Treatment of Services Under Section 482; Allocation of Income and Deductions From Intangibles; Stewardship Expense

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 31

[TD 9278]

RIN 1545-BB31, 1545-AY38, 1545-BC52

Treatment of Services Under Section 482; Allocation of Income and Deductions From Intangibles; Stewardship Expense

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final and temporary regulations.

SUMMARY:

This document contains final and temporary regulations that provide guidance regarding the treatment of controlled services transactions under section 482 and the allocation of income from intangibles, in particular with respect to contributions by a controlled party to the value of an intangible owned by another controlled party. This document also contains final and temporary regulations that modify the regulations under section 861 concerning stewardship expenses to be consistent with the changes made to the regulations under section 482. These final and temporary regulations potentially affect controlled taxpayers within the meaning of section 482. They provide updated guidance necessary to reflect economic and legal developments since the issuance of the current guidance.

DATES:

Effective Date:

These regulations are effective on January 1, 2007.

Applicability Dates:

These regulations apply to taxable years beginning after December 31, 2006.

FOR FURTHER INFORMATION CONTACT:

Thomas A. Vidano, (202) 435-5265, or Carol B. Tan, (202) 435-5265 for matters relating to section 482, or David Bergkuist (202) 622-3850 for matters relating to stewardship expenses (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 482 of the Internal Revenue Code generally provides that the Secretary may allocate gross income, deductions and credits between or among two or more taxpayers owned or controlled by the same interests in order to prevent evasion of taxes or to clearly reflect income of a controlled taxpayer. Regulations under section 482 published in the

Federal Register

(33 FR 5849) on April 16, 1968, provided guidance with respect to a wide range of controlled transactions, including transfers of tangible and intangible property and the provision of services. Revised and updated transfer pricing regulations were published in the

Federal Register

(59 FR 34971, 60 FR 65553 and 61 FR 21955) on July 8, 1994, December 20, 1995, and May 13, 1996. A notice of proposed rulemaking and notice of public hearing were published in the

Federal Register

(68 FR 53448) on September 10, 2003. A correction to the notice of proposed rulemaking and notice of public hearing was published in the

Federal Register

(68 FR 70214) on December 17, 2003. A public hearing was held on January 14, 2004.

The Treasury Department and the IRS received a substantial volume of comments on a wide range of issues addressed in the 2003 proposed regulations. These comments were very helpful and substantial changes have been incorporated in response. In order to achieve the goal of updating the 1968 regulations, while facilitating consideration of further public input in refining final rules, these regulations are issued in temporary form with a delayed effective date for taxable years beginning after December 31, 2006.

These regulations are issued a significant amount of time after proposed revisions to the regulations pertaining to cost sharing arrangements were issued. Commentators suggested that this type of timing sequence was important so that each regulation could be assessed properly. Commentators also suggested, among other things, that the services regulations be reissued in temporary and proposed form. By issuing these regulations in temporary and proposed form, the Treasury Department and the IRS provide taxpayers an opportunity to submit additional comments prior to the time these regulations become effective, allowing commentators to consider the potential interaction between these regulations and the cost sharing regulations.

Explanation of Provisions

A. Controlled Services

1. Services Cost Method—Temp. Treas. Reg. § 1.482-9T(b)

a. The Simplified Cost Based Method and Public Comments

The 2003 proposed regulations set forth a simplified cost based method (SCBM). The SCBM was intended to preserve the salutary aspects of the current § 1.482-2(b) cost safe harbor that provide appropriately reduced administrative and compliance burdens for low margin services. At the same time, the existing rules would be brought more in line with the arm's length standard, and various problematic features of those rules would be eliminated. The goal was to provide certainty concerning the pricing of low margin services, thus allowing the compliance efforts of both taxpayers and the IRS to concentrate on those services for which a robust transfer pricing analysis is particularly appropriate. The preamble to the 2003 proposed regulations also indicated that in certain cases, the allocation or sharing among group members of expenses or charges relating to corporate headquarters or other centralized service activities may be consistent with the proposed regulations, but no further guidance was provided on such service sharing arrangements.

A number of commentators argued that the SCBM was actually counterproductive to its stated goals. These commentators contended that to apply the SCBM, taxpayers would potentially need to expend substantial sums to prepare comparability studies, perhaps separately for each of the numerous categories of back office services. They contended that, although taxpayers have in-depth knowledge concerning their businesses and the relative value added by their back offices, the SCBM called for quantitative judgments that business people are not qualified to make by themselves, especially in the prevailing compliance environment. As a matter of proper accountability, taxpayers would be required as a practical matter to devote significant compliance resources to enlist outside consultants or otherwise to develop support for those judgments.

Commentators suggested a range of proposed alternatives to the SCBM regime. One such proposal was simply to return to the approach in the existing regulations under § 1.482-2(b). The 1968 regulations are fairly rudimentary in nature, particularly, in today's tax compliance environment. In addition, those regulations were open to substantial manipulation by taxpayers (both inbound and outbound). Moreover, there have been extensive and far-reaching developments in the services economy since the existing regulations were published in 1968, with real prospects that many intragroup services have values significantly in excess of their cost. As a result, in the course of considering comments on the 2003 proposed regulations, the Treasury Department and the IRS have concluded that it would not be appropriate simply to readopt the standard in the 1968 regulations. Additional proposals by commentators included development of

a list of activities that would qualify to be priced at cost or detailed provisions regarding cost sharing arrangements for low value services performed on a centralized basis, and other options.

The Treasury Department and the IRS may have decided not to return to the 1968 regulations, but have nonetheless taken the full range of comments on the 2003 proposed regulations seriously. Therefore, in light of the extensive comments on these issues, the Treasury Department and the IRS have substantially redesigned the relevant provisions. The Treasury Department and the IRS recognize that the section 482 services regulations potentially affect a large volume of intragroup back office services that are common across many industries. It is in the interest of good tax administration to minimize the compliance burdens applicable to such services, especially to the extent that the arm's length markups are low and the activities do not significantly contribute to business success or failure.

Accordingly, based on the comments, these temporary regulations eliminate the SCBM and replace it with the services cost method (SCM), as set forth in § 1.482-9T(b). The SCM evaluates whether the price for covered services, as defined, is arm's length by reference to the total services costs with no markup. Where the conditions on application of the method are met, the SCM will be considered the best method for purposes of § 1.482-1(c).

b. Services Cost Method: Identification of Covered Services and Other Eligibility Criteria

Section 1.482-9T(b)(4) provides for two categories of covered services that are eligible for the SCM if the other conditions on application of the method are met. If the conditions are satisfied, covered services in each category may be charged at cost with no markup. The first category consists of specified covered services identified in a revenue procedure published by the IRS. This revenue procedure approach is consistent with taxpayer comments. Services will be identified in such revenue procedure based upon the determination of the Treasury Department and the IRS that they constitute support services of a type common across industry sectors and generally do not involve a significant arm's length markup on total services costs. Because the government performs the analysis necessary to determine the eligibility of specified covered services, the compliance burden that was previously imposed by the SCBM is eliminated for a broad class of commonly provided services.

An initial proposed list of specified covered services is contained in an Announcement being published contemporaneously with these temporary regulations. This Announcement will be published in the Internal Revenue Bulletin. For copies of the Internal Revenue Bulletin, see § 601.601(d)(2)(ii)(

b

). The Treasury Department and the IRS solicit public input on whether the list of services sufficiently covers the full range of back office services typical within multinational groups, on the descriptions provided for these covered services, and on other matters related to the Announcement. It is contemplated that a final revenue procedure, reflecting appropriate comments, will be issued to coincide with the effective date of the temporary regulations for taxable years beginning after December 31, 2006. In the future, particular services may be added to, clarified in, or deleted from the list, depending on ongoing developments.

The second category of covered services is certain low margin covered services. Taxpayers objected to the requirement under the SCBM that all services qualify for that method based on a quantitative analysis, but based on comments the Treasury Department and the IRS believe that controlled taxpayers might nonetheless want the discretion to show that particular services—not otherwise covered by the revenue procedure—qualify for the SCM, using a modified quantitative approach. Low margin covered services consist of services for which the median comparable arm's length markup on total services costs is less than or equal to seven percent. As under the SCBM, the median comparable arm's length markup on total services costs means the excess of the arm's length price of the controlled services transaction over total services costs, expressed as a percentage of total services costs. For this purpose, the arm's length price is determined under the general transfer pricing rules without regard to the SCM, using the interquartile range (including any adjustment to the median in the case of results outside such range). Again, if the markup on costs for eligible services is seven percent or less, this category of services can be charged out at cost with no markup.

Under § 1.482-9T(b)(2), specified covered services or low margin covered services otherwise eligible for the SCM will qualify for the method if the taxpayer reasonably concludes in its business judgment that the services do not contribute significantly to key competitive advantages, core capabilities, or fundamental chances of success or failure in one or more trades or businesses of the renderer, the recipient, or both. Unlike the quantitative judgment called for under the SCBM, this is a business judgment preeminently within the business person's own expertise. Exact precision is not needed and it is expected that the taxpayer's judgment will be accepted in most cases. This condition is intended to focus transfer pricing compliance resources of both taxpayers and the IRS principally on significant valuation issues. Thus, it is anticipated that in most cases the examination of relevant services will focus only on verification of total services costs and their appropriate allocation. These are issues even under the 1968 regulations. There will be little need in all but the most unusual cases to challenge the taxpayer's reasonable business judgment in concluding that such typical back office services do not contribute significantly to fundamental risks of success or failure. The condition effectively is reserved to allow the IRS to reject any attempt to claim that a core competency of the taxpayer's business qualifies as a mere back office service. For illustrations of the role performed by this condition, see the contrasting pairs of

Example 1

and

Example 2,

Example 3

and

Example 4,

Example 5

and

Example 6,

Example 8

and

Example 9,

Example 10

and

Example 11,

and

Example 12

and

Example 13

in § 1.482-9T(b)(6).

As indicated in this preamble, it is expected that in all but unusual cases, the taxpayer's business judgment will be respected. In evaluating the reasonableness of the taxpayer's conclusion, the Commissioner will consider all the relevant facts and circumstances. This provision avoids the need to exclude from the SCM certain back office services that as a general matter and across a range of industry sectors are low margin, but that in the context of a particular business nonetheless constitute high margin services. That is, it permits the Treasury Department and the IRS to include a greater range of service categories under the SCM, even though in specific circumstances an otherwise covered service of a particular taxpayer will be ineligible.

In addition, under § 1.482-9T(b)(3)(i), a single procedural requirement applies under the SCM. The taxpayer must maintain documentation of covered services costs and their allocation. The documentation must include a statement evidencing the taxpayer's intention to apply the SCM.

In § 1.482-9T(b)(3)(ii), the SCM preserves the same list of categories of

controlled transactions that are not eligible to be priced under the method as under the SCBM. The Treasury Department and the IRS continue to believe that these transactions tend to be high margin transactions, transactions for which total services costs constitute an inappropriate reference point, or other types of transactions that should be subject to a more robust arm's length analysis under the general section 482 rules. Comments are requested in this regard in light of the other substantial changes made in the regulations.

Consistent with the purpose of providing for appropriately reduced compliance burdens for services subject to the SCM, the temporary regulations retain provisions in § 1.6662-6T(d)(2) similar to those associated with the SCBM.

c. Shared Services Arrangements

Section 1.482-9T(b)(5) of the temporary regulations provides explicit guidance on shared services arrangements (SSAs). In general, an SSA must include two or more participants; must include as participants all controlled taxpayers that benefit from one or more covered services subject to the SSA; and must be structured such that each covered service (or group of covered services) confers a benefit on at least one participant. A participant is a controlled taxpayer that reasonably anticipates benefits from covered services subject to the SSA and that substantially complies with the SSA requirements.

Under an SSA, the arm's length charge to each participant is the portion of the total costs of the services otherwise determined under the SCM that is properly allocated to such participant under the arrangement. For purposes of an SSA, two or more covered services may be aggregated, provided that the aggregation is reasonable based on the facts and circumstances, including whether it reasonably reflects the relative magnitude of the benefits that the participants reasonably anticipate from the services in question. Such aggregation may, but need not, correspond to the aggregation used in applying other provisions of the SCM. If the taxpayer reasonably concludes that the SSA (including any aggregation for purposes of the SSA) results in an allocation of the costs of covered services that provides the most reliable measure of the participants' respective shares of the reasonably anticipated benefits from those services, then the Commissioner may not adjust such allocation basis.

In addition, as a procedural matter, the taxpayer must maintain documentation concerning the SSA, including a statement that it intends to apply the SCM under the SSA and information on the participants, the allocation basis, and grouping of services for purposes of the SSA. Guidance is also provided on the coordination of cost allocations under an SSA and cost allocations under a qualified cost sharing arrangement.

d. Deleted Provisions

The SCM is considerably streamlined as compared to the SCBM. Upon further consideration, and in light of public comments, many of the conditions, contractual requirements, quantitative screens, and other technicalities associated with the SCBM have been eliminated. The Treasury Department and the IRS believe this streamlined approach serves the interests of both the government and taxpayers by reducing complexity and administrative burden.

2. Comparable Uncontrolled Services Price Method—Temp. Treas. Reg. § 1.482-9T(c)

The 2003 proposed regulations set forth the comparable uncontrolled services price (CUSP) method. This method evaluated whether the consideration in a controlled services transaction is arm's length by comparison to the price charged in a comparable uncontrolled services transaction. This method was closely analogous to the comparable uncontrolled price (CUP) method in existing § 1.482-3(b).

One commentator objected to the statement in § 1.482-9(b)(1) of the 2003 proposed regulations that, to be evaluated under the CUSP method, a controlled service ordinarily needed to be “identical to or have a high degree of similarity” to the uncontrolled comparable transactions. The commentator viewed the comparability analysis in the examples in proposed § 1.482-9(b)(4) as more consistent with the standard in existing § 1.482-3(b)(2)(ii)(A). The Treasury Department and the IRS agree that the comparability standards under the CUSP method for services should run parallel to those under the CUP method for sales of tangible property. Indeed, the provisions are parallel. The commentator misconstrues the purpose of the quoted provision.

Although the provision contains general guidance on situations in which the method ordinarily applies, it is not intended to and does not alter the substantive comparability standards. Just like the CUP method, the standards under the CUSP method emphasize the relative similarity of the controlled services to the uncontrolled transaction and the presence or absence of nonroutine intangibles. Section 1.482-9T(c)(2)(ii) of the temporary regulations also provides, consistent with the best method rule, that the CUSP method generally provides the most direct and reliable measure of an arm's length result if the uncontrolled transaction either has no differences from the controlled services transaction or has only minor differences that have a definite and reasonably ascertainable effect on price, and appropriate adjustments may be made for such differences. If such adjustments cannot be made, or if there are more than minor differences between the controlled and uncontrolled transactions, the comparable uncontrolled services price method may be used, but the reliability of the results as a measure of the arm's length price will be reduced. Further, if there are material differences for which reliable adjustments cannot be made, this method ordinarily will not provide a reliable measure of an arm's length result.

