# Section 482: Methods To Determine Taxable Income in Connection With a Cost Sharing Arrangement

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2011-32458

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** December 22, 2011
- **Citation:** 76 FR 80082

## Text

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 301, and 602
[TD 9568]
RIN 1545-BI47
Section 482: Methods To Determine Taxable Income in Connection With a Cost Sharing Arrangement

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations and removal of temporary regulations.

SUMMARY:

This document contains final regulations regarding methods to determine taxable income in connection with a cost sharing arrangement under section 482 of the Internal Revenue Code (Code). The final regulations address issues that have arisen in administering the current cost sharing regulations. The final regulations affect domestic and foreign entities that enter into cost sharing arrangements described in the final regulations.

DATES:

Effective Date:
These regulations are effective on December 16, 2011.

Applicability Date:
For dates of applicability, see §§ 1.482-1(j)(6)(i), 1.482-2(f), 1.482-4(h), 1.482-7(l), 1.482-8(c), 1.482-9(n)(3), and 1.301-7701-1(f).

FOR FURTHER INFORMATION CONTACT:

Joseph L. Tobin, (202) 435-5265 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1364. The collections of information in these final regulations are in § 1.482-7(b)(2) and (k). Responses to the collections of information are required by the IRS to monitor compliance of controlled taxpayers with the provisions applicable to cost sharing arrangements.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by section 6103 of the Code.

Background

A notice of proposed rulemaking and notice of public hearing regarding additional guidance to improve compliance with, and administration of, the rules in connection with a cost sharing arrangement (CSA) were published in the
Federal Register
(70 FR 51116) (REG-144615-02) on August 29, 2005 (2005 proposed regulations). A correction to the notice of proposed rulemaking and notice of public hearing was published in the
Federal Register
(70 FR 56611) on September 28, 2005. A public hearing was held on December 16, 2005.

The Treasury Department and the IRS received numerous comments on a wide range of issues addressed in the 2005 proposed regulations. In response to these comments, temporary and proposed regulations were published in the
Federal Register
(74 FR 340-01 and 74 FR 236-01) (REG-144615-02) on January 5, 2009 (2008 temporary regulations). Corrections to the 2008 temporary regulations were published in the
Federal Register
on February 27, 2009 (74 FR 8863-01), March 5, 2009 (74 FR 9570-01, 74 FR 9570-02, and 74 FR 9577-01), and March 19, 2009 (74 FR 11644-01). A public hearing was held on April 21, 2009.

The Treasury Department and the IRS received comments on a range of issues addressed in the 2008 temporary regulations. These final regulations make several changes to the 2008 temporary regulations in response to these comments. In addition, a number of editorial clarifications have been made. These regulations adopt the effective date and transition rules under the 2008 temporary regulations so that they are generally applicable for all CSAs, with transition rules for certain preexisting arrangements in existence prior to January 5, 2009.

Explanation of Provisions

A. Overview—Economic Contributions and Their Arm's Length Compensation in a CSA

These final regulations provide guidance on the determination of and compensation for all economic contributions by all controlled participants in connection with a CSA in accordance with the arm's length standard.

The arm's length analysis under section 482 begins with the factual and functional analysis of the actual transaction or transactions among the controlled taxpayers. In a CSA, the controlled participants make economic contributions of two types, namely, mutual commitments to prospectively share intangible development costs in proportion to their reasonably anticipated benefits from exploitation of the cost shared intangibles (cost contributions) and to provide any existing resources, capabilities, or rights that are reasonably anticipated to contribute to developing cost shared intangibles (platform contributions). CSAs may also involve economic contributions by the controlled participants of other existing resources, capabilities, or rights related to the exploitation of cost shared intangibles (operating contributions). The concepts of platform and operating contributions are intended to encompass any existing inputs that are reasonably anticipated to facilitate developing or exploiting cost shared intangibles at any time, including resources, capabilities, or rights, such as expertise in decision-making concerning research and product development, manufacturing or marketing intangibles or services, and management oversight and direction. Other prospective economic contributions consist of costs incurred to develop or acquire resources, capabilities, and rights that facilitate the exploitation of cost shared intangibles (operating cost contributions). These regulations provide guidance for determining the arm's length charge for all such contributions to clearly reflect the incomes of the controlled participants.

The valuation guidance in the regulations applies to determine the most reliable measure of arm's length results for these economic contributions over the duration of the activity of developing and exploiting cost shared intangibles (CSA Activity). The combined effect of multiple contributions, potentially including controlled transactions outside of the CSA (for example, make-or-sell licenses, or intangible transfers governed by section 367(d)), may need to be evaluated on an aggregate basis, where that approach provides the most reliable measure of an arm's length result. So, for example, if a taxpayer transfers intangibles in a transaction governed by section 367(d) in connection with contributions related to those same intangibles in connection with a CSA, then the pricing of the intangibles under section 367(d) may need to be evaluated along with the pricing of all contributions in connection with the CSA on an aggregate basis, where that approach provides the most reliable measure of an arm's length result. Under

the principles of the investor model, the relative reliability of the analysis will depend on the degree of consistency of the valuation with the expectation that each controlled participant's net investment attributable to cost contributions, platform contributions, operating contributions, and operating cost contributions, is reasonably anticipated to earn a rate of return (which might be reflected in a discount rate used in applying a method) appropriate to the riskiness of the controlled participant's CSA Activity over the entire period of the CSA Activity. The duration of the CSA Activity may, or may not, correspond to the conventional concept of useful life with respect to any of the underlying economic contributions; it represents the period over which the controlled participants reasonably anticipate returns from the CSA Activity.

For purposes of determining the best method of measuring the arm's length results of a CSA, and any related controlled transactions, these regulations adopt the guidance included in the 2008 temporary regulations on assessing the potential applicability of the comparable uncontrolled transaction (CUT) method. The arm's length standard seeks to determine the results that would obtain had uncontrolled taxpayers engaged in the same transaction under the same circumstances. It is immaterial whether the arrangement among uncontrolled taxpayers is denominated as a “cost sharing arrangement,” so long as the arrangement involves the same circumstances (or similar circumstances, assuming that reliable adjustments can be made to account for any differences). Thus, long-term licenses or research and development services contracts may provide CUTs, provided and to the extent they involve the same or similar scope and contractual terms, uncertainty of outcomes, profit potential, allocation of intangible development and exploitation risks, including allocation of the risks of existing contributions and the risks of developing future contributions, consistent with the actual allocation of risks under the CSA and through related controlled transactions.

A CSA may benefit from, and contribute to, a controlled group's unique competitive advantages. Therefore, there may be no uncontrolled transactions that reliably reflect the same contributions by the parties, over a similar period of commitment, and with the same risk profile and profit potential. The arm's length standard requires application of the method that most reliably reflects the results that would have been realized had uncontrolled taxpayers engaged in the same transaction. Where comparable uncontrolled transactions are unavailable, these regulations, like other regulations under section 482, allow for reference to the results the controlled taxpayers could have realized by choosing a realistic alternative. These regulations adopt a specified income method included in the 2008 temporary regulations that represents an application of the realistic alternatives principle. These regulations adopt the 2008 temporary regulations' provision of a licensing alternative to the CSA that closely aligns with the economics of the CSA, but takes account of the licensor's commitment to bear the entire risk of the intangible development that would otherwise have been shared. The realistic alternatives analysis effectively constructs a comparable uncontrolled transaction that, depending on the facts and circumstances, may more reliably reflect the economics of the actual contributions to the CSA than can be derived from third party transactions. For cases where more than one controlled participant makes significant contributions to residual profits (including platform or operating contributions), these regulations adopt the guidance included in the 2008 temporary regulations on a specified residual profit split method (RPSM), which is also an application of the realistic alternatives principle.

These regulations also adopt guidance on the application of two other specified methods included in the 2008 temporary regulations—the acquisition price method and the market capitalization method. The guidance regarding unspecified methods adopted from the 2008 temporary regulations reemphasizes that any such method should take into account the general principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction, and enter into a particular transaction only if none of the alternatives is clearly preferable to it.

These regulations resolve issues that have been raised under the 1995 regulations. No inference is intended regarding the appropriate resolution of those issues under the 1995 regulations. These regulations do not turn on whether a given transaction in connection with a CSA involves intangible property within the meaning of section 936(h)(3)(B), or whether such item has been transferred, licensed, or retained. Rather, if a controlled participant devotes, in whole or part, any existing resource, capability, or right to intangible development for the benefit of another controlled participant, whether by transfer or license to the other controlled participant, or by leveraging such resource, capability, or right within the context of the CSA, then the regulations require an arm's length charge for such platform contribution, in addition to the funding of intangible development costs.

For example, the regulations require an arm's length charge for one controlled participant's platform contribution commitment of a particular research team's experience and expertise to intangible development under a CSA, in addition to the controlled participants' sharing of the ongoing intangible development costs of the salaries of such researchers. To limit the arm's length charge in these circumstances to sharing the ongoing salary costs would ignore the value of having the particular research team already in place to undertake the intangible development with the benefit of its particular knowhow. See § 1.482-7(c)(5),
Example 2.
As another example, the contribution of core entrepreneurial functions such as product selection, market positioning, research strategy, and risk determinations and management requires an arm's length charge under these regulations. To omit charges for these or any other significant economic contributions one controlled taxpayer makes for another's benefit would fail to clearly reflect the incomes of such controlled taxpayers.

A unifying underpinning of the section 482 regulations is that controlled transactions reflecting similar economics, regardless of the type of transaction (such as transfer of intangibles or provision of services), should be valued in accordance with similar principles and methods. See, for example, § 1.482-1(b)(2)(iii). In conjunction with finalizing § 1.482-7, parallel rules are also finalized in §§ 1.482-4(g) and 1.482-9(m)(3). Under these provisions, the principles and methods for valuing platform and operating contributions under a CSA may also apply for purposes of determining the best method, which may be an unspecified method, for valuing similar contributions in connection with controlled transfers of intangibles or provisions of services.

B. Platform Contributions, Make-or-Sell Rights Excluded—§ 1.482-7(c)(4)

A comment requested clarification of the treatment of an item—e.g., a program or tool to facilitate research (research tools)—used under a CSA to further the development of intangibles targeted by the CSA, as within, or

outside, the definition of make-or-sell rights. The Treasury Department and the IRS intend research tools to be treated as platform contributions, and not as excluded make-or-sell rights. Accordingly, § 1.482-7(c)(4)(i) has been modified and a new example added to illustrate this concept.

C. Intangible Development Activity and Costs—§ 1.482-7(d)(3)

The Treasury Department and the IRS requested comments in Notice 2005-99, 2005-52 CB 1214, regarding the valuation of stock options and other stock-based compensation. Several comments were received. The Treasury Department and the IRS continue to consider the matters described in Notice 2005-99, and intend to address these issues in a subsequent regulations project.

D. Reasonably Anticipated Benefit Shares—§ 1.482-7(e)(1)(i)

Several comments requested clarification concerning how and when to update reasonably anticipated benefit (RAB) shares, and whether such updates may be made retroactively or only prospectively. In response to these comments, the Treasury Department and the IRS added several sentences to § 1.482-7(e)(1)(i) to clarify that RAB shares determined for a particular purpose should not be further updated for that purpose based on information not available at the time that determination needed to be made. For example, RAB shares determined in order to determine intangible development cost shares for a particular taxable year should not be recomputed based on information not available during that particular taxable year, and RAB shares determined for the purpose of using a particular transfer pricing method to evaluate the arm's length amount charged in a PCT should not be recomputed based on information not available on the date of that PCT. An example is added to illustrate this clarification. See § 1.482-7(e)(1)(iii),
Example 2.
For readability, a portion of the text of § 1.482-7T(e)(1)(i) was redesignated as § 1.482-7(e)(1)(ii), and § 1.482-7T(e)(1)(ii) was redesignated as § 1.482-7(e)(1)(iii). The Treasury Department and the IRS also observe in these clarifications that nothing in § 1.482-7(e)(1) limits the Commissioner's use of subsequently available information for purposes of its allocation determinations in accordance with the provisions of § 1.482-7(i) (Allocations by the Commissioner in connection with a CSA).

