general.
(B) Unreliable projections.
(C) Foreign-to-foreign
adjustments.
(D) Examples.
(4) Timing of allocations.
(g) Allocations of income, deductions
or other tax items to reflect
transfers of intangibles (buy-in).
(1) In general.
(2) Pre-existing intangibles.
(3) New controlled participant.
(4) Controlled participant relinquishes interests.
(5) Conduct inconsistent with
the terms of a cost sharing
arrangement.
(6) Failure to assign interests
under a qualified cost sharing arrangement.
(7) Form of consideration.
(i) Lump sum payments.
(ii) Installment payments.
(iii) Royalties.
(8) Examples.
(h) Character of payments made pursuant to a qualified cost sharing
arrangement.
(1) In general.
(2) Examples.
(i) Accounting requirements.
(j) Administrative requirements.
(1) In general.
(2) Documentation.
(3) Reporting requirements.
(k) Effective
date.
(l) Transition rule.
*
*
*
*
*
*
Par. 3. Section 1.482–7 is added to
read as follows:
§1.482–7 Sharing of costs.
(a) In general—(1) Scope and application of the rules in this section. A
cost sharing arrangement is an agreement under which the parties agree to
share the costs of development of one
or more intangibles in proportion to
their shares of reasonably anticipated
benefits from their individual exploitation of the interests in the intangibles
assigned to them under the arrangement. A taxpayer may claim that a cost
sharing arrangement is a qualified cost
sharing arrangement only if the agreement meets the requirements of paragraph (b) of this section. Consistent
with the rules of §1.482–1(d)(3)(ii)(B)
(Identifying contractual terms), the district director may apply the rules of
this section to any arrangement that in
substance constitutes a cost sharing
arrangement, notwithstanding a failure
to comply with any requirement of this
section. A qualified cost sharing arrangement, or an arrangement to which
the district director applies the rules of
this section, will not be treated as a
partnership to which the rules of subchapter K apply. See §301.7701–3(e)
of this chapter. Furthermore, a participant that is a foreign corporation or
nonresident alien individual will not be
treated as engaged in trade or business
11
within the United States solely by
reason of its participation in such an
arrangement. See generally §1.864–
2(a).
(2) Limitation on allocations. The
district director shall not make allocations with respect to a qualified cost
sharing arrangement except to the
extent necessary to make each controlled participant’s share of the costs
(as determined under paragraph (d) of
this section) of intangible development
under the qualified cost sharing arrangement equal to its share of reasonably anticipated benefits attributable to
such development, under the rules of
this section. If a controlled taxpayer
acquires an interest in intangible property from another controlled taxpayer
(other than in consideration for bearing
a share of the costs of the intangible’s
development), then the district director
may make appropriate allocations to
reflect an arm’s length consideration
for the acquisition of the interest in
such intangible under the rules of
§§1.482–1 and 1.482–4 through 1.482–
6. See paragraph (g) of this section. An
interest in an intangible includes any
commercially transferable interest, the
benefits of which are susceptible of
valuation. See §1.482–4(b) for the
definition of an intangible.
(3) Cross references. Paragraph (c)
of this section defines participant.
Paragraph (d) of this section defines
the costs of intangible development.
Paragraph (e) of this section defines the
anticipated benefits of intangible development. Paragraph (f) of this section
provides rules governing cost allocations. Paragraph (g) of this section
provides rules governing transfers of
intangibles other than in consideration
for bearing a share of the costs of the
intangible’s development. Rules governing the character of payments made
pursuant to a qualified cost sharing
arrangement are provided in paragraph
(h) of this section. Paragraph (i) of this
section provides accounting requirements. Paragraph (j) of this section
provides administrative requirements.
Paragraph (k) of this section provides
an effective date. Paragraph (l) provides a transition rule.
(b) Qualified cost sharing arrangement. A qualified cost sharing arrangement must—
(1) Include two or more participants;
(2) Provide a method to calculate
each controlled participant’s share of
intangible development costs, based on
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factors that can reasonably be expected
to reflect that participant’s share of
anticipated benefits;
(3) Provide for adjustment to the
controlled participants’ shares of intangible development costs to account for
changes in economic conditions, the
business operations and practices of the
participants, and the ongoing development of intangibles under the arrangement; and
(4) Be recorded in a document that
is contemporaneous with the formation
(and any revision) of the cost sharing
arrangement and that includes—
(i) A list of the arrangement’s participants, and any other member of the
controlled group that will benefit from
the use of intangibles developed under
the cost sharing arrangement;
(ii) The information described in
paragraphs (b)(2) and (b)(3) of this
section;
(iii) A description of the scope of
the research and development to be
undertaken, including the intangible or
class of intangibles intended to be
developed;
(iv) A description of each participant’s interest in any covered intangibles. A covered intangible is any
intangible property that is developed as
a result of the research and development undertaken under the cost sharing
arrangement (intangible development
area);
(v) The duration of the arrangement;
and
(vi) The conditions under which the
arrangement may be modified or terminated and the consequences of such
modification or termination, such as the
interest that each participant will receive in any covered intangibles.
(c) Participant—(1) In general. For
purposes of this section, a participant is
a controlled taxpayer that meets the
requirements of this paragraph (c)(1)
(controlled participant) or an uncontrolled taxpayer that is a party to the
cost sharing arrangement (uncontrolled
participant). See §1.482–1(i)(5) for the
definitions of controlled and uncontrolled taxpayers. A controlled taxpayer
may be a controlled participant only if
it—
(i) Uses or reasonably expects to use
covered intangibles in the active conduct of a trade or business, under the
rules of paragraphs (c)(2) and (c)(3) of
this section;
(ii) Substantially complies with the
accounting requirements described in
paragraph (i) of this section; and
(iii) Substantially complies with the
administrative requirements described
in paragraph (j) of this section.
(2) Active conduct of a trade or
business—(i) Trade or business. The
rules of §1.367(a)–2T(b)(2) apply in
determining whether the activities of a
controlled taxpayer constitute a trade or
business. For this purpose, the term
controlled taxpayer must be substituted
for the term foreign corporation.
(ii) Active conduct. In general, a
controlled taxpayer actively conducts a
trade or business only if it carries out
substantial managerial and operational
activities. For purposes only of this
paragraph (c)(2), activities carried out
on behalf of a controlled taxpayer by
another person may be attributed to the
controlled taxpayer, but only if the
controlled taxpayer exercises substantial managerial and operational control
over those activities.
(iii) Examples. The following examples illustrate this paragraph (c)(2):
Example 1. Foreign Parent (FP) enters into a
cost sharing arrangement with its U.S. Subsidiary
(USS) to develop a cheaper process for manufacturing widgets. USS is to receive the right to
exploit the intangible to make widgets in North
America, and FP is to receive the right to exploit
the intangible to make widgets in the rest of the
world. However, USS does not manufacture
widgets; rather, USS acts as a distributor for
FP’s widgets in North America. Because USS is
simply a distributor of FP’s widgets, USS does
not use or reasonably expect to use the manufacturing intangible in the active conduct of its
trade or business, and thus USS is not a controlled participant.
Example 2. The facts are the same as in
Example 1, except that USS contracts to have
widgets it sells in North America made by a
related manufacturer (that is not a controlled
participant) using USS’ cheaper manufacturing
process. USS purchases all the manufacturing
inputs, retains ownership of the work in process
as well as the finished product, and bears the risk
of loss at all times in connection with the
operation. USS compensates the manufacturer for
the manufacturing functions it performs and
receives substantially all of the intangible value
attributable to the cheaper manufacturing process. USS exercises substantial managerial and
operational control over the manufacturer to
ensure USS’s requirements are satisfied concerning the timing, quantity, and quality of the
widgets produced. USS uses the manufacturing
intangible in the active conduct of its trade or
business, and thus USS is a controlled
participant.
(3) Use of covered intangibles in the
active conduct of a trade or business—
(i) In general. A covered intangible
will not be considered to be used, nor
will the controlled taxpayer be considered to reasonably expect to use it, in
the active conduct of the controlled
12
taxpayer’s trade or business if a principal purpose for participating in the
arrangement is to obtain the intangible
for transfer or license to a controlled or
uncontrolled taxpayer.
(ii) Example. The following example
illustrates the absence of such a principal purpose:
Example. Controlled corporations A, B, and C
enter into a qualified cost sharing arrangement
for the purpose of developing a new technology.
Costs are shared equally among the three controlled taxpayers. A, B, and C have the exclusive
rights to manufacture and sell products based on
the new technology in North America, South
America, and Europe, respectively. When the
new technology is developed, C expects to use it
to manufacture and sell products in most of
Europe. However, for sound business reasons, C
expects to license to an unrelated manufacturer
the right to use the new technology to manufacture and sell products within a particular
European country owing to its relative remoteness and small size. In these circumstances, C
has not entered into the arrangement with a
principal purpose of obtaining covered intangibles for transfer or license to controlled or
uncontrolled taxpayers, because the purpose of
licensing the technology to the unrelated manufacturer is relatively insignificant in comparison
to the overall purpose of exploiting the European
market.
(4) Treatment of a controlled taxpayer that is not a controlled
participant—(i) In general. If a controlled taxpayer that is not a controlled
participant (within the meaning of this
paragraph (c)) provides assistance in
relation to the research and development undertaken in the intangible development area, it must receive consideration from the controlled participants
under the rules of §1.482–4(f)(3)(iii)
(Allocations with respect to assistance
provided to the owner). For purposes of
paragraph (d) of this section, such
consideration is treated as an operating
expense and each controlled participant
must be treated as incurring a share of
such consideration equal to its share of
reasonably anticipated benefits (as defined in paragraph (f)(3) of this
section).
(ii) Example. The following example
illustrates this paragraph (c)(4):
Example. (i) U.S. Parent (USP), one foreign
subsidiary (FS), and a second foreign subsidiary
constituting the group’s research arm (R+D)
enter into a cost sharing agreement to develop
manufacturing intangibles for a new product line
A. USP and FS are assigned the exclusive rights
to exploit the intangibles respectively in the
United States and Europe, where each presently
manufactures and sells various existing product
lines. R+D, whose activity consists solely in
carrying out research for the group, is assigned
the rights to exploit the new technology in Asia,
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where no group member presently operates, but
which is reliably projected to be a major market
for product A. R+D will license the Asian rights
to an unrelated third party. It is reliably projected
that the shares of reasonably anticipated benefits
of USP and FS (i.e., not taking R+D into
account) will be 66 2/3% and 33 1/3%, respectively. The parties’ agreement provides that
USP and FS will reimburse 40% and 20%, respectively, of the intangible development costs
incurred by R+D with respect to the new
intangible.
(ii) R+D does not qualify as a controlled
participant within the meaning of paragraph (c)
of this section. Therefore, R+D is treated as a
service provider for purposes of this section and
must receive arm’s length consideration for the
assistance it is deemed to provide to USP and
FS, under the rules of §1.482–4(f)(3)(iii). Such
consideration must be treated as intangible
development costs incurred by USP and FS in
proportion to their shares of reasonably anticipated benefits (i.e., 66 2/3% and 33 1/3%,
respectively). R+D will not be considered to bear
any share of the intangible development costs
under the arrangement.
