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

Federal RegisterJan 5, 2009

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9441]

RIN 1545-BI46

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

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final and temporary regulations.

SUMMARY:

This document contains temporary regulations that provide further guidance and clarification regarding methods under section 482 to determine taxable income in connection with a cost sharing arrangement in order to address issues that have arisen in administering the current regulations. The temporary regulations affect domestic and foreign entities that enter into cost sharing arrangements described in the temporary regulations. The text of these temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the

Federal Register

DATES:

Effective Date:

These regulations are effective on January 5, 2009.

Applicability Date:

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

FOR FURTHER INFORMATION CONTACT:

Kenneth P. Christman, (202) 435-5265 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

These temporary regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collection of information contained in these regulations has been reviewed and pending receipt and valuation of public comments, approved by the Office of Management and Budget under control number 1545-1364.

The collections of information in these temporary regulations are in § 1.482-7T(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 the collection of information 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 26 U.S.C. 6103.

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) on (REG-144615-02) August 29, 2005 (the 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 substantial comments on a wide range of issues addressed in the 2005 proposed regulations. In response to these comments, these temporary regulations make several significant changes to the rules of the 2005 proposed regulations. The temporary regulations are generally applicable for CSAs commencing on or after January 5, 2009, with transition rules for certain preexisting arrangements. These regulations are being issued in temporary and proposed form so that taxpayers and the IRS may apply the new cost sharing rules while maintaining the opportunity for further input and refinements before the issuance of final rules.

Explanation of Provisions

A. Overview

The temporary regulations generally provide guidance regarding the application of section 482 and the arm's length method to cost sharing arrangements. Several comments on the proposed regulations questioned whether and how the proposed regulations conform to the arm's length standard, as well as its corollary, the commensurate with income (CWI) requirement added by the Tax Reform Act of 1986. In response, the temporary regulations provide further guidance on the evaluation of the arm's length results of cost sharing transactions (CSTs) and platform contribution transactions (PCTs). The regulations address the material functional and risk allocations in the context of a CSA, including the reasonably anticipated duration of the commitments, the intended scope of the intangible development, the degree and uncertainty of profit potential of the intangibles to be developed, and the extent of platform and other contributions of resources, capabilities, and rights to the development and exploitation of cost shared intangibles (CSA Activity).

Under the temporary regulations, if available data of uncontrolled transactions reflect, or may be reliably adjusted to reflect, similar facts and circumstances to a CSA, they may be the basis for application of a comparable uncontrolled transaction method to value the CST and PCT results. Because of the difficulty of finding data that reliably reflects such facts and circumstances (even after adjustments), the temporary regulations also provide for other methods. These include the newly specified income, acquisition price, market capitalization, and residual profit split methods. The temporary regulations also make related changes to other sections of the regulations, including Temp. Treas. Reg. §§ 1.482-1T, 1.482-4T, 1.482-8T, and 1.482-9T, and Treas. Reg. § 1.6662-6.

B. Flexibility and Scope of CSA Coverage

Commentators criticized the 2005 proposed regulations for lack of flexibility concerning the types and provisions of arrangements eligible for CSA treatment. Some comments also addressed non-conforming intangible development arrangements that would not be treated as CSAs.

In response to these comments, the temporary regulations provide taxpayers with greater flexibility in designing certain aspects of CSAs. The temporary regulations also address the treatment of non-conforming intangible development arrangements.

1. Intangible Development Arrangements Other Than CSAs—Temp. Treas. Reg. §§ 1.482-1T(b)(2)(i) and (iii), 1.482-4T(g), 1.482-7T(b)(5), and 1.482-9T(m)(3)

The 2005 proposed regulations defined the contractual terms, risk allocations, and other material provisions of a CSA covered by the cost sharing rules. While other intangible development arrangements might be referred to colloquially as cost sharing arrangements, they were not to be treated as CSAs by the 2005 proposed regulations unless either a taxpayer

substantially complied with the CSA administrative requirements and reasonably concluded that its arrangement was a CSA, or a taxpayer substantially complied with the CSA administrative requirements and the Commissioner determined to apply the CSA rules to the arrangement.

Commentators suggested broadening the scope of intangible development arrangements that meet the CSA definition. Some commentators urged the regulations not to define CSA terms and conditions but to extend CSA treatment to any arrangement that uncontrolled parties might call a cost sharing arrangement, even though such arrangement may involve materially different risk allocations and provisions than addressed in the cost sharing rules. Still other commentators, while accepting that the regulations should define the scope of arrangements treated under the cost sharing rules, suggested that non-conforming arrangements would be subject only to the general principles of Treas. Reg. § 1.482-1 and would not be governed by the sections of the regulations addressed to specific transactional types. Some commentators also expressed concern that the Commissioner might treat a non-conforming arrangement as a CSA even in a situation where that result was not warranted.