E. Transfer Pricing Methods—§ 1.482-7(g)

1. Supplemental Guidance on Methods Applicable to PCTs—§ 1.482-7(g)(1)

One method for determining the arm's length charge for a contribution is to calculate the total present value of the stream of future economic benefits one can expect in connection with such contribution. In a CSA, the stream of anticipated economic benefits to be discounted will reflect the economic benefits expected to arise from cost shared intangibles to be developed under the CSA. Consequently, the arm's length charge for a PCT can appropriately be determined by taking into account the economic benefits anticipated to be produced in the future by cost shared intangibles developed under the CSA. Accordingly, a sentence has been added to paragraph (g)(1) to clarify that each method used for evaluating the arm's length amount charged in a PCT must yield results consistent with measuring the value of a platform contribution by reference to the future income anticipated to be generated by the resulting cost shared intangibles.

2. Best Method Analysis Considerations and the Income Method—§ 1.482-7(g)(2) and (4)

a. Discounting Operating Income—§ 1.482-7(g)(2)(v)

The preamble to the 2008 temporary regulations solicited comments on whether and how the cost sharing rules could reliably be administered on the basis of cash flows instead of operating income, and whether such a basis is consistent with the second sentence of section 482. No comments were received that addressed this request, though some comments did object to the use of operating income, rather than cash flows, in the cost sharing rules.

The Treasury Department and the IRS believe that, while the use of cash flow projections is permitted under the regulations, detailed guidance on the specific applications of the methods should be based on discounting operating income rather than cash flows for a number of practical and administrative reasons and, accordingly, no changes were adopted to address this issue.

b. Financial Projections and Discount Rates—§ 1.482-7(g)(2)(v) and (vi)

Under the temporary regulations, the specific applications of the income method discussed in § 1.482-7(g)(4) require a number of input parameters, including financial projections and the associated discount rate under the licensing alternative, and financial projections and the associated discount rate under the cost sharing alternative. These regulations modify the 2008 temporary regulations in several respects to clarify the interaction of these input parameters in applying the income method.

i. Financial Projections for the Licensing and Cost Sharing Alternatives Are Interrelated

These regulations provide that, under the specific applications of the income method, the financial projections associated with the licensing and cost sharing alternatives are the same except for the licensing payments to be made under the licensing alternative, and the cost contributions and PCT Payments to be made under the cost sharing alternative. Thus, for example, if the PCT Payor anticipates sales associated with the cost shared intangibles to third parties of $100 in the cost sharing alternative, then it must anticipate sales associated with the licensed intangible to third parties of this same $100 under the licensing alternative. Similarly, if the PCT Payor's anticipated selling costs associated with those sales are $60 in the cost sharing alternative, then its anticipated selling costs are the same $60 in the licensing alternative. The financial projections associated with the licensing alternative to the CSA are closely associated with the financial projections associated with the cost sharing alternative, differing only in the treatment of licensing payments, cost contributions, and PCT Payments. As a result, the income method, as in the case of the more traditional discounted cash flow methods, builds off of the (single) probability-weighted financial projections associated with the CSA Activity.

ii. Discount Rates for the Licensing and Cost Sharing Alternatives Are Interrelated

The Treasury Department and the IRS received several comments requesting further guidance on the relationship between the discount rate that is appropriate for discounting the operating income associated with the cost sharing alternative and the discount rate that is appropriate for discounting the operating income associated with the licensing alternative. In response to these comments, and as a corollary to the interrelationship of the financial projections for the licensing and cost sharing alternatives discussed in the preceding paragraph, these regulations provide further guidance on the discount rates appropriate for these two alternatives. Specifically, the difference,

if any, in market-correlated risks between the licensing and cost sharing alternatives is due solely to the different effects on risks of the PCT Payor making licensing payments under the licensing alternative, and the PCT Payor making cost contributions and PCT Payments under the cost sharing alternative. That is, the difference in risk between the two scenarios solely reflects (1) the incremental risk, if any, associated with the cost contributions taken on by the PCT Payor in developing the cost shared intangible under the cost sharing alternative, and (2) the difference in risk, if any, associated with the particular payment forms of the licensing payments and the PCT Payments, in light of the fact that the licensing payments in the licensing alternative are partially replaced by cost contributions and partially replaced by PCT Payments in the cost sharing alternative, each with its own payment form.

c. Valuation Undertaken on a Pre-Tax Basis—§ 1.482-7(g)(2)(x)

Several comments requested that the final regulations clarify the term “tax rate” for purposes of determining amounts on a pre-tax basis. In response, that term has been clarified in § 1.482-7(j)(1) to mean the reasonably anticipated effective tax rate with respect to the pre-tax income to which the rate of tax is being applied. For example, under the income method, this rate would be the reasonably anticipated effective tax rate of the PCT Payor or PCT Payee under the cost sharing alternative or licensing alternative, as appropriate. See § 1.482-7(g)(4)(i)(G).

Several comments also requested clarification on the guidance concerning the determination of pre-tax PCT Payments under the income method. While PCT Payments must be determined on a pre-tax basis, in general, the financial projections and discount rates used to apply the income method are post-tax measures. Comments suggested that this discrepancy makes such a determination difficult and raises concerns about valuation principles to derive a pre-tax PCT Payment based on post-tax data.

The Treasury Department and the IRS believe that the requirement that PCT Payments be determined on a pre-tax basis is fundamental to the determination of an arm's length result, and, while no changes were made to the regulations in this regard, examples were added to illustrate this concept. Under the income method, the operative rule in all cases is to derive the pre-tax PCT Payments that set the post-tax present value of the cost sharing alternative equal to the post-tax present value of the licensing alternative. The operative rule can be satisfied in a number of ways. For example, annual pre-tax PCT Payments can be directly determined such that, when incorporated into the PCT Payor's financial projections (which should reflect the deductibility of the pre-tax PCT Payments), the post-tax net present values of the licensing and cost sharing alternatives are equated. See § 1.482-7(g)(4)(viii),
Example 4.
Alternatively, the present value of post-tax PCT Payments can be directly determined by subtracting the present value of the post-tax income associated with the licensing alternative from the present value of the post-tax income associated with the cost sharing alternative (exclusive of the PCT Payment). This difference, which reflects the post-tax present value of the PCT Payment, must be grossed up to derive the pre-tax PCT Payment. See § 1.482-7(g)(4)(viii),
Example 5.
Another alternative, in certain situations (for example, when financial projections are based on income, rather than cash flows, and when a controlled participant's tax rate is not materially affected by whether it enters into the cost sharing or licensing alternative), is for the present value of pre-tax PCT Payments to be directly determined by subtracting the present value of the pre-tax income associated with the licensing alternative from the present value of the pre-tax income associated with the cost sharing alternative (exclusive of the PCT Payment), both discounted at post-tax discount rates. That is, under certain conditions the pre-tax PCT Payments that equate the pre-tax present values of the two alternatives will also equate the post-tax present values of the two alternatives (which satisfies the operative rule). This last method does not reflect a violation of valuation theory, but merely a method that applies under certain conditions to derive the pre-tax PCT Payment more directly, rather than deriving the post-tax PCT Payment under the operative rule and grossing it up. Discounting pre-tax income with post-tax discount rates conceptually provides a measure of pre-tax income. Discounting pre-tax income with pre-tax discount rates, on the other hand, conceptually provides a measure of post-tax income. See § 1.482-7(g)(4)(viii),
Example 6.
The specific applications of the income method described in paragraphs (g)(4)(ii) through (iv) and the examples set forth in paragraph (g)(4)(viii) of these final regulations assume that such circumstances apply, but the regulations do not exclude other applications.

3. Acquisition Price and Market Capitalization Methods—§ 1.482-7(g)(5) and (6)

The acquisition price method as specified in § 1.482-7(g)(5) typically may be considered for determining PCT Payments with respect to platform contributions as a result of asset or stock acquisitions. Comments were received that, with some acquisitions, there may be benefits to the controlled group whose scope extends beyond the development of cost shared intangibles. The Treasury Department and the IRS agree that these facts and circumstances should be taken into account in the appropriate application of the acquisition price method and any other methods for purposes of determining the best method, but believe that this is adequately addressed by other provisions of the section 482 regulations. See, for example, §§ 1.482-1(c) (Best method rule) and (d) (Comparability), and 1.482-7(g)(2)(iv) (Aggregation of transactions).

Several comments requested that the final regulations provide more guidance on what types of tax adjustments may be needed with respect to PCT Payments determined under the acquisition price or market capitalization method. The Treasury Department and the IRS believe that the determination as to whether to make such adjustments should be based on facts and circumstances of each case and thus are best addressed under the general comparability guidance in Treas. Reg. § 1.482-1(d) (Comparability). Therefore, the specific references to tax adjustments under those methods were removed.

4. Residual Profit Split Method—§ 1.482-7(g)(7)

The residual profit split method under § 1.482-7(g)(7) allocates a PCT Payor's nonroutine residual divisional profit or loss according to the controlled participants' relative nonroutine contributions. The calculation of nonroutine residual divisional profit or loss includes a subtraction of market returns for routine contributions. See § 1.482-7(g)(7)(iii)(B). These regulations clarify that market returns for operating cost contributions are included in, and market returns for cost contributions are excluded from, that subtraction. Market returns are not assigned to cost contributions because, under this method, resources, capabilities, and rights that benefit the development of cost shared intangibles (and thus make such development more valuable than

its cost) are compensated as platform contributions.

F. Form of Payment—§ 1.482-7(h)

1. Consistency of Form of Payment With Arm's Length Charge

Under the section 482 regulations, controlled taxpayers have flexibility to choose a form of payment with respect to an arm's length charge, provided that the form of payment may be reasonably expected to yield a value consistent with such arm's length charge determined as of the date of the PCT. Thus, a taxpayer must not only determine an arm's length charge correctly under § 1.482-7(g) but also designate a form of payment that is consistent with that arm's length charge determined as of the date of the PCT. This dual concept of the flexibility in selecting the form of payment as well as the obligation to preserve the arm's length charge through determining the form of payment as of the date of the PCT is clarified by a new sentence added to § 1.482-7(h)(2)(i).

2. Services Markup Form of Payment

Several comments suggested that the final regulations should expressly permit the use of methods in § 1.482-9, particularly the cost of services plus method, for valuing and determining the form of payment of PCT Payments for services provided as, for example, by a research team. As noted in the preceding paragraph, these regulations clarify the flexibility taxpayers enjoy to adopt a form of payment consistent with the arm's length charge determined for a PCT. In theory, therefore, the arm's length charge for a platform contribution of services of a research team might be converted into a cost-of-services-plus form of payment, provided that, among other conditions, the method and form of payment treating the platform value of such research team separately from the arm's length charge for any other platform contributions provide the most reliable measures of the arm's length charges. The experience of the IRS, however, is that the arm's length charges for platform contributions of the services of a research team along with other platform contributions (e.g., of a base technology) are most often most reliably determined in the aggregate.