The CUSP provisions in these temporary regulations are substantially similar to the corresponding provisions in the 2003 proposed regulations.

3. Gross Services Margin Method—Temp. Treas. Reg. § 1.482-9T(d)

The 2003 proposed regulations provided for a gross services margin method, which evaluated the amount charged in a controlled services transaction by reference to the gross services profit margin in uncontrolled transactions that involve similar services. The method was analogous to the resale price method for transfers of tangible property in existing § 1.482-3(c).

Under the 2003 proposed regulations, this method would ordinarily be used where a controlled taxpayer performs activities in connection with a “related uncontrolled transaction” between a member of the controlled group and an uncontrolled taxpayer. For example, the method may be used where a controlled taxpayer renders services to another member of the controlled group in connection with a transaction between that other member and an uncontrolled party (agent services), or where a controlled taxpayer contracts to provide services to an uncontrolled taxpayer and another member of the controlled group actually performs the services (intermediary function).

The 2003 proposed regulations defined the terms “related uncontrolled transaction,” “applicable uncontrolled

price,” and “appropriate gross services profit”. A “related uncontrolled transaction” is a transaction between a member of the controlled group and an uncontrolled taxpayer for which a controlled taxpayer performs either agent services or an intermediary function. The “applicable uncontrolled price” is the sales price paid by the uncontrolled party in the related uncontrolled transaction. The “appropriate gross services profit” is the product of the applicable uncontrolled price and the gross services profit margin in comparable uncontrolled services transactions. The gross services profit margin takes into account all functions performed by other members of the controlled group and any other relevant factors.

One commentator mistakenly interpreted the term “related uncontrolled transaction” to suggest that the comparable transaction under this method is one that takes place between controlled parties. While this was not intended, the Treasury Department and the IRS agree that the nomenclature is potentially confusing, and as a result, these regulations substitute the term “relevant uncontrolled transaction” in lieu of “related uncontrolled transaction” wherever that appeared. In other respects, the gross services margin provisions in these temporary regulations are substantially similar to the provisions in the 2003 proposed regulations.

4. Cost of Services Plus Method—Temp. Treas. Reg. § 1.482-9T(e)

The 2003 proposed regulations set forth the cost of services plus method. This method evaluated the amount charged in a controlled services transaction by reference to the gross services profit markup in comparable uncontrolled services transactions. The gross services profit is determined by reference to the markup as a percentage of comparable transactional costs in comparable uncontrolled transactions. This method would ordinarily apply where the renderer of controlled services provides the same or similar services to both controlled and uncontrolled parties. In general, those are the only circumstances in which a controlled taxpayer would likely have the detailed information concerning comparable transactional costs necessary to apply this method reliably.

The cost of services plus method in the 2003 proposed regulations was generally analogous to the cost plus method for transfers of tangible property in existing § 1.482-3(d). The method implicitly recognized that financial accounting standards applicable to services have not developed to the same degree as the standards applicable to other categories of transactions, such as manufacturing or distribution of tangible property. For that reason, the method adopted the concept of “comparable transactional costs,” which the 2003 proposed regulations defined as all costs of providing the services taken into account in determining the gross services profit markup in comparable uncontrolled services transactions. In this context, comparable uncontrolled transactions could be either services transactions between the controlled taxpayer and uncontrolled parties (internal comparables), or services transactions between two uncontrolled parties (external comparables).

The 2003 proposed regulations also recognized that comparable transactional costs could be a subset of total services costs. Generally accepted accounting principles (GAAP) or Federal income tax accounting rules (if income tax data for comparable uncontrolled transactions are available) could provide an appropriate platform for analysis under this provision, but neither is necessarily conclusive.

Commentators objected that the concept of comparable transactional costs was imprecise, and they suggested that such costs should in any event include only the direct costs associated with providing a particular service, as determined under GAAP or Federal income tax accounting rules. As noted above, the financial accounting standards for services transactions are not as precise as the standards applicable to other types of transactions. The relative lack of uniformity in turn makes it impractical to derive a single definition of cost that would apply generally to controlled services transactions.

Comparable transactional costs may potentially include direct and indirect costs, if such costs are included in the internal or external uncontrolled transactions that form the basis for comparison. Section 1.482-9T(e)(4)

Example 1

has been modified to clarify this concept.

Several commentators objected to § 1.482-9(d)(3)(ii)(A) of the 2003 proposed regulations. In their view, this provision required the results obtained under the cost of services plus method to be confirmed by means of a separate analysis under the comparable profits method (CPM) for services. If a confirming analysis under the CPM for services were required in all cases, commentators reasoned, the cost of services plus method could not be viewed as a specified method in its own right.

The Treasury Department and the IRS agree and clarify that the intent of the rules is not to require confirmation of the results under the cost of services plus method. In response to public comments, § 1.482-9T(e)(3)(ii)(A) of these temporary regulations incorporates several changes. First, restatement of the price under this method in the form of a markup on total costs of the controlled taxpayer is necessary only if the cost of services plus method utilizes external comparables. If internal comparables are used, this calculation need not be performed. Second, in situations where the price is restated, the sole purpose is to determine whether it is necessary to perform additional evaluation of functional comparability.

For example, if the price under the cost of services plus method, when restated, indicates a markup on the renderer's total services costs that is either low or negative, this may indicate differences in functions that have not been accounted for under the traditional comparability factors. A low or negative markup suggests the need for additional inquiry, the outcome of which may suggest that the cost of services plus method is not the most reliable measure of an arm's length result under the best method rule. Conforming changes have been made in § 1.482-9T(e)(4)

Example 3

of these temporary regulations.

5. Comparable Profits Method for Services—Temp. Treas. Reg. § 1.482-9T(f)

The 2003 proposed regulations provided for a Comparable Profits Method (CPM) for services, which was similar to the CPM in existing § 1.482-5. In general, the CPM for services evaluated whether the amount charged in a controlled services transaction is arm's length by reference to objective measures of profitability (profit level indicators or PLIs) derived from financial information regarding uncontrolled taxpayers that engage in similar services transactions under similar circumstances. The CPM for services applied only where the renderer of controlled services is the tested party.

Section 1.482-9(e) of the 2003 proposed regulations provided that the profit level indicators (PLIs) provided for in existing § 1.482-5(b)(4)(ii) may also be used under the CPM for services. The relative lack of uniformity in financial accounting standards for services, combined with potentially incomplete information regarding the cost accounting practices of the

uncontrolled comparables, strongly suggest that PLIs that require accurate segmentation of costs may have limited reliability.

The 2003 proposed regulations stated that the degree of consistency in accounting practices between the controlled services transaction and the uncontrolled services transaction might affect the reliability of the results under the CPM for services. If appropriate adjustments to account for such differences are not possible, the reliability of the results under this method will be reduced.

Section 1.482-9(e)(2)(ii) of the 2003 proposed regulations provided for a new profit level indicator that may be particularly useful for controlled services transactions: the ratio of operating profits to total services costs, or the markup on total costs (also referred to as the “net cost plus”). Because this profit level indicator evaluates operating profits by reference to the markup on all costs related to the provision of services, it is more likely to use a cost base of the tested party that is comparable to the cost base used by uncontrolled parties in performing similar business activities.

The Treasury Department and the IRS received a number of comments concerning the CPM for services. Commentators questioned whether the definition of “total services costs,” which provides the net cost plus cost base under the CPM for services, included stock-based compensation. In response to these comments, the Treasury Department and the IRS clarify their intent that § 1.482-5(c)(2)(iv) of the existing regulations apply to the CPM for services. Accordingly, new

Example 3

,

Example 4

,

Example 5

, and

Example 6

are included in § 1.482-9T(f)(3) of these temporary regulations. These examples show the application of existing § 1.482-5(c)(2)(iv) to fact patterns that involve differences in the utilization of or accounting for stock-based compensation in the context of controlled services transactions.

One commentator expressed reservations concerning a statement in the preamble to the 2003 proposed regulations, which indicated that PLIs based on return on capital or assets might be unreliable for controlled services because the reliability of these PLIs decreases as operating assets play a less prominent role in generating operating profits. This commentator contended that such PLIs are reliable for all firms, including service providers. The Treasury Department and the IRS clarify that, although return on capital PLIs may produce reliable results in the case of certain service providers, in general, such PLIs are subject to the general reservation in existing § 1.482-5(b)(4)(i) to the effect that the reliability of such PLIs increases as operating assets play a greater role in general operating profits.

Aside from the addition of the examples described above, the CPM for services provisions in these temporary regulations are substantially similar to the provisions in the 2003 proposed regulations.

6. Profit Split Method—Temp. Treas. Reg. §§ 1.482-9T(g) and 1.482-6T(c)(3)(i)(B)

The 2003 proposed regulations provided additional guidance concerning application of the comparable profit split and the residual profit split methods to controlled services transactions. Generally, these methods evaluated whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contributions to the combined operating profit or loss.

The 2003 proposed regulations provided that the guidance regarding the profit split methods in existing § 1.482-6, as amended by proposed § 1.482-6(c)(3)(i)(B) and by other changes, applied to controlled services transactions. Section 1.482-9(g) of the 2003 proposed regulations also provided specific additional guidance concerning application of existing § 1.482-6, as amended, to controlled services transactions.

The Treasury Department and the IRS received numerous comments on the profit split method. Commentators objected in particular to references in the 2003 proposed regulations to “interrelated” transactions in § 1.482-6(c)(3)(i)(B)(

1

), and to “high-value services” and “highly integrated transactions” in § 1.482-9(g)(1). Commentators viewed these terms as vague and subjective. Commentators also sought more specific guidance concerning the circumstances in which the residual profit split method would constitute the best method under the principles of existing § 1.482-1(c). In addition, some commentators suggested that one hallmark of a nonroutine contribution in the context of controlled services is that the renderer bears substantial risks. Another commentator suggested that the arm's length compensation for a function performed by an employee or group of employees should not in any event be evaluated under a profit split method. In this commentator's view, such an activity should be classified as routine because the market return for the function is equivalent to the total compensation paid to the employees. Commentators also raised several objections to the factual assumptions in the proposed analysis concerning § 1.482-9(g)(2)

Example 2

of the 2003 proposed regulations.

The Treasury Department and the IRS agreed with a number of comments and, as a result, have made substantial changes to these provisions. Under these temporary regulations, all references to “interrelated” transactions in § 1.482-6(c)(3)(i)(B)(

1

), as well as references to “high-value services” and “highly integrated transactions” in § 1.482-9(g)(1) have been eliminated. Section 1.482-9T(g)(1) now states that the profit split method is “ordinarily used in controlled services transactions involving a combination of nonroutine contributions by multiple controlled taxpayers.” This change from the 2003 proposed regulations (which referred to “high-value” or “highly-integrated” transactions), conforms to the changes to § 1.482-6T(c)(3)(i)(B)(

1

), as described below.

Section 1.482-6T(c)(3)(i)(B)(

1

) of these temporary regulations defines a nonroutine contribution as “a contribution that is not accounted for as a routine contribution.” In other words, a nonroutine contribution is one for which the return cannot be determined by reference to market benchmarks. Importantly, in this context, the term “routine” does not necessarily signify that a contribution is low value. In fact, comparable uncontrolled transactions may indicate that the returns to a routine contribution are very significant.

In response to the comments and in accordance with the revised definition of nonroutine contribution in these temporary regulations, the following references were eliminated as unnecessary: (1) Contributions not fully accounted for by market returns; and (2) contributions so interrelated with other transactions that they cannot be reliably evaluated on a separate basis. These changes will bring added clarity to the temporary regulations.

The Treasury Department and the IRS believe that these revised provisions respond to the public comments and offer more specific guidance concerning the circumstances in which the profit split method would likely constitute the best method under existing § 1.482-1(c). In particular, the term “high-value” is not included in temporary § 1.482-9T(g)(1), thus eliminating any implication that the profit split method is a “default” method for controlled services that have value significantly in excess of cost. This shift in emphasis is

also reflected in section B.2 of this preamble, which describes the deletion of language from several examples that some believed suggested that the residual profit split is a default method. The clear intent is that no method, including the profit split, is a default method for purposes of the best method rule. Rather, the profit split method applies if a controlled services transaction has one or more material elements for which it is not possible to determine a market-based return. The Treasury Department and the IRS believe that the above changes address the comments made and so do not believe that it is necessary for the regulations to adopt alternative definitions of nonroutine contribution put forward by commentators, such as definitions based on the degree of risk borne by the renderer of services or the extent to which an activity is performed solely by employees of the taxpayer.

Finally, based on the public comments, and in light of the changes described in this preamble, § 1.482-9(g)(2)

Example 2

of the 2003 proposed regulations has been withdrawn and replaced by a new example that more effectively illustrates application of the profit split method to nonroutine contributions by multiple controlled parties.

7. Unspecified Methods—§ 1.482-9T(h)

The 2003 proposed regulations provided that an unspecified method may provide the most reliable measure of an arm's length result under the best method rule. Such an unspecified method must take into account that uncontrolled taxpayers compare the terms of a particular transaction to the realistic alternatives to that transaction.

No significant comments were received concerning the unspecified method provisions. Consistent with the general aim to coordinate the analyses under the various sections of the regulations under section 482 so that economically similar transactions will be evaluated similarly, however, § 1.482-9T(h) has been modified to provide that in applying an unspecified method to services, the realistic alternatives to be considered include “economically similar transactions structured as other than services transactions.” This provision allows flexibility to consider non-services alternatives to a services transaction, for example, a transfer or license of intangible property, if such an approach provides the most reliable measure of an arm's length result. The Treasury Department and the IRS are considering similar changes to §§ 1.482-3(e)(1) and 1.482-4(d)(1) of the existing regulations. Public comments are requested regarding the advisability of such changes and the form they should take. Aside from this change, the unspecified method provisions in these temporary regulations are substantially similar to the provisions in the 2003 proposed regulations.

8. Contingent-Payment Contractual Terms—Temp. Treas. Reg. § 1.482-9T(i)

The contingent-payment contractual term provisions in the 2003 proposed regulations built on the fundamental principle that, in structuring controlled transactions, taxpayers are free to choose from among a wide range of risk allocations. This provision in the 2003 proposed regulations also acknowledged that contingent-payment terms—terms requiring compensation to be paid only if specified results are obtained—may be particularly relevant in the context of controlled services transactions. The 2003 proposed regulations provided detailed guidance concerning contingent-payment contractual terms, including economic substance considerations as well as documentation requirements.

Under § 1.482-9(i)(2) of the 2003 proposed regulations, a contingent-payment arrangement was given effect if it met three basic requirements: (1) The arrangement is contained in a written contract executed prior to the start of the activity; (2) the contract makes payment contingent on a future benefit directly related to the outcome of the controlled services transaction; and (3) the contract provides for payment on a basis that reflects the recipient's benefit from the services rendered and the risks borne by the renderer.