(iii) The Asian rights nominally assigned to
R+D under the agreement must be treated as
being held by USP and FS in accordance with
their shares of the intangible development costs
(i.e., 66 2/3% and 33 1/3%, respectively). See
paragraph (g)(6) of this section. Thus, since
under the cost sharing agreement the Asian rights
are owned by R+D, the district director may
make allocations to reflect an arm’s length
consideration owed by R+D to USP and FS for
these rights under the rules of §§1.482–1 and
1.482–4 through 1.482–6.
(5) Treatment of consolidated group.
For purposes of this section, all members of the same affiliated group
(within the meaning of section 1504(a))
that join in the filing of a consolidated
return for the taxable year under
section 1501 shall be treated as one
taxpayer.
(d) Costs—(1) Intangible development costs. For purposes of this section, a controlled participant’s costs of
developing intangibles for a taxable
year mean all of the costs incurred by
that participant related to the intangible
development area, plus all of the cost
sharing payments it makes to other
controlled and uncontrolled participants, minus all of the cost sharing
payments it receives from other controlled and uncontrolled participants.
Costs incurred related to the intangible
development area consist of the following items: operating expenses as defined in §1.482–5(d)(3), other than
depreciation or amortization expense,
plus (to the extent not included in such
operating expenses, as defined in
§1.482–5(d)(3)) the charge for the use
of any tangible property made available
to the qualified cost sharing arrangement. If tangible property is made
available to the qualified cost sharing
arrangement by a controlled participant,
the determination of the appropriate
charge will be governed by the rules of
§1.482–2(c) (Use of tangible property).
Intangible development costs do not
include the consideration for the use of
any intangible property made available
to the qualified cost sharing arrangement. See paragraph (g)(2) of this
section. If a particular cost contributes
to the intangible development area and
other areas or other business activities,
the cost must be allocated between the
intangible development area and the
other areas or business activities on a
reasonable basis. In such a case, it is
necessary to estimate the total benefits
attributable to the cost incurred. The
share of such cost allocated to the
intangible development area must correspond to covered intangibles’ share
of the total benefits. Costs that do not
contribute to the intangible development area are not taken into account.
(2) Examples. The following examples illustrate this paragraph (d):
Example 1. Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a qualified cost
sharing arrangement to develop a better
mousetrap. USS and FP share the costs of FP’s
research and development facility that will be
exclusively dedicated to this research, the salaries of the researchers, and reasonable overhead
costs attributable to the project. They also share
the cost of a conference facility that is at the
disposal of the senior executive management of
each company but does not contribute to the
research and development activities in any
measurable way. In this case, the cost of the
conference facility must be excluded from the
amount of intangible development costs.
Example 2. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a qualified cost
sharing arrangement to develop a new device.
USP and FS share the costs of a research and
development facility, the salaries of researchers,
and reasonable overhead costs attributable to the
project. USP also incurs costs related to field
testing of the device, but does not include them
in the amount of intangible development costs of
the cost sharing arrangement. The district director may determine that the field testing costs are
intangible development costs that must be
shared.
(e) Anticipated benefits—(1) Benefits. Benefits are additional income
generated or costs saved by the use of
covered intangibles.
(2) Reasonably anticipated benefits.
For purposes of this section, a controlled participant’s reasonably anticipated benefits are the aggregate benefits that it reasonably anticipates that it
will derive from covered intangibles.
(f) Cost allocations—(1) In general.
For purposes of determining whether a
13
cost allocation authorized by paragraph
(a)(2) of this section is appropriate for
a taxable year, a controlled participant’s share of intangible development
costs for the taxable year under a
qualified cost sharing arrangement must
be compared to its share of reasonably
anticipated benefits under the arrangement. A controlled participant’s share
of intangible development costs is
determined under paragraph (f)(2) of
this section. A controlled participant’s
share of reasonably anticipated benefits
under the arrangement is determined
under paragraph (f)(3) of this section.
In determining whether benefits were
reasonably anticipated, it may be appropriate to compare actual benefits to
anticipated benefits, as described in
paragraph (f)(3)(iv) of this section.
(2) Share of intangible development
costs—(i) In general. A controlled
participant’s share of intangible development costs for a taxable year is
equal to its intangible development
costs for the taxable year (as defined in
paragraph (d) of this section), divided
by the sum of the intangible development costs for the taxable year (as
defined in paragraph (d) of this section)
of all the controlled participants.
(ii) Example. The following example
illustrates this paragraph (f)(2):
Example. (i) U.S. Parent (USP), Foreign
Subsidiary (FS), and Unrelated Third Party
(UTP) enter into a cost sharing arrangement to
develop new audio technology. In the first year
of the arrangement, the controlled participants
incur $2,250,000 in the intangible development
area, all of which is incurred directly by USP. In
the first year, UTP makes a $250,000 cost
sharing payment to USP, and FS makes a
$800,000 cost sharing payment to USP, under the
terms of the arrangement. For that year, the
intangible development costs borne by USP are
$1,200,000 (its $2,250,000 intangible development costs directly incurred, minus the cost
sharing payments it receives of $250,000 from
UTP and $800,000 from FS); the intangible
development costs borne by FS are $800,000 (its
cost sharing payment); and the intangible development costs borne by all of the controlled
participants are $2,000,000 (the sum of the
intangible development costs borne by USP and
FS of $1,200,000 and $800,000, respectively).
Thus, for the first year, USP’s share of intangible
development costs is 60% ($1,200,000 divided
by $2,000,000), and FS’s share of intangible
development costs is 40% ($800,000 divided by
$2,000,000).
(ii) For purposes of determining whether a
cost allocation authorized by paragraph §1.482–
7(a)(2) is appropriate for the first year, the
district director must compare USP’s and FS’s
shares of intangible development costs for that
year to their shares of reasonably anticipated
benefits. See paragraph (f)(3) of this section.
(3) Share of reasonably anticipated
benefits—(i) In general. A controlled
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participant’s share of reasonably anticipated benefits under a qualified cost
sharing arrangement is equal to its
reasonably anticipated benefits (as defined in paragraph (e)(2) of this section), divided by the sum of the
reasonably anticipated benefits (as defined in paragraph (e)(2) of this section) of all the controlled participants.
The anticipated benefits of an uncontrolled participant will not be included
for purposes of determining each controlled participant’s share of anticipated
benefits. A controlled participant’s
share of reasonably anticipated benefits
will be determined using the most
reliable estimate of reasonably anticipated benefits. In determining which of
two or more available estimates is most
reliable, the quality of the data and
assumptions used in the analysis must
be taken into account, consistent with
§1.482–1(c)(2)(ii) (Data and assumptions). Thus, the reliability of an
estimate will depend largely on the
completeness and accuracy of the data,
the soundness of the assumptions, and
the relative effects of particular deficiencies in data or assumptions on different estimates. If two estimates are
equally reliable, no adjustment should
be made based on differences in the
results. The following factors will be
particularly relevant in determining the
reliability of an estimate of anticipated
benefits—
(A) The reliability of the basis used
for measuring benefits, as described in
paragraph (f)(3)(ii) of this section; and
(B) The reliability of the projections
used to estimate benefits, as described
in paragraph (f)(3)(iv) of this section.
(ii) Measure of benefits. In order to
estimate a controlled participant’s share
of anticipated benefits from covered
intangibles, the amount of benefits that
each of the controlled participants is
reasonably anticipated to derive from
covered intangibles must be measured
on a basis that is consistent for all such
participants. See paragraph (f)(3)(iii)(E), Example 8, of this section. Anticipated benefits are measured either on a
direct basis, by reference to estimated
additional income to be generated or
costs to be saved by the use of covered
intangibles, or on an indirect basis, by
reference to certain measurements that
reasonably can be assumed to be
related to income generated or costs
saved. Such indirect bases of measurement of anticipated benefits are described in paragraph (f)(3)(iii) of this
section. A controlled participant’s an-
ticipated benefits must be measured on
the most reliable basis, whether direct
or indirect. In determining which of
two bases of measurement of reasonably anticipated benefits is most reliable, the factors set forth in §1.482–
1(c)(2)(ii) (Data and assumptions) must
be taken into account. It normally will
be expected that the basis that provided
the most reliable estimate for a particular year will continue to provide the
most reliable estimate in subsequent
years, absent a material change in the
factors that affect the reliability of the
estimate. Regardless of whether a direct or indirect basis of measurement is
used, adjustments may be required to
account for material differences in the
activities that controlled participants
undertake to exploit their interests in
covered intangibles. See Example 6 of
paragraph (f)(3)(iii)(E) of this section.
(iii) Indirect bases for measuring
anticipated benefits. Indirect bases for
measuring anticipated benefits from
participation in a qualified cost sharing
arrangement include the following:
(A) Units used, produced or sold.
Units of items used, produced or sold
by each controlled participant in the
business activities in which covered
intangibles are exploited may be used
as an indirect basis for measuring its
anticipated benefits. This basis of
measurement will be more reliable to
the extent that each controlled participant is expected to have a similar
increase in net profit or decrease in net
loss attributable to the covered intangibles per unit of the item or items used,
produced or sold. This circumstance is
most likely to arise when the covered
intangibles are exploited by the controlled participants in the use, production or sale of substantially uniform
items under similar economic
conditions.
(B) Sales. Sales by each controlled
participant in the business activities in
which covered intangibles are exploited
may be used as an indirect basis for
measuring its anticipated benefits. This
basis of measurement will be more
reliable to the extent that each controlled participant is expected to have a
similar increase in net profit or decrease in net loss attributable to covered intangibles per dollar of sales.
This circumstance is most likely to
arise if the costs of exploiting covered
intangibles are not substantial relative
to the revenues generated, or if the
principal effect of using covered intangibles is to increase the controlled
14
participants’ revenues (e.g., through a
price premium on the products they
sell) without affecting their costs substantially. Sales by each controlled
participant are unlikely to provide a
reliable basis for measuring benefits
unless each controlled participant operates at the same market level (e.g.,
manufacturing, distribution, etc.).
(C) Operating profit. Operating
profit of each controlled participant
from the activities in which covered
intangibles are exploited may be used
as an indirect basis for measuring its
anticipated benefits. This basis of
measurement will be more reliable to
the extent that such profit is largely
attributable to the use of covered
intangibles, or if the share of profits
attributable to the use of covered
intangibles is expected to be similar for
each controlled participant. This circumstance is most likely to arise when
covered intangibles are integral to the
activity that generates the profit and the
activity could not be carried on or
would generate little profit without use
of those intangibles.
(D) Other bases for measuring anticipated benefits. Other bases for
measuring anticipated benefits may, in
some circumstances, be appropriate, but
only to the extent that there is expected
to be a reasonably identifiable relationship between the basis of measurement
used and additional income generated
or costs saved by the use of covered
intangibles. For example, a division of
costs based on employee compensation
would be considered unreliable unless
there were a relationship between the
amount of compensation and the expected income of the controlled participants from the use of covered
intangibles.