G. Periodic Adjustments—§ 1.482-7(i)

1. Determination of Periodic Adjustments—§ 1.482-7(i)(6)(v) and (vi)

a. In General—§ 1.482-7(i)(6)(i)

The temporary regulations provided detailed guidance for the calculation of periodic adjustments in situations where there is a single adjustment with respect to a single controlled participant. The Treasury Department and the IRS intended that the principles of that detailed guidance should also be applied in cases involving multiple periodic adjustments (whether with respect to one or multiple controlled participants, or with respect to one or multiple PCT Payments) and, accordingly, § 1.482-7T(i)(6)(i) provided that the Commissioner may make periodic adjustments with respect to all PCT Payments between all PCT Payors and PCT Payees for the Adjustment Year and all subsequent years for the duration of the CSA Activity. In response to these comments, a new example in § 1.482-7(i)(6)(vii) illustrates the application of § 1.482-7(i)(6)(i) when more than one periodic adjustment is required.

b. Adjusted RPSM—§ 1.482-7(i)(6)(v)(B)

One comment suggested that the requirement that an adjusted RPSM be used for determining periodic adjustments is inconsistent with the arm's length standard because the arm's length standard requires that the best method rule be applied in all circumstances, and the adjusted RPSM will not be the best method in every circumstance. The Treasury Department and the IRS believe that this is sufficiently addressed by the 2008 temporary regulations, which provide for periodic adjustments to be administered consistent with the arm's length standard. Specifically, § 1.482-7(i)(6)(i) provides that, in determining whether to make periodic adjustments, the Commissioner may consider whether the outcome as adjusted more reliably reflects an arm's length result under all the relevant facts and circumstances.

c. Exceptions to Periodic Adjustments—§ 1.482-7(i)(6)(vi)

Several comments suggested that the definition of “divisional profits or losses” is too broad and includes too much value in the concept of the actually experienced return ratio (AERR), thereby making the numerator in the Periodic Trigger too large relative to the denominator, and thus too easily triggered. In response to this comment, the exception to periodic adjustments in § 1.482-7T(i)(6)(vi)(A)(
3
) is expanded to take into account the PCT Payor's routine platform contributions. The language is further clarified to provide that, in addition to the exclusion of certain profits or losses, the PCT Payor's divisional profits or losses are calculated by taking into account the expenses on account of operating cost contributions and routine platform contributions.

d. Contractual CWI Provisions—§ 1.482-1(d)(3)(ii)(C), Examples 3 Through 7

The IRS has encountered a number of contracts that contain price terms for transactions that are subject to section 482, including buy-ins and PCTs, that provide for contingent terms based on subsequent actual income experience. Some such terms specify a charge for the transaction and then further provide for adjustments to that charge based generally on the actual income results. Certain of these terms are specifically tied to the mechanics of the CWI regulations (for example, a price adjustment is required if the income is less than 80 percent or greater than 120 percent of the price charged). See §§ 1.482-4(f)(2)(ii)(B)(
6
) and (C)(
4
) and 1.482-7T(i)(6)(i) and (ii).

Controlled participants have flexibility in agreeing to contingent payment terms and, thus, in allocating upside or downside risk among the parties. In so doing, the parties can tie their prices to the income actually earned with respect to the subject of the buy-in or PCT. Such price terms must be determined on an upfront basis and must be coordinated and consistent with the arm's length charge. The IRS has experience, however, with taxpayers failing to provide for arm's length compensation for the allocation of risk, as well as failing to provide price terms that are sufficiently clear so as to constitute an upfront allocation of risk that has economic substance. Accordingly, several examples have been added to § 1.482-7(h)(2)(iii)(C) to illustrate the treatment of certain types of contingent price terms under these regulations, and apply the principles set forth in §§ 1.482-7(h)(2)(iii)(B) and (k)(1)(iv) and 1.482-1(d)(3)(ii)(B)(
1
) and (iii)(B).

2. Advance Pricing Agreement

As stated in the Preamble to the 2008 temporary regulations, the Treasury Department and the IRS are considering issuing a revenue procedure providing an exception to periodic adjustments, similar to exceptions provided in § 1.482-7(i)(6)(vi), in the context of an advance pricing agreement (APA) entered into pursuant to Rev. Proc. 2006-9, 2006-1 CB 278. Accordingly, no periodic adjustments would be made in any year based on a Trigger PCT that is a covered transaction under the APA. See § 601.601(d)(2)(ii)(
b
).

H. Administrative Requirements—§ 1.482-7(k)

1. CSA Statements, mailing to Ogden Campus—§ 1.482-7(k)(4)(iii)

A number of comments requested that the regulations provide a specific address for mailing CSA Statements to the Ogden Campus. In response to these comments, a specific mailing address for CSA Statements has been added to the regulations.

2. Advance Pricing Agreements

One comment requested that taxpayers with CSAs covered by APAs be relieved from the administrative requirements in § 1.482-7(k)(2) through (4). The Treasury Department and the IRS are considering guidance addressing this issue, and solicit further comments concerning the extent to which compliance with the APA procedures should be deemed to satisfy any of the administrative requirements under § 1.482-7(k)(2) through (4). These comments should address the impact of any such change on the ability of the IRS to properly examine CSA-related transactions.

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 has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collections of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that this rule applies to U.S. businesses and foreign affiliates that enter into cost sharing arrangements. Few small entities are expected to enter into cost sharing agreements, as defined by these regulations. Accordingly, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration (CCASBA) for comment on their impact on small businesses. CCASBA did not have any comments.

Drafting Information

The principal author of these regulations is Joseph L. Tobin of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and the Treasury Department participated in their development.

List of Subjects

26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR Part 602
Reporting and recordkeeping requirements.

Amendment to the Regulations

Accordingly, 26 CFR parts 1, 301, and 602 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 as follows:

Authority:

26 U.S.C. 7805 * * *

Section 1.482-7 also issued under 26 U.S.C. 482. * * *

Par 2.
Section 1.367(a)-1 is amended by revising paragraph (d)(3) to read as follows:

§ 1.367(a)-1
Transfers to foreign corporations subject to section 367(a): In general.

(d) * * *

(3)
Transfer.
For purposes of section 367 and regulations thereunder, the term “transfer” means any transaction that constitutes a transfer for purposes of section 332, 351, 354, 355, 356, or 361, as applicable. A person's entering into a cost sharing arrangement under § 1.482-7 or acquiring rights to intangible property under such an arrangement shall not be considered a transfer of property described in section 367(a)(1). See § 1.6038B-1T(b)(4) for the date on which the transfer is considered to be made.

Par. 3.
Section 1.367(a)-1T is amended by revising paragraph (d)(3) to read as follows:

§ 1.367(a)-1T
Transfers to foreign corporations subject to section 367(a): In general (temporary).

(d) * * *

(3) [Reserved]. For further guidance, see § 1.367(a)-1(d)(3).

Par. 4.
Section 1.482-0 is amended as follows:

1. The entries for § 1.482-1(b)(2)(i) and (iii) are revised.
2. The entries for § 1.482-2(e) and (f) are revised.
3. The entries for § 1.482-4(f)(3)(i)(B), (g) and (h) are revised.
4. The entry for § 1.482-7 is revised.
5. The entries for § 1.482-9(m)(3) and (n) are revised.
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.

(b) * * *

(2) * * *

(i) Methods.

(iii) Coordination of methods applicable to certain intangible development arrangements.

§ 1.482-2
Determination of taxable income in specific situations.

(e) Cost sharing arrangement.

(f) Effective/applicability Date.

(1) In general.

(2) Election to apply paragraph (b) to earlier taxable years.

§ 1.482-4
Methods to determine taxable income in connection with a transfer of intangible property.

(f) * * *

(3) * * *

(i) * * *

(B) Cost sharing arrangements.

(g) Coordination with rules governing cost sharing arrangements.

(h) Effective/applicability date.

(1) In general.

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

§ 1.482-7
Methods to determine taxable income in connection with a cost sharing arrangement.
(a) In general.

(1) RAB share method for cost sharing transactions (CSTs).

(2) Methods for platform contribution transactions (PCTs).

(3) Methods for other controlled transactions.

(i) Contribution to a CSA by a controlled taxpayer that is not a controlled participant.

(ii) Transfer of interest in a cost shared intangible.

(iii) Other controlled transactions in connection with a CSA.

(iv) Controlled transactions in the absence of a CSA.

(4) Coordination with the arm's length standard.

(b) Cost sharing arrangement.

(1) Substantive requirements.

(i) CSTs.

(ii) PCTs.

(iii) Divisional interests.

(iv) Examples.

(2) Administrative requirements.

(3) Date of a PCT.

(4) Divisional interests.

(i) In general.

(ii) Territorial based divisional interests.

(iii) Field of use based divisional interests.

(iv) Other divisional bases.

(v) Examples.

(5) Treatment of certain arrangements as CSAs.

(i) Situation in which Commissioner must treat arrangement as a CSA.

(ii) Situation in which Commissioner may treat arrangement as a CSA.

(iii) Examples.

(6) Entity classification of CSAs.

(c) Platform contributions.

(1) In general.

(2) Terms of platform contributions.

(i) Presumed to be exclusive.

(ii) Rebuttal of Exclusivity.

(iii) Proration of PCT Payments to the extent allocable to other business activities.

(A) In general.

(B) Determining the proration of PCT Payments.

(3) Categorization of the PCT.

(4) Certain make-or-sell rights excluded.

(i) In general.

(ii) Examples.

(5) Examples.

(d) Intangible development costs.

(1) Determining whether costs are IDCs.

(i) Definition and scope of the IDA.

(ii) Reasonably anticipated cost shared intangible.

(iii) Costs included in IDCs.

(iv) Examples.

(2) Allocation of costs.

(3) Stock-based compensation.

(i) In general.

(ii) Identification of stock-based compensation with the IDA.

(iii) Measurement and timing of stock-based compensation IDC.

(A) In general.

(
1
) Transfers to which section 421 applies.

(
2
) Deductions of foreign controlled participants.

(
3
) Modification of stock option.

(
4
) Expiration or termination of CSA.

(B) Election with respect to options on publicly traded stock.

(
1
) In general.

(
2
) Publicly traded stock.

(
3
) Generally accepted accounting principles.

(
4
) Time and manner of making the election.

(C) Consistency.

(4) IDC share.

(5) Examples.

(e) Reasonably anticipated benefits share.

(1) Definition.

(i) In general.

(ii) Reliability.

(iii) Examples.

(2) Measure of benefits.

(i) In general.

(ii) Indirect bases for measuring anticipated benefits.

(A) Units used, produced, or sold.

(B) Sales.

(C) Operating profit.

(D) Other bases for measuring anticipated benefits.

(E) Examples.

(iii) Projections used to estimate benefits.

(A) In general.

(B) Examples.

(f) Changes in participation under a CSA.

(1) In general.

(2) Controlled transfer of interests.

(3) Capability variation.

(4) Arm's length consideration for a change in participation.

(5) Examples.

(g) Supplemental guidance on methods applicable to PCTs.

(1) In general.

(2) Best method analysis applicable for evaluation of a PCT pursuant to a CSA.

(i) In general.

(ii) Consistency with upfront contractual terms and risk allocation—the investor model.

(A) In general.

(B) Example.

(iii) Consistency of evaluation with realistic alternatives.

(A) In general.

(B) Examples.

(iv) Aggregation of transactions.

(v) Discount rate.

(A) In general.

(B) Considerations in best method analysis of discount rate.

(
1
) Discount rate variation between realistic alternatives.

(
2
) [Reserved].

(
3
) Discount rate variation between forms of payment.

(
4
) Post-tax rate.

(C) Example.

(vi) Financial projections.

(vii) Accounting principles.

(A) In general.

(B) Examples.

(viii) Valuations of subsequent PCTs.

(A) Date of subsequent PCT.

(B) Best method analysis for subsequent PCT.

(ix) Arm's length range.

(A) In general.

(B) Methods based on two or more input parameters.

(C) Variable input parameters.

(D) Determination of arm's length PCT Payment.

(
1
) No variable input parameters.

(
2
) One variable input parameter.

(
3
) More than one variable input parameter.

(E) Adjustments.

(x) Valuation undertaken on a pre-tax basis.

(3) Comparable uncontrolled transaction method.

(4) Income method.

(i) In general.

(A) Equating cost sharing and licensing alternatives.