Commentators generally supported the contingent-payment terms provision as providing guidance concerning a contractual structure with particular relevance to controlled services transactions. However, they also raised three fundamental concerns regarding the scope and operation of this provision. First, the commentators questioned whether controlled taxpayers would need to identify uncontrolled comparables for any contingent-payment terms that they seek to adopt. Second, they pointed out that certain references to economic substance provisions and documentation requirements were either unclear or duplicative of provisions in existing § 1.482-1(d)(3). Third, commentators expressed concern that the IRS might improperly impute contingent-payment terms as a means of addressing erroneous transfer pricing in situations that do not involve lack of economic substance, for example, non-arm's length pricing of activities such as marketing or research and development.

The temporary regulations respond to each of these concerns. First, under § 1.482-9(i)(1) of the 2003 proposed regulations, one factor that needed to be considered was whether an uncontrolled taxpayer would have paid a contingent fee if it engaged in a similar transaction under comparable circumstances. In response to comments, the temporary regulations eliminate this requirement and instead emphasize the importance of the economic substance principles under § 1.482-1(d)(3) of the existing regulations. That is, whether a particular arrangement entered into by controlled parties has economic substance is not determined by reference to whether it corresponds to arrangements adopted by uncontrolled parties.

Second, in response to comments, the temporary regulations eliminate duplicative or unnecessary references to the economic substance rules. For example, § 1.482-9T(i)(2)(ii) has been modified to provide that the contingent-payment arrangement as a whole, including both the contingency and the basis of payment, must be consistent with economic substance, as evaluated under existing § 1.482-1(d)(3)(ii)(B). This section eliminates the additional requirement under the 2003 proposed regulations, that the arm's length charge under a contingent-payment arrangement must be evaluated by reference to economic substance principles.

Third, the temporary regulations respond to the concern identified by commentators that the IRS might apply the contingent-payment provisions in an inappropriate manner, for example, to correct erroneous transfer pricing in prior taxable years that are not under examination. As discussed in more detail in section C of this preamble, the temporary regulations include an example to illustrate factual circumstances in which contractual terms pertaining to risk allocations (provided they are otherwise consistent with taxpayers' conduct and arrangements) are fully respected, notwithstanding that on examination the activities were determined to have been priced on a non-arm's length basis. Other concerns, relating to interaction of the contingent-payment terms provision with the commensurate with income standard, are also addressed in section C of this preamble.

New § 1.482-9T(i)(5)

Example 3

illustrates the application of these rules to a situation in which the contingency identified in a contingent-payment

provision is not satisfied. The example responds to a request by commentators for additional guidance to address such a factual scenario.

9. Total Services Costs—Temp. Treas. Reg. § 1.482-9T(j)

Section 1.482-9(j) of the 2003 proposed regulations defined “total services costs” for purposes of the SCBM, the CPM for services, and the cost of services plus method where the gross services profit was restated in the form of a markup on total services costs.

Under the 2003 proposed regulations, total services costs included all costs directly identified with provision of the controlled services, as well as all other costs reasonably allocable to such services under § 1.482-9(k). The Treasury Department and the IRS intended that, in this context, “costs” must comprise provision for all resources expended, used, or made available to render the service. Generally accepted accounting principles (GAAP) or Federal income tax accounting rules may provide an appropriate analytic platform, but neither would necessarily be conclusive in evaluating whether an item must be included in total services costs. The issue of determining total services costs is not a new one; it is relevant under the current 1968 regulations as well.

Commentators objected that § 1.482-9(j) of the 2003 proposed regulations failed to list the specific items that were included in total services costs. Some commentators suggested that, absent more precise guidance in this regard, controlled taxpayers should be permitted to rely on the definition of costs applicable under GAAP or Federal income tax principles. Commentators also requested clarification whether total services costs included stock-based compensation.

The Treasury Department and the IRS view the definition of total services costs in the 2003 proposed regulations as having struck the correct balance between specificity and flexibility. In general, the accounting standards applicable to services do not provide a uniform means of determining all costs that relate to the provision of services. Consequently, the Treasury Department and the IRS conclude that total services costs for purposes of section 482 cannot be determined solely by reference to GAAP or other accounting standards or practices.

In response to comments, however, § 1.482-9T(j) of the temporary regulations clarifies that all contributions in cash or in kind (including stock-based compensation) are included in total services costs. In addition, the third sentence of § 1.482-9T(j) states that “costs for this purpose should comprise provision for all resources expended, used, or made available to achieve the specific objective for which the service is rendered.” To better reflect, for example, the inclusion of stock-based compensation in total services costs, the term “provision” is adopted in place of the term “consideration” as used in the 2003 proposed regulations.

Commentators also observed that the definition of total services costs in the 2003 proposed regulations did not address situations in which the costs of a controlled service provider include significant charges from uncontrolled parties. Commentators posited that such third-party costs should be permitted to “pass through,” rather than being subject to a markup under the transfer pricing method used to analyze the controlled services transaction. The Treasury Department and the IRS agree that these comments raised an issue that needs to be addressed, but decided to do so in a manner different from that suggested by the commentators. In response to this comment, the temporary regulations add § 1.482-9T(l)(4), which under certain circumstances allows a controlled services transaction that involves third-party costs to be evaluated on a disaggregated basis. See section A.11.e of this preamble.

10. Allocation of Costs—Temp. Treas. Reg. § 1.482-9T(k)

Section 1.482-9(k) of the 2003 proposed regulations retained the flexible approach of existing § 1.482-2(b)(3) through (6), which permitted taxpayers to use any reasonable allocation and apportionment of costs in determining an arm's length charge for services. In evaluating whether the allocation used by the taxpayer is appropriate, the 2003 proposed regulations required that consideration be given to all bases and factors, including practices used by the taxpayer to apportion costs for other (non-tax) purposes. Such practices, although relevant, need not be given conclusive weight by the Commissioner in evaluating the arms length charge for controlled services.

Commentators urged that any technique that a taxpayer uses to allocate costs should be entitled to deference, provided it is consistent with GAAP. For the reasons expressed above concerning § 1.482-9T(j), GAAP may provide an appropriate analytic platform but is not necessarily controlling in evaluating the arm's length charge for controlled services.

In the case of administrative or support services, commentators suggested that the Commissioner should accept any reasonable allocation used by the taxpayer, for example, revenue, sales, or employee headcount. In general, the cost of a service that provides benefits to multiple parties must be allocated in a manner that reliably reflects the proportional benefit received by each of those parties. This standard is intended to be substantially equivalent to the standard in § 1.482-2(b)(2)(i) and 1.482-2(b)(6) of the existing regulations. In response to comments, § 1.482-9T(b)(5)(i)(B) of these temporary regulations also provides rules whereby the costs of covered services subject to a shared services arrangement are allocated to participants in a manner that the taxpayer reasonably concludes will most reliably reflect each participant's reasonably anticipated benefits from the services. See section A.1.c of this preamble.

11. Controlled Services Transactions—Temp. Treas. Reg. § 1.482-9T(l)

a. Definition of Activity—Temp. Treas. Reg. § 1.482-9T(l)(2)

Section 1.482-9(l) of the 2003 proposed regulations set forth a threshold test for determining whether an activity constituted a controlled services transaction subject to the general framework of § 1.482-9. The 2003 proposed regulations broadly defined a controlled services transaction as any activity by a controlled taxpayer that resulted in a benefit to one or more other controlled taxpayers. An “activity” was in turn defined as the use by the renderer, or the making available to the recipient, of any property or other resources of the renderer.

One commentator interpreted this provision as indicating that any activity properly analyzed under one or more other provisions of the transfer pricing regulations should not be subject to §1.482-9 of the 2003 proposed regulations. Other commentators suggested that the “predominant character” of a transaction should control whether it is analyzed as a controlled service under §1.482-9 of the 2003 proposed regulations or under other provisions of the section 482 regulations.

Controlled taxpayers have a great deal of flexibility to structure transactions in various ways that are economically equivalent. In some cases, an overall transaction may include separate elements of differing characters, for example, a transfer of tangible property bundled together with the provision of

a service. The structure adopted may sometimes be more reliably analyzed on either a disaggregated or an aggregated basis under the relevant section of the section 482 regulations, for example, either as a separate transfer of tangible property under the existing section 482 regulations in § 1.482-3 and a separate controlled services transaction under these temporary regulations in § 1.482-9T, or as an overall controlled services transaction under these temporary regulations. To the extent that a controlled transaction is structured so that it is most reliably evaluated as a controlled services transaction, it will be analyzed as such. To the extent that multiple elements of a single overall transaction potentially create an overlap between the section 482 regulations applicable to other types of transactions and these temporary regulations concerning controlled services transactions, the Treasury Department and the IRS believe that the appropriate coordination is achieved by applying the rules in § 1.482-9T(m). See section A.12.a of this preamble.

b. Benefit Test—Temp. Treas. Reg. § 1.482-9T(l)(3)

Section 1.482-9(l)(3) of the 2003 proposed regulations provided rules for determining whether an activity provides a benefit. Under § 1.482-9(l)(3)(i), a benefit is present if the activity directly results in a reasonably identifiable increment of economic or commercial value that enhances the recipient's commercial position, or is reasonably anticipated to do so. Another requirement is that an uncontrolled taxpayer in circumstances comparable to those of the recipient would be willing to pay an uncontrolled party to perform the same or a similar activity, or be willing to perform for itself the same or similar activity. The 2003 proposed regulations thus made significant changes to the benefit test under the existing regulations, which is based on whether an uncontrolled party in the position of the renderer would expect payment for a particular activity. The 2003 proposed regulations adopted the so-called “specific benefit” approach, which mandates an arm's length charge only if a particular activity provides an identifiable benefit to a particular taxpayer. In addition, § 1.482-9(l)(3)(ii) of the 2003 proposed regulations provided that no benefit is present if an activity has only indirect or remote effects.

Commentators viewed the 2003 proposed regulations as providing insufficient guidance concerning methods that controlled taxpayers might use to allocate or share expenses or charges, in particular with respect to centralized services performed on a centralized basis for multiple affiliates.

In response to these comments, the temporary regulations authorize the use of shared services arrangements for centralized services that qualify for the SCM in § 1.482-9T(b). By entering into such arrangements, taxpayers can, among other things, reduce the burden associated with analysis of centralized services, which would presumably include activities that provide benefits on only an occasional or intermittent basis. See section A.1.c of this preamble, concerning shared services arrangements.

One commentator suggested that, because the benefit test in the 2003 proposed regulations focused on the recipient, the arm's length charge should also be analyzed from the perspective of the recipient and economic conditions in the recipient's geographic market. The commentator misunderstands the application of the benefit test. Although the benefit test focuses on the recipient, evaluation of the arm's length charge under the best method rule in a particular case (for example, under a profit split method) may require analysis of the recipient, the renderer, or both (depending, for example, on which party performs the simplest, most easily measurable functions).

c. Specific Applications of the Benefit Test—Temp Treas. Reg. § 1.482-9T(l)(3)(ii) through (v)

The 2003 proposed regulations provided additional rules concerning application of the benefit test to particular circumstances, such as application to activities with indirect or remote effects, duplicative activities, shareholder activities, and passive association. These rules in the 2003 proposed regulations were substantially similar to the rules in existing § 1.482-2(b)(2). For example, § 1.482-9(l)(3)(ii) and (l)(3)(iii) provided that no benefit is present if an activity has only indirect or remote effects or merely duplicates an activity that the recipient has already performed on its own behalf. Section 1.482-9(l)(3)(iv) provided that shareholder activities do not confer a benefit on controlled parties and therefore do not give rise to an arm's length charge. Shareholder activities were defined as activities that primarily benefit the owner-member of a controlled group in its capacity as owner, rather than other controlled parties.

In addition, § 1.482-9(l)(3)(v) of the 2003 proposed regulations provided that certain “passive association” effects do not give rise to a benefit within the meaning of the regulations concerning controlled services. Passive association was defined as an increment of value that a controlled party obtains on account of its membership in the controlled group. Section 1.482-9(l)(3)(v) of the 2003 proposed regulations provided, however, that membership in a controlled group may be considered in evaluating comparability between controlled and uncontrolled transactions.

Concerning indirect or remote effects, one commentator suggested that if a centralized activity by a parent confers only occasional or intermittent benefits on a subsidiary, such benefits should be classified as indirect or remote. As to the shareholder provisions, commentators noted that the 2003 proposed regulations failed to address the potential that an activity that confers a reasonably identifiable increment of value on a controlled party might also be appropriately classified as a shareholder activity. As to the passive association provisions, commentators questioned whether membership in a controlled group is relevant to evaluation of comparability. Commentators raised the concern that virtually any uncontrolled transaction could potentially be considered unreliable, because it generally would not reflect the same efficiencies and synergies as the controlled services transaction.

Regarding the comments concerning indirect or remote effects, the Treasury Department and the IRS believe that to equate occasional or intermittent benefits in all cases with indirect or remote effects would conflict with the specific-benefit rule. That rule requires that any service that produces an identifiable and direct benefit warrants an arm's length charge, even if the service is provided only occasionally or intermittently. Accordingly, the temporary regulations retain this provision without change.

In response to comments relating to shareholder activities, § 1.482-9T(l)(3)(iv) of the temporary regulations refers to the “sole effect” rather than the “primary effect” of an activity. This change clarifies that a shareholder activity is one of which the sole effect is either to protect the renderer's capital investment in one or more members of the controlled group, or to facilitate compliance by the renderer with reporting, legal, or regulatory requirements specifically applicable to the renderer, or both. As modified, the definition in temporary § 1.482-9T(l)(3)(iv) now conforms to the general

definition of benefit in § 1.482-9T(l)(3)(i).

In response to commentators' request for clarification regarding the passive association rules, new § 1.482-9T(l)(5)

Example 19

illustrates a situation in which group membership would be taken into account in evaluating comparability.

The Treasury Department and the IRS have inserted the word “generally” in the description of duplicative activities in § 1.482-9T(l)(3)(iii). This change clarifies that although a duplicative activity does not generally give rise to a benefit, under certain circumstances, such an activity may provide an increment of value to the recipient by reference to the general rule in § 1.482-9T(l)(3)(i). In such cases, the activity would be appropriately classified as a controlled services transaction.

d. Guarantees, Including Financial Guarantees

The proposed regulations appear to have created confusion on the part of some taxpayers regarding the appropriate characterization of financial guarantees for tax purposes. The provision of a financial guarantee does not constitute a service for purposes of determining the source of the guarantee fees. See

Centel Communications, Inc.

v.

Commissioner

, 920 F.2d 1335 (7th Cir. 1990);

Bank of America

v.