(E) Examples. The following examples illustrate this paragraph
(f)(3)(iii):
Example 1. Foreign Parent (FP) and U.S.
Subsidiary (USS) both produce a feedstock for
the manufacture of various high-performance
plastic products. Producing the feedstock requires
large amounts of electricity, which accounts for a
significant portion of its production cost. FP and
USS enter into a cost sharing arrangement to
develop a new process that will reduce the
amount of electricity required to produce a unit
of the feedstock. FP and USS currently both
incur an electricity cost of X% of its other
production costs and rates for each are expected
to remain similar in the future. How much the
new process, if it is successful, will reduce the
amount of electricity required to produce a unit
of the feedstock is uncertain, but it will be about
the same amount for both companies. Therefore,
the cost savings each company is expected to
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achieve after implementing the new process are
similar relative to the total amount of the
feedstock produced. Under the cost sharing
arrangement FP and USS divide the costs of
developing the new process based on the units of
the feedstock each is anticipated to produce in
the future. In this case, units produced is the
most reliable basis for measuring benefits and
dividing the intangible development costs because each participant is expected to have a
similar decrease in costs per unit of the feedstock
produced.
Example 2. The facts are the same as in
Example 1, except that USS pays X% of its other
production costs for electricity while FP pays
2X% of its other production costs. In this case,
units produced is not the most reliable basis for
measuring benefits and dividing the intangible
development costs because the participants do
not expect to have a similar decrease in costs per
unit of the feedstock produced. The district
director determines that the most reliable measure of benefit shares may be based on units of
the feedstock produced if FP’s units are weighted
relative to USS’ units by a factor of 2. This
reflects the fact that FP pays twice as much as
USS as a percentage of its other production costs
for electricity and, therefore, FP’s savings per
unit of the feedstock would be twice USS’s
savings from any new process eventually
developed.
Example 3. The facts are the same as in
Example 2, except that to supply the particular
needs of the U.S. market USS manufactures the
feedstock with somewhat different properties
than FP’s feedstock. This requires USS to
employ a somewhat different production process
than does FP. Because of this difference, it will
be more costly for USS to adopt any new
process that may be developed under the cost
sharing agreement. In this case, units produced is
not the most reliable basis for measuring benefit
shares. In order to reliably determine benefit
shares, the district director offsets the reasonably
anticipated costs of adopting the new process
against the reasonably anticipated total savings in
electricity costs.
Example 4. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a cost sharing
arrangement to develop new anesthetic drugs.
USP obtains the right to use any resulting patent
in the U.S. market, and FS obtains the right to
use the patent in the European market. USP and
FS divide costs on the basis of anticipated
operating profit from each patent under development. USP anticipates that it will receive a much
higher profit than FS per unit sold because drug
prices are uncontrolled in the U.S., whereas drug
prices are regulated in many European countries.
In this case, the controlled taxpayers’ basis for
measuring benefits is the most reliable.
Example 5. (i) Foreign Parent (FP) and U.S.
Subsidiary (USS) both manufacture and sell
fertilizers. They enter into a cost sharing
arrangement to develop a new pellet form of a
common agricultural fertilizer that is currently
available only in powder form. Under the cost
sharing arrangement, USS obtains the rights to
produce and sell the new form of fertilizer for
the U.S. market while FP obtains the rights to
produce and sell the fertilizer for the rest of the
world. The costs of developing the new form of
fertilizer are divided on the basis of the
anticipated sales of fertilizer in the participants’
respective markets.
(ii) If the research and development is successful the pellet form will deliver the fertilizer
more efficiently to crops and less fertilizer will
be required to achieve the same effect on crop
growth. The pellet form of fertilizer can be
expected to sell at a price premium over the
powder form of fertilizer based on the savings in
the amount of fertilizer that needs to be used. If
the research and development is successful, the
costs of producing pellet fertilizer are expected
to be approximately the same as the costs of
producing powder fertilizer and the same for
both FP and USS. Both FP and USS operate at
approximately the same market levels, selling
their fertilizers largely to independent
distributors.
(iii) In this case, the controlled taxpayers’
basis for measuring benefits is the most reliable.
Example 6. The facts are the same as in
Example 5, except that FP distributes its
fertilizers directly while USS sells to independent distributors. In this case, sales of USS and
FP are not the most reliable basis for measuring
benefits unless adjustments are made to account
for the difference in market levels at which the
sales occur.
Example 7. Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a cost sharing
arrangement to develop materials that will be
used to train all new entry-level employees. FP
and USS determine that the new materials will
save approximately ten hours of training time per
employee. Because their entry-level employees
are paid on differing wage scales, FP and USS
decide that they should not divide costs based on
the number of entry-level employees hired by
each. Rather, they divide costs based on compensation paid to the entry-level employees hired by
each. In this case, the basis used for measuring
benefits is the most reliable because there is a
direct relationship between compensation paid to
new entry-level employees and costs saved by FP
and USS from the use of the new training
materials.
Example 8. U.S. Parent (USP), Foreign Subsidiary 1 (FS1) and Foreign Subsidiary 2 (FS2)
enter into a cost sharing arrangement to develop
computer software that each will market and
install on customers’ computer systems. The
participants divide costs on the basis of projected
sales by USP, FS1, and FS2 of the software in
their respective geographic areas. However, FS1
plans for sound business reasons not only to sell
but also to license the software, and FS1’s
licensing income (which is a percentage of the
licensees’ sales) is not counted in the projected
benefits. In this case, the basis used for
measuring the benefits of each participant is not
the most reliable because all of the benefits
received by participants are not taken into
account. In order to reliably determine benefit
shares, FS1’s projected benefits from licensing
must be included in the measurement on a basis
that is the same as that used to measure its own
and the other participants’ projected benefits
from sales (e.g., all participants might measure
their benefits on the basis of operating profit).
(iv) Projections used to estimate
anticipated benefits—(A) In general.
The reliability of an estimate of anticipated benefits also depends upon the
reliability of projections used in making the estimate. Projections required
for this purpose generally include a
determination of the time period between the inception of the research and
15
development and the receipt of benefits, a projection of the time over which
benefits will be received, and a projection of the benefits anticipated for each
year in which it is anticipated that the
intangible will generate benefits. A
projection of the relevant basis for
measuring anticipated benefits may require a projection of the factors that
underlie it. For example, a projection
of operating profits may require a
projection of sales, cost of sales,
operating expenses, and other factors
that affect operating profits. If it is
anticipated that there will be significant
variation among controlled participants
in the timing of their receipt of
benefits, and consequently benefit
shares are expected to vary significantly over the years in which benefits
will be received, it may be necessary to
use the present discounted value of the
projected benefits to reliably determine
each controlled participant’s share of
those benefits. If it is not anticipated
that benefit shares will significantly
change over time, current annual benefit shares may provide a reliable
projection of anticipated benefit shares.
This circumstance is most likely to
occur when the cost sharing arrangement is a long-term arrangement, the
arrangement covers a wide variety of
intangibles, the composition of the
covered intangibles is unlikely to
change, the covered intangibles are
unlikely to generate unusual profits,
and each controlled participant’s share
of the market is stable.
(B) Unreliable projections. A significant divergence between projected
benefit shares and actual benefit shares
may indicate that the projections were
not reliable. In such a case, the district
director may use actual benefits as the
most reliable measure of anticipated
benefits. If benefits are projected over
a period of years, and the projections
for initial years of the period prove to
be unreliable, this may indicate that the
projections for the remaining years of
the period are also unreliable and thus
should be adjusted. Projections will not
be considered unreliable based on a
divergence between a controlled participant’s projected benefit share and
actual benefit share if the amount of
such divergence for every controlled
participant is less than or equal to 20%
of the participant’s projected benefit
share. Further, the district director will
not make an allocation based on such
divergence if the difference is due to
an extraordinary event, beyond the
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control of the participants, that could
not reasonably have been anticipated at
the time that costs were shared. For
purposes of this paragraph, all controlled participants that are not U.S.
persons will be treated as a single
controlled participant. Therefore, an
adjustment based on an unreliable
projection will be made to the cost
shares of foreign controlled participants
only if there is a matching adjustment
to the cost shares of controlled participants that are U.S. persons. Nothing in
this paragraph (f)(3)(iv)(B) will prevent
the district director from making an
allocation if the taxpayer did not use
the most reliable basis for measuring
anticipated benefits. For example, if the
taxpayer measures anticipated benefits
based on units sold, and the district
director determines that another basis is
more reliable for measuring anticipated
benefits, then the fact that actual units
sold were within 20% of the projected
unit sales will not preclude an allocation under this section.
(C) Foreign-to-foreign adjustments.
Notwithstanding the limitations on adjustments provided in paragraph (f)(3)(iv)(B) of this section, adjustments to
cost shares based on an unreliable
projection also may be made solely
among foreign controlled participants if
the variation between actual and projected benefits has the effect of substantially reducing U.S. tax.
(D) Examples. The following examples illustrate this paragraph
(f)(3)(iv):
Example 1. (i) Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a cost sharing
arrangement to develop a new car model. The
participants plan to spend four years developing
the new model and four years producing and
selling the new model. USS and FP project total
sales of $4 billion and $2 billion, respectively,
over the planned four years of exploitation of the
new model. Cost shares are divided for each year
based on projected total sales. Therefore, USS
bears 66 2/3% of each year’s intangible development costs and FP bears 33 1/3% of such costs.
(ii) USS typically begins producing and selling new car models a year after FP begins
producing and selling new car models. The
district director determines that in order to reflect
USS’ one-year lag in introducing new car
models, a more reliable projection of each
participant’s share of benefits would be based on
a projection of all four years of sales for each
participant, discounted to present value.
Example 2. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a cost sharing
arrangement to develop new and improved
household cleaning products. Both participants
have sold household cleaning products for many
years and have stable market shares. The
products under development are unlikely to
produce unusual profits for either participant.
The participants divide costs on the basis of each
participant’s current sales of household cleaning
products. In this case, the participants’ future
benefit shares are reliably projected by current
sales of cleaning products.
Example 3. The facts are the same as in
Example 2, except that FS’s market share is
rapidly expanding because of the business failure
of a competitor in its geographic area. The
district director determines that the participants’
future benefit shares are not reliably projected by
current sales of cleaning products and that FS’s
benefit projections should take into account its
growth in sales.
Example 4. Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a cost sharing
arrangement to develop synthetic fertilizers and
insecticides. FP and USS share costs on the basis
of each participant’s current sales of fertilizers
and insecticides. The market shares of the
participants have been stable for fertilizers, but
FP’s market share for insecticides has been
expanding. The district director determines that
the participants’ projections of benefit shares are
reliable with regard to fertilizers, but not reliable
with regard to insecticides; a more reliable
projection of benefit shares would take into
account the expanding market share for
insecticides.