(B) Cost sharing alternative.

(C) Licensing alternative.

(D) Only one controlled participant with nonroutine platform contributions.

(E) Income method payment forms.

(F) Discount rates appropriate to cost sharing and licensing alternatives.

(G) The effect of taxation on determining the arm's length amount.

(ii) Evaluation of PCT Payor's cost sharing alternative.

(iii) Evaluation of PCT Payor's licensing alternative.

(A) Evaluation based on CUT.

(B) Evaluation based on CPM.

(iv) Lump sum payment form.

(v) [Reserved].

(vi) Best method analysis considerations.

(A) Coordination with § 1.482-1(c).

(B) Assumptions Concerning Tax Rates.

(C) Coordination with § 1.482-4(c)(2).

(D) Coordination with § 1.482-5(c).

(E) Certain Circumstances Concerning PCT Payor.

(F) Discount rates.

(
1
) Reflection of similar risk profiles of cost sharing alternative and licensing alternative.

(
2
) [Reserved].

(vii) Routine platform and operating contributions.

(viii) Examples.

(5) Acquisition Price Method.

(i) In general.

(ii) Determination of arm's length charge.

(iii) Adjusted acquisition price.

(iv) Best method analysis considerations.

(v) Example.

(6) Market capitalization method.

(i) In general.

(ii) Determination of arm's length charge.

(iii) Average market capitalization.

(iv) Adjusted average market capitalization.

(v) Best method analysis considerations.

(vi) Examples.

(7) Residual profit split method.

(i) In general.

(ii) Appropriate share of profits and losses.

(iii) Profit split.

(A) In general.

(B) Determine nonroutine residual divisional profit or loss.

(C) Allocate nonroutine residual divisional profit or loss.

(
1
) In general.

(
2
) Relative value determination.

(
3
) Determination of PCT Payments.

(
4
) Routine platform and operating contributions.

(iv) Best method analysis considerations.

(A) In general.

(B) Comparability.

(C) Data and assumptions.

(D) Other factors affecting reliability.

(v) Examples.

(8) Unspecified methods.

(h) Form of payment rules.

(1) CST Payments.

(2) PCT Payments.

(i) In general.

(ii) No PCT Payor stock.

(iii) Specified form of payment.

(A) In general.

(B) Contingent payments.

(C) Examples.

(iv) Conversion from fixed to contingent form of payment.

(3) Coordination of best method rule and form of payment.

(i) Allocations by the Commissioner in connection with a CSA.

(1) In general.

(2) CST allocations.

(i) In general.

(ii) Adjustments to improve the reliability of projections used to estimate RAB shares.

(A) Unreliable projections.

(B) Foreign-to-foreign adjustments.

(C) Correlative adjustments to PCTs.

(D) Examples.

(iii) Timing of CST allocations.

(3) PCT allocations.

(4) Allocations regarding changes in participation under a CSA.

(5) Allocations when CSTs are consistently and materially disproportionate to RAB shares.

(6) Periodic adjustments.

(i) In general.

(ii) PRRR.

(iii) AERR.

(A) In general.

(B) PVTP.

(C) PVI.

(iv) ADR.

(A) In general.

(B) Publicly traded companies.

(C) Publicly traded.

(D) PCT Payor WACC.

(E) Generally accepted accounting principles.

(v) Determination of periodic adjustments.

(A) In general.

(B) Adjusted RPSM as of Determination Date.

(vi) Exceptions to periodic adjustments.

(A) Controlled participants establish periodic adjustment not warranted.

(
1
) Transactions involving the same platform contribution as in the Trigger PCT.

(
2
) Results not reasonably anticipated.

(
3
) Reduced AERR does not cause Periodic Trigger.

(
4
) Increased AERR does not cause Periodic Trigger.

(B) Circumstances in which Periodic Trigger deemed not to occur.

(
1
) 10-year period.

(
2
) 5-year period.

(vii) Examples.

(j) Definitions and special rules.

(1) Definitions.

(i) In general.

(ii) Examples.

(2) Special rules.

(i) Consolidated group.

(ii) Trade or business.

(iii) Partnership.

(3) Character.

(i) CST Payments.

(ii) PCT Payments.

(iii) Examples.

(k) CSA administrative requirements.

(1) CSA contractual requirements.

(i) In general.

(ii) Contractual provisions.

(iii) Meaning of contemporaneous.

(A) In general.

(B) Example.

(iv) Interpretation of contractual provisions.

(A) In general.

(B) Examples.

(2) CSA documentation requirements.

(i) In general.

(ii) Additional CSA documentation requirements.

(iii) Coordination rules and production of documents.

(A) Coordination with penalty regulations.

(B) Production of documentation.

(3) CSA accounting requirements.

(i) In general.

(ii) Reliance on financial accounting.

(4) CSA reporting requirements.

(i) CSA Statement.

(ii) Content of CSA Statement.

(iii) Time for filing CSA Statement.

(A) 90-day rule.

(B) Annual return requirement.

(
1
) In general.

(
2
) Special filing rule for annual return requirement.

(iv) Examples.

(l) Effective/applicability date.

(m) Transition rule.

(1) In general.

(2) Transitional modification of applicable provisions.

(3) Special rule for certain periodic adjustments.

§ 1.482-9
Methods to determine taxable income in connection with a controlled services transaction.

(m) * * *

(3) Coordination with rules governing cost sharing arrangements.

(n) Effective/applicability dates.

§ 1.482-0T
[Removed]

Par. 5.
Section 1.482-0T is removed.

Par. 6.
Section 1.482-1 is amended by:

1. Revising paragraph (b)(2)(i) and the last sentence in paragraph (c)(1).
2. Adding a new paragraph (b)(2)(iii).
3. Adding a new sentence to the end of paragraph (j)(6)(i).
The additions and revisions read as follows:

§ 1.482-1
Allocation of income and deductions among taxpayers.

(b) * * *

(2)
Arm's length methods
—(i)
Methods.
Sections 1.482-2 through 1.482-6, 1.482-7, and 1.482-9 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 1.482-1 and this section provide general principles applicable in determining arm's length results of such controlled transactions, but do not provide methods, for which reference must be made to those other sections in accordance with paragraphs (b)(2)(ii) and (iii) of this section. Section 1.482-7 provides the specific methods to be used to evaluate whether a cost sharing arrangement as defined in § 1.482-7 produces results consistent with an arm's length result.

(iii)
Coordination of methods applicable to certain intangible development arrangements.
Section 1.482-7 provides the specific methods to be used to determine arm's length

results of controlled transactions in connection with a cost sharing arrangement as defined in § 1.482-7. Sections 1.482-4 and 1.482-9, as appropriate, provide the specific methods to be used to determine arm's length results of arrangements, including partnerships, for sharing the costs and risks of developing intangibles, other than a cost sharing arrangement covered by § 1.482-7. See also §§ 1.482-4(g) (Coordination with rules governing cost sharing arrangements) and 1.482-9(m)(3) (Coordination with rules governing cost sharing arrangements).

(c) * * *

(1) * * * See § 1.482-7 for the applicable methods in the case of a cost sharing arrangement.

(j) * * *

(6) * * *

(i) * * * The provision of paragraph (b)(2)(iii) of this section is generally applicable on January 5, 2009.

§ 1.482-1T
[Removed]

Par. 7.
Section 1.482-1T is removed.

Par. 8.
Section 1.482-2 is amended by revising paragraphs (e) and (f) to read as follows:

§ 1.482-2
Determination of taxable income in specific situations.

(e)
Cost sharing arrangement.
For rules governing allocations under section 482 to reflect an arm's length consideration for controlled transactions involving a cost sharing arrangement, see § 1.482-7.

(f)
Effective/applicability date
—(1)
In general.
The provision of paragraph (b) of this section is generally applicable for taxable years beginning after December 31, 2006. The provision of paragraph (e) of this section is generally applicable on January 5, 2009.

(2)
Election to apply paragraph (b) 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 § 1.482-9(n)(2).

§ 1.482-2T
[Removed]

Par. 9.
Section 1.482-2T is removed.

Par. 10.
Section 1.482-4 is amended as follows

1. Paragraphs (f)(3)(i)(B), (g) and (h) are revised.
2. Paragraph (f)(7) is removed.
The revisions read as follows:

§ 1.482-4
Methods to determine taxable income in connection with a transfer of intangible property.

(f) * * *

(3) * * *

(i) * * *

(B)
Cost sharing arrangements.
The rules in this paragraph (f)(3) regarding ownership with respect to cost shared intangibles and cost sharing arrangements will apply only as provided in § 1.482-7.

(g)
Coordination with rules governing cost sharing arrangements.
Section 1.482-7 provides the specific methods to be used to determine arm's length results of controlled transactions in connection with a cost sharing arrangement. This section provides the specific methods to be used to determine arm's length results of a transfer of intangible property, including in an arrangement for sharing the costs and risks of developing intangibles other than a cost sharing arrangement covered by § 1.482-7. In the case of such an arrangement, consideration of the principles, methods, comparability, and reliability considerations set forth in § 1.482-7 is relevant in determining the best method, including an unspecified method, under this section, as appropriately adjusted in light of the differences in the facts and circumstances between such arrangement and a cost sharing arrangement.

(h)
Effective/applicability date
—(1)
In general.
Except as provided in the succeeding sentence, the provisions of paragraphs (f)(3) and (4) of this section are generally applicable for taxable years beginning after December 31, 2006. The provisions of paragraphs (f)(3)(i)(B) and (g) of this section are generally applicable on January 5, 2009.

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

§ 1.482-4T
[Removed].

Par. 11.
Section 1.482-4T is removed.

Par. 12.
Section 1.482-5 is amended by revising the last sentence of paragraph (c)(2)(iv) to read as follows:

§ 1.482-5
Comparable profits method.

(c) * * *

(2) * * *

(iv) * * * As another example, it may be appropriate to adjust the operating profit of a party to account for material differences in the utilization of or accounting for stock-based compensation (as defined by § 1.482-7(d)(3)(i)) among the tested party and comparable parties.

Par. 13.
Section 1.482-7 is added to read as follows:

§ 1.482-7
Methods to determine taxable income in connection with a cost sharing arrangement.

(a)
In general.
The arm's length amount charged in a controlled transaction reasonably anticipated to contribute to developing intangibles pursuant to a cost sharing arrangement (CSA), as described in paragraph (b) of this section, must be determined under a method described in this section. Each method must be applied in accordance with the provisions of § 1.482-1, except as those provisions are modified in this section.

(1)
RAB share method for cost sharing transactions (CSTs).
See paragraph (b)(1)(i) of this section regarding the requirement that controlled participants, as defined in section (j)(1)(i) of this section, share intangible development costs (IDCs) in proportion to their shares of reasonably anticipated benefits (RAB shares) by entering into cost sharing transactions (CSTs).

(2)
Methods for platform contribution transactions (PCTs).
The arm's length amount charged in a platform contribution transaction (PCT) described in paragraph (b)(1)(ii) of this section must be determined under the method or methods applicable under the other section or sections of the section 482 regulations, as supplemented by paragraph (g) of this section. See § 1.482-1(b)(2)(ii) (Selection of category of method applicable to transaction), § 1.482-1(b)(2)(iii) (Coordination of methods applicable to certain intangible development arrangements), and paragraph (g) of this section (Supplemental guidance on methods applicable to PCTs).

(3)
Methods for other controlled transactions
—(i)
Contribution to a CSA by a controlled taxpayer that is not a controlled participant.
If a controlled taxpayer that is not a controlled participant contributes to developing a cost shared intangible, as defined in section (j)(1)(i) of this section, it must receive consideration from the controlled participants under the rules of § 1.482-4(f)(4) (Contribution to the value of an intangible owned by another). Such consideration will be treated as an intangible development cost for purposes of paragraph (d) of this section.