United States,

680 F.2d 142 (Ct. Cl. 1980). Nevertheless, some taxpayers have suggested that guarantees are services that could qualify for the cost safe harbor and that the provision of a guarantee has no cost. This position would mean that in effect guarantees are uniformly non-compensatory. The Treasury Department and the IRS do not agree with this uniform no charge rule for guarantees. As a result, financial transactions, including guarantees, are explicitly excluded from eligibility for the SCM by § 1.482-9T(b)(3)(ii)(H). However, no inference is intended by this exclusion that financial transactions (including guarantees) would otherwise be considered the provision of services for transfer pricing purposes. The Treasury Department and the IRS subsequently intend to issue transfer pricing guidance regarding financial guarantees, in particular, along with other guidance concerning the treatment of global dealing operations. See Section A.12.e of this preamble for a discussion of coordination with global dealing operations. Such guidance will also include rules to determine the source of income from financial guarantees.

e. Third-Party Costs—Temp. Treas. Reg. § 1.482-9T(l)(4)

Commentators observed that the definition of “total services costs” in § 1.482-9(j) of the 2003 proposed regulations did not address situations in which the costs of a controlled service provider included significant charges from uncontrolled parties. Commentators claimed that such third-party costs should be treated as “pass through” items that, in most cases, should not be subject to the markup (if any) applicable to costs incurred by the renderer in its capacity as service provider. This comment was potentially relevant to all cost-based methods in § 1.482-9 of the 2003 proposed regulations. The Treasury Department and the IRS agreed that these comments raised an issue that needed to be addressed, but decided to do so in a manner different from that suggested by the commentators.

In response to this comment, these temporary regulations include a new § 1.482-9T(l)(4). Under this provision, if total services costs include material third-party costs, the controlled services transaction may be analyzed either as a single transaction or as two separate transactions, depending on which approach provides the most reliable measure of the arm's length result under the best method rule in existing § 1.482-1(c). Consistent with the best method rule, in determining which approach provides the most reliable indication of the arm's length result, the primary factors are the degree of comparability between the controlled services transaction and the uncontrolled comparables and the quality of the data and assumptions used. New § 1.482-9T(l)(5)

Example 20

and

Example 21

provide illustrations of this rule.

The rule in § 1.482-9T(l)(4) of the temporary regulations applies to all specified methods that use cost to evaluate the arm's length charge for controlled services, including the SCM in § 1.482-9T(b). A determination that a controlled services transaction is more reliably evaluated on a disaggregated basis may have an effect on the analysis of that transaction under other provisions of these regulations.

f. Examples, Temp. Treas. Reg. § 1.482-9T(l)(5)

Section 1.482-9T(l)(5) of the temporary regulations provides numerous examples that illustrate applications of the rules in § 1.482-9T(l). Changes have been made to certain of these examples to conform to the modifications described under the previous headings in this section.

12. Coordination With Other Transfer Pricing Rules—Temp. Treas. Reg. § 1.482-9T(m)

Section 1.482-9(m) of the 2003 proposed regulations provided coordination rules applicable to a controlled services transaction that is combined with, or includes elements of, a non-services transaction. These coordination rules relied on the best method rule in existing § 1.482-1(c)(1) to determine which method or methods would provide the most reliable measure of an arm's length result for a particular controlled transaction.

a. Services Transactions That Include Other Types of Transactions—Temp. Treas. Reg. § 1.482-9T(m)(1)

A transaction structured as a controlled services transaction may include material elements that do not constitute controlled services. Section 1.482-9(m)(1) of the 2003 proposed regulations provided that, the decision whether to evaluate such a transaction in an integrated manner under the transfer pricing methods in § 1.482-9 or to evaluate one or more elements separately under services and non-services methods depends on which of these approaches would provide the most reliable measure of an arm's length result. If the non-services component(s) of an integrated transaction could be adequately accounted for in evaluating the comparability of the controlled transaction to the uncontrolled comparables, then the transaction could generally be evaluated solely as a controlled service under § 1.482-9.

One commentator criticized this coordination rule as inherently subjective and proposed that a “predominant character” test be adopted instead. Another commentator interpreted certain statements in the preamble as indicating that any controlled transaction that was reliably analyzed under one of the transfer pricing methods applicable to tangible or intangible property would necessarily be outside the scope of the regulations regarding controlled services.

Upon further consideration, the Treasury Department and the IRS believe that no changes are necessary to the coordination rule in § 1.482-9T(m)(1) because these commentators have misconstrued the application of this rule to integrated transactions. The coordination rule in § 1.482-9T(m)(1) focuses on the underlying economics of such transactions and the most reliable means of evaluating those economics under the best method rule. The Treasury Department and the IRS recognize that controlled taxpayers have

substantial flexibility to structure transactions in a variety of economically equivalent ways. Provided that the structure adopted has economic substance, the coordination rule is designed to respect that structure and to seek the most reliable means of evaluating the arm's length price. Consequently, if a taxpayer structures a transaction so that it constitutes a controlled service, the transaction will generally be analyzed under the principles of § 1.482-9T, without regard to other provisions of the section 482 regulations.

b. Services Transactions That Effect a Transfer of Intangible Property—Temp. Treas. Reg. § 1.482-9T(m)(2)

Section 1.482-9(m)(2) of the 2003 proposed regulations provided that a transaction structured as a controlled service may result in the transfer of intangible property, may include an element that constitutes the transfer of intangible property, or may have an effect similar to the transfer of intangible property. In such cases, if the element of the transaction that related to intangible property was material, the arm's length result for that element would be determined or corroborated under a method provided for in the regulations applicable to transfers of intangible property. See existing § 1.482-4.

Commentators viewed this rule as potentially authorizing the Commissioner to recharacterize a controlled services transaction as a transaction that involved a transfer of intangible property. Such authority, commentators claimed, was inconsistent with existing § 1.482-4(b), which defines an intangible as an item that has “substantial value independent of the services of any individual.” Commentators also contended that the coordination rules impermissibly extended the commensurate with income standard to controlled services transactions. Commentators suggested that, assuming each component of a controlled services transaction may be reliably accounted for under a specified transfer pricing method, no additional analysis is necessary concerning elements that arguably pertain to intangible property.

The Treasury Department and the IRS agree with the commentators that the phrase “may have an effect similar to the transfer of intangible property” could be interpreted as improperly expanding § 1.482-4 of the existing regulations to non-intangible transactions. This is not the intent of this provision. Consequently, to make this clear, the temporary regulations omit this phrase.

Other concerns raised by commentators misinterpret the interaction between this coordination rule and the definition of intangibles in § 1.482-4(b). Section 1.482-4(b) of the existing regulations contains a list of specified intangibles and a residual category of other similar items, all of which must have “substantial value independent of the services of any individual.” In contrast, the coordination rule in § 1.482-9T(m)(2) applies after it is determined that an integrated transaction includes an intangible component that is material. Because the coordination rule in § 1.482-9T(m)(2) applies only to transactions that incorporate a material intangible component, it is not inconsistent with existing § 1.482-4(b), nor does it apply the commensurate with income standard of existing § 1.482-4(f)(2) to transactions that do not have a material element that constitutes an intangible transfer.

Section 1.482-9(m)(6)

Example 4

of the 2003 proposed regulations illustrated the application of this rule to a controlled services transaction that included an element constituting the transfer of an intangible. Several commentators questioned the factual assumptions in

Example 4

. Commentators contended that a controlled party performing R&D for another controlled party generally would not have rights in any know-how or technical data arising out of the R&D activity; instead the contract would specify that the party that paid for the research would obtain such rights.

The Treasury Department and the IRS agree with these comments and have concluded that the factual assumptions in this example are unclear. Consequently,

Example 4

has been redrafted to illustrate a situation in which the controlled party performing the R&D is the owner of know-how or technical data that resulted from that R&D activity. The controlled party then transfers its rights to another controlled party. As revised, this example more clearly illustrates application of the rule in § 1.482-9T(m)(2).

c. Services Subject to a Qualified Cost Sharing Arrangement—Temp. Treas. Reg. § 1.482-9T(m)(3)

Section 1.482-9(m)(3) of the 2003 proposed regulations provided that services provided by a controlled participant under a qualified cost sharing arrangement are subject to existing § 1.482-7. The Treasury Department and the IRS are in the process of comprehensively revising the regulations applicable to cost sharing. In the interim, and pending issuance of final regulations that coordinate these two provisions, the rule § 1.482-9T(m)(3) retains this coordination rule.

d. Other Types of Transaction That Include a Services Transaction—Temp. Treas. Reg. § 1.482-9T(m)(4)

Section 1.482-9T(m)(4) is adopted in substantially the same form as in the 2003 proposed regulations. A transaction structured other than as a controlled services transaction may include material elements that constitute controlled services. Section 1.482-9T(m)(4) of these temporary regulations provides rules for evaluating such integrated transactions. As with the corresponding rules in the 2003 proposed regulations, these rules complement the more general rule in § 1.482-9(m)(1), which relates to integrated transactions structured as controlled services transactions.

e. Global Dealing Operations

In § 1.482-9(m)(5) of the 2003 proposed regulations, the section for coordination with the global dealing regulations was “reserved.” In response to comments, this provision is omitted in these temporary regulations, based on the view that reserved treatment is not appropriate. The Treasury Department and the IRS are presently working on new global dealing regulations. The intent of the Treasury Department and the IRS is that when final regulations are issued, those regulations, not § 1.482-9T, will govern the evaluation of the activities performed by a global dealing operation within the scope of those regulations. Pending finalization of the global dealing regulations, taxpayers may rely on the proposed global dealing regulations, not the temporary services regulations, to govern financial transactions entered into in connection with a global dealing operation as defined in proposed § 1.482-8. Therefore, proposed regulations under § 1.482-9(m)(5) issued elsewhere in the

Federal Register

clarify that a controlled services transaction does not include a financial transaction entered into in connection with a global dealing operation.

B. Income Attributable to Intangibles—Temp. Treas. Reg. § 1.482-4T(f)(3) and (4)

The 2003 proposed regulations substantially replaced § 1.482-4(f)(3) of the existing regulations, which dealt with issues relating to the allocation of income from intangibles. The 2003 proposed regulations adopted new § 1.482-4(f)(3) and (f)(4), which

provided modified rules for determining the owner of an intangible for purposes of section 482 and also provided rules for determining the arm's length compensation in situations where a controlled party other than the owner makes contributions to the value of an intangible.

1. Ownership of Intangible Property—Temp. Treas. Reg. § 1.482-4T(f)(3)

Section 1.482-4(f)(3)(i)(A) of the 2003 proposed regulations contained modified rules for determining the owner of intangible property for purposes of section 482. In general, under these rules, the controlled party that was identified as the owner of a legally protected intangible under the intellectual property laws of the relevant jurisdiction or other legal provision was treated as the owner of that intangible for purposes of section 482.

The 2003 proposed regulations also clarified that a license or other right to use an intangible may constitute an item of intangible property for purposes of section 482. This provision, which contemplated the identification of a single owner for each discrete set of rights that constitutes an intangible, replaced provisions in the existing regulations that could be interpreted as providing for multiple owners of an intangible. See Proposed § 1.482-4(f)(3)(i) and (f)(3)(iv),

Example 4.

The 2003 proposed regulations also adopted a provision that parallels the requirement in the existing regulations, to the effect that ownership for purposes of section 482 must be consistent with the economic substance of the controlled transaction. Intellectual property law generally places relatively few limitations on the ability of members of a controlled group to assign or transfer legal ownership among themselves. As a result, this rule is a safeguard against purely formal assignments of ownership that, if given effect for purposes of section 482, could produce results that are inconsistent with the arm's length standard.

Under § 1.482-4(f)(3)(i)(A) of the 2003 proposed regulations, in situations where it was not possible to identify the owner of an intangible under the intellectual property law of the relevant jurisdiction, contractual term, or other legal provision, the controlled taxpayer with practical control over the intangible would be treated as the owner for purposes of section 482. This provision replaced the so-called “developer-assister” rule in existing § 1.482-4(f)(3)(ii)(B). In the case of non-legally protected intangibles, the developer-assister rule assigned ownership of an intangible to the controlled taxpayer that bore the largest portion of the costs of development.

The 2003 proposed regulations did not adopt the developer-assister rule, so they also eliminated related provisions pertaining to assistance to the owner of intangible property. In place of those rules, the 2003 proposed regulations contained new provisions relating to contributions to the value of intangible property owned by another controlled party. See Proposed § 1.482-4(f)(4)(i). These rules are discussed in greater detail in section B.2 of this preamble.

Section 1.482-4(f)(3)(i)(B) of the 2003 proposed regulations excluded certain intangibles that are subject to the cost sharing provisions of § 1.482-7. The Treasury Department and the IRS are currently revising the existing regulations related to cost sharing. When final cost sharing regulations are issued, § 1.482-4(f)(3) and (4) will take into account the changes made to the cost sharing provisions.

Extensive comments were received concerning the revised approach to determining ownership of intangibles under section 482. To varying degrees, many commentators supported the new ownership standard, noting that it should be easier to apply and should produce more certainty of results in this area. Other commentators, however, took issue with the proposed rules. Some of these commentators took the position that legal ownership does not provide an appropriate basis for determining ownership under section 482, while others believed that the determination of ownership under section 482 should include a full-scale application of substantive intellectual property law, including relevant statutory provisions as well as judicial doctrines and common law principles that may bear on the issue of ownership.

After considering the public comments, the Treasury Department and the IRS conclude that legal ownership provides the appropriate framework for determining ownership of intangibles under section 482. In this specific context, the Treasury Department and the IRS intend that the “legal owner” under these rules will be the controlled party that possesses title to the intangible, based on consideration of the facts and circumstances. This analysis would take into account applications filed with a central government registry (such as the U.S. Patent and Trademark Office or the Copyright Office in the United States), any contractual provisions in effect between the controlled parties, and other legal provisions. Legal ownership, understood in this manner, provides a practical and administrable framework for determining ownership of intangibles for purposes of section 482.

The suggestions that the ownership rules under section 482 should in effect incorporate by reference the substantive intellectual property rules have not been adopted. In the view of the Treasury Department and the IRS, it would be counterproductive to require an in-depth application of intellectual property law in determining which controlled party is treated as the owner under section 482. The primary function of intellectual property law is to define the rights of a legal entity, which in some cases might be a controlled group, as compared with one or more uncontrolled parties that have competing claims to the same item of intangible property. For this reason, application of the substantive provisions of intellectual property law would not be useful, and might in fact produce inappropriate results, given that under section 482 the relevant determination is which of several controlled parties should be classified as the owner of an intangible.

The Treasury Department and the IRS anticipate that ownership of an intangible as determined under the legal owner standard will not conflict with the simultaneous requirement that ownership under section 482 be determined in accordance with the economic substance. For example, if the economic substance of the controlled parties' dealings conflicts with treatment of the legal owner as the owner under section 482, the Commissioner may determine ownership by reference to the economic substance of the transaction. In other cases, ownership for purposes of section 482 should be consistent with the ownership determined by reference to either legal ownership or practical control.

The Treasury Department and the IRS also believe that the 2003 proposed regulations properly adopted a practical control standard for “non-legally protected” intangibles. The control standard should not displace valid contractual terms intended to specify that a particular controlled party is the owner of an existing intangible or an intangible under development. Because a contractual term constitutes a “legal provision,” the intangible would be analyzed as a legally protected intangible, as opposed to a non-legally protected intangible subject to the practical control rule.

