Revision of Section 482 Cost Sharing Regulations

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8670]

RIN 1545-AU20

Revision of Section 482 Cost Sharing Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations relating to qualified

cost sharing arrangements under section 482 of the Internal Revenue

Code. These regulations reflect technical changes to the requirements

for qualification as a controlled participant under the final cost

sharing regulations published in the Federal Register on December 20,

1995.

DATES: These regulations are effective May 13, 1996.

These regulations are applicable for taxable years beginning on or

after January 1, 1996.

FOR FURTHER INFORMATION CONTACT: Lisa Sams of the Office of Associate

Chief Counsel (International), IRS (202) 622-3840 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background

Section 482 was amended by the Tax Reform Act of 1986, Public Law

99-514, 100 Stat. 2085, 2561, et. seq. (1986-3 C.B. (Vol. 1) 1, 478).

On January 30, 1992, a notice of proposed rulemaking concerning the

section 482 amendment in the context of cost sharing was published in

the Federal Register (INTL-0372-88, 57 FR 3571).

Written comments were received with respect to the notice of

proposed rulemaking, and a public hearing was held on August 31, 1992.

On December 20, 1995, final regulations were published in the

Federal Register (INTL-0372-88, 60 FR 65553) as Treasury Decision 8632.

These final regulations amend the regulations contained in Treasury

Decision 8632 by making technical changes to the requirements for

qualification as a controlled participant contained in Sec. 1.482-7(c).

The agency has decided not to issue a second notice of proposed

rulemaking with respect to the modifications to TD 8632 contained in

these final regulations. The rules to which the modifications relate

(concerning qualification as a controlled participant) were the subject

of the notice of proposed rulemaking published on January 30, 1992, and

comments on those rules were received in connection with those proposed

regulations. Therefore, a further comment period on these rules is

unnecessary. Taxpayers need prompt guidance on how to conform their

arrangements to the rules set forth in TD 8632, which is effective for

taxable years beginning on or after January 1, 1996, and which provides

a one year transition period for amending arrangements. The

modifications contained in these final regulations will aid taxpayers

in that regard, and any delay caused by a second notice of proposed

rulemaking would be impracticable and contrary to the public interest.

Unsolicited comment letters were received in connection with TD 8632

and are available for public inspection in the FOIA reading room.

Explanation of Provisions

The purpose of these regulations is to rectify problems in

qualifying as a controlled participant caused by the technical

requirements of the active conduct rule of Sec. 1.482-7(c). This rule

provided that a controlled taxpayer may be a controlled participant

only if it uses or reasonably expects to use covered intangibles in the

active conduct of a trade or business.

Under the 1992 proposed cost sharing regulations, a member of a

group of controlled taxpayers could participate in a qualified cost

sharing arrangement on behalf of, and could satisfy the active conduct

rule based on activities performed by, one or more other members of the

group (a cost sharing subgroup). The participating subgroup member

would then transfer or license the intangibles developed under the

arrangement to the nonparticipating subgroup member(s). The proposed

regulations would have measured benefits in such case on the basis of

the benefits of the entire subgroup from exploiting the intangibles. TD

8632, in streamlining the participation rules, omitted the subgroup

rules. Taxpayers commented that the change would force them to amend

existing arrangements to include as a participant every operating

company that predictably would be using covered intangibles.

These regulations further streamline the participation rules. The

principal reason for the active conduct rule was to ensure that a

controlled participant stands to benefit from the use of covered

intangibles in a manner that can be reliably measured. The Treasury and

Service have concluded that this purpose can be accomplished without

the active conduct rule. No distinction need be made based on the

nature of a participant's use of covered intangibles, so long as its

benefits from such use (whether from directly exploiting the

intangibles or from transferring or licensing them to others) can be

reliably measured.

Accordingly, these regulations eliminate the active conduct rule of

Sec. 1.482-7(c) as a requirement for qualification as a controlled

participant in a qualified cost sharing arrangement. Section 1.482-

7(c)(1) of these regulations substitutes a general rule that a

controlled taxpayer may be a controlled participant in a cost sharing

arrangement only if it reasonably anticipates that it will derive

benefits

[[Page 21956]]

from the use of covered intangibles. In addition, Sec. 1.482-

7(f)(3)(ii) provides that if a controlled participant transfers covered

intangibles to another controlled taxpayer, the participant's benefits

will be measured with reference to the transferee's benefits rather

than with reference to any consideration paid by the transferee. (This

gives rise to results similar to those under the subgroup rules of the

proposed regulations by different mechanics.) Finally, Sec. 1.482-

7(f)(3)(ii) continues to provide that the amount of benefits that each

of the controlled participants is reasonably anticipated to derive from

covered intangibles must be measured on a basis that is consistent for

all such participants.

These changes ensure that a controlled participant must benefit

from the arrangement, that the basis for measuring benefits must be

consistent for all controlled participants, and that, in the event of

intragroup transfers, there will be ``look through'' treatment for

reliably measuring benefits. These rules allow a participant to exploit

covered intangibles itself or through transferring or licensing them to

others, so long as the benefits to be derived can be consistently and

reliably measured for all controlled participants.

These regulations also clarify that the documentation requirements

of Sec. 1.482-7(j)(2) will satisfy the principal document requirement

of Sec. 1.6662-6(d)(iii)(B) with respect to a qualified cost sharing

arrangement.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations, and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information

The principal author of these regulations is Lisa Sams, Office of

Associate Chief Counsel (International), IRS. However, other personnel

from the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority for part 1 continues to read in part as

follows:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.482-0 is amended by revising the entries for

Secs. 1.482-7 (c) and (j) to read as follows:

Sec. 1.482-0 Outline of regulations under 482.