(ii)
Transfer of interest in a cost shared intangible.
If at any time (during the term, or upon or after the termination, of a CSA) a controlled participant transfers an interest in a cost shared intangible to another controlled taxpayer, the controlled participant must receive an arm's length amount of consideration from the transferee under the rules of §§ 1.482-4 through 1.482-6 as supplemented by paragraph (f)(4) of this section regarding arm's length consideration for a change in participation. For this purpose, a capability variation described in paragraph (f)(3) of this section is considered to be a controlled transfer of interests in cost shared intangibles.

(iii)
Other controlled transactions in connection with a CSA.
Controlled transactions between controlled participants that are not PCTs or CSTs and are not described in paragraph (a)(3)(ii) of this section (for example, provision of a cross operating contribution, as defined in paragraph (j)(1)(i) of this section, or make-or-sell rights, as defined in paragraph (c)(4) of this section) require arm's length consideration under the rules of §§ 1.482-1 through 1.482-6, and 1.482-9 as supplemented by paragraph (g)(2)(iv) of this section.

(iv)
Controlled transactions in the absence of a CSA.
If a controlled transaction is reasonably anticipated to contribute to developing intangibles pursuant to an arrangement that is not a CSA described in paragraph (b)(1) or (5) of this section, whether the results of any such controlled transaction are consistent with an arm's length result must be determined under the applicable rules of the other sections of the regulations under section 482. For example, an arrangement for developing intangibles in which one controlled taxpayer's costs of developing the intangibles significantly exceeds its share of reasonably anticipated benefits from exploiting the developed intangibles would not in substance be a CSA, as described in paragraphs (b)(1)(i) through (iii) of this section or paragraph (b)(5)(i) of this section. In such a case, unless the rules of this section are applicable by reason of paragraph (b)(5) of this section, the arrangement must be analyzed under other applicable sections of regulations under section 482 to determine whether it achieves arm's length results, and if not, to determine any allocations by the Commissioner that are consistent with such other regulations under section 482. See § 1.482-1(b)(2)(ii) (Selection of category of method applicable to transaction) and (iii) (Coordination of methods applicable to certain intangible development arrangements).

(4)
Coordination with the arm's length standard.
A CSA produces results that are consistent with an arm's length result within the meaning of § 1.482-1(b)(1) if, and only if, each controlled participant's IDC share (as determined under paragraph (d)(4) of this section) equals its RAB share, each controlled participant compensates its RAB share of the value of all platform contributions by other controlled participants, and all other requirements of this section are satisfied.

(b)
Cost sharing arrangement.
A cost sharing arrangement is an arrangement by which controlled participants share the costs and risks of developing cost shared intangibles in proportion to their RAB shares. An arrangement is a CSA if and only if the requirements of paragraphs (b)(1) through (4) of this section are met.

(1)
Substantive requirements
-(i)
CSTs.
All controlled participants must commit to, and in fact, engage in cost sharing transactions. In CSTs, the controlled participants make payments to each other (CST Payments) as appropriate, so that in each taxable year each controlled participant's IDC share is in proportion to its respective RAB share.

(ii)
PCTs.
All controlled participants must commit to, and in fact, engage in platform contributions transactions to the extent that there are platform contributions pursuant to paragraph (c) of this section. In a PCT, each other controlled participant (PCT Payor) is obligated to, and must in fact, make arm's length payments (PCT Payments) to each controlled participant (PCT Payee) that provides a platform contribution. For guidance on determining such arm's length obligation, see paragraph (g) of this section.

(iii)
Divisional interests.
Each controlled participant must receive a non-overlapping interest in the cost shared intangibles without further obligation to compensate another controlled participant for such interest.

(iv)
Examples.
The following examples illustrate the principles of this paragraph (b)(1):

Example 1.

Company A and Company B, who are members of the same controlled group, execute an agreement to jointly develop vaccine X and own the exclusive rights to commercially exploit vaccine X in their respective territories, which together comprise the whole world. The agreement provides that they will share some, but not all, of the costs for developing Vaccine X in proportion to RAB share. Such agreement is not a CSA because Company A and Company B have not agreed to share all of the IDCs in proportion to their respective RAB shares.

Example 2.

Company A and Company B agree to share all the costs of developing Vaccine X. The agreement also provides for employing certain resources and capabilities of Company A in this program including a skilled research team and certain research facilities, and provides for Company B to make payments to Company A in this respect. However, the agreement expressly provides that the program will not employ, and so Company B is expressly relieved of the payments in regard to, certain software developed by Company A as a medical research tool to model certain cellular processes expected to be implicated in the operation of Vaccine X even though such software would reasonably be anticipated to be relevant to developing Vaccine X and, thus, would be a platform contribution. See paragraph (c) of this section. Such agreement is not a CSA because Company A and Company B have not engaged in a necessary PCT for purposes of developing Vaccine X.

Example 3.

Companies C and D, who are members of the same controlled group, enter into a CSA. In the first year of the CSA, C and D conduct the intangible development activity, as described in paragraph (d)(1) of this section. The total IDCs in regard to such activity are $3,000,000 of which C and D pay $2,000,000 and $1,000,000, respectively, directly to third parties. As between C and D, however, their CSA specifies that they will share all IDCs in accordance with their RAB shares (as described in paragraph (e)(1) of this section), which are 60% for C and 40% for D. It follows that C should bear $1,800,000 of the total IDCs (60% of total IDCs of $3,000,000) and D should bear $1,200,000 of the total IDCs (40% of total IDCs of $3,000,000). D makes a CST payment to C of $200,000, that is, the amount by which D's share of IDCs in accordance with its RAB share exceeds the amount of IDCs initially borne by D ($1,200,000-$1,000,000), and which also equals the amount by which the total IDCs initially borne by C exceeds its share of IDCS in accordance with its RAB share ($2,000,000—$1,800,000). As a result of D's CST payment to C, the IDC shares of C and D are in proportion to their respective RAB shares.

(2)
Administrative requirements.
The CSA must meet the requirements of paragraph (k) of this section.

(3)
Date of a PCT.
The controlled participants must enter into a PCT as of the earliest date on or after the CSA is entered into on which a platform contribution is reasonably anticipated to contribute to developing cost shared intangibles.

(4)
Divisional interests
—(i)
In general.
Pursuant to paragraph (b)(1)(iii) of this section, each controlled participant must receive a non-overlapping interest in the cost shared intangibles without further obligation to compensate another controlled participant for such interest. Each controlled participant must be entitled to the perpetual and exclusive right to the profits from

transactions of any member of the controlled group that includes the controlled participant with uncontrolled taxpayers to the extent that such profits are attributable to such interest in the cost shared intangibles.

(ii)
Territorial based divisional interests.
The CSA may divide all interests in cost shared intangibles on a territorial basis as follows. The entire world must be divided into two or more non-overlapping geographic territories. Each controlled participant must receive at least one such territory, and in the aggregate all the participants must receive all such territories. Each controlled participant will be assigned the perpetual and exclusive right to exploit the cost shared intangibles through the use, consumption, or disposition of property or services in its territories. Thus, compensation will be required if other members of the controlled group exploit the cost shared intangibles in such territory.

(iii)
Field of use based divisional interests.
The CSA may divide all interests in cost shared intangibles on the basis of all uses (whether or not known at the time of the division) to which cost shared intangibles are to be put as follows. All anticipated uses of cost shared intangibles must be identified. Each controlled participant must be assigned at least one such anticipated use, and in the aggregate all the participants must be assigned all such anticipated uses. Each controlled participant will be assigned the perpetual and exclusive right to exploit the cost shared intangibles through the use or uses assigned to it and one controlled participant must be assigned the exclusive and perpetual right to exploit cost shared intangibles through any unanticipated uses.

(iv)
Other divisional bases.
(A) In the event that the CSA does not divide interests in the cost shared intangibles on the basis of exclusive territories or fields of use as described in paragraphs (b)(4)(ii) and (iii) of this section, the CSA may adopt some other basis on which to divide all interests in the cost shared intangibles among the controlled participants, provided that each of the following criteria is met:

(
1
) The basis clearly and unambiguously divides all interests in cost shared intangibles among the controlled participants.

(
2
) The consistent use of such basis for the division of all interests in the cost shared intangibles can be dependably verified from the records maintained by the controlled participants.

(
3
) The rights of the controlled participants to exploit cost shared intangibles are non-overlapping, exclusive, and perpetual.

(
4
) The resulting benefits associated with each controlled participant's interest in cost shared intangibles are predictable with reasonable reliability.

(B) See paragraph (f)(3) of this section for rules regarding the requirement of arm's length consideration for changes in participation in CSAs involving divisions of interest described in this paragraph (b)(4)(iv).

(v)
Examples.
The following examples illustrate the principles of this paragraph (b)(4):

Example 1.

Companies P and S, both members of the same controlled group, enter into a CSA to develop product Z. Under the CSA, P receives the interest in product Z in the United States and S receives the interest in product Z in the rest of the world, as described in paragraph (b)(4)(ii) of this section. Both P and S have plants for manufacturing product Z located in their respective geographic territories. However, for commercial reasons, product Z is nevertheless manufactured by P in the United States for sale to customers in certain locations just outside the United States in close proximity to P's U.S. manufacturing plant. Because S owns the territorial rights outside the United States, P must compensate S to ensure that S realizes all the cost shared intangible profits from P's sales of product Z in S's territory. The pricing of such compensation must also ensure that P realizes an appropriate return for its manufacturing efforts. Benefits projected with respect to such sales will be included for purposes of estimating S's, but not P's, RAB share.

Example 2.

The facts are the same as in
Example 1
except that P and S agree to divide their interest in product Z based on site of manufacturing. P will have exclusive and perpetual rights in product Z manufactured in facilities owned by P. S will have exclusive and perpetual rights to product Z manufactured in facilities owned by S. P and S agree that neither will license manufacturing rights in product Z to any related or unrelated party. Both P and S maintain books and records that allow production at all sites to be verified. Both own facilities that will manufacture product Z and the relative capacities of these sites are known. All facilities are currently operating at near capacity and are expected to continue to operate at near capacity when product Z enters production so that it will not be feasible to shift production between P's and S's facilities. P and S have no plans to build new facilities and the lead time required to plan and build a manufacturing facility precludes the possibility that P or S will build a new facility during the period for which sales of Product Z are expected. Based on these facts, this basis for the division of interests in Product Z is a division described in paragraph (b)(4)(iv) of this section. The basis for the division of interest is unambiguous and clearly defined and its use can be dependably verified. P and S both have non-overlapping, exclusive and perpetual rights in Product Z. The division of interest results in the participant's relative benefits being predictable with reasonable reliability.

Example 3.

The facts are the same as in
Example 2
except that P's and S's manufacturing facilities are not expected to operate at full capacity when product Z enters production. Production of Product Z can be shifted at any time between sites owned by P and sites owned by S, although neither P nor S intends to shift production as a result of the agreement. The division of interests in Product Z between P and S based on manufacturing site is not a division described in paragraph (b)(4)(iv) of this section because their relative shares of benefits are not predictable with reasonable reliability. The fact that neither P nor S intends to shift production is irrelevant.

(5)
Treatment of certain arrangements as CSAs
—(i)
Situation in which Commissioner must treat arrangement as a CSA.
The Commissioner must apply the rules of this section to an arrangement among controlled taxpayers if the administrative requirements of paragraph (b)(2) of this section are met with respect to such arrangement and the controlled taxpayers reasonably concluded that such arrangement was a CSA meeting the requirements of paragraphs (b)(1), (3), and (4) of this section.