Commentators suggested that certain statements in the 2003 proposed regulations incorrectly equated a licensee of intangible property with a

distributor of tangible property. In response to these comments, the Treasury Department and the IRS have revised the examples in § 1.482-4T(f)(4)(ii) to avoid any implication that these regulations equate or distinguish these business relationships.

2. Contributions to the Value of an Intangible—Temp. Treas. Reg. § 1.482-4T(f)(4)

Under § 1.482-4(f)(4)(i) of the 2003 proposed regulations, the rules of section 482 were applied to determine the arm's length compensation for any activity that was reasonably anticipated to increase the value of an intangible owned by another controlled party. Such an activity was defined as a “contribution” under this provision. This provision replaced certain rules in the existing regulations that required arm's length compensation to be provided for any assistance by a controlled party to the owner of the intangible.

This new guidance concerning contributions to the value of an intangible was intended to provide a more refined framework than the rules in existing § 1.482-4(f)(3), in particular by reducing the potential for inappropriate, all-or-nothing results. Moreover, because the revised rules afforded heightened deference to contractual arrangements, they were intended to give controlled taxpayers incentives to document transactions on a contemporaneous basis and to adhere to the contractual terms agreed upon at the outset of the arrangement.

Section 1.482-4(f)(4)(i) of the 2003 proposed regulations provided that compensation for a contribution may be embedded within the terms of another transaction, may be stated separately as a fee for services, or may be provided for as a reduction in the royalty or the transfer price of tangible property. The regulations also recognized that if a controlled party's activities are reasonably anticipated to enhance only the value of its own rights under a license or exclusive distribution arrangement, no compensation is due under the arm's length standard. The rules addressed the most commonly encountered factual scenarios that potentially give rise to contributions on the part of a controlled party.

Section 1.482-4(f)(4)(i) of the 2003 proposed regulations provided that in general a separate allocation is not appropriate if the compensation for a contribution was embedded within the terms of a related controlled transaction. In such cases, the contribution is taken into account in evaluating the comparability of the controlled transaction to the uncontrolled comparables and in determining the arm's length consideration for the controlled transaction that includes the embedded contribution.

This rule potentially interacted with § 1.482-3(f) of the existing regulations, concerning transfers of tangible property together with an embedded intangible. For example, assume that a reseller of trademarked goods performs activities that are classified as contributions within the meaning of § 1.482-4(f)(4). If no separate compensation for these activities is provided for by a contractual term, then ordinarily no allocation would be appropriate either for the embedded trademark or for the underlying activities. Both elements would, however, be taken into account in evaluating the comparability of the controlled transfer to the uncontrolled comparables and in determining the arm's length consideration for the controlled transfer of the trademarked goods. See § 1.482-4T(f)(4)(ii)

Example 2.

Commentators objected to certain aspects of

Example 2, Example 3, Example 5,

and

Example 6

in § 1.482-4(f)(4)(ii) of the 2003 proposed regulations. Those examples stated that, if it is not possible to identify uncontrolled transactions that incorporated a similar range of interrelated elements as the nonroutine contributions by the controlled parties, it may be appropriate to apply a residual profit split analysis. In the opinion of commentators, these statements implied that profit split methods were preferred methods in any case that involved a contribution to the value of an intangible.

The Treasury Department and the IRS agree with these comments. There was no intention to imply any such treatment of the residual profit split method. As a result, these statements in the examples have been eliminated. In addition, the examples in the temporary regulations specifically refer to the best method rule and cross-reference new

Example 10, Example 11,

and

Example 12

in § 1.482-8, which show application of the best method rule to intangible development activities. See also section A.6 of this preamble, concerning definition of nonroutine contribution for purposes of the profit split methods.

In addition, and in response to comments, a new

Example 5

in § 1.482-1T(d)(3)(ii)(C) illustrates factual circumstances in which contractual terms pertaining to intangible development activities are respected, although on examination the activities are found to be priced on a non-arm's length basis. Together, these changes clarify that, subject to the best method rule and satisfaction of economic substance requirements, controlled parties may adopt contractual terms that provide for marketing, research and development, or other intangible development activities to be compensated based on reimbursement of specified costs plus a profit element. The underlying contractual compensation terms will be given effect for purposes of section 482 as long as they have economic substance.

Commentators sought clarification regarding the term “incremental marketing activities,” which was used in several examples in § 1.482-4(f)(4)(ii) of the 2003 proposed regulations.

In the examples, the term “incremental marketing activities” referred to activities by a controlled party that are quantitatively greater (in terms of volume, expense, etc.) than the activities undertaken by comparable uncontrolled parties in the transactions used to analyze the controlled transaction. Such activities must be taken into account by either evaluating a separate transaction that accounts for such incremental activities or analyzing the underlying transaction and making necessary adjustments to the uncontrolled transactions to incorporate such activities into the comparability analysis. Discrete changes were made to the examples to clarify these principles. As a result, apart from this additional clarification, these comments are not adopted.

Commentators proposed that the Treasury Department and the IRS adopt discounted cash-flow analysis (DCF) as a specified method for analysis of contributions. The Treasury Department and the IRS find it unnecessary to do so because they already recognize DCF as one of several approaches that may be reliably applied to evaluate intangible property. This method may be particularly useful, either as an unspecified method or in conjunction with one of the specified methods, in evaluating contributions within the meaning of § 1.482-4T(f)(4)(i). Further consideration is being given to the suggestion to adopt DCF as a specified method in its own right.

C. Contractual Terms Imputed From Economic Substance—§ 1.482-1(d)(3)(ii)(C), Examples 3, 4, 5, and 6

Central to the approach taken in the 2003 proposed regulations were the concepts that controlled taxpayers have substantial freedom to adopt contractual terms, and that such contractual terms are given effect under section 482, provided they are in accord with the economic substance of the controlled

parties' dealings. An important corollary of these principles, however, applies where controlled parties fail to specify contractual terms, or specify terms that are not consistent with economic substance. In such cases, the Commissioner may impute contractual terms to accord with the economic substance of the controlled parties' activities. See § 1.482-1(d)(3) of the existing regulations.

Commentators raised several concerns regarding the potential interaction between the economic substance rules in existing § 1.482-1(d)(3) and certain provisions in the 2003 proposed regulations, including those relating to contributions to the value of intangibles and contingent-payment contractual terms. Some commentators suggested that application of these provisions together with the existing economic substance rules could create incentives for the Commissioner to make inappropriate adjustments, e.g., to impute contingent-payment terms or transfers of intangibles in any situation in which non-arm's length pricing was identified.

It bears emphasis that the Commissioner may invoke his authority under § 1.482-1(d)(3)(ii) in only two situations: (1) Controlled taxpayers fail to specify contractual terms for the transaction; or (2) controlled taxpayers specify contractual terms that are not in accordance with economic substance. Clearly, if contributions within the meaning of § 1.482-4T(f)(4)(i) are present, the contractual terms of the controlled transaction should address those contributions in a manner that accords with economic substance. If this is not the case, the Commissioner must impute an arrangement that best conforms to the economic substance of the transaction. In given facts and circumstances, it may be possible to rely on evidence that the taxpayer brings forward. In other circumstances, the Commissioner will impute an arrangement based on economic substance, taking into account the facts and circumstances, the parties' conduct, and other relevant evidence, including any that the taxpayer brings forward on examination. See

Example 3

,

Example 4

, and

Example 6

in § 1.482-1T(d)(3)(ii)(C).

In response to comments, § 1.482-1T(d)(3)(ii)(C) includes a new

Example 5

, which illustrates the interaction of the economic substance rule with general transfer pricing rules in the context of intangible development activities. In the example, the contractual terms specify that intangible development activities are priced by reference to reimbursement of specified costs plus a markup or profit component. On examination, the Commissioner determines that the specified compensation falls outside the arm's length range, as determined by comparison to uncontrolled transactions. The example illustrates that this determination, without more, does not support a conclusion that the contractual terms lacked economic substance. If, however, the compensation paid is outside the arm's length range by a substantial amount, the Commissioner may take that fact into account in determining whether the contractual arrangement as a whole possessed economic substance.

The examples in § 1.482-1(d)(3)(ii)(C) of the 2003 proposed regulations described alternative constructions that the Commissioner might adopt if the contractual terms for the controlled transaction were not in accordance with economic substance: These alternatives included: (1) Imputation of a separate services arrangement, with contingent-payment terms; (2) imputation of a long-term, exclusive distribution arrangement; or (3) requiring compensation for termination of an imputed long-term license arrangement. The Treasury Department and the IRS believe that one or more of these arrangements may be appropriate, depending on the facts of the specific case.

Commentators expressed concerns regarding the scope of the Commissioner's authority to impute arrangements based on economic substance. Some commentators suggested that a single set of contractual terms should apply in any situation where the Commissioner determines that the controlled parties' contractual terms lack economic substance. Another commentator recommended that the Commissioner should impute only contractual terms similar to those observed in comparable uncontrolled transactions. After much consideration, the Treasury Department and the IRS have not adopted these comments. The determination of the economic substance of a transaction between related parties necessarily turns on an examination of all the facts and circumstances. Under the regulations, the taxpayer is in control of this issue in the first instance to the extent it expressly sets forth the economic substance in contractual terms and its conduct and arrangements are consistent with these terms. Otherwise, the IRS is forced to try and impute the economic substance based on whatever facts and circumstances are available, including any information the taxpayer brings forward on examination.

Commentators also suggested that under the 2003 proposed regulations, the Commissioner's authority to impute contingent-payment contractual terms was unnecessarily broad. In the commentators' view, this authority would lead the Commissioner to apply commensurate with income principles to controlled transactions that have no significant intangible property component. The Commissioner's authority to impute contingent-payment contractual terms was appropriately tailored to result in application of economic substance principles in those situations where it was warranted. The Treasury Department and the IRS believe that the commensurate with income principle of the statute is consistent with the arm's length principle and fundamentally relates to the underlying economic substance and true risk allocations inherent in the relevant controlled transactions. Related parties may, with economic substance, agree to compensate one another for services with compensation payable only in future periods contingent on the success or failure of the services to produce the contemplated results. Related parties may expressly enter into those contractual terms and, in the absence of express terms or where the related parties' conduct and arrangements are inconsistent with their contractual terms, the IRS may in appropriate facts and circumstances impute contingent-payment contractual terms.

D. Stewardship Expenses—§ 1.861-8T

The temporary regulations would modify the present regulations under § 1.861-8(e)(4) to conform to, and to be consistent with, the revised language relating to controlled services transactions as set forth in § 1.482-9T(l).

E. Effective Date—§ 1.482-9T(n)

In order to achieve the goal of updating the 1968 regulations, while facilitating consideration of further public input in refining final rules, these regulations are issued in temporary form with a delayed effective date for taxable years beginning after December 31, 2006. Controlled taxpayers may also elect to apply these temporary regulations to any taxable year beginning after September 10, 2003, the date of publication of the 2003 proposed regulations. Where such an election is made, the temporary regulations will apply in full to such taxable year and all subsequent taxable years of the taxpayer making the election. Such an election must be made by attaching a statement to the taxpayer's timely filed U.S. tax return

(including extensions) for its first taxable year after December 31, 2006.

These regulations are issued after proposed revisions to the regulations pertaining to cost sharing arrangements. By issuing regulations in temporary and proposed form concerning controlled services and the allocation of income from intangibles, the Treasury Department and the IRS also provide taxpayers an opportunity to submit comments that take into account the potential interaction between these two sets of regulations.

The initial list of specified covered services for purposes of the SCM is being issued for public input in the form of an Announcement in tandem with these temporary regulations. This Announcement will be published in the Internal Revenue Bulletin. For copies of the Internal Revenue Bulletin, see § 601.601(d)(2)(ii)(b). The Treasury Department and the IRS intend to take all public comments into account and issue a final revenue procedure that will be effective coincident with the delayed effective date of these temporary regulations.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 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) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special Analyses section of the preamble to the cross-reference notice of proposed rulemaking published in the Proposed Rules section in this issue of the

Federal Register

. Pursuant to section 7805(f) of the Internal Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal authors of these regulations are Thomas A. Vidano and Carol B. Tan, Office of Associate Chief Counsel (International) for matters relating to section 482, and David Bergkuist, Office of Associate Chief Counsel (International) for matters relating to stewardship.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 31

Employment taxes, Income taxes, Penalties, Pensions, Railroad retirement, Reporting and recordkeeping requirements, Social Security and Unemployment compensation.

Amendment to the Regulations

Accordingly, 26 CFR parts 1 and 31 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1.

The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

Authority:

26 U.S.C. 7805 * * *

Section 1.482-9 also issued under 26 U.S.C. 482. * * *

Par. 2.

Section 1.482-0 is amended as follows:

1. The section heading is revised.

2. The entries for 1.482-1(a)(1), (b)(2)(i), (d)(3)(ii)(C), (d)(3)(v), (f)(2)(ii)(A), (f)(2)(ii)(B), (g)(4)(iii), (i) and (j) are revised.

3. The entries for § 1.482-2(b) are revised.

4. The entries for § 1.482-4(f)(3), (f)(4) and (f)(5) are revised and new entries for § 1.482-4(f)(6) and (f)(7) are added.

5. The entries for 1.482-6(c)(2)(ii)(B)(

1

), (c)(2)(ii)(D), (c)(3)(i)(A), (c)(3)(i)(B) and (c)(3)(ii)(D) are revised and the entry for 1.482-6(d) is added.

6. The entry for 1.482-8(a) is revised.

7. The entries for 1.482-9 are added.

The additions and revisions read as follows:

§ 1.482-0

Outline of regulations under section 482.

§ 1.482-1

Allocation of income and deductions among taxpayers.

(a)(1) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(a)(1).

(b) * * *

(2) * * *

(i) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(b)(2)(i).

(d) * * *

(3) * * *

(ii) * * *

(C) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(d)(3)(ii)(C).

(v) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(d)(3)(v).

(f) * * *

(2) * * *

(ii) * * *

(A) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(f)(2)(ii)(A).

(iii) * * *

(B) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(f)(2)(iii)(B).

(g) * * *

(4) * * *

(iii) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(g)(4)(iii).

(i) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(i).

(j) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-1T(j).

§ 1.482-2

Determination of taxable income in specific situations.

(b) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-2T(b).

§ 1.482-4

Methods to determine taxable income in connection with a transfer of intangible property.

(f) * * *

(3) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-4T(f)(3).

(4) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-4T(f)(4).

(5) Consideration not artificially limited.

(6) Lump sum payments

(i) In general.

(ii) Exceptions.

(iii) Example.

(7) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-4T(f)(7).

§ 1.482-6

Profit split method.

(c) * * *

(2) * * *

(ii) * * *

(B) * * *

(

1

) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-6T(c)(2)(ii)(B)(

1

).