Example 5. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a cost sharing
arrangement to develop new food products,
dividing costs on the basis of projected sales two
years in the future. In year 1, USP and FS
project that their sales in year 3 will be equal,
and they divide costs accordingly. In year 3, the
district director examines the participants’
method for dividing costs. USP and FS actually
accounted for 42% and 58% of total sales,
respectively. The district director agrees that
sales two years in the future provide a reliable
basis for estimating benefit shares. Because the
differences between USP’s and FS’s actual and
projected benefit shares are less than 20% of
their projected benefit shares, the projection of
future benefits for year 3 is reliable.
Example 6. The facts are the same as in
Example 5, except that the in year 3 USP and FS
actually accounted for 35% and 65% of total
sales, respectively. The divergence between
USP’s projected and actual benefit shares is
greater than 20% of USP’s projected benefit
share and is not due to an extraordinary event
beyond the control of the participants. The
district director concludes that the projection of
anticipated benefit shares was unreliable, and
uses actual benefits as the basis for an adjustment to the cost shares borne by USP and FS.
Example 7. U.S. Parent (USP), a U.S. corporation, and its foreign subsidiary (FS) enter a cost
sharing arrangement in year 1. They project that
they will begin to receive benefits from covered
intangibles in years 4 through 6, and that USP
will receive 60% of total benefits and FS 40% of
total benefits. In years 4 through 6, USP and FS
actually receive 50% each of the total benefits.
In evaluating the reliability of the participants’
projections, the district director compares these
actual benefit shares to the projected benefit
shares. Although USP’s actual benefit share
(50%) is within 20% of its projected benefit
share (60%), FS’s actual benefit share (50%) is
not within 20% of its projected benefit share
(40%). Based on this discrepancy, the district
director may conclude that the participants’
projections were not reliable and may use actual
16
benefit shares as the basis for an adjustment to
the cost shares borne by USP and FS.
Example 8. Three controlled taxpayers, USP,
FS1 and FS2 enter into a cost sharing arrangement. FS1 and FS2 are foreign. USP is a United
States corporation that controls all the stock of
FS1 and FS2. The participants project that they
will share the total benefits of the covered
intangibles in the following percentages: USP
50%; FS1 30%; and FS2 20%. Actual benefit
shares are as follows: USP 45%; FS1 25%; and
FS2 30%. In evaluating the reliability of the
participants’ projections, the district director
compares these actual benefit shares to the
projected benefit shares. For this purpose, FS1
and FS2 are treated as a single participant. The
actual benefit share received by USP (45%) is
within 20% of its projected benefit share (50%).
In addition, the non-US participants’ actual
benefit share (55%) is also within 20% of their
projected benefit share (50%). Therefore, the
district director concludes that the participants’
projections of future benefits were reliable,
despite the fact that FS2’s actual benefit share
(30%) is not within 20% of its projected benefit
share (20%).
Example 9. The facts are the same as in
Example 8. In addition, the district director
determines that FS2 has significant operating
losses and has no earnings and profits, and that
FS1 is profitable and has earnings and profits.
Based on all the evidence, the district director
concludes that the participants arranged that FS1
would bear a larger cost share than appropriate
in order to reduce FS1’s earnings and profits and
thereby reduce inclusions USP otherwise would
be deemed to have on account of FS1 under
subpart F. Pursuant to §1.482–7 (f)(3)(iv)(C), the
district director may make an adjustment solely
to the cost shares borne by FS1 and FS2 because
FS2’s projection of future benefits was unreliable
and the variation between actual and projected
benefits had the effect of substantially reducing
USP’s U.S. income tax liability (on account of
FS1 subpart F income).
Example 10. (i) (A) Foreign Parent (FP) and
U.S. Subsidiary (USS) enter into a cost sharing
arrangement in 1996 to develop a new treatment
for baldness. USS’s interest in any treatment
developed is the right to produce and sell the
treatment in the U.S. market while FP retains
rights to produce and sell the treatment in the
rest of the world. USS and FP measure their
anticipated benefits from the cost sharing arrangement based on their respective projected
future sales of the baldness treatment. The
following sales projections are used:
Sales ($ millions)
Year
USS
FP
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
5
20
30
40
40
40
40
20
10
5
10
20
30
40
40
40
40
20
10
5
(B) in 1997, the first year of sales, USS is
projected to have lower sales than FP due to lags
in U.S. regulatory approval for the baldness
treatment. In each subsequent year USS and FP
are projected to have equal sales. Sales are
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projected to build over the first three years of the
period, level off for several years, and then
decline over the final years of the period as new
and improved baldness treatments reach the
market.
(ii) To account for USS’s lag in sales in the
first year, the present discounted value of sales
over the period is used as the basis for
measuring benefits. Based on the risk associated
with this venture, a discount rate of 10 percent is
selected. The present discounted value of projected sales is determined to be approximately
$154.4 million for USS and $158.9 million for
FP. On this basis USS and FP are projected to
obtain approximately 49.3% and 50.7% of the
benefit, respectively, and the costs of developing
the baldness treatment are shared accordingly.
(iii) (A) In the year 2002 the district director
examines the cost sharing arrangement. USS and
FP have obtained the following sales results
through the year 2001:
Sales ($ millions)
Year
USS
FP
1997
1998
1999
2000
2001
0
17
25
38
39
17
35
41
41
41
(B) USS’s sales initially grew more slowly
than projected while FP’s sales grew more
quickly. In each of the first three years of the
period the share of total sales of at least one of
the parties diverged by over 20% from its
projected share of sales. However, by the year
2001 both parties’ sales had leveled off at
approximately their projected values. Taking into
account this leveling off of sales and all the facts
and circumstances, the district director determines that it is appropriate to use the original
projections for the remaining years of sales.
Combining the actual results through the year
2001 with the projections for subsequent years,
and using a discount rate of 10%, the present
discounted value of sales is approximately
$141.6 million for USS and $187.3 million for
FP. This result implies that USS and FP obtain
approximately 43.1% and 56.9%, respectively, of
the anticipated benefits from the baldness treatment. Because these benefit shares are within
20% of the benefit shares calculated based on the
original sales projections, the district director
determines that, based on the difference between
actual and projected benefit shares, the original
projections were not unreliable. No adjustment is
made based on the difference between actual and
projected benefit shares.
Example 11. (i) The facts are the same as in
Example 10, except that the actual sales results
through the year 2001 are as follows:
Year
Sales ($ millions)
USS
FP
1997
1998
1999
2000
2001
0
17
25
34
36
17
35
44
54
55
(ii) Based on the discrepancy between the
projections and the actual results and on
consideration of all the facts, the district director
determines that for the remaining years the
following sales projections are more reliable than
the original projections:
Year
Sales ($ millions)
USS
FP
2002
2003
2004
2005
2006
36
36
18
9
4.5
55
55
28
14
7
(iii) Combining the actual results through the
year 2001 with the projections for subsequent
years, and using a discount rate of 10%, the
present discounted value of sales is approximately $131.2 million for USS and $229.4
million for FP. This result implies that USS and
FP obtain approximately 35.4% and 63.6%, respectively, of the anticipated benefits from the
baldness treatment. These benefit shares diverge
by greater than 20% from the benefit shares calculated based on the original sales projections,
and the district director determines that, based on
the difference between actual and projected
benefit shares, the original projections were
unreliable. The district director adjusts costs
shares for each of the taxable years under
examination to conform them to the recalculated
shares of anticipated benefits.
(4) Timing of allocations. If the
district director reallocates costs under
the provisions of this paragraph (f), the
allocation must be reflected for tax
purposes in the year in which the costs
were incurred. When a cost sharing
payment is owed by one member of a
qualified cost sharing arrangement to
another member, the district director
may make appropriate allocations to
reflect an arm’s length rate of interest
for the time value of money, consistent
with the provisions of §1.482–2(a)
(Loans or advances).
(g) Allocations of income, deductions or other tax items to reflect
transfers of intangibles (buy-in)—(1) In
general. A controlled participant that
makes intangible property available to
a qualified cost sharing arrangement
will be treated as having transferred
interests in such property to the other
controlled participants, and such other
controlled participants must make buyin payments to it, as provided in
paragraph (g)(2) of this section. If the
other controlled participants fail to
make such payments, the district director may make appropriate allocations,
under the provisions of §§1.482–1 and
1.482–4 through 1.482–6, to reflect an
arm’s length consideration for the
transferred intangible property. Further,
if a group of controlled taxpayers
participates in a qualified cost sharing
arrangement, any change in the controlled participants’ interests in covered
intangibles, whether by reason of entry
of a new participant or otherwise by
reason of transfers (including deemed
transfers) of interests among existing
17
participants, is a transfer of intangible
property, and the district director may
make appropriate allocations, under the
provisions of §§1.482–1 and 1.482–4
through 1.482–6, to reflect an arm’s
length consideration for the transfer.
See paragraphs (g)(3), (4), and (5) of
this section. Paragraph (g)(6) of this
section provides rules for assigning
unassigned interests under a qualified
cost sharing arrangement.
(2) Pre-existing intangibles. If a
controlled participant makes preexisting intangible property in which it
owns an interest available to other
controlled participants for purposes of
research in the intangible development
area under a qualified cost sharing
arrangement, then each such other
controlled participant must make a buyin payment to the owner. The buy-in
payment by each such other controlled
participant is the arm’s length charge
for the use of the intangible under the
rules of §§1.482–1 and 1.482–4
through 1.482–6, multiplied by the
controlled participant’s share of reasonably anticipated benefits (as defined in
paragraph (f)(3) of this section). A
controlled participant’s payment required under this paragraph (g)(2) is
deemed to be reduced to the extent of
any payments owed to it under this
paragraph (g)(2) from other controlled
participants. Each payment received by
a payee will be treated as coming pro
rata out of payments made by all
payors. See paragraph (g)(8), Example
4, of this section. Such payments will
be treated as consideration for a
transfer of an interest in the intangible
property made available to the qualified
cost sharing arrangement by the payee.
Any payment to or from an uncontrolled participant in consideration for
intangible property made available to
the qualified cost sharing arrangement
will be shared by the controlled participants in accordance with their shares of
reasonably anticipated benefits (as defined in paragraph (f)(3) of this section). A controlled participant’s
payment required under this paragraph
(g)(2) is deemed to be reduced by such
a share of payments owed from an uncontrolled participant to the same extent as by any payments owed from
other controlled participants under this
paragraph (g)(2). See paragraph (g)(8),
Example 5, of this section.
(3) New controlled participant. If a
new controlled participant enters a
qualified cost sharing arrangement and
acquires any interest in the covered
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intangibles, then the new participant
must pay an arm’s length consideration,
under the provisions of §§1.482–1 and
1.482–4 through 1.482–6, for such
interest to each controlled participant
from whom such interest was acquired.
(4) Controlled participant relinquishes interests. A controlled participant in a qualified cost sharing
arrangement may be deemed to have
acquired an interest in one or more
covered intangibles if another controlled participant transfers, abandons,
or otherwise relinquishes an interest
under the arrangement, to the benefit of
the first participant. If such a relinquishment occurs, the participant relinquishing the interest must receive an
arm’s length consideration, under the
provisions of §§1.482–1 and 1.482–4
through 1.482–6, for its interest. If the
controlled participant that has relinquished its interest subsequently uses
that interest, then that participant must
pay an arm’s length consideration,
under the provisions of §§1.482–1 and
1.482–4 through 1.482–6, to the controlled participant that acquired the
interest.