* * * * *

Sec. 1.482-7 Sharing of costs.

* * * * *

(c) Participant.

(1) In general.

(2) Treatment of a controlled taxpayer that is not a controlled

participant.

(i) In general.

(ii) Example.

(3) Treatment of consolidated group.

* * * * *

(j) Administrative requirements.

(1) In general.

(2) Documentation.

(i) Requirements.

(ii) Coordination with penalty regulation.

(3) Reporting requirements.

* * * * *

Par. 3. Section 1.482-7 is amended as follows:

a. By revising paragraph (c)(1)(i).

b. By adding paragraph (c)(1)(iv).

c. By removing paragraphs (c)(2) and (c)(3) and redesignating

paragraphs (c)(4) and (c)(5) as paragraphs (c)(2) and (c)(3),

respectively.

d. By revising newly designated paragraph (c)(2)(ii).

e. By adding a sentence after the second sentence in paragraph

(f)(3)(ii).

f. By revising Example 8 of paragraph (f)(3)(iii)(E).

g. By redesignating the text of paragraph (j)(2) following the

heading as paragraph (j)(2)(i) and adding a heading for newly

designated paragraph (j)(2)(i).

h. By removing the language ``(j)(2)'' and adding ``(j)(2)(i)'' in

its place in the first sentence of newly designated paragraph

(j)(2)(i).

i. By adding a paragraph (j)(2)(ii).

The additions and revisions read as follows:

Sec. 1.482-7 Sharing of costs.

* * * * *

(c) * * * (1) * * *

(i) Reasonably anticipates that it will derive benefits from the

use of covered intangibles;

* * * * *

(iv) The following example illustrates paragraph (c)(1)(i) of this

section:

Example. Foreign Parent (FP) is a foreign corporation engaged in

the extraction of a natural resource. FP has a U.S. subsidiary (USS)

to which FP sells supplies of this resource for sale in the United

States. FP enters into a cost sharing arrangement with USS to

develop a new machine to extract the natural resource. The machine

uses a new extraction process that will be patented in the United

States and in other countries. The cost sharing arrangement provides

that USS will receive the rights to use the machine in the

extraction of the natural resource in the United States, and FP will

receive the rights in the rest of the world. This resource does not,

however, exist in the United States. Despite the fact that USS has

received the right to use this process in the United States, USS is

not a qualified participant because it will not derive a benefit

from the use of the intangible developed under the cost sharing

arrangement.

(2) * * *

(ii) Example. The following example illustrates this paragraph

(c)(2):

Example. (i) U.S. Parent (USP), one foreign subsidiary (FS), and

a second foreign subsidiary constituting the group's research arm

(R+D) enter into a cost sharing agreement to develop manufacturing

intangibles for a new product line A. USP and FS are assigned the

exclusive rights to exploit the intangibles respectively in the

United States and the rest of the world, where each presently

manufactures and sells various existing product lines. R+D is not

assigned any rights to exploit the intangibles. R+D's activity

consists solely in carrying out research for the group. It is

reliably projected that the shares of reasonably anticipated

benefits of USP and FS will be 66\2/3\% and 33\1/3\, respectively,

and the parties' agreement provides that USP and FS will reimburse

66\2/3\% and 33\1/3\%, respectively, of the intangible development

costs incurred by R+D with respect to the new intangible.

(ii) R+D does not qualify as a controlled participant within the

meaning of paragraph (c) of this section, because it will not derive

any benefits from the use of covered intangibles. Therefore, R+D is

treated as a service provider for purposes of this section and must

receive arm's length consideration for the assistance it is deemed

to provide to USP and FS, under the rules of Sec. 1.482-

4(f)(3)(iii). Such consideration must be treated as intangible

development costs incurred by USP and FS in proportion to their

shares of reasonably anticipated benefits (i.e., 66\2/3\% and 33\1/

3\%, respectively). R+D will not be considered to bear any share of

the intangible development costs under the arrangement.

* * * * *

(f) * * *

(3) * * *

(ii) * * * If a controlled participant transfers covered

intangibles to another

[[Page 21957]]

controlled taxpayer, such participant's benefits from the transferred

intangibles must be measured by reference to the transferee's benefits,

disregarding any consideration paid by the transferee to the controlled

participant (such as a royalty pursuant to a license agreement). * * *

(iii) * * *

(E) * * *

Example 8. U.S. Parent (USP), Foreign Subsidiary 1 (FS1) and

Foreign Subsidiary 2 (FS2) enter into a cost sharing arrangement to

develop computer software that each will market and install on

customers' computer systems. The participants divide costs on the

basis of projected sales by USP, FS1, and FS2 of the software in

their respective geographic areas. However, FS1 plans not only to

sell but also to license the software to unrelated customers, and

FS1's licensing income (which is a percentage of the licensees'

sales) is not counted in the projected benefits. In this case, the

basis used for measuring the benefits of each participant is not the

most reliable because all of the benefits received by participants

are not taken into account. In order to reliably determine benefit

shares, FS1's projected benefits from licensing must be included in

the measurement on a basis that is the same as that used to measure

its own and the other participants' projected benefits from sales

(e.g., all participants might measure their benefits on the basis of

operating profit).

* * * * *

(j) * * *

(2) Documentation--(i) Requirements. * * *

(ii) Coordination with penalty regulation. The documents described

in paragraph (j)(2)(i) of this section will satisfy the principal

documents requirement under Sec. 1.6662-6(d)(2)(iii)(B) with respect to

a qualified cost sharing arrangement.

* * * * *

Approved: May 2, 1996.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 96-11781 Filed 5-9-96; 8:45 am]

BILLING CODE 4830-01-U