(D) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-6T(c)(2)(ii)(D).

(3) * * *

(i) * * *

(A) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-6T(c)(3)(i)(A).

(B) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-6T(c)(3)(i)(B).

(ii) * * *

(D) [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-6T(c)(3)(ii)(D).

(d) Effective date. [Reserved]. For further guidance, see § 1.482-0T, the entry for § 1.482-6T(d).

§ 1.482-8

Examples of the best method rule.

(a) Introduction.

§ 1.482-9

Methods to determine taxable income in connection with a controlled services transaction. [Reserved].

For further guidance, see § 1.482-0T, the entries for § 1.482-9T.

Par. 3.

Section 1.482-0T is added to read as follows:

§ 1.482-0T

Outline of regulations under section 482.

This section contains major captions for §§ 1.482-1T, 1.482-2T, 1.482-4T, 1.482-6T, 1.482-8T, and § 1.482-9T.

§ 1.482-1T

Allocation of income and deductions among taxpayers.

(a) In general.

(1) Purpose and scope.

(2) through (b)(1) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(a)(2) through (b)(1).

(b)(2) Arm's length methods.

(i) Methods.

(b)(2)(ii) through (d)(3)(ii)(B) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(b)(2)(ii) through (c)(3)(ii)(B).

(C) Examples.

(d)(3)(iii) and (iv) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(d)(3)(iii) and (iv).

(v) Property or services.

(d)(4) through (f)(2)(i) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(d)(4) through (f)(2)(i).

(ii) Allocation based on taxpayer's actual transactions.

(A) In general.

(f)(2)(ii)(B) through (f)(2)(iii)(A) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(f)(2)(ii)(B) through (f)(2)(iii)(A).

(B) Circumstances warranting consideration of multiple year data.

(f)(2)(iii)(C) through (g)(3) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(f)(2)(iii)(C) through (g)(3).

(4) Setoffs.

(i) In general.

(g)(4)(ii) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(g)(4)(ii).

(iii) Examples.

(g)(4)(iii) Example 2 through (h) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(g)(4)(iii) Example 2 through (h).

(i) Definitions.

(i)(1) through (10) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-1(i)(1) through (10).

(j) Effective date.

(1) In general.

(2) Election to apply regulation to earlier years.

(3) Expiration date.

§ 1.482-2T

Determination of taxable income in specific situations.

(a) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-2(a).

(b) Rendering of services.

(c) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-2(c).

(d) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-2(d).

(e) Effective date.

(1) In general.

(2) Election to apply regulation to earlier years.

(3) Expiration date.

§ 1.482-4T

Methods to determine taxable income in connection with a transfer of intangible property.

(a) through (f)(2) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-4(a) through (f)(2).

(3) Ownership of intangible property.

(i) Identification of owner.

(A) In general.

(B) Cost sharing arrangements.

(ii) Examples.

(4) Contribution to the value of an intangible owned by another.

(i) In general.

(ii) Examples.

(f)(5) and (f)(6) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-4(f)(5) and (f)(6).

(7) Effective date.

(i) In general.

(ii) Election to apply regulation to earlier years.

(iii) Expiration date.

§ 1.482-6T

Profit split method.

(a) through (c)(2)(ii)(A) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-6(a) through (c)(2)(ii)(A).

(B) Comparability.

(

1

) In general.

(c)(2)(ii)(B)(

2

) through (C) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-6(c)(2)(ii)(B)(

2

) through (C).

(D) Other factors affecting reliability.

(c)(3)(i) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-6(c)(3)(i).

(A) Allocate income to routine contributions.

(B) Allocate residual profit.

(

1

) Nonroutine contributions generally.

(

2

) Nonroutine contributions of intangible property.

(c)(3)(ii)(A) through (C) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-6(c)(3)(ii)(A) through (C).

(D) Other factors affecting reliability.

(c)(3)(iii) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-6(c)(3)(iii).

(d) Effective date.

(1) In general.

(2) Election to apply regulation to earlier taxable years.

(3) Expiration date.

§ 1.482-8T

Examples of the best method rule.

(a) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-8(a).

(b) [Reserved]. For further guidance, see § 1.482-0, the entry for § 1.482-8(b)

(c) Effective date.

(1) In general.

(2) Election to apply regulation to earlier taxable years.

(3) Expiration date.

§ 1.482-9T

Methods to determine taxable income in connection with a controlled services transaction.

(a) In general.

(b) Services cost method

(1) In general.

(2) Not services that contribute significantly to fundamental risks of business success or failure.

(3) Other conditions on application of services cost method.

(i) Adequate books and records.

(ii) Excluded transactions.

(4) Covered services.

(i) Specified covered services.

(ii) Low margin covered services.

(5) Shared services arrangement.

(i) In general.

(ii) Requirements for shared services arrangement.

(A) Eligibility.

(B) Allocation.

(C) Documentation.

(iii) Definition and special rules.

(A) Participant.

(B) Aggregation.

(C) Coordination with cost sharing arrangements.

(6) Examples.

(c) Comparable uncontrolled services price method.

(1) In general.

(2) Comparability and reliability considerations.

(i) In general.

(ii) Comparability.

(A) In general.

(B) Adjustments for differences between controlled and uncontrolled transactions.

(iii) Data and assumptions.

(3) Arm's length range.

(4) Examples.

(5) Indirect evidence of the price of a comparable uncontrolled services transaction.

(i) In general.

(ii) Example.

(d) Gross services margin method.

(1) In general.

(2) Determination of arm's length price.

(i) In general.

(ii) Relevant uncontrolled transaction.

(iii) Applicable uncontrolled price.

(iv) Appropriate gross services profit.

(v) Arm's length range.

(3) Comparability and reliability considerations.

(i) In general.

(ii) Comparability.

(A) Functional comparability.

(B) Other comparability factors.

(C) Adjustments for differences between controlled and uncontrolled transactions.

(D) Buy-sell distributor.

(iii) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(4) Examples.

(e) Cost of services plus method.

(1) In general.

(2) Determination of arm's length price.

(i) In general.

(ii) Appropriate gross services profit.

(iii) Comparable transactional costs.

(iv) Arm's length range.

(3) Comparability and reliability considerations.

(i) In general.

(ii) Comparability.

(A) Functional comparability.

(B) Other comparability factors.

(C) Adjustments for differences between the controlled and uncontrolled transactions.

(iii) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(4) Examples.

(f) Comparable profits method.

(1) In general.

(2) Determination of arm's length result.

(i) Tested party.

(ii) Profit level indicators.

(iii) Comparability and reliability considerations—Data and assumptions—Consistency in accounting.

(3) Examples.

(g) Profit split method.

(1) In general.

(2) Examples.

(h) Unspecified methods.

(i) Contingent-payment contractual terms for services.

(1) Contingent-payment contractual terms recognized in general.

(2) Contingent-payment arrangement.

(i) General Requirements

(A) Written contract.

(B) Specified contingency.

(C) Basis for payment.

(ii) Economic Substance and Conduct

(3) Commissioner's authority to impute contingent-payment terms.

(4) Evaluation of arm's length charge.

(5) Examples.

(j) Total services costs.

(k) Allocation of costs.

(1) In general.

(2) Appropriate method of allocation and apportionment.

(i) Reasonable method standard.

(ii) Use of general practices.

(3) Examples.

(l) Controlled services transaction.

(1) In general.

(2) Activity.

(3) Benefit.

(i) In general.

(ii) Indirect or remote benefit.

(iii) Duplicative activities.

(iv) Shareholder activities.

(v) Passive association.

(4) Disaggregation of Transactions

(5) Examples.

(m) Coordination with transfer pricing rules for other transactions.

(1) Services transactions that include other types of transactions.

(2) Services transactions that effect a transfer of intangible property.

(3) Services subject to a qualified cost sharing arrangement.

(4) Other types of transactions that include controlled services transactions.

(5) Examples.

(n) Effective date.

(1) In general.

(2) Election to apply regulations to earlier taxable years.

(3) Expiration date.

Par. 4.

Section 1.482-1 is amended as follows:

1. Paragraphs (a)(1), (b)(2)(i), (d)(3)(ii)(C)

Example 3,

(d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii) and paragraph (i) are revised.

2. Paragraph (d)(3)(ii)(C)

Examples 4

through

6

are added.

3. Paragraph (j)(6) is added.

The addition and revisions read as follows:

§ 1.482-1

Allocation of income and deductions among taxpayers.

(a)(1) [Reserved]. For further guidance, see § 1.482-1T(a)(1).

(b) * * * (1) * * *

(b)(2)(i) [Reserved]. For further guidance, see § 1.482-1T(b)(2)(i).

(d) * * *

(3) * * *

(ii) * * *

(C) * * *

Example 3.

[Reserved]. For further guidance, see § 1.482-1T(d)(3)(ii)(C), Example 3.

Examples 4

through

6.

[Reserved]. For further guidance, see 1.482-1T(d)(3)(ii)(C)

Examples 4

through

6

.

(v) [Reserved]. For further guidance, see § 1.482-1T(d)(3)(v).

(f) * * *

(2) * * *

(ii)(A) [Reserved]. For further guidance, see § 1.482-1T(f)(2)(ii)(A).

(iii) * * *

(B) [Reserved]. For further guidance, see § 1.482-1T(f)(3)(iii)(B).

(g) * * *

(4) * * * (i) * * * [Reserved]. For further guidance, see § 1.482-1T(g)(4)(i).

(iii) * * *

Example 1.

[Reserved]. For further guidance, see § 1.482-1T(g)(4)(iii),

Example 1.

(i) [Reserved]. For further guidance, see § 1.482-1T(i).

(j) * * *

(6) [Reserved]. For further guidance, see § 1.482-1T(j)(6).

Par. 5.

Section 1.482-1T is added to read as follows:

§ 1.482-1T

Allocation of income and deductions among taxpayers (temporary).

(a)

In general

—(1)

Purpose and scope.

The purpose of section 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions. Section 482 places a controlled taxpayer on a tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer. This section sets forth general principles and guidelines to be followed under section 482. Section 1.482-2 provides rules for the determination of the true taxable income of controlled taxpayers in specific situations, including controlled transactions involving loans or advances or the use of tangible property. Sections 1.482-3 through 1.482-6 provide rules for the determination of the true taxable income of controlled taxpayers in cases involving the transfer of property. Section 1.482-7T sets forth the cost sharing provisions applicable to taxable years beginning on or after October 6, 1994, and before January 1, 1996. Section 1.482-7 sets forth the cost sharing provisions applicable to taxable years beginning on or after January 1, 1996. Section 1.482-8 provides examples illustrating the application of the best method rule. Finally, § 1.482-9T provides rules for the determination of the true taxable income of controlled taxpayers in cases involving the performance of services.

(a)(2) through (b)(1) [Reserved]. For further guidance, see § 1.482-1(a)(2) through (b)(1).

(b)(2)

Arm's length methods

—(i)

Methods.

Sections 1.482-2 through 1.482-6 and § 1.482-9T provide specific methods to be used to evaluate whether transactions between or among members of the controlled group satisfy the arm's length standard and, if they do not, to determine the arm's length result. Section 1.482-7 provides the specific method to be used to evaluate whether a qualified cost sharing arrangement produces results consistent with an arm's length result.

(b)(2)(ii) through (d)(3)(ii)(C),

Examples 1,

and

2

[Reserved]. For further guidance, see § 1.482-1(b)(2)(ii) through (d)(3)(ii)(C),

Examples 1

and

2.

Example 3.

Contractual terms imputed from economic substance.

(i) FP, a foreign producer of wristwatches, is the registered holder of the YY trademark in the United States and in other countries worldwide. In year 1, FP enters the United States market by selling YY wristwatches to its newly organized United States subsidiary, USSub, for distribution in the United States market. USSub pays FP a fixed price per wristwatch. USSub and FP undertake, without separate compensation, marketing activities to establish the YY trademark in the United States market. Unrelated foreign producers of trademarked wristwatches and their authorized United States distributors respectively undertake similar marketing activities in independent arrangements involving distribution of trademarked wristwatches in the United States market. In years 1 through 6, USSub markets and sells YY wristwatches in the United States. Further, in years 1 through 6, USSub undertakes incremental marketing activities in addition to the activities similar to those observed in the independent distribution transactions in the United States market. FP does not directly or indirectly compensate USSub for performing these incremental activities during years 1 through 6. Assume

that, aside from these incremental activities, and after any adjustments are made to improve the reliability of the comparison, the price paid per wristwatch by the independent, authorized distributors of wristwatches would provide the most reliable measure of the arm's length price paid per YY wristwatch by USSub.

(ii) By year 7, the wristwatches with the YY trademark generate a premium return in the United States market, as compared to wristwatches marketed by the independent distributors. In year 7, substantially all the premium return from the YY trademark in the United States market is attributed to FP, for example through an increase in the price paid per watch by USSub, or by some other means.

(iii) In determining whether an allocation of income is appropriate in year 7, the Commissioner may consider the economic substance of the arrangements between USSub and FP, and the parties' course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that, ex ante, an uncontrolled taxpayer operating at arm's length would engage in the incremental marketing activities to develop or enhance an intangible owned by another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of receiving a future benefit from those activities. In this case, USSub's undertaking the incremental marketing activities in years 1 through 6 is a course of conduct that is inconsistent with the parties' attribution to FP in year 7 of substantially all the premium return from the enhanced YY trademark in the United States market. Therefore, the Commissioner may impute one or more agreements between USSub and FP, consistent with the economic substance of their course of conduct, which would afford USSub an appropriate portion of the premium return from the YY trademark wristwatches. For example, the Commissioner may impute a separate services agreement that affords USSub contingent-payment compensation for its incremental marketing activities in years 1 through 6, which benefited FP by contributing to the value of the trademark owned by FP. In the alternative, the Commissioner may impute a long-term, exclusive agreement to exploit the YY trademark in the United States that allows USSub to benefit from the incremental marketing activities it performed. As another alternative, the Commissioner may require FP to compensate USSub for terminating USSub's imputed long-term, exclusive agreement to exploit the YY trademark in the United States, an agreement that USSub made more valuable at its own expense and risk. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties' course of conduct in the particular case.

Example 4.

Contractual terms imputed from economic substance.

(i) FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries worldwide. In year 1, FP enters into a licensing agreement that affords its newly organized United States subsidiary, USSub, exclusive rights to certain manufacturing and marketing intangibles (including the AA trademark) for purposes of manufacturing and marketing athletic gear in the United States under the AA trademark. The contractual terms of this agreement obligate USSub to pay FP a royalty based on sales, and also obligate both FP and USSub to undertake without separate compensation specified types and levels of marketing activities. Unrelated foreign businesses license independent United States businesses to manufacture and market athletic gear in the United States, using trademarks owned by the unrelated foreign businesses. The contractual terms of these uncontrolled transactions require the licensees to pay royalties based on sales of the merchandise, and obligate the licensors and licensees to undertake without separate compensation specified types and levels of marketing activities. In years 1 through 6, USSub manufactures and sells athletic gear under the AA trademark in the United States. Assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangibles, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm's length royalty owed by USSub to FP, apart from the additional facts in paragraph (ii) of this example.