(5) Conduct inconsistent with the
terms of a cost sharing arrangement.
If, after any cost allocations authorized
by paragraph (a)(2) of this section, a
controlled participant bears costs of
intangible development that over a
period of years are consistently and
materially greater or lesser than its
share of reasonably anticipated benefits, then the district director may
conclude that the economic substance
of the arrangement between the controlled participants is inconsistent with
the terms of the cost sharing arrangement. In such a case, the district
director may disregard such terms and
impute an agreement consistent with
the controlled participants’ course of
conduct, under which a controlled
participant that bore a disproportionately greater share of costs received
additional interests in covered intangibles. See §1.482–1(d)(3)(ii)(B) (Identifying contractual terms) and §1.482–
4(f)(3)(ii) (Identification of owner).
Accordingly, that participant must receive an arm’s length payment from
any controlled participant whose share
of the intangible development costs is
less than its share of reasonably anticipated benefits over time, under the
provisions of §§1.482–1 and 1.482–4
through 1.482–6.
(6) Failure to assign interests under
a qualified cost sharing arrangement.
If a qualified cost sharing arrangement
fails to assign an interest in a covered
intangible, then each controlled participant will be deemed to hold a share in
such interest equal to its share of the
costs of developing such intangible.
For this purpose, if cost shares have
varied materially over the period during
which such intangible was developed,
then the costs of developing the intangible must be measured by their present
discounted value as of the date when
the first such costs were incurred.
(7) Form of consideration. The consideration for an acquisition described
in this paragraph (g) may take any of
the following forms:
(i) Lump sum payments. For the
treatment of lump sum payments, see
§1.482–4(f)(5) (Lump sum payments);
(ii) Installment payments. Installment payments spread over the period
of use of the intangible by the transferee, with interest calculated in accordance with §1.482–2(a) (Loans or
advances); and
(iii) Royalties. Royalties or other
payments contingent on the use of the
intangible by the transferee.
(8) Examples. The following examples illustrate allocations described in
this paragraph (g):
Example 1. In year one, four members of a
controlled group enter into a cost sharing
arrangement to develop a commercially feasible
process for capturing energy from nuclear fusion.
Based on a reliable projection of their future
benefits, each cost sharing participant bears an
equal share of the costs. The cost of developing
intangibles for each participant with respect to
the project is approximately $1 million per year.
In year ten, a fifth member of the controlled
group joins the cost sharing group and agrees to
bear one-fifth of the future costs in exchange for
part of the fourth member’s territory reasonably
anticipated to yield benefits amounting to onefifth of the total benefits. The fair market value
of intangible property within the arrangement at
the time the fifth company joins the arrangement
is $45 million. The new member must pay onefifth of that amount (that is, $9 million total) to
the fourth member from whom it acquired its
interest in covered intangibles.
Example 2. U.S. Subsidiary (USS), Foreign
Subsidiary (FS) and Foreign Parent (FP) enter
into a cost sharing arrangement to develop new
products within the Group X product line. USS
manufactures and sells Group X products in
North America, FS manufactures and sells Group
X products in South America, and FP manufactures and sells Group X products in the rest of
the world. USS, FS and FP project that each will
manufacture and sell a third of the Group X
products under development, and they share costs
on the basis of projected sales of manufactured
products. When the new Group X products are
developed, however, USS ceases to manufacture
Group X products, and FP sells its Group X
18
products to USS for resale in the North
American market. USS earns a return on its
resale activity that is appropriate given its
function as a distributor, but does not earn a
return attributable to exploiting covered intangibles. The district director determines that USS’
share of the costs (one-third) was greater than its
share of reasonably anticipated benefits (zero)
and that it has transferred an interest in the
intangibles for which it should receive a payment
from FP, whose share of the intangible development costs (one-third) was less than its share of
reasonably anticipated benefits over time (twothirds). An allocation is made under §§1.482–1
and 1.482–4 through 1.482–6 from FP to USS to
recognize USS’ one-third interest in the intangibles. No allocation is made from FS to USS
because FS did not exploit USS’ interest in
covered intangibles.
Example 3. U.S. Parent (USP), Foreign Subsidiary 1 (FS1), and Foreign Subsidiary 2 (FS2)
enter into a cost sharing arrangement to develop
a cure for the common cold. Costs are shared
USP–50%, FS1–40% and FS2–10% on the basis
of projected units of cold medicine to be
produced by each. After ten years of research
and development, FS1 withdraws from the
arrangement, transferring its interests in the
intangibles under development to USP in exchange for a lump sum payment of $10 million.
The district director may review this lump sum
payment, under the provisions of §1.482–4(f)(5),
to ensure that the amount is commensurate with
the income attributable to the intangibles.
Example 4. (i) Four members A, B, C, and D
of a controlled group form a cost sharing
arrangement to develop the next generation
technology for their business. Based on a reliable
projection of their future benefits, the participants agree to bear shares of the costs incurred
during the term of the agreement in the following percentages: A 40%; B 15%; C 25%; and
D 20%. The arm’s length charges, under the
rules of §§1.482–1 and 1.482–4 through 1.482–6,
for the use of the existing intangible property
they respectively make available to the cost
sharing arrangement are in the following
amounts for the taxable year: A 80X; B 40X; C
30X; and D 30X. The provisional (before offsets)
and final buy-in payments/receipts among A, B,
C, and D are shown in the table as follows:
(All amounts stated in X’s)
A
B
C
D
PAYMENTS , 40 . , 21 . , 37.5 . , 30 .
34
22.5
24
RECEIPTS
48
FINAL
8
13
, 15 . , 6 .
(ii) The first row/first column shows A’s
provisional buy-in payment equal to the product
of 100X (sum of 40X, 30X, and 30X) and A’s
share of anticipated benefits of 40%. The second
row/first column shows A’s provisional buy-in
receipts equal to the sum of the products of 80X
and B’s, C’s, and D’s anticipated benefits shares
(15%, 25%, and 20%, respectively). The other
entries in the first two rows of the table are
similarly computed. The last row shows the final
buy-in receipts/payments after offsets. Thus, for
the taxable year, A and B are treated as receiving
the 8X and 13X, respectively, pro rata out of
payments by C and D of 15X and 6X,
respectively.
Example 5. A and B, two members of a
controlled group form a cost sharing arrangement
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with an unrelated third party C to develop a new
technology useable in their respective businesses.
Based on a reliable projection of their future
benefits, A and B agree to bear shares of 60%
and 40%, respectively, of the costs incurred
during the term of the agreement. A also makes
available its existing technology for purposes of
the research to be undertaken. The arm’s length
charge, under the rules of §§1.482–1 and 1.482–
4 through 1.482–6, for the use of the existing
technology is 100X for the taxable year. Under
its agreement with A and B, C must make a
specified cost sharing payment as well as a
payment of 50X for the taxable year on account
of the pre-existing intangible property made
available to the cost sharing arrangement. B’s
provisional buy-in payment (before offsets) to A
for the taxable year is 40X (the product of 100X
and B’s anticipated benefits share of 40%). C’s
payment of 50X is shared provisionally between
A and B in accordance with their shares of
reasonably anticipated benefits, 30X (50X times
60%) to A and 20X (50X times 40%) to B. B’s
final buy-in payment (after offsets) is 20X (40X
less 20X). A is treated as receiving the 70X total
provisional payments (40X plus 30X) pro rata
out of the final payments by B and C of 20X and
50X, respectively.
(h) Character of payments made
pursuant to a qualified cost sharing
arrangement—(1) In general. Payments
made pursuant to a qualified cost
sharing arrangement (other than payments described in paragraph (g) of
this section) generally will be considered costs of developing intangibles of
the payor and reimbursements of the
same kind of costs of developing
intangibles of the payee. For purposes
of this paragraph (h), a controlled
participant’s payment required under a
qualified cost sharing arrangement is
deemed to be reduced to the extent of
any payments owed to it under the
arrangement from other controlled or
uncontrolled participants. Each payment received by a payee will be
treated as coming pro rata out of
payments made by all payors. Such
payments will be applied pro rata
against deductions for the taxable year
that the payee is allowed in connection
with the qualified cost sharing arrangement. Payments received in excess of
such deductions will be treated as in
consideration for use of the tangible
property made available to the qualified
cost sharing arrangement by the payee.
For purposes of the research credit
determined under section 41, cost sharing payments among controlled participants will be treated as provided for
intra-group transactions in §1.41-8(e).
Any payment made or received by a
taxpayer pursuant to an arrangement
that the district director determines not
to be a qualified cost sharing arrangement, or a payment made or received
pursuant to paragraph (g) of this
section, will be subject to the provisions of §§1.482–1 and 1.482–4
through 1.482–6. Any payment that in
substance constitutes a cost sharing
payment will be treated as such for
purposes of this section, regardless of
its characterization under foreign law.
(2) Examples. The following examples illustrate this paragraph (h):
Example 1. U.S. Parent (USP) and its wholly
owned Foreign Subsidiary (FS) form a cost
sharing arrangement to develop a miniature
widget, the Small R. Based on a reliable
projection of their future benefits, USP agrees to
bear 40% and FS to bear 60% of the costs
incurred during the term of the agreement. The
principal costs in the intangible development area
are operating expenses incurred by FS in
Country Z of 100X annually, and operating
expenses incurred by USP in the United States
also of 100X annually. Of the total costs of
200X, USP’s share is 80X and FS’s share is
120X, so that FS must make a payment to USP
of 20X. This payment will be treated as a
reimbursement of 20X of USP’s operating
expenses in the United States. Accordingly,
USP’s Form 1120 will reflect an 80X deduction
on account of activities performed in the United
States for purposes of allocation and apportionment of the deduction to source. The Form 5471
for FS will reflect a 100X deduction on account
of activities performed in Country Z, and a 20X
deduction on account of activities performed in
the United States.
Example 2. The facts are the same as in
Example 1, except that the 100X of costs borne
by USP consist of 5X of operating expenses
incurred by USP in the United States and 95X of
fair market value rental cost for a facility in the
United States. The depreciation deduction attributable to the U.S. facility is 7X. The 20X net
payment by FS to USP will first be applied in
reduction pro rata of the 5X deduction for
operating expenses and the 7X depreciation
deduction attributable to the U.S. facility. The
8X remainder will be treated as rent for the U.S.
facility.
(i) Accounting requirements. The accounting requirements of this paragraph
are that the controlled participants in a
qualified cost sharing arrangement must
use a consistent method of accounting
to measure costs and benefits, and must
translate foreign currencies on a consistent basis.
(j) Administrative requirements—(1)
In general. The administrative requirements of this paragraph consist of the
documentation requirements of paragraph (j)(2) of this section and the
reporting requirements of paragraph
(j)(3) of this section.