(ii)
Situation in which Commissioner may treat arrangement as a CSA.
For arrangements among controlled taxpayers not described in paragraph (b)(5)(i) of this section, the Commissioner may apply the provisions of this section if the Commissioner concludes that the administrative requirements of paragraph (b)(2) of this section are met, and, notwithstanding technical failure to meet the substantive requirements of paragraph (b)(1), (3), or (4) of this section, the rules of this section will provide the most reliable measure of an arm's length result. See § 1.482-1(c)(1) (the best method rule). For purposes of applying this paragraph (b)(5)(ii), any such arrangement shall be interpreted by reference to paragraph (k)(1)(iv) of this section.

(iii)
Examples.
The following examples illustrate the principles of this paragraph (b)(5). In the examples, assume that Companies P and S are both members of the same controlled group.

Example 1.

(i) P owns the patent on a formula for a capsulated pain reliever, P-Cap. P reasonably anticipates, pending further research and experimentation, that the P-Cap formula could form the platform for a formula for P-Ves, an effervescent version of P-Cap. P also owns proprietary software that it reasonably anticipates to be critical to the research efforts. P and S execute a contract that purports to be a CSA by which they agree to proportionally share the costs and risks of developing a formula for P-Ves. The

agreement reflects the various contractual requirements described in paragraph (k)(1) of this section and P and S comply with the documentation, accounting, and reporting requirements of paragraphs (k)(2) through (4) of this section. Both the patent rights for P-Cap and the software are reasonably anticipated to contribute to the development of P-Ves and therefore are platform contributions for which compensation is due from S as part of PCTs. Though P and S enter into and implement a PCT for the P-Cap patent rights that satisfies the arm's length standard, they fail to enter into a PCT for the software.

(ii) In this case, P and S have substantially complied with the contractual requirements of paragraph (k)(1) of this section and the documentation, accounting, and reporting requirements of paragraphs (k)(2) through (4) of this section and therefore have met the administrative requirements of paragraph (b)(2) of this section. However, because they did not enter into a PCT, as required under paragraphs (b)(1)(ii) and (b)(3) of this section, for the software that was reasonably anticipated to contribute to the development of P-Ves (see paragraph (c) of this section), they cannot reasonably conclude that their arrangement was a CSA. Accordingly, the Commissioner is not required under paragraph (b)(5)(i) of this section to apply the rules of this section to their arrangement.

(iii) Nevertheless, the arrangement between P and S closely resembles a CSA. If the Commissioner concludes that the rules of this section provide the most reliable measure of an arm's length result for such arrangement, then pursuant to paragraph (b)(5)(ii) of this section, the Commissioner may apply the rules of this section and treat P and S as entering into a PCT for the software in accordance with the requirements of paragraph (b)(1)(ii) of this section, and make any appropriate allocations under paragraph (i) of this section. Alternatively, the Commissioner may conclude that the rules of this section do not provide the most reliable measure of an arm's length result. In such case, the arrangement would be analyzed under the methods under other sections of the 482 regulations to determine whether the arrangement reaches an arm's length result.

Example 2.

The facts are the same as in
Example 1
except that P and S do enter into and implement a PCT for the software as required under this paragraph (b). The Commissioner determines that the PCT Payments for the software were not arm's length; nevertheless, under the facts and circumstances at the time they entered into the CSA and PCTs, P and S reasonably concluded their arrangement to be a CSA. Because P and S have met the requirements of paragraph (b)(2) of this section and reasonably concluded their arrangement is a CSA, pursuant to paragraph (b)(5)(i) of this section, the Commissioner must apply the rules of this section to their arrangement. Accordingly, the Commissioner treats the arrangement as a CSA and makes adjustments to the PCT Payments as appropriate under this section to achieve an arm's length result for the PCT for the software.

Example 3.

(i) The facts are the same as in
Example 1
except that P and S do enter into a PCT for the software as required under this paragraph (b). The agreement entered into by P and S provides for a fixed consideration of $50 million per year for four years, payable at the end of each year. This agreement satisfies the arm's length standard. However, S actually pays P consideration at the end of each year in the form of four annual royalties equal to two percent of sales. While such royalties at the time of the PCT were expected to be $50 million per year, actual sales during the first year were less than anticipated and the first royalty payment was only $25 million.

(ii) In this case, P and S failed to implement the terms of their agreement. Under these circumstances, P and S could not reasonably conclude that their arrangement was a CSA, as described in paragraph (b)(1) of this section. Accordingly, the Commissioner is not required under paragraph (b)(5)(i) of this section to apply the rules of this section to their arrangement.

(iii) Nevertheless, the arrangement between P and S closely resembles a CSA. If the Commissioner concludes that the rules of this section provide the most reliable measure of an arm's length result for such arrangement, then pursuant to paragraph (b)(5)(ii) of this section, the Commissioner may apply the rules of this section and make any appropriate allocations under paragraph (i) of this section. Alternatively, the Commissioner may conclude that the rules of this section do not provide the most reliable measure of an arm's length result. In such case, the arrangement would be analyzed under the methods under other sections of the 482 regulations to determine whether the arrangement reaches an arm's length result.

Example 4.

(i) The facts are the same as in
Example 1
except that P does not own proprietary software and P and S use a method for determining the arm's length amount of the PCT Payment for the P-Cap patent rights different from the method used in
Example 1.

(ii) P and S determine that the arm's length amount of the PCT Payments for the P-Cap patent is $10 million. However, the Commissioner determines the best method for determining the arm's length amount of the PCT Payments for the P-Cap patent rights and under such method the arm's length amount is $100 million. To determine this $10 million present value, P and S assumed a useful life of eight years for the platform contribution, because the P-Cap patent rights will expire after eight years. However, the P-Cap patent rights are expected to lead to benefits attributable to exploitation of the cost shared intangibles extending many years beyond the expiration of the P-Cap patent, because use of the P-Cap patent rights will let P and S bring P-Ves to market before the competition, and because P and S expect to apply for additional patents covering P-Ves, which would bar competitors from selling that product for many future years. The assumption by P and S of a useful life for the platform contribution that is less than the anticipated period of exploitation of the cost shared intangibles is contrary to paragraph (g)(2)(ii) of this section, and reduces the reliability of the method used by P and S.

(iii) The method used by P and S employs a declining royalty. The royalty starts at 8% of sales, based on an application of the CUT method in which the purported CUTs all involve licenses to manufacture and sell the current generation of P-Cap, and declines to 0% over eight years, declining by 1% each year. Such make-or-sell rights are fundamentally different from use of the P-Cap patent rights to generate a new product. This difference raises the issue of whether the make-or-sell rights are sufficiently comparable to the rights that are the subject of the PCT Payment. See § 1.482-4(c). While a royalty rate for make-or-sell rights can form the basis for a reliable determination of an arm's length PCT Payment in the CUT-based implementation of the income method described in paragraph (g)(4) of this section, under that method such royalty rate does not decline to zero. Therefore, the use of a declining royalty rate based on an initial rate for make-or-sell rights further reduces the reliability of the method used by P and S.

(iv) Sales of the next-generation product are not anticipated until after seven years, at which point the royalty rate will have declined to 1%. The temporal mismatch between the period of the royalty rate decline and the period of exploitation raises further concerns about the method's reliability.

(v) For the reasons given in paragraphs (ii) through (iv) of this
Example 4,
the method used by P and S is so unreliable and so contrary to provisions of this section that P and S could not reasonably conclude that they had contracted to make arm's length PCT Payments as required by paragraphs (b)(1)(ii) and (b)(3) of this section, and thus could not reasonably conclude that their arrangement was a CSA. Accordingly, the Commissioner is not required under paragraph (b)(5)(i) of this section to apply the rules of this section to their arrangement.

(vi) Nevertheless, the arrangement between P and S closely resembles a CSA. If the Commissioner concludes that the rules of this section provide the most reliable measure of an arm's length result for such arrangement, then pursuant to paragraph (b)(5)(ii) of this section, the Commissioner may apply the rules of this section and make any appropriate allocations under paragraph (i) of this section. Alternatively, the Commissioner may conclude that the rules of this section do not provide the most reliable measure of an arm's length result. In such case, the arrangement would be analyzed under the methods under other section 482 regulations to determine whether the arrangement reaches an arm's length result.

(6)
Entity classification of CSAs.
See § 301.7701-1(c) of this chapter for the classification of CSAs for purposes of the Internal Revenue Code.

(c)
Platform contributions
—(1)
In general.
A platform contribution is any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity (whether prior to or during the course of the CSA) that is reasonably anticipated to contribute to developing

cost shared intangibles. The determination whether a resource, capability, or right is reasonably anticipated to contribute to developing cost shared intangibles is ongoing and based on the best available information. Therefore, a resource, capability, or right reasonably determined not to be a platform contribution as of an earlier point in time, may be reasonably determined to be a platform contribution at a later point in time. The PCT obligation regarding a resource or capability or right once determined to be a platform contribution does not terminate merely because it may later be determined that such resource or capability or right has not contributed, and no longer is reasonably anticipated to contribute, to developing cost shared intangibles. Notwithstanding the other provisions of this paragraph (c), platform contributions do not include rights in land or depreciable tangible property, and do not include rights in other resources acquired by IDCs. See paragraph (d)(1) of this section.

(2)
Terms of platform contributions
—(i)
Presumed to be exclusive.
For purposes of a PCT, the PCT Payee's provision of a platform contribution is presumed to be exclusive. Thus, it is presumed that the platform resource, capability, or right is not reasonably anticipated to be committed to any business activities other than the CSA Activity, as defined in paragraph (j)(1)(i) of this section, whether carried out by the controlled participants, other controlled taxpayers, or uncontrolled taxpayers.

(ii)
Rebuttal of exclusivity.
The controlled participants may rebut the presumption set forth in paragraph (c)(2)(i) of this section to the satisfaction of the Commissioner. For example, if the platform resource is a research tool, then the controlled participants could rebut the presumption by establishing to the satisfaction of the Commissioner that, as of the date of the PCT, the tool is reasonably anticipated not only to contribute to the CSA Activity but also to be licensed to an uncontrolled taxpayer. In such case, the PCT Payments may need to be prorated as described in paragraph (c)(2)(iii) of this section.

(iii)
Proration of PCT Payments to the extent allocable to other business activities
—(A)
In general.
Some transfer pricing methods employed to determine the arm's length amount of the PCT Payments do so by considering the overall value of the platform contributions as opposed to, for example, the value of the anticipated use of the platform contributions in the CSA Activity. Such a transfer pricing method is consistent with the presumption that the platform contribution is exclusive (that is, that the resources, capabilities or rights that are the subject of a platform contribution are reasonably anticipated to contribute only to the CSA Activity). See paragraph (c)(2)(i) (Terms of platform contributions—Presumed to be exclusive) of this section. The PCT Payments determined under such transfer pricing method may have to be prorated if the controlled participants can rebut the presumption that the platform contribution is exclusive to the satisfaction of the Commissioner as provided in paragraph (c)(2)(ii) of this section. In the case of a platform contribution that also contributes to lines of business of a PCT Payor that are not reasonably anticipated to involve exploitation of the cost shared intangibles, the need for explicit proration may in some cases be avoided through aggregation of transactions. See paragraph (g)(2)(iv) of this section (Aggregation of transactions).

(B)
Determining the proration of PCT Payments.
Proration will be done on a reasonable basis in proportion to the relative economic value, as of the date of the PCT, reasonably anticipated to be derived from the platform contribution by the CSA Activity as compared to the value reasonably anticipated to be derived from the platform contribution by other business activities. In the case of an aggregate valuation done under the principles of paragraph (g)(2)(iv) of this section that addresses payment for resources, capabilities, or rights used for business activities other than the CSA Activity (for example, the right to exploit an existing intangible without further development), the proration of the aggregate payments may have to reflect the economic value attributable to such resources, capabilities, or rights as well. For purposes of the best method rule under § 1.482-1(c), the reliability of the analysis under a method that requires proration pursuant to this paragraph is reduced relative to the reliability of an analysis under a method that does not require proration.