(ii) In years 1 through 6, USSub performs incremental marketing activities with respect to the AA trademark athletic gear, in addition to the activities required under the terms of the license agreement with FP, that are also incremental as compared to those observed in the comparables. FP does not directly or indirectly compensate USSub for performing these incremental activities during years 1 through 6. By year 7, AA trademark athletic gear generates a premium return in the United States, as compared to similar athletic gear marketed by independent licensees. In year 7, USSub and FP enter into a separate services agreement under which FP agrees to compensate USSub on a cost basis for the incremental marketing activities that USSub performed during years 1 through 6, and to compensate USSub on a cost basis for any incremental marketing activities it may perform in year 7 and subsequent years. In addition, the parties revise the license agreement executed in year 1, and increase the royalty to a level that attributes to FP substantially all the premium return from sales of the AA trademark athletic gear in the United States.

(iii) In determining whether an allocation of income is appropriate in year 7, the Commissioner may consider the economic substance of the arrangements between USSub and FP and the parties' course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that, ex ante, an uncontrolled taxpayer operating at arm's length would engage in the incremental marketing activities to develop or enhance an intangible owned by another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of a future benefit. In this case, USSub's undertaking the incremental marketing activities in years 1 through 6 is a course of conduct that is inconsistent with the parties' adoption in year 7 of contractual terms by which FP compensates USSub on a cost basis for the incremental marketing activities that it performed. Therefore, the Commissioner may impute one or more agreements between USSub and FP, consistent with the economic substance of their course of conduct, which would afford USSub an appropriate portion of the premium return from the AA trademark athletic gear. For example, the Commissioner may impute a separate services agreement that affords USSub contingent-payment compensation for the incremental activities it performed during years 1 through 6, which benefited FP by contributing to the value of the trademark owned by FP. In the alternative, the Commissioner may impute a long-term, exclusive United States license agreement that allows USSub to benefit from the incremental activities. As another alternative, the Commissioner may require FP to compensate USSub for terminating USSub's imputed long-term United States license agreement, a license that USSub made more valuable at its own expense and risk. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties' course of conduct in this particular case.

Example 5.

Non-arm's length compensation.

(i) The facts are the same as in paragraph (i) of

Example 4.

As in

Example 4,

assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangibles, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm's length royalty owed by USSub to FP, apart from the additional facts described in paragraph (ii) of this example.

(ii) In years 1 through 4, USSub performs certain incremental marketing activities with respect to the AA trademark athletic gear, in addition to the activities required under the terms of the basic license agreement, that are also incremental as compared with those activities observed in the comparables. At the start of year 1, FP enters into a separate services agreement with USSub, which states that FP will compensate USSub quarterly, in an amount equal to specified costs plus X%, for these incremental marketing functions. Further, these written agreements reflect the intent of the parties that USSub receive such compensation from FP throughout the term of the agreement, without regard to the success or failure of the promotional activities. During years 1 though 4, USSub performs marketing activities pursuant to the separate services agreement and in each year USSub receives the specified compensation from FP on a cost of services plus basis.

(iii) In evaluating year 4, the Commissioner performs an analysis of independent parties that perform promotional activities comparable to those performed by USSub

and that receive separately-stated compensation on a current basis without contingency. The Commissioner determines that the magnitude of the specified cost plus X% is outside the arm's length range in each of years 1 through 4. Based on an evaluation of all the facts and circumstances, the Commissioner makes an allocation to require payment of compensation to USSub for the promotional activities performed in year 4, based on the median of the interquartile range of the arm's length markups charged by the uncontrolled comparables described in § 1.482-1(e)(3).

(iv) Given that based on facts and circumstances, the terms agreed by the controlled parties were that FP would bear all risks associated with the promotional activities performed by USSub to promote the AA trademark product in the United States market, and given that the parties' conduct during the years examined was consistent with this allocation of risk, the fact that the cost of services plus markup on USSub's services was outside the arm's length range does not, without more, support imputation of additional contractual terms based on alternative views of the economic substance of the transaction, such as terms indicating that USSub, rather than FP, bore the risk associated with these activities. In other facts and circumstances, had the compensation paid to USSub been significantly outside the arm's length range, that might lead the Commissioner to examine further whether, despite the contractual terms that require cost-plus reimbursement of USSub, the economic substance of the transaction was not consistent with FP's bearing the risk associated with promotional activities in the United States market.

Example 6.

Contractual terms imputed from economic substance.

(i) Company X is a member of a controlled group that has been in operation in the pharmaceutical sector for many years. In years 1 through 4, Company X undertakes research and development activities. As a result of those activities, Company X developed a compound that may be more effective than existing medications in the treatment of certain conditions.

(ii) Company Y is acquired in year 4 by the controlled group that includes Company X. Once Company Y is acquired, Company X makes available to Company Y a large amount of technical data concerning the new compound, which Company Y uses to register patent rights with respect to the compound in several jurisdictions, making Company Y the legal owner of such patents. Company Y then enters into licensing agreements with group members that afford Company Y 100% of the premium return attributable to use of the intangible by its subsidiaries.

(iii) In determining whether an allocation is appropriate in year 4, the Commissioner may consider the economic substance of the arrangements between Company X and Company Y, and the parties' course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that an uncontrolled taxpayer operating at arm's length would make available the results of its research and development or perform services that resulted in transfer of valuable know how to another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of receiving a future benefit from those activities. In this case, Company X's undertaking the research and development activities and then providing technical data and know-how to Company Y in year 4 is inconsistent with the registration and subsequent exploitation of the patent by Company Y. Therefore, the Commissioner may impute one or more agreements between Company X and Company Y consistent with the economic substance of their course of conduct, which would afford Company X an appropriate portion of the premium return from the patent rights. For example, the Commissioner may impute a separate services agreement that affords Company X contingent-payment compensation for its services in year 4 for the benefit of Company Y, consisting of making available to Company Y technical data, know-how, and other fruits of research and development conducted in previous years. These services benefited Company Y by giving rise to and contributing to the value of the patent rights that were ultimately registered by Company Y. In the alternative, the Commissioner may impute a transfer of patentable intangible rights from Company X to Company Y immediately preceding the registration of patent rights by Company Y. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties' course of conduct in the particular case.

(d)(3)(iii) and (iv) [Reserved]. For further guidance, see § 1.482-1(d)(3)(iii) and (d)(3)(iv).

(d)(3)(v)

Property or services.

Evaluating the degree of comparability between controlled and uncontrolled transactions requires a comparison of the property or services transferred in the transactions. This comparison may include any intangibles that are embedded in tangible property or services being transferred. The comparability of the embedded intangibles will be analyzed using the factors listed in § 1.482-4(c)(2)(iii)(B)(

1

) (comparable intangible property). The relevance of product comparability in evaluating the relative reliability of the results will depend on the method applied. For guidance concerning the specific comparability considerations applicable to transfers of tangible and intangible property and performance of services, see §§ 1.482-3 through 1.482-6 and § 1.482-9T; see also § 1.482-3(f), § 1.482-4T(f)(4), and § 1.482-9T(m), dealing with the coordination of the intangible and tangible property and performance of services rules.

(d)(4) through (f)(2)(i) [Reserved]. For further guidance, see § 1.482-1(d)(4) through (f)(2)(i).

(f)(2)(ii)

Allocation based on taxpayer's actual transactions

—(A)

In general.

The Commissioner will evaluate the results of a transaction as actually structured by the taxpayer unless its structure lacks economic substance. However, the Commissioner may consider the alternatives available to the taxpayer in determining whether the terms of the controlled transaction would be acceptable to an uncontrolled taxpayer faced with the same alternatives and operating under comparable circumstances. In such cases the Commissioner may adjust the consideration charged in the controlled transaction based on the cost or profit of an alternative as adjusted to account for material differences between the alternative and the controlled transaction, but will not restructure the transaction as if the alternative had been adopted by the taxpayer. See § 1.482-1(d)(3) (factors for determining comparability; contractual terms and risk); §§ 1.482-3(e), 1.482-4(d), and 1.482-9T(h) (unspecified methods).

(f)(2)(ii)(B) through (f)(2)(iii)(A) [Reserved]. For further guidance, see § 1.482-1(f)(2)(ii)(B) through (f)(2)(iii)(A).

(f)(2)(iii)(B)

Circumstances warranting consideration of multiple year data.

The extent to which it is appropriate to consider multiple year data depends on the method being applied and the issue being addressed. Circumstances that may warrant consideration of data from multiple years include the extent to which complete and accurate data are available for the taxable year under review, the effect of business cycles in the controlled taxpayer's industry, or the effects of life cycles of the product or intangible being examined. Data from one or more years before or after the taxable year under review must ordinarily be considered for purposes of applying the provisions of paragraph (d)(3)(iii) of this section (risk), paragraph (d)(4)(i) of this section (market share strategy), § 1.482-4(f)(2) (periodic adjustments), § 1.482-5 (comparable profits method), § 1.482-9T(f) (comparable profits method for services), and § 1.482-9T(i) (contingent-payment contractual terms for services). On the other hand, multiple year data ordinarily will not be considered for purposes of applying the comparable uncontrolled price method of § 1.482-3(b) or the comparable uncontrolled services price method of § 1.482-9T(c) (except to the extent that risk or market share strategy issues are present).

(f)(2)(iii)(C) through (g)(3) [Reserved]. For further guidance, see § 1.482-1(f)(2)(iii)(C) through (g)(3).

(g)(4)

Setoffs

—(i)

In general.

If an allocation is made under section 482 with respect to a transaction between

controlled taxpayers, the Commissioner will take into account the effect of any other non-arm's length transaction between the same controlled taxpayers in the same taxable year which will result in a setoff against the original section 482 allocation. Such setoff, however, will be taken into account only if the requirements of paragraph (g)(4)(ii) of this section are satisfied. If the effect of the setoff is to change the characterization or source of the income or deductions, or otherwise distort taxable income, in such a manner as to affect the U.S. tax liability of any member, adjustments will be made to reflect the correct amount of each category of income or deductions. For purposes of this setoff provision, the term arm's length refers to the amount defined in paragraph (b) of this section (Arm's length standard), without regard to the rules in § 1.482-2(a) that treat certain interest rates as arm's length rates of interest.

(g)(4)(ii) [Reserved]. For further guidance, see § 1.482-1(g)(4)(ii).

(g)(4)(iii)

Examples.

The following examples illustrate this paragraph (g)(4):

Example 1.

P, a U.S. corporation, renders construction services to S, its foreign subsidiary in Country Y, in connection with the construction of S's factory. An arm's length charge for such services determined under § 1.482-9T would be $100,000. During the same taxable year P makes available to S the use of a machine to be used in the construction of the factory, and the arm's length rental value of the machine is $25,000. P bills S $125,000 for the services, but does not charge S for the use of the machine. No allocation will be made with respect to the undercharge for the machine if P notifies the district director of the basis of the claimed setoff within 30 days after the date of the letter from the district director transmitting the examination report notifying P of the proposed adjustment, establishes that the excess amount charged for services was equal to an arm's length charge for the use of the machine and that the taxable income and income tax liabilities of P are not distorted, and documents the correlative allocations resulting from the proposed setoff.

(g)(4)(iii)

Example 2

through (h) [Reserved]. For further guidance, see § 1.482-1(g)(4)(iii)

Example 2

through (h).

(i)

Definitions.

The definitions set forth in paragraphs (i)(1) through (i)(10) of this section apply to this section and §§ 1.482-2T through 1.482-9T.

(j)(1) through (j)(5) [Reserved]. For further guidance, see 1.482-1(j)(1) through (j)(5).

(j)(6)(i) The provisions of paragraphs (a)(1), (b)(2)(i), (d)(3)(ii)(C)

Example 3,

Example 4, Example 5,

and

Example 6,

(d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii), and (i) of this section are generally applicable for taxable years beginning after December 31, 2006.

(ii) A person may elect to apply the provisions of paragraphs (a)(1), (b)(2)(i), (d)(3)(ii)(C)

Example 3, Example 4, Example 5,

and

Example 6,

(d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii), and (i) of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9T(n)(2).

(iii) The applicability of § 1.482-1T expires on or before July 31, 2009.

Par. 6.

Section 1.482-2 is amended as follows:

1. Paragraph (b) is revised.

2. Paragraph (e) is added.

The addition and revision read as follows:

§ 1.482-2

Determination of taxable income in specific situations.

(b)

Rendering of services.

[Reserved]. For further guidance, see § 1.482-2T(b).

(e)

Effective date.

[Reserved]. For further guidance, see § 1.482-2T(e).

Par. 7.

Section 1.482-2T is added to read as follows:

§ 1.482-2T

Determination of taxable income in specific situations (temporary).

(a) [Reserved]. For further guidance, see § 1.482-2(a).

(b)

Rendering of services.

For rules governing allocations under section 482 to reflect an arm's length charge for controlled transactions involving the rendering of services, see § 1.482-9T.

(c) [Reserved]. For further guidance, see § 1.482-2(c).

(d) [Reserved]. For further guidance, see § 1.482-2(d).

(e)

Effective date

—(1)

In general.

The provision of paragraph (b) of this section is generally applicable for taxable years beginning after December 31, 2006.

(2)

Election to apply regulation to earlier taxable years.

A person may elect to apply the provisions of paragraph (b) of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9T(n)(2).

(3)

Expiration date.

The applicability of § 1.482-2T expires on or before July 31, 2009.

Par. 8.

Section 1.482-4 is amended as follows:

1. Paragraph (f)(3) is revised.

2. Paragraphs (f)(4) and (f)(5) are redesignated as paragraphs (f)(5) and (f)(6), respectively.

3. New paragraphs (f)(4) and (f)(7) are added.

The revision and additions read as follows:

§ 1.482-4

Methods to determine taxable income in connection with a transfer of intangible property.

(f) * * *

(3) [Reserved]. For further guidance, see § 1.482-4T(f)(3).

(4) [Reserved]. For further guidance, see § 1.482-4T(f)(4).

(7) [Reserved]. For further guidance, see § 1.482-4T(f)(7).

Par. 9.

Section 1.482-4T is added to read as follows:

§ 1.482-4T

Methods to determine taxable income in connection with a transfer of intangible property (temporary).

(a) through (f)(2) [Reserved]. For further guidance, see § 1.482-4(a) through (f)(2).

(f)(3)

Ownership of intangible property

—(i)

Identification of owner

—(A)

In general.