(2) Documentation. A controlled
participant must maintain sufficient
documentation to establish that the
requirements of paragraphs (b)(4) and
(c)(1) of this section have been met, as
19
well as the additional documentation
specified in this paragraph (j)(2), and
must provide any such documentation
to the Internal Revenue Service within
30 days of a request (unless an
extension is granted by the district
director). Documents necessary to
establish the following must also be
maintained—
(i) The total amount of costs incurred pursuant to the arrangement;
(ii) The costs borne by each controlled participant;
(iii) A description of the method
used to determine each controlled
participant’s share of the intangible
development costs, including the projections used to estimate benefits, and
an explanation of why that method was
selected;
(iv) The accounting method used to
determine the costs and benefits of the
intangible development (including the
method used to translate foreign currencies), and, to the extent that the
method materially differs from U.S.
generally accepted accounting principles, an explanation of such material
differences; and
(v) Prior research, if any, undertaken
in the intangible development area, any
tangible or intangible property made
available for use in the arrangement, by
each controlled participant, and any
information used to establish the value
of pre-existing and covered intangibles.
(3) Reporting requirements. A controlled participant must attach to its
U.S. income tax return a statement
indicating that it is a participant in a
qualified cost sharing arrangement, and
listing the other controlled participants
in the arrangement. A controlled participant that is not required to file a
U.S. income tax return must ensure that
such a statement is attached to Schedule M of any Form 5471 or to any
Form 5472 filed with respect to that
participant.
(k) Effective date. This section is
effective for taxable years beginning on
or after January 1, 1996.
(l) Transition rule. A cost sharing
arrangement will be considered a
qualified cost sharing arrangement,
within the meaning of this section, if,
prior to January 1, 1996, the arrangement was a bona fide cost sharing
arrangement under the provisions of
§1.482–7T (as contained in the 26 CFR
part 1 edition revised as of April 1,
1995), but only if the arrangement is
amended, if necessary, to conform with
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the provisions of this
December 31, 1996.
section
by
§1.482–7T [Removed]
Par. 4. Section 1.482–7T is removed.
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 5. The authority for part 301
continues to read in part as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 6. Section 301.7701–3 is
amended by adding paragraph (e) to
read as follows:
§301.7701–3 Partnerships.
*
*
*
*
*
Section 671.—Trust Income,
Deductions, and Credit Attributable to
Grantors and Others as Substantial
Owners
26 CFR 1.671–4: Method of reporting.
T.D. 8633
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 25, 301, and 602
Grantor Trust Reporting Requirements
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
*
(e) Qualified cost sharing arrangements. A qualified cost sharing arrangement that is described in §1.482–7
of this chapter and any arrangement
that is treated by the Service as a
qualified cost sharing arrangement under §1.482–7 of this chapter is not
classified as a partnership for purposes
of the Internal Revenue Code. See
§1.482–7 of this chapter for the proper
treatment of qualified cost sharing
arrangements.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 7. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 8. In §602.101, paragraph (c) is
amended by adding an entry to the
table in numerical order to read as
follows:
‘‘1.482–7 . . . . . . . . . . . . . 1545–1364’’.
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
Approved November 30, 1995.
Leslie Samuels,
Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 19, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 20, 1995, 60 F.R. 65553)
SUMMARY: This document contains
final regulations relating to the method
of reporting for trusts that are treated
as owned by grantors or other persons
under the provisions of subpart E
(section 671 and following), part I,
subchapter J, chapter 1 of the Internal
Revenue Code. These regulations are
intended to reduce the current filing
burden on trustees, to provide necessary information to grantors or other
persons treated as the owners of trusts,
to reduce any cases of duplicate filing,
and to provide more meaningful information to the IRS. These regulations
affect grantors and trustees of trusts
that are treated as owned by grantors or
other persons, as well as persons who
are required to file information returns
with respect to payments to these
trusts.
DATES: These regulations are effective
January 1, 1996.
For dates of applicability of these
regulations, see §1.671–4(h).
FOR FURTHER INFORMATION
CONTACT: Steven Schneider, (202)
622-3060 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations has
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545–1442. This infor-
20
mation is required by the IRS to insure
the proper reporting of income and
proceeds paid to a trust any portion of
which is treated as owned by the
grantor or another person.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number.
The estimated annual burden per
respondent is 30 minutes.
Comments concerning the accuracy
of this burden estimate and suggestions
for reducing this burden should be sent
to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, T:FP,
Washington, DC 20224, and to the
Office of Management and Budget,
Attn: Desk Officer for the Department
of the Treasury, Office of Information
and Regulatory Affairs, Washington,
DC 20503.
Books or records relating to this
collection of information must be retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
On July 22, 1994, the IRS published
in the Federal Register a notice of
proposed rulemaking and notice of
public hearing (59 FR 37450 [PS–79–
93, 1994–2 C.B. 916]) proposing
amendments to the Income Tax Regulations (26 CFR part 1) under section
671 of the Internal Revenue Code
(Code) and to the Procedure and
Administration Regulations (26 CFR
part 301) under sections 6012 and 6109
of the Code.
Written comments responding to the
notice were received. A public hearing
was held on September 21, 1994,
pursuant to the notice published in the
Federal Register on July 22, 1994.
After consideration of all written and
oral comments regarding the proposed
amendments, those amendments are
adopted as revised by this Treasury
decision.
Explanation of provisions and
significant changes in the final
regulations
Subject to certain new limitations
under §1.671–4(b)(6) and (7), discussed
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below, §1.671–4(b) of the final regulations retains the optional alternative
methods of reporting contained in the
proposed regulations published on July
22, 1994.
Several comments were submitted requesting confirmation that the alternative methods of reporting described in
the proposed regulations are optional
and not mandatory. Section 1.671–4(b)
of the final regulations clarifies that the
trustee of a trust all of which is treated
as owned by one or more grantors or
other persons may, but is not required
to, report pursuant to one of the
alternative methods.
Certain commentators were unsure of
which persons are considered payors
for purposes of the alternative filing
methods. The final regulations define
the term payor as including any person
who is required by any provision of the
Code and the regulations thereunder to
make any type of information return
with respect to the trust for the taxable
year.
With respect to the alternative
methods of reporting, several commentators were unsure of the items and the
amounts of income that must be reported on any Forms 1099 required to
be filed by the trustee. Section 1.671–
4(b)(5) of the final regulations clarifies
that the amounts that must be included
on any Forms 1099 required to be filed
by the trustee do not include any
amounts that are reportable by the
payor on an information return other
than Form 1099.
For example, in the case of a trustee
who furnishes the name, TIN, and
address of the trust to all payors
pursuant to §1.671–4(b)(2)(i)(B) of the
final regulations, the trustee does not
include items of income attributable to
an interest in a partnership on any
Forms 1099 filed by the trustee because those items are reportable by the
partnership on Schedule K–1 of Form
1065 (reporting distributive shares to
members of a partnership). While the
statement furnished to the grantor or
other person treated as the owner of the
trust by the trustee will show all items
of income, deduction, and credit attributable to the partnership interest,
those items will not be reported to the
IRS by the trustee on any type of form.
Several commentators were unsure of
the dates by which a trustee must file
any required Forms 1099 and must
furnish any required statements to
grantors or other persons treated as
owners of the trust. Section 1.671–4(c)
of the final regulations provides that
the due date for any Forms 1099 required to be filed with the IRS by a
trustee is the due date otherwise in
effect for filing Forms 1099. Currently,
the due date is February 28 of the
following year.
Section 1.671–4(d) of the final regulations provides that the due date for
the statement required to be furnished
by a trustee to the grantor or other
person treated as an owner of the trust
is the date specified by section
6034A(a). Currently, the due date is
April 15 of the following year.
Comments were received requesting
clarification of the trustee’s obligation,
under the first of the alternative reporting methods, to furnish the name and
TIN of the grantor to all payors. The
final regulations provide that: (1) a
trustee may not report under the first
alternative reporting method unless the
grantor or other person treated as the
owner of the trust provides to the
trustee a complete Form W–9 or other
acceptable substitute form; (2) a trustee
reporting under the first alternative
reporting method acts as the agent of
the grantor or other person treated as
the owner of the trust for purposes of
furnishing backup withholding information to a payor; and (3) the payor may
rely on the name and TIN provided to
the payor by the trustee. If the Form
W–9 indicates that the grantor or other
person is subject to backup withholding, then the trustee must notify all
payors of reportable interest and dividend payments of the requirement to
backup withhold.
Comments were received requesting
clarification of the annuity and unitrust
payment dates under §25.2702–3 of the
Gift Tax Regulations for trusts electing
one of the alternative methods of reporting. The final regulations contain
conforming amendments to §25.2702–
3(b)(1)(i) and §25.2702–3(c)(1)(i).
One commentator noted the need for
more guidance concerning the reporting
requirements for widely held fixed
investment trusts. Because that guidance is outside the scope of this
regulation, the final regulations do not
provide special rules for these trusts.
However IRS and Treasury anticipate
providing guidance for these trusts in a
separate project and would welcome
comments from interested taxpayers
and practitioners regarding such
guidance.
21
Several of the comments received
with respect to the proposed regulations
emphasized the necessity of making the
trustee’s choice to report under one of
the alternative methods revocable. The
final regulations provide that a trustee
who has reported pursuant to one of the
alternative methods may report pursuant to the general rule requiring the
trustee to file a Form 1041 for any
subsequent taxable years of the trust,
provided that certain conditions are
met.
The final regulations provide that the
trustee of a trust all of which is treated
as owned by one grantor or one other
person that is an exempt recipient for
information reporting purposes may not
report under an alternative method.
However, if the trust is treated as
owned by two or more grantors or
other persons, the trustee may report
pursuant to the alternative method for
multiple grantors if (1) at least one
grantor or one other person who is
treated as an owner of the trust is a
person who is not an exempt recipient
for information reporting purposes and
(2) the trustee reports without regard to
whether any of the grantors or other
persons treated as owners of the trust
are exempt recipients for information
reporting purposes.
The final regulations also provide
that the trustee of a trust all of which is
treated as owned by one grantor or
other person whose taxable year is a
fiscal year may not report under an
alternative method. However, the
trustee of a trust that is treated as
owned by two or more grantors or
other persons may report pursuant to
the alternative method for multiple
grantors even though one or more of
the grantors or other persons treated as
an owner of the trust has a taxable year
that is the fiscal year.
In addition, the final regulations
provide that a trustee of a trust that is a
qualified subchapter S trust as defined
in section 1361(d)(3) may not report
under an alternative method.
The final regulations also provide
that the trustee of a trust may not
report under an alternative method if
any person who is treated as an owner
of the trust is not a United States
person.
Effective date and transition rule
The final regulations are effective for
taxable years beginning on or after
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January 1, 1996, subject to a requirement that certain trustees file a final
Form 1041 before adopting one of the
alternative methods of reporting. The
final regulations retain the transition
rule contained in the proposed regulations providing that, for taxable years
beginning prior to January 1, 1996, the
IRS will not challenge the manner of
reporting by trustees of certain trusts.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not
apply to these regulations, and, therefore, a Regulatory Flexibility Analysis
is not required. Pursuant to section
7805(f) of the Code, the notice of
proposed rulemaking preceding these
regulations was submitted to the Small
Business Administration for comment
on its impact on small business.