(3)
Categorization of the PCT.
For purposes of § 1.482-1(b)(2)(ii) and paragraph (a)(2) of this section, a PCT must be identified by the controlled participants as a particular type of transaction (for example, a license for royalty payments). See paragraph (k)(2)(ii)(H) of this section. Such designation must be consistent with the actual conduct of the controlled participants. If the conduct is consistent with different, economically equivalent types of transaction, then the controlled participants may designate the PCT as being any of such types of transaction. If the controlled participants fail to make such designation in their documentation, the Commissioner may make a designation consistent with the principles of paragraph (k)(1)(iv) of this section.

(4)
Certain make-or-sell rights excluded
—(i)
In general.
Any right to exploit an existing resource, capability, or right without further development of such item, such as the right to make, replicate, license, or sell existing products, does not constitute a platform contribution to a CSA (and the arm's length compensation for such rights (make-or-sell rights) does not satisfy the compensation obligation under a PCT) unless exploitation without further development of such item is reasonably anticipated to contribute to developing or further developing a cost shared intangible.

(ii)
Examples.
The following examples illustrate the principles of this paragraph (c)(4):

Example 1.

P and S, which are members of the same controlled group, execute a CSA. Under the CSA, P and S will bear their RAB shares of IDCs for developing the second generation of ABC, a computer software program. Prior to that arrangement, P had incurred substantial costs and risks to develop ABC. Concurrent with entering into the arrangement, P (as the licensor) executes a license with S (as the licensee) by which S may make and sell copies of the existing ABC. Such make-or-sell rights do not constitute a platform contribution to the CSA. The rules of §§ 1.482-1 and 1.482-4 through 1.482-6 must be applied to determine the arm's length consideration in connection with the make-or-sell licensing arrangement. In certain circumstances, this determination of the arm's length consideration may be done on an aggregate basis with the evaluation of compensation obligations pursuant to the PCTs entered into by P and S in connection with the CSA. See paragraph (g)(2)(iv) of this section.

Example 2.

(i) P, a software company, has developed and currently exploits software program ABC. P and S enter into a CSA to develop future generations of ABC. The ABC source code is the platform on which future generations of ABC will be built and is therefore a platform contribution of P for which compensation is due from S pursuant to a PCT. Concurrent with entering into the CSA, P licenses to S the make-or-sell rights for the current version of ABC. P has entered into similar licenses with uncontrolled parties calling for sales-based royalty payments at a rate of 20%. The current version of ABC has an expected product life of three years. P and S enter into a contingent payment agreement to cover both the PCT Payments due from S for P's platform contribution and payments due from S for the make-or-sell license. Based on the uncontrolled make-or-sell licenses, P and S agree on a sales-based royalty rate of 20% in

Year 1 that declines on a straight line basis to 0% over the 3 year product life of ABC.

(ii) The make-or-sell rights for the current version of ABC are not platform contributions, though paragraph (g)(2)(iv) of this section provides for the possibility that the most reliable determination of an arm's length charge for the platform contribution and the make-or-sell license may be one that values the two transactions in the aggregate. A contingent payment schedule based on the uncontrolled make-or-sell licenses may provide an arm's length charge for the separate make-or-sell license between P and S, provided the royalty rates in the uncontrolled licenses similarly decline, but as a measure of the aggregate PCT and licensing payments it does not account for the arm's length value of P's platform contributions which include the rights in the source code and future development rights in ABC.

Example 3.

S is a controlled participant that owns Patent Q, which protects S's use of a research tool that is helpful in developing and testing new pharmaceutical compounds. The research tool, which is not itself such a compound, is used in the CSA Activity to develop such compounds. However, the CSA Activity is not anticipated to result in the further development of the research tool or in patents based on Patent Q. Although the right to use Patent Q is not anticipated to result in the further development of Patent Q or the technology that it protects, that right constitutes a platform contribution (as opposed to make-or-sell rights) because it is anticipated to contribute to the research activity to develop cost shared intangibles relating to pharmaceutical compounds covered by the CSA.

(5)
Examples.
The following examples illustrate the principles of this paragraph (c). In each example, Companies P and S are members of the same controlled group, and execute a CSA providing that each will have the exclusive right to exploit cost shared intangibles in its own territory. See paragraph (b)(4)(ii) of this section (Territorial based divisional interests).

Example 1.

Company P has developed and currently markets version 1.0 of a new software application XYZ. Company P and Company S execute a CSA under which they will share the IDCs for developing future versions of XYZ. Version 1.0 is reasonably anticipated to contribute to the development of future versions of XYZ and therefore Company P's rights in version 1.0 constitute a platform contribution from Company P that must be compensated by Company S pursuant to a PCT. Pursuant to paragraph (c)(3) of this section, the controlled participants designate the platform contribution as a transfer of intangibles that would otherwise be governed by § 1.482-4, if entered into by controlled parties. Accordingly, pursuant to paragraph (a)(2) of this section, the applicable method for determining the arm's length value of the compensation obligation under the PCT between Company P and Company S will be governed by § 1.482-4 as supplemented by paragraph (g) of this section. Absent a showing to the contrary by P and S, the platform contribution in this case is presumed to be the exclusive provision of the benefit of all rights in version 1.0, other than the rights described in paragraph (c)(4) of this section (Certain make-or-sell rights excluded). This includes the right to use version 1.0 for purposes of research and the exclusive right in S's territory to exploit any future products that incorporated the technology of version 1.0, and would cover a term extending as long as the controlled participants were to exploit future versions of XYZ or any other product based on the version 1.0 platform. The compensation obligation of Company S pursuant to the PCT will reflect the full value of the platform contribution, as limited by Company S's RAB share.

Example 2.

Company P and Company S execute a CSA under which they will share the IDCs for developing Vaccine Z. Company P will commit to the project its research team that has successfully developed a number of other vaccines. The expertise and existing integration of the research team is a unique resource or capability of Company P which is reasonably anticipated to contribute to the development of Vaccine Z. Therefore, P's provision of the capabilities of the research team constitute a platform contribution for which compensation is due from Company S as part of a PCT. Pursuant to paragraph (c)(3) of this section, the controlled parties designate the platform contribution as a provision of services that would otherwise be governed by § 1.482-9(a) if entered into by controlled parties. Accordingly, pursuant to paragraph (a)(2) of this section, the applicable method for determining the arm's length value of the compensation obligation under the PCT between Company P and Company S will be governed by § 1.482-9(a) as supplemented by paragraph (g) of this section. Absent a showing to the contrary by P and S, the platform contribution in this case is presumed to be the exclusive provision of the benefits by Company P of its research team to the development of Vaccine Z. Because the IDCs include the ongoing compensation of the researchers, the compensation obligation under the PCT is only for the value of the commitment of the research team by Company P to the CSA's development efforts net of such researcher compensation. The value of the compensation obligation of Company S for the PCT will reflect the full value of the provision of services, as limited by Company S's RAB share.

(d)
Intangible development costs
—(1)
Determining whether costs are IDCs.
Costs included in IDCs are determined by reference to the scope of the intangible development activity (IDA).

(i)
Definition and scope of the IDA.
For purposes of this section, the IDA means the activity under the CSA of developing or attempting to develop reasonably anticipated cost shared intangibles. The scope of the IDA includes all of the controlled participants' activities that could reasonably be anticipated to contribute to developing the reasonably anticipated cost shared intangibles. The IDA cannot be described merely by a list of particular resources, capabilities, or rights that will be used in the CSA, because such a list would not identify reasonably anticipated cost shared intangibles. Also, the scope of the IDA may change as the nature or identity of the reasonably anticipated cost shared intangibles changes or the nature of the activities necessary for their development become clearer. For example, the relevance of certain ongoing work to developing reasonably anticipated cost shared intangibles or the need for additional work may only become clear over time.

(ii)
Reasonably anticipated cost shared intangible.
For purposes of this section,
reasonably anticipated cost shared intangible
means any intangible, within the meaning of § 1.482-4(b), that, at the applicable point in time, the controlled participants intend to develop under the CSA. Reasonably anticipated cost shared intangibles may change over the course of the CSA. The controlled participants may at any time change the reasonably anticipated cost shared intangibles but must document any such change pursuant to paragraph (k)(2)(ii)(A)(
1
) of this section. Removal of reasonably anticipated cost shared intangibles does not affect the controlled participants' interests in cost shared intangibles already developed under the CSA. In addition, the reasonably anticipated cost shared intangibles automatically expand to include the intended result of any further development of a cost shared intangible already developed under the CSA, or applications of such an intangible. However, the controlled participants may override this automatic expansion in a particular case if they separately remove specified further development of such intangible (or specified applications of such intangible) from the IDA, and document such separate removal pursuant to paragraph (k)(2)(ii)(A)(
3
) of this section.

(iii)
Costs included in IDCs.
For purposes of this section,
IDCs
mean all costs, in cash or in kind (including stock-based compensation, as described in paragraph (d)(3) of this section), but excluding acquisition costs for land or depreciable property, in the ordinary course of business after the formation of a CSA that, based on analysis of the facts and circumstances, are directly identified with, or are reasonably allocable to, the IDA. Thus, IDCs include costs incurred in attempting to develop reasonably anticipated cost

shared intangibles regardless of whether such costs ultimately lead to development of those intangibles, other intangibles developed unexpectedly, or no intangibles. IDCs shall also include the arm's length rental charge for the use of any land or depreciable tangible property (as determined under § 1.482-2(c) (Use of tangible property)) directly identified with, or reasonably allocable to, the IDA. Reference to generally accepted accounting principles or Federal income tax accounting rules may provide a useful starting point but will not be conclusive regarding inclusion of costs in IDCs. IDCs do not include interest expense, foreign income taxes (as defined in § 1.901-2(a)), or domestic income taxes.

(iv)
Examples.
The following examples illustrate the principles of this paragraph (d)(1):

Example 1.

A contract that purports to be a CSA provides that the IDA to which the agreement applies consists of all research and development activity conducted at laboratories A, B, and C but not at other facilities maintained by the controlled participants. The contract does not describe the reasonably anticipated cost shared intangibles with respect to which research and development is to be undertaken. The contract fails to meet the requirements set forth in paragraph (k)(1)(ii)(B) of this section because it fails to adequately describe the scope of the IDA to be undertaken.

Example 2.

A contract that purports to be a CSA provides that the IDA to which the agreement applies consists of all research and development activity conducted by any of the controlled participants with the goal of developing a cure for a particular disease. Such a cure is thus a reasonably anticipated cost shared intangible. The contract also contains a provision that the IDA will exclude any activity that builds on the results of the controlled participants' prior research concerning Enzyme X even though such activity could reasonably be anticipated to contribute to developing such cure. The contract fails to meet the requirement set forth in paragraph (d)(1)(i) of this section that the scope of the IDA include all of the controlled participants' activities that could reasonably be anticipated to contribute to developing reasonably anticipated cost shared intangibles.

(2)
Allocation of costs.
If a particular cost is directly identified with, or reasonably allocable to, a function the results of which will benefit both the IDA and other business activities, the cost must be allocated on a reasonable basis between the IDA and such other business activities in proportion to the relative economic value that the IDA and such other business activities are anticipated to derive from such results.

(3)
Stock-based compensation
—(i)
In general.
As used in this section, the term
stock-based compensation
means any compensation provided by a controlled participant to an employee or independent contractor in the form of equity instruments, options to acquire stock (stock options), or rights with respect to (or determined by reference to) equity instruments or stock options, including but not limited to property to which section 83 applies and stock options to which section 421 applies, regardless of whether ultimately settled in the form of cash, stock, or other property.