The legal owner of an intangible pursuant to the intellectual property law of the relevant jurisdiction, or the holder of rights constituting an intangible pursuant to contractual terms (such as the terms of a license) or other legal provision, will be considered the sole owner of the respective intangible for purposes of this section unless such ownership is inconsistent with the economic substance of the underlying transactions. See § 1.482-1(d)(3)(ii)(B) (identifying contractual terms). If no owner of the respective intangible is identified under the intellectual property law of the relevant jurisdiction, or pursuant to contractual terms (including terms imputed pursuant to § 1.482-1(d)(3)(ii)(B)) or other legal provision, then the controlled taxpayer who has control of the intangible, based on all the facts and circumstances, will be considered the sole owner of the intangible for purposes of this section.

(B)

Cost sharing arrangements.

The rule in paragraph (f)(3)(i)(A) of this section will apply to interests in covered intangibles, as defined in § 1.482-7(b)(4)(iv), only as provided in § 1.482-7 (sharing of costs).

(ii)

Examples.

The principles of this paragraph (f)(3) are illustrated by the following examples:

Example 1.

FP, a foreign corporation, is the registered holder of the AA trademark in the United States. FP licenses to its U.S. subsidiary, USSub, the exclusive rights to manufacture and market products in the United States under the AA trademark. FP is the owner of the trademark pursuant to intellectual property law. USSub is the owner of the license pursuant to the terms of the license, but is not the owner of the trademark. See paragraphs (b)(3) and (4) of this section (defining an intangible as, among other things, a trademark or a license).

Example 2.

The facts are the same as in

Example 1

. As a result of its sales and marketing activities, USSub develops a list of several hundred creditworthy customers that regularly purchase AA trademarked products. Neither the terms of the contract between FP and USSub nor the relevant intellectual property law specify which party owns the customer list. Because USSub has knowledge of the contents of the list, and has practical control over its use and dissemination, USSub is considered the sole owner of the customer list for purposes of this paragraph (f)(3).

(4)

Contribution to the value of an intangible owned by another

—(i)

In general.

The arm's length consideration for a contribution by one controlled taxpayer that develops or enhances the value, or may be reasonably anticipated to develop or enhance the value, of an intangible owned by another controlled taxpayer will be determined in accordance with the applicable rules under section 482. If the consideration for such a contribution is embedded within the contractual terms for a controlled transaction that involves such intangible, then ordinarily no separate allocation will be made with respect to such contribution. In such cases, pursuant to § 1.482-1(d)(3), the contribution must be accounted for in evaluating the comparability of the controlled transaction to uncontrolled comparables, and accordingly in determining the arm's length consideration in the controlled transaction.

(ii)

Examples.

The principles of this paragraph (f)(4) are illustrated by the following examples:

Example 1.

A, a member of a controlled group, allows B, another member of the controlled group, to use tangible property, such as laboratory equipment, in connection with B's development of an intangible that B owns. By furnishing tangible property, A makes a contribution to the development of an intangible owned by another controlled taxpayer, B. Pursuant to paragraph (f)(4)(i) of this section, the arm's length charge for A's furnishing of tangible property will be determined under the rules for use of tangible property in § 1.482-2(c).

Example 2.

(i)

Facts.

FP, a foreign producer of wristwatches, is the registered holder of the YY trademark in the United States and in other countries worldwide. FP enters into an exclusive, five-year, renewable agreement with its newly organized U.S. subsidiary, USSub. The contractual terms of the agreement grant USSub the exclusive right to re-sell trademark YY wristwatches in the United States, obligate USSub to pay a fixed price per wristwatch throughout the entire term of the contract, and obligate both FP and USSub to undertake without separate compensation specified types and levels of marketing activities.

(ii) The consideration for FP's and USSub's marketing activities, as well as the consideration for the exclusive right to re-sell YY trademarked merchandise in the United States, are embedded in the transfer price paid for the wristwatches. Accordingly, pursuant to paragraph (f)(4)(i) of this section, ordinarily no separate allocation would be appropriate with respect to these embedded contributions.

(iii) Whether an allocation is warranted with respect to the transfer price for the wristwatches is determined under §§ 1.482-1, 1.482-3, and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, including the nature of the intangible embedded in the wristwatches and the nature of the marketing activities required under the agreement. This analysis would also take into account that the compensation for the activities performed by USSub and FP, as well as the consideration for USSub's use of the YY trademark, is embedded in the transfer price for the wristwatches, rather than provided for in separate agreements. See §§ 1.482-3(f) and 1.482-9T(m)(4).

Example 3.

(i)

Facts.

FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries. In year 1, FP licenses to a newly organized U.S. subsidiary, USSub, the exclusive rights to use certain manufacturing and marketing intangibles to manufacture and market athletic gear in the United States under the AA trademark. The license agreement obligates USSub to pay a royalty based on sales of trademarked merchandise. The license agreement also obligates FP and USSub to perform without separate compensation specified types and levels of marketing activities. In year 1, USSub manufactures and sells athletic gear under the AA trademark in the United States.

(ii) The consideration for FP's and USSub's respective marketing activities is embedded in the contractual terms of the license for the AA trademark. Accordingly, pursuant to paragraph (f)(4)(i) of this section, ordinarily no separate allocation would be appropriate with respect to the embedded contributions in year 1. See § 1.482-9T(m)(4).

(iii) Whether an allocation is warranted with respect to the royalty under the license agreement would be analyzed under § 1.482-1 and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of the license, the nature of the intangibles subject to the license, and the nature of the marketing activities required to be undertaken pursuant to the license. Pursuant to paragraph (f)(4)(i) of this section, the analysis would also take into account the fact that the compensation for the marketing services is embedded in the royalty paid for use of the AA trademark, rather than provided for in a separate services agreement. For illustrations of application of the best method rule, see § 1.482-8T

Example 10

,

Example 11

, and

Example 12

.

Example 4.

(i)

Facts.

The year 1 facts are the same as in

Example 3

, with the following exceptions. In year 2, USSub undertakes certain incremental marketing activities, in addition to those required by the contractual terms of the license for the AA trademark executed in year 1. The parties do not execute a separate agreement with respect to these incremental marketing activities performed by USSub The license agreement executed in year 1 is of sufficient duration that it is reasonable to anticipate that USSub will obtain the benefit of its incremental activities, in the form of increased sales or revenues of trademarked products in the U.S. market.

(ii) To the extent that it was reasonable to anticipate that USSub's incremental marketing activities would increase the value only of USSub's intangible (that is, USSub's license to use the AA trademark for a specified term), and not the value of the AA trademark owned by FP, USSub's incremental activities do not constitute a contribution for which an allocation is warranted under paragraph (f)(4)(i) of this section.

Example 5.

(i)

Facts.

The year 1 facts are the same as in

Example 3.

In year 2, FP and USSub enter into a separate services agreement that obligates USSub to perform certain incremental marketing activities to promote AA trademark athletic gear in the United States, above and beyond the activities specified in the license agreement executed in year 1. In year 2, USSub begins to perform these incremental activities, pursuant to the separate services agreement with FP.

(ii) Whether an allocation is warranted with respect to USSub's incremental marketing activities covered by the separate services agreement would be evaluated under §§ 1.482-1 and 1.482-9T, including a comparison of the compensation provided for the services with the results obtained under a method pursuant to § 1.482-9T, selected and applied in accordance with the best method rule of § 1.482-1(c).

(iii) Whether an allocation is warranted with respect to the royalty under the license agreement is determined under § 1.482-1 and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of the license, the nature of the intangibles subject to the license, and the nature of the marketing activities required to be undertaken pursuant to the license. The comparability analysis would take into account that the compensation for the incremental activities by USSub is provided for in the separate services agreement, rather than embedded in the royalty paid for use of the AA trademark. For illustrations of application of the best method rule, see § 1.482-8T

Example 10

,

Example 11

, and

Example 12.

Example 6.

(i)

Facts.

The year 1 facts are the same as in

Example 3.

In year 2, FP and USSub enter into a separate services agreement that obligates FP to perform incremental marketing activities, not specified in the year 1 license, by advertising AA trademarked athletic gear in selected international sporting events, such as the Olympics and the soccer World Cup. FP's corporate advertising department develops and coordinates these special promotions. The separate services agreement obligates USSub to pay an amount to FP for the benefit

to USSub that may reasonably be anticipated as the result of FP's incremental activities. The separate services agreement is not a qualified cost sharing arrangement under § 1.482-7. FP begins to perform the incremental activities in year 2 pursuant to the separate services agreement.

(ii) Whether an allocation is warranted with respect to the incremental marketing activities performed by FP under the separate services agreement would be evaluated under § 1.482-9T. Under the circumstances, it is reasonable to anticipate that FP's activities would increase the value of USSub's license as well as the value of FP's trademark. Accordingly, the incremental activities by FP may constitute in part a controlled services transaction for which USSub must compensate FP. The analysis of whether an allocation is warranted would include a comparison of the compensation provided for the services with the results obtained under a method pursuant to § 1.482-9T, selected and applied in accordance with the best method rule of § 1.482-1(c).

(iii) Whether an allocation is appropriate with respect to the royalty under the license agreement would be evaluated under § 1.482-1 through § 1.482-6 of this section. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of USSub's license, the nature of the intangibles subject to the license, and the marketing activities required to be undertaken by both FP and USSub pursuant to the license. This comparability analysis would take into account that the compensation for the incremental activities performed by FP was provided for in the separate services agreement, rather than embedded in the royalty paid for use of the AA trademark. For illustrations of application of the best method rule, see § 1.482-8T,

Example 10

,

Example 11

, and

Example 12.

(f)(5) and (f)(6) [Reserved]. For further guidance, see § 1.482-4(f)(5) and (f)(6).

(f)(7)

Effective date.

(i)

In general.

The provisions of paragraphs (f)(3) and (f)(4) are generally applicable for taxable years beginning after December 31, 2006.

(ii)

Election to apply regulation to earlier taxable years.

A person may elect to apply the provisions of paragraphs (f)(3) and (f)(4) of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9T(n)(2).

(iii)

Expiration date.

The applicability of § 1.482-4T expires on or before July 31, 2009.

Par. 10.

Section 1.482-6 is amended by revising paragraphs (c)(2)(ii)(B)(

1

), (c)(2)(ii)(D), (c)(3)(i)(A), (c)(3)(i)(B), and (c)(3)(ii)(D) to read as follows:

The revisions and addition read as follows:

§ 1.482-6

Profit split method.

(c) * * *

(2) * * *

(ii) * * *

(B) * * * (

1

) * * * [Reserved]. For further guidance, see § 1.482-6T(c)(2)(ii)(B)(

1

).

(D) [Reserved]. For further guidance, see § 1.482-6T(c)(2)(ii)(D).

(3) * * *

(i) * * *

(A) [Reserved]. For further guidance, see § 1.482-6T(c)(3)(i)(A).

(B) [Reserved]. For further guidance, see § 1.482-6T(c)(3)(i)(B).

(ii) * * *

(D) [Reserved]. For further guidance, see § 1.482-6T(c)(3)(ii)(D).

Par. 11.

Section 1.482-6T is added to read as follows:

§ 1.482-6T

Profit split method (temporary).

(a) through (c)(2)(ii)(A) [Reserved]. For further guidance, see § 1.482-6(a) through (c)(2)(ii)(A).

(c)(2)(ii)(B)

Comparability

—(

1

)

In general.

The degree of comparability between the controlled and uncontrolled taxpayers is determined by applying the comparability provisions of § 1.482-1(d). The comparable profit split compares the division of operating profits among the controlled taxpayers to the division of operating profits among uncontrolled taxpayers engaged in similar activities under similar circumstances. Although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on the considerations described under the comparable profits method in § 1.482-5(c)(2) or § 1.482-9T(f)(2)(iii) because this method is based on a comparison of the operating profit of the controlled and uncontrolled taxpayers. In addition, because the contractual terms of the relationship among the participants in the relevant business activity will be a principal determinant of the allocation of functions and risks among them, comparability under this method also depends particularly on the degree of similarity of the contractual terms of the controlled and uncontrolled taxpayers. Finally, the comparable profit split may not be used if the combined operating profit (as a percentage of the combined assets) of the uncontrolled comparables varies significantly from that earned by the controlled taxpayers.

(c)(2)(ii)(B)(

2

) through (C) [Reserved]. For further guidance, see § 1.482-6(c)(2)(ii)(B)(

2

) through (C).

(c)(2)(ii)(D)

Other factors affecting reliability.

Like the methods described in §§ 1.482-3, 1.482-4, 1.482-5 and 1.482-9T, the comparable profit split relies exclusively on external market benchmarks. As indicated in § 1.482-1(c)(2)(i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the comparable profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and assumptions are significantly more reliable with respect to one of the parties than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results.

(c)(3)(i) [Reserved]. For further guidance, see § 1.482-6(c)(3)(i).

(c)(3)(i)(A)

Allocate income to routine contributions.

The first step allocates operating income to each party to the controlled transactions to provide a market return for its routine contributions to the relevant business activity. Routine contributions are contributions of the same or a similar kind to those made by uncontrolled taxpayers involved in similar business activities for which it is possible to identify market returns. Routine contributions ordinarily include contributions of tangible property, services and intangibles that are generally owned by uncontrolled taxpayers engaged in similar activities. A functional analysis is required to identify these contributions according to the functions performed, risks assumed, and resources employed by each of the controlled taxpayers. Market returns for the routine contributions should be determined by reference to the returns achieved by uncontrolled taxpayers engaged in similar activities, consistent with the methods described in §§ 1.482-3, 1.482-4, 1.482-5 and 1.482-9T.

(B)

Allocate residual profit

—(

1

)

Nonroutine contributions generally.

The allocation of income to the controlled taxpayer's routine contributions will not reflect profits attributable to each controlled taxpayer's contributions to the relevant business activity that are not routine (nonroutine contributions). A nonroutine contribution is a contribution that is not accounted for as a routine contribution. Thus, in cases where such nonroutine contributions are present there normally will be an unallocated residual profit after the allocation of income described in

paragraph (c)(3)(i)(A) of this section. Under this second step, the residual profit generally should be divided among the controlled taxpayers based upon the relative value of their nonroutine contributions to the relevant business activity. The relative value of the nonroutine contributions of each taxpayer should be measured in a manner that most reliably reflects each nonroutine contribution made to the controlled transaction and each controlled taxpayer's role in the nonroutine contributions. If the nonroutine contribution by one of the controlled taxpayers is also used in other business activities (such as transactions with other controlled taxpayers), an appropriate allocation of the value of the nonroutine contribution must be made among all the business activities in which it is used.

(

2

)

Nonroutine contributions of intangible property.

In many cases, nonroutine contributions of a taxpayer to the relevant business activity may be contributions of intangible property. For purposes of paragraph (c)(3)(i)(B)(

1

) of this section, the relative value of nonroutine intangible property contributed by taxpayers may be measured by external market benchmarks that reflect the fair market value of such intangible property. Alternatively, the relative value of nonroutine intangible property contributions may be estimated by the capitalized cost of developing the intangible property and all related improvements and updates, less an appropriate amount of amortization based on the useful life of each intangible. Finally, if the intangible development expenditures of the parties are relatively constant over time and the useful life of the intangible property contributed by all parties is approximately the same, the amount of actual expenditures

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