Drafting Information
The principal author of these regulations is Robert Rio, formerly of the
Office of Assistant Chief Counsel
(Passthroughs and Special Industries),
IRS. However, other personnel from
the IRS and Treasury Department
participated in their development.
*
*
*
*
*
*
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1, 25,
301, and 602 are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805. * * *
Par. 2. Section 1.671–4 is revised to
read as follows:
§1.671-4 Method of reporting.
(a) Portion of trust treated as owned
by the grantor or another person.
Except as otherwise provided in para-
graph (b) of this section, items of
income, deduction, and credit attributable to any portion of a trust which,
under the provisions of subpart E
(section 671 and following), part I,
subchapter J, chapter 1 of the Internal
Revenue Code, is treated as owned by
the grantor or another person are not
reported by the trust on Form 1041, but
are shown on a separate statement to be
attached to that form.
(b) A trust all of which is treated as
owned by one or more grantors or
other persons—(1) In general. In the
case of a trust all of which is treated as
owned by one or more grantors or
other persons, and which is not described in paragraph (b)(6) or (7) of
this section, the trustee may, but is not
required to, report by one of the
methods described in this paragraph (b)
rather than by the method described in
paragraph (a) of this section. A trustee
may not report, however, pursuant to
paragraph (b)(2)(i)(A) of this section
unless the grantor or other person
treated as the owner of the trust
provides to the trustee a complete Form
W–9 or acceptable substitute Form W–
9 signed under penalties of perjury. See
section 3406 and the regulations thereunder for the information to include on,
and the manner of executing, the Form
W–9, depending upon the type of reportable payments made.
(2) A trust all of which is treated as
owned by one grantor or by one other
person—(i) In general. In the case of a
trust all of which is treated as owned
by one grantor or one other person, the
trustee reporting under this paragraph
(b) must either—
(A) Furnish the name and taxpayer
identification number (TIN) of the
grantor or other person treated as the
owner of the trust, and the address of
the trust, to all payors during the
taxable year, and comply with the
additional requirements described in
paragraph (b)(2)(ii) of this section; or
(B) Furnish the name, TIN, and address of the trust to all payors during
the taxable year, and comply with the
additional requirements described in
paragraph (b)(2)(iii) of this section.
(ii) Additional obligations of the
trustee when name and TIN of the
grantor or other person treated as the
owner of the trust and the address of
the trust are furnished to payors. (A)
Unless the grantor or other person
treated as the owner of the trust is the
trustee or a co-trustee of the trust, the
22
trustee must furnish the grantor or
other person treated as the owner of the
trust with a statement that—
(1) Shows all items of income,
deduction, and credit of the trust for
the taxable year;
(2) Identifies the payor of each item
of income;
(3) Provides the grantor or other
person treated as the owner of the trust
with the information necessary to take
the items into account in computing the
grantor’s or other person’s taxable
income; and
(4) Informs the grantor or other
person treated as the owner of the trust
that the items of income, deduction and
credit and other information shown on
the statement must be included in
computing the taxable income and
credits of the grantor or other person
on the income tax return of the grantor
or other person.
(B) The trustee is not required to file
any type of return with the Internal
Revenue Service.
(iii) Additional obligations of the
trustee when name, TIN, and address of
the trust are furnished to payors—(A)
Obligation to file Forms 1099. The
trustee must file with the Internal
Revenue Service the appropriate Forms
1099, reporting the income or gross
proceeds paid to the trust during the
taxable year, and showing the trust as
the payor and the grantor or other
person treated as the owner of the trust
as the payee. The trustee has the same
obligations for filing the appropriate
Forms 1099 as would a payor making
reportable payments, except that the
trustee must report each type of income
in the aggregate, and each item of
gross proceeds separately. See paragraph (b)(5) of this section regarding
the amounts required to be included on
any Forms 1099 filed by the trustee.
(B) Obligation to furnish statement.
(1) Unless the grantor or other person
treated as the owner of the trust is the
trustee or a co-trustee of the trust, the
trustee must also furnish to the grantor
or other person treated as the owner of
the trust a statement that—
(i) Shows all items of income, deduction, and credit of the trust for the
taxable year;
(ii) Provides the grantor or other
person treated as the owner of the trust
with the information necessary to take
the items into account in computing the
grantor’s or other person’s taxable
income; and
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(iii) Informs the grantor or other
person treated as the owner of the trust
that the items of income, deduction and
credit and other information shown on
the statement must be included in computing the taxable income and credits
of the grantor or other person on the
income tax return of the grantor or
other person.
(2) By furnishing the statement, the
trustee satisfies the obligation to furnish statements to recipients with respect to the Forms 1099 filed by the
trustee.
(iv) Examples. The following examples illustrate the provisions of this
paragraph (b)(2):
to G, as the owner of the trust, of $2,500; a
Form 1099–DIV on which T reports dividends
attributable to G, as the owner of the trust, of
$3,205; and a Form 1099-B on which T reports
gross proceeds from the sale of B stock
attributable to G, as the owner of the trust, of
$2,000. On or before April 15, 1997, T furnishes
a statement to G which lists the following items
of income and information necessary for G to
take the items into account in computing G’s
taxable income:
Example 1. G, a United States citizen, creates
an irrevocable trust which provides that the
ordinary income is to be payable to him for life
and that on his death the corpus shall be
distributed to B, an unrelated person. Except for
the right to receive income, G retains no right or
power which would cause him to be treated as an
owner under sections 671 through 679. Under the
applicable local law, capital gains must be added
to corpus. Since G has a right to receive income,
he is treated as an owner of a portion of the trust
under section 677. The tax consequences of any
items of capital gain of the trust are governed by
the provisions of subparts A, B, C, and D
(section 641 and following), part I, subchapter J,
chapter 1 of the Internal Revenue Code. Because
not all of the trust is treated as owned by the
grantor or another person, the trustee may not
report by the methods described in paragraph
(b)(2) of this section.
Example 2. (i)(A) On January 2, 1996, G, a
United States citizen, creates a trust all of which
is treated as owned by G. The trustee of the trust
is T. During the 1996 taxable year the trust has
the following items of income and gross
proceeds:
(C) T informs G that any items of income,
deduction and credit and other information
shown on the statement must be included in
computing the taxable income and credits of the
grantor or other person on the income tax return
of the grantor or other person.
(D) T has complied with T’s obligations under
this section.
(iii)(A) Same facts as paragraphs (i) and (ii) of
this Example 2, except that G contributed the B
stock to the trust on January 2, 1996. On or
before April 15, 1997, T furnishes a statement to
G which lists the following items of income and
information necessary for G to take the items
into account in computing G’s taxable income:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 3,205
Proceeds from sale of B stock . . . . . . . 2,000
(B) The trust has no items of deduction or
credit.
(ii)(A) The payors of the interest paid to the
trust are X ($2,000), Y ($300), and Z ($200).
The payors of the dividends paid to the trust are
A ($3,200), and D ($5). The payor of the gross
proceeds paid to the trust is D, a brokerage firm,
which held the B stock as the nominee for the
trust. The B stock was purchased by T for
$1,500 on January 3, 1996, and sold by T on
November 29, 1996. T chooses to report pursuant
to paragraph (b)(2)(i)(B) of this section, and
therefore furnishes the name, TIN, and address
of the trust to X, Y, Z, A, and D. X, Y, and Z
each furnish T with a Form 1099–INT showing
the trust as the payee. A furnishes T with a Form
1099–DIV showing the trust as the payee. D
does not furnish T with a Form 1099–DIV
because D paid a dividend of less than $10 to T.
D furnishes T with a Form 1099–B showing the
trust as the payee.
(B) On or before February 28, 1997, T files a
Form 1099–INT with the Internal Revenue
Service on which T reports interest attributable
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 3,205
Gain from sale of B stock . . . . . . . . . . . . 500
Information regarding sale of B stock:
Proceeds . . . . . . . . . . . . . . . . . . . . . . . . $2,000
Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Date acquired . . . . . . . . . . . . . . . . . . 1/03/96
Date sold . . . . . . . . . . . . . . . . . . . . . 11/29/96
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 3,205
Information regarding sale of B stock:
Proceeds . . . . . . . . . . . . . . . . . . . . . . . . $2,000
Date sold . . . . . . . . . . . . . . . . . . . . . 11/29/96
(B) T informs G that any items of income,
deduction and credit and other information
shown on the statement must be included in
computing the taxable income and credits of the
grantor or other person on the income tax return
of the grantor or other person.
(C) T has complied with T’s obligations under
this section.
Example 3. On January 2, 1996, G, a United
States citizen, creates a trust all of which is
treated as owned by G. The trustee of the trust is
T. The only asset of the trust is an interest in C,
a common trust fund under section 584(a). T
chooses to report pursuant to paragraph
(b)(2)(i)(B) of this section and therefore furnishes the name, TIN, and address of the trust to
C. C files a Form 1065 and a Schedule K–1
(Partner’s Share of Income, Credits, Deductions,
etc.) showing the name, TIN, and address of the
trust with the Internal Revenue Service and
furnishes a copy to T. Because the trust did not
receive any amounts described in paragraph
(b)(5) of this section, T does not file any type of
return with the Internal Revenue Service. On or
before April 15, 1997, T furnishes G with a
statement that shows all items of income,
deduction, and credit of the trust for the 1996
taxable year. In addition, T informs G that any
items of income, deduction and credit and other
information shown on the statement must be
included in computing the taxable income and
23
credits of the grantor or other person on the
income tax return of the grantor or other person.
T has complied with T’s obligations under this
section.
(3) A trust all of which is treated as
owned by two or more grantors or
other persons—(i) In general. In the
case of a trust all of which is treated as
owned by two or more grantors or
other persons, the trustee must furnish
the name, TIN, and address of the trust
to all payors for the taxable year, and
comply with the additional requirements described in paragraph (b)(3)(ii)
of this section.
(ii) Additional obligations of
trustee—(A) Obligation to file Forms
1099. The trustee must file with the
Internal Revenue Service the appropriate Forms 1099, reporting the items of
income paid to the trust by all payors
during the taxable year attributable to
the portion of the trust treated as
owned by each grantor or other person,
and showing the trust as the payor and
each grantor or other person treated as
an owner of the trust as the payee. The
trustee has the same obligations for
filing the appropriate Forms 1099 as
would a payor making reportable payments, except that the trustee must
report each type of income in the
aggregate, and each item of gross
proceeds separately. See paragraph
(b)(5) of this section regarding the
amounts required to be included on any
Forms 1099 filed by the trustee.
(B) Obligation to furnish statement.