(ii)
Identification of stock-based compensation with the IDA.
The determination of whether stock-based compensation is directly identified with, or reasonably allocable to, the IDA is made as of the date that the stock-based compensation is granted. Accordingly, all stock-based compensation that is granted during the term of the CSA and, at date of grant, is directly identified with, or reasonably allocable to, the IDA is included as an IDC under paragraph (d)(1) of this section. In the case of a repricing or other modification of a stock option, the determination of whether the repricing or other modification constitutes the grant of a new stock option for purposes of this paragraph (d)(3)(ii) will be made in accordance with the rules of section 424(h) and related regulations.

(iii)
Measurement and timing of stock-based compensation IDC
—(A)
In general.
Except as otherwise provided in this paragraph (d)(3)(iii), the cost attributable to stock-based compensation is equal to the amount allowable to the controlled participant as a deduction for federal income tax purposes with respect to that stock-based compensation (for example, under section 83(h)) and is taken into account as an IDC under this section for the taxable year for which the deduction is allowable.

(
1
)
Transfers to which section 421 applies.
Solely for purposes of this paragraph (d)(3)(iii)(A), section 421 does not apply to the transfer of stock pursuant to the exercise of an option that meets the requirements of section 422(a) or 423(a).

(
2
)
Deductions of foreign controlled participants.
Solely for purposes of this paragraph (d)(3)(iii)(A), an amount is treated as an allowable deduction of a foreign controlled participant to the extent that a deduction would be allowable to a United States taxpayer.

(
3
)
Modification of stock option.
Solely for purposes of this paragraph (d)(3)(iii)(A), if the repricing or other modification of a stock option is determined, under paragraph (d)(3)(ii) of this section, to constitute the grant of a new stock option not identified with, or reasonably allocable to, the IDA, the stock option that is repriced or otherwise modified will be treated as being exercised immediately before the modification, provided that the stock option is then exercisable and the fair market value of the underlying stock then exceeds the price at which the stock option is exercisable. Accordingly, the amount of the deduction that would be allowable (or treated as allowable under this paragraph (d)(3)(iii)(A)) to the controlled participant upon exercise of the stock option immediately before the modification must be taken into account as an IDC as of the date of the modification.

(
4
)
Expiration or termination of CSA.
Solely for purposes of this paragraph (d)(3)(iii)(A), if an item of stock-based compensation identified with, or reasonably allocable to, the IDA is not exercised during the term of a CSA, that item of stock-based compensation will be treated as being exercised immediately before the expiration or termination of the CSA, provided that the stock-based compensation is then exercisable and the fair market value of the underlying stock then exceeds the price at which the stock-based compensation is exercisable. Accordingly, the amount of the deduction that would be allowable (or treated as allowable under this paragraph (d)(3)(iii)(A)) to the controlled participant upon exercise of the stock-based compensation must be taken into account as an IDC as of the date of the expiration or termination of the CSA.

(B)
Election with respect to options on publicly traded stock
—(
1
)
In general.
With respect to stock-based compensation in the form of options on publicly traded stock, the controlled participants in a CSA may elect to take into account all IDCs attributable to those stock options in the same amount, and as of the same time, as the fair value of the stock options reflected as a charge against income in audited financial statements or disclosed in footnotes to such financial statements, provided that such statements are prepared in accordance with United States generally accepted accounting principles by or on behalf of the company issuing the publicly traded stock.

(
2
)
Publicly traded stock.
As used in this paragraph (d)(3)(iii)(B), the term
publicly traded stock
means stock that is regularly traded on an established United States securities market and is issued by a company whose financial statements are prepared in accordance with United States generally accepted accounting principles for the taxable year.

(
3
)
Generally accepted accounting principles.
For purposes of this paragraph (d)(3)(iii)(B), a financial statement prepared in accordance with a comprehensive body of generally accepted accounting principles other than United States generally accepted accounting principles is considered to be prepared in accordance with United States generally accepted accounting principles provided that either—

(
i
) The fair value of the stock options under consideration is reflected in the reconciliation between such other accounting principles and United States generally accepted accounting principles required to be incorporated into the financial statement by the securities laws governing companies whose stock is regularly traded on United States securities markets; or

(
ii
) In the absence of a reconciliation between such other accounting principles and United States generally accepted accounting principles that reflects the fair value of the stock options under consideration, such other accounting principles require that the fair value of the stock options under consideration be reflected as a charge against income in audited financial statements or disclosed in footnotes to such statements.

(
4
)
Time and manner of making the election.
The election described in this paragraph (d)(3)(iii)(B) is made by an explicit reference to the election in the written contract required by paragraph (k)(1) of this section or in a written amendment to the CSA entered into with the consent of the Commissioner pursuant to paragraph (d)(3)(iii)(C) of this section. In the case of a CSA in existence on August 26, 2003, the election by written amendment to the CSA may be made without the consent of the Commissioner if such amendment is entered into not later than the latest due date (with regard to extensions) of a federal income tax return of any controlled participant for the first taxable year beginning after August 26, 2003.

(C)
Consistency.
Generally, all controlled participants in a CSA taking options on publicly traded stock into account under paragraph (d)(3)(ii), (d)(3)(iii)(A), or (d)(3)(iii)(B) of this section must use that same method of identification, measurement and timing for all options on publicly traded stock with respect to that CSA. Controlled participants may change their method only with the consent of the Commissioner and only with respect to stock options granted during taxable years subsequent to the taxable year in which the Commissioner's consent is obtained. All controlled participants in the CSA must join in requests for the Commissioner's consent under this paragraph (d)(3)(iii)(C). Thus, for example, if the controlled participants make the election described in paragraph (d)(3)(iii)(B) of this section upon the formation of the CSA, the election may be revoked only with the consent of the Commissioner, and the consent will apply only to stock options granted in taxable years subsequent to the taxable year in which consent is obtained. Similarly, if controlled participants already have granted stock options that have been or will be taken into account under the general rule of paragraph (d)(3)(iii)(A) of this section, then except in cases specified in the last sentence of paragraph (d)(3)(iii)(B)(
4
) of this section, the controlled participants may make the election described in paragraph (d)(3)(iii)(B) of this section only with the consent of the Commissioner, and the consent will apply only to stock options granted in taxable years subsequent to the taxable year in which consent is obtained.

(4)
IDC share.
A controlled participant's IDC share for a taxable year is equal to the controlled participant's cost contribution for the taxable year, divided by the sum of all IDCs for the taxable year. A controlled participant's cost contribution for a taxable year means all of the IDCs initially borne by the controlled participant, plus all of the CST Payments that the participant makes to other controlled participants, minus all of the CST Payments that the participant receives from other controlled participants.

(5)
Examples.
The following examples illustrate this paragraph (d):

Example 1.

Foreign parent (FP) and its U.S. subsidiary (USS) enter into a CSA to develop a better mousetrap. USS and FP share the costs of FP's R&D facility that will be exclusively dedicated to this research, the salaries of the researchers at the facility, and overhead costs attributable to the project. They also share the cost of a conference facility that is at the disposal of the senior executive management of each company. Based on the facts and circumstances, the cost of the conference facility cannot be directly identified with, and is not reasonably allocable to, the IDA. In this case, the cost of the conference facility must be excluded from the amount of IDCs.

Example 2.

U.S. parent (USP) and its foreign subsidiary (FS) enter into a CSA to develop intangibles for producing a new device. USP and FS share the costs of an R&D facility, the salaries of the facility's researchers, and overhead costs attributable to the project. Although USP also incurs costs related to field testing of the device, USP does not include those costs in the IDCs that USP and FS will share under the CSA. The Commissioner may determine, based on the facts and circumstances, that the costs of field testing are IDCs that the controlled participants must share.

Example 3.

U.S. parent (USP) and its foreign subsidiary (FS) enter into a CSA to develop a new process patent. USP assigns certain employees to perform solely R&D to develop a new mathematical algorithm to perform certain calculations. That algorithm will be used both to develop the new process patent and to develop a new design patent the development of which is outside the scope of the CSA. During years covered by the CSA, USP compensates such employees with cash salaries, stock-based compensation, or a combination of both. USP and FS anticipate that the economic value attributable to the R&D will be derived from the process patent and the design patent in a relative proportion of 75% and 25%, respectively. Applying the principles of paragraph (d)(2) of this section, 75% of the compensation of such employees must be allocated to the development of the new process patent and, thus, treated as IDCs. With respect to the cash salary compensation, the IDC is 75% of the face value of the cash. With respect to the stock-based compensation, the IDC is 75% of the value of the stock-based compensation as determined under paragraph (d)(3)(iii) of this section.

Example 4.

Foreign parent (FP) and its U.S. subsidiary (USS) enter into a CSA to develop a new computer source code. FP has an executive officer who oversees a research facility and employees dedicated solely to the IDA. The executive officer also oversees other research facilities and employees unrelated to the IDA, and performs certain corporate overhead functions. The full amount of the costs of the research facility and employees dedicated solely to the IDA can be directly identified with the IDA and, therefore, are IDCs. In addition, based on the executive officer's records of time worked on various matters, the controlled participants reasonably allocate 20% of the executive officer's compensation to supervision of the facility and employees dedicated to the IDA, 50% of the executive officer's compensation to supervision of the facilities and employees unrelated to the IDA, and 30% of the executive officer's compensation to corporate overhead functions. The controlled participants also reasonably determine that the results of the executive officer's corporate overhead functions yield equal economic benefit to the IDA and the other business activities of FP. Applying the principles of paragraph (d)(1) of this section, the executive officer's compensation allocated to supervising the facility and employees dedicated to the IDA (amounting to 20% of the executive officer's total compensation) must be treated as IDCs. Applying the principles of paragraph (d)(2) of this section, half of the executive officer's compensation allocated to corporate overhead functions (that is, half of 30% of the executive officer's total compensation), must be treated as IDCs. Therefore, a total of 35% (20% plus 15%) of the executive officer's total compensation must be treated as IDCs.

(e)
Reasonably anticipated benefits share
—(1)
Definition
—(i)
In general.
A controlled participant's share of

reasonably anticipated benefits is equal to its reasonably anticipated benefits divided by the sum of the reasonably anticipated benefits, as defined in paragraph (j)(1)(i) of this section, of all the controlled participants. RAB shares must be updated to account for changes in economic conditions, the business operations and practices of the participants, and the ongoing development of intangibles under the CSA. For purposes of determining RAB shares at any given time, reasonably anticipated benefits must be estimated over the entire period, past and future, of exploitation of the cost shared intangibles, and must reflect appropriate updates to take into account the most reliable data regarding past and projected future results available at such time. RAB shares determined for a particular purpose shall not be further updated for that purpose based on information not available at the time that determination needed to be made. For example, RAB shares determined in order to determine IDC shares for a particular taxable year (as set forth in paragraphs (b)(1)(i) and (d)(4) of this section) shall not be recomputed based on information not available at that time. Similarly, RAB shares determined for the purpose of using a particular method such as the acquisition price method (as set forth in paragraph (g)(5)(ii) of this section) to evaluate the arm's length amount charged in a PCT shall not be recomputed based on information not available at the date of that PCT. However, nothing in this paragraph (e)(1)(i) shall limit the Commissioner's use of subsequently available information for purposes of its allocation determinations in accordance with the provisions of paragraph (i) (Allocations by the Commissioner in connection with a CSA) of this section.

(ii)
Reliability.
A controlled participant's RAB share must be determined by using the most reliable estimate. In determining which of two or more available estimates is most reliable, the quality of the data and assumptions used in the analysis must be taken into account, consistent with § 1.482-1(c)(2)(ii) (Data and assumptions). Thus, the reliability of an estimate will depend largely on the completeness and accuracy of the data, the soundness of the assumptions, and the relative effects of particular deficiencies in data or assumptions on different estimates. If two estimates are equally reliable, no adjustment should be made based on differences between the estimates. The following factors will be particularly relevant in determining the reliability of an estimate of RAB shares:

(A) The basis used for measuring benefits, as described in paragraph (e)(2)(ii) of this section.

(B) The p

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2011-32458. Public record. Not legal advice.