(1) The trustee must also furnish to
each grantor or other person treated as
an owner of the trust a statement that—
(i) Shows all items of income, deduction, and credit of the trust for the
taxable year attributable to the portion
of the trust treated as owned by the
grantor or other person;
(ii) Provides the grantor or other
person treated as an owner of the trust
with the information necessary to take
the items into account in computing the
grantor’s or other person’s taxable
income; and
(iii) Informs the grantor or other
person treated as the owner of the trust
that the items of income, deduction and
credit and other information shown on
the statement must be included in
computing the taxable income and
credits of the grantor or other person
on the income tax return of the grantor
or other person.
(2) Except for the requirements pursuant to section 3406 and the regula-
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tions thereunder, by furnishing the
statement, the trustee satisfies the obligation to furnish statements to recipients with respect to the Forms 1099
filed by the trustee.
(4) Persons treated as payors—(i) In
general. For purposes of this section,
the term payor means any person who
is required by any provision of the
Internal Revenue Code and the regulations thereunder to make any type of
information return (including Form
1099 or Schedule K–1) with respect to
the trust for the taxable year, including
persons who make payments to the
trust or who collect (or otherwise act as
middlemen with respect to) payments
on behalf of the trust.
(ii) Application to brokers and customers. For purposes of this section, a
broker, within the meaning of section
6045, is considered a payor. A customer, within the meaning of section
6045, is considered a payee.
(5) Amounts required to be included
on Forms 1099 filed by the trustee—(i)
In general. The amounts that must be
included on any Forms 1099 required
to be filed by the trustee pursuant to
this section do not include any amounts
that are reportable by the payor on an
information return other than Form
1099. For example, in the case of a
trust which owns an interest in a
partnership, the trust’s distributive
share of the income and gain of the
partnership is not includible on any
Forms 1099 filed by the trustee pursuant to this section because the
distributive share is reportable by the
partnership on Schedule K-1.
(ii) Example. The following example
illustrates the provisions of this paragraph (b)(5):
Example. (i)(A) On January 2, 1996, G, a
United States citizen, creates a trust all of which
is treated as owned by G. The trustee of the trust
is T. The assets of the trust during the 1996
taxable year are shares of stock in X, an S
corporation, a limited partnership interest in P,
shares of stock in M, and shares of stock in N. T
chooses to report pursuant to paragraph
(b)(2)(i)(B) of this section and therefore furnishes the name, TIN, and address of the trust to
X, P, M, and N. M furnishes T with a Form
1099–DIV showing the trust as the payee. N
does not furnish T with a Form 1099–DIV
because N paid a dividend of less than $10 to T.
X and P furnish T with Schedule K–1 (Shareholder’s Share of Income, Credits, Deductions,
etc.) and Schedule K–1 (Partner’s Share of
Income, Credits, Deductions, etc.), respectively,
showing the trust’s name, TIN, and address.
(B) For the 1996 taxable year the trust has the
following items of income and deduction:
Dividends paid by M . . . . . . . . . . . . . . . . . $12
Dividends paid by N . . . . . . . . . . . . . . . . . . . 6
Administrative expense . . . . . . . . . . . . . . . . $20
Items reported by X on Schedule K–1
attributable to trust’s shares of stock in X:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $20
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Items reported by P on Schedule K-1 attributable to trust’s limited partnership interest in P:
Ordinary income . . . . . . . . . . . . . . . . . . $300
(ii)(A) On or before February 28, 1997, T files
with the Internal Revenue Service a Form 1099DIV on which T reports dividends attributable to
G as the owner of the trust in the amount of $18.
T does not file any other returns.
(B) T has complied with T’s obligation under
paragraph (b)(2)(iii)(A) of this section to file the
appropriate Forms 1099.
(6) Trusts that cannot report under
this paragraph (b). The following
trusts cannot use the methods of
reporting described in this paragraph
(b)—
(i) A common trust fund as defined
in section 584(a);
(ii) A trust that has its situs or any
of its assets located outside the United
States;
(iii) A trust that is a qualified
subchapter S trust as defined in section
1361(d)(3);
(iv) A trust all of which is treated as
owned by one grantor or one other
person whose taxable year is a fiscal
year;
(v) A trust all of which is treated as
owned by one grantor or one other
person who is not a United States
person; or
(vi) A trust all of which is treated as
owned by two or more grantors or
other persons, one of whom is not a
United States person.
(7) Grantors or other persons who
are treated as owners of the trust and
are exempt recipients for information
reporting purposes—(i) Trust treated
as owned by one grantor or one other
person. The trustee of a trust all of
which is treated as owned by one
grantor or one other person may not
report pursuant to this paragraph (b) if
the grantor or other person is an
exempt recipient for information reporting purposes.
(ii) Trust treated as owned by two or
more grantors or other persons. The
trustee of a trust, all of which is treated
as owned by two or more grantors or
other persons, may not report pursuant
to this paragraph (b) if one or more
24
grantors or other persons treated as
owners are exempt recipients for information reporting purposes unless—
(A) At least one grantor or one other
person who is treated as an owner of
the trust is a person who is not an
exempt recipient for information reporting purposes; and
(B) The trustee reports without regard to whether any of the grantors or
other persons treated as owners of the
trust are exempt recipients for information reporting purposes.
(8) Husband and wife who make a
single return jointly. A trust all of
which is treated as owned by a husband
and wife who make a single return
jointly of income taxes for the taxable
year under section 6013 is considered
to be owned by one grantor for
purposes of this paragraph (b).
(c) Due date for Forms 1099 required to be filed by trustee. The due
date for any Forms 1099 required to be
filed with the Internal Revenue Service
by a trustee pursuant to this section is
the due date otherwise in effect for
filing Forms 1099.
(d) Due date and other requirements
with respect to statement required to be
furnished by trustee. The due date for
the statement required to be furnished
by a trustee to the grantor or other
person treated as an owner of the trust
pursuant to this section is the date
specified by section 6034A(a). The
trustee must maintain in its records a
copy of the statement furnished to the
grantor or other person treated as an
owner of the trust for a period of three
years from the due date for furnishing
such statement specified in this paragraph (d).
(e) Backup withholding requirements—(1) Trustee reporting under
paragraph (b)(2)(i)(A) of this section.
In order for the trustee to be able to
report pursuant to paragraph
(b)(2)(i)(A) of this section and to
furnish to all payors the name and TIN
of the grantor or other person treated as
the owner of the trust, the grantor or
other person must provide a complete
Form W–9 to the trustee in the manner
provided in paragraph (b)(1) of this
section, and the trustee must give the
name and TIN shown on that Form W–
9 to all payors. In addition, if the Form
W–9 indicates that the grantor or other
person is subject to backup withholding, the trustee must notify all payors
of reportable interest and dividend
payments of the requirement to backup
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withhold. If the Form W–9 indicates
that the grantor or other person is not
subject to backup withholding, the
trustee does not have to notify the
payors that backup withholding is not
required. The trustee should not give
the Form W–9, or a copy thereof, to a
payor because the Form W–9 contains
the address of the grantor or other
person and paragraph (b)(2)(i)(A) of
this section requires the trustee to
furnish the address of the trust to all
payors and not the address of the
grantor or other person. The trustee
acts as the agent of the grantor or other
person for purposes of furnishing to the
payors the information required by this
paragraph (e)(1). Thus, a payor may
rely on the name and TIN provided to
the payor by the trustee, and, if given,
on the trustee’s statement that the
grantor is subject to backup
withholding.
(2) Other backup withholding requirements. Whether a trustee is treated
as a payor for purposes of backup
withholding is determined pursuant to
section 3406 and the regulations
thereunder.
(f) Penalties for failure to file a
correct Form 1099 or furnish a correct
statement. A trustee who fails to file a
correct Form 1099 or to furnish a
correct statement to a grantor or other
person treated as an owner of the trust
as required by paragraph (b) of this
section is subject to the penalties
provided by sections 6721 and 6722
and the regulations thereunder.
(g) Changing reporting methods—
(1) Changing from reporting by filing
Form 1041 to a method described in
paragraph (b) of this section. If the
trustee has filed a Form 1041 for any
taxable year ending before January 1,
1996 (and has not filed a final Form
1041 pursuant to §1.671–4(b)(3) (as
contained in the 26 CFR part 1 edition
revised as of April 1, 1995)), or files a
Form 1041 for any taxable year thereafter, the trustee must file a final Form
1041 for the taxable year which ends
after January 1, 1995, and which
immediately precedes the first taxable
year for which the trustee reports
pursuant to paragraph (b) of this
section, on the front of which form the
trustee must write: ‘‘Pursuant to
§1.671–4(g), this is the final Form
1041 for this grantor trust.’’.
(2) Changing from reporting by a
method described in paragraph (b) of
this section to the filing of a Form
1041. The trustee of a trust who
reported pursuant to paragraph (b) of
this section for a taxable year may
report pursuant to paragraph (a) of this
section for subsequent taxable years. If
the trustee reported pursuant to paragraph (b)(2)(i)(A) of this section, and
therefore furnished the name and TIN
of the grantor to all payors, the trustee
must furnish the name, TIN, and address of the trust to all payors for such
subsequent taxable years. If the trustee
reported pursuant to paragraph
(b)(2)(i)(B) or (b)(3)(i) of this section,
and therefore furnished the name and
TIN of the trust to all payors, the
trustee must indicate on each Form
1096 (Annual Summary and Transmittal of U.S. Information Returns) that it
files (or appropriately on magnetic
media) for the final taxable year for
which the trustee so reports that it is
the final return of the trust.
(3) Changing between methods described in paragraph (b) of this
section—(i) Changing from furnishing
the TIN of the grantor to furnishing the
TIN of the trust. The trustee of a trust
who reported pursuant to paragraph
(b)(2)(i)(A) of this section for a taxable
year, and therefore furnished the name
and TIN of the grantor to all payors,
may report pursuant to paragraph
(b)(2)(i)(B) of this section, and furnish
the name and TIN of the trust to all
payors, for subsequent taxable years.
(ii) Changing from furnishing the
TIN of the trust to furnishing the TIN
of the grantor. The trustee of a trust
who reported pursuant to paragraph
(b)(2)(i)(B) of this section for a taxable
year, and therefore furnished the name
and TIN of the trust to all payors, may
report pursuant to paragraph (b)(2)(i)(A) of this section, and furnish the
name and TIN of the grantor to all
payors, for subsequent taxable years.
The trustee, however, must indicate on
each Form 1096 (Annual Summary and
Transmittal of U.S. Information Returns) that it files (or appropriately on
magnetic media) for the final taxable
year for which the trustee reports
pursuant to paragraph (b)(2)(i)(B) of
this section that it is the final return of
the trust.
(4) Example. The following example
illustrates the provisions of paragraph
(g) of this section:
Example. (i) On January 3, 1994, G, a United
States citizen, creates a trust all of which is
treated as owned by G. The trustee of the trust is
T. On or before April 17, 1995, T files with the
25
Internal Revenue Service a Form 1041 with an
attached statement for the 1994 taxable year
showing the items of income, deduction, and
credit of the trust. On or before April 15, 1996,
T files with the Internal Revenue Service a Form
1041 with an attached statement for the 1995
taxable year showing the items of income,
deduction, and credit of the trust. On the Form
1041, T states that ‘‘pursuant to §1.671-4(g), t
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