Because the cost sharing rules are designed to provide guidance for specific types of transactions and arrangements, the Treasury Department and the IRS continue to believe that the new rules set forth for CSAs should apply only to the transactions intended. From the standpoint of the purpose of the cost sharing rules and their administrability, it is important that the rules be applicable only to the defined scope of intangible development arrangements and apply no more broadly or narrowly than intended. In recognition of taxpayer concerns, however, the temporary regulations seek to provide taxpayers with greater flexibility and scope in the types and provisions of arrangements that may qualify as CSAs.

Under Treas. Reg. § 1.482-1(b)(2)(ii) (Selection of category of method applicable to transaction), non-conforming arrangements are governed by methods provided in other sections of the regulations under section 482, as applied in accordance with Treas. Reg. § 1.482-1. See also Treas. Reg. §§ 1.482-2(d), 3(a), and 4(a), and Temp. Treas. Reg. § 1.482-9T(a). Thus, intangible development arrangements, including partnerships, outside the scope of the cost sharing rules are governed by the transfer of intangible rules of Treas. Reg. § 1.482-4(a), or the controlled services provisions of Temp. Treas. Reg. § 1.482-9T, as appropriate. The temporary regulations make clarifying amendments to Temp. Treas. Reg. §§ 1.482-1T(b)(2)(i) and (iii), 1.482-4T(g), and 1.482-9T(m)(3). These amendments confirm that Treas. Reg. § 1.482-1 provides principles, not methods. For methods, reference must be made to the other sections of the regulations under section 482. While treatment of a CSA is governed by Temp. Treas. Reg. § 1.482-7T, Temp. Treas. Reg. §§ 1.482-4T(g) and 1.482-9T(m)(3), as appropriate, govern intangible development arrangements other than CSAs, including partnerships.

Nevertheless, the methods and best method considerations under the cost sharing rules may be adapted for purposes of the evaluation of non-conforming intangible development arrangements. Importantly, the temporary regulations provide that the analysis under the intangible transfer or controlled services provisions, as applicable, should take into account the principles, methods, comparability, and reliability considerations set forth in Temp. Treas. Reg. § 1.482-7T in determining the best method for purposes of those provisions, including an unspecified method, as those methods and considerations may be appropriately adjusted in light of the differences in the facts and circumstances between the non-conforming arrangement and a CSA.

Finally, Temp. Treas. Reg. § 1.482-7(b)(5) clarifies the circumstances under which the Commissioner may treat an arrangement as a CSA, notwithstanding a technical failure to meet the substantive requirements of a CSA. Namely, the Commissioner must conclude that the taxpayer substantially complied with the CSA administrative requirements and that application of the CSA rules to such non-conforming arrangement will provide the most reliable measure of an arm's length result. For these purposes, the temporary regulations also clarify that applicable contractual provisions will be interpreted by reference to economic substance and the parties' actual conduct, and the Commissioner may disregard terms lacking economic substance and impute terms consistent with the economic substance.

2. Territorial and Other Divisional Interests—Temp. Treas. Reg. § 1.482-7T(b)(1)(iii) and (4)

The 2005 proposed regulations required the controlled participants in a CSA to receive non-overlapping territorial interests that entitled each controlled participant to the perpetual and exclusive right to the profits in its territory attributable cost shared intangibles. Commentators suggested that requiring territorial divisions of interests was overly restrictive and did not align with common business models. They also questioned the need for the non-overlapping, perpetual, and exclusivity conditions.

To provide taxpayers with more flexibility in designing qualifying divisional interests, the temporary regulations permit use of a new basis—the field of use division of interests—in addition to the territorial basis. Further, the regulations also authorize other non-overlapping divisional interests provided that the basis used meets four criteria: (1) The basis must clearly and unambiguously divide all interests in cost shared intangibles among the controlled participants; (2) the consistent use of such basis 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; and (4) the resulting benefits associated with each controlled participant's interest in cost shared intangibles are predictable with reasonable reliability. The temporary regulations illustrate instances in which divisional interests tied to specific manufacturing facilities, as an example, would, and would not, qualify under these criteria. See Temp. Treas. Reg. § 1.482-7T(b)(4)(v), Examples 2 and 3.

3. Platform and Other Contributions—Temp. Treas. Reg. § 1.482-7T(c) and (g)(2)(ii)

The 2005 proposed regulations described external contributions for which compensation was due from other controlled participants, that is, preliminary or contemporaneous transactions. A preliminary or contemporaneous transaction corresponded to the buy-in pursuant to § 1.482-7(g) of the 1995 final regulations. Under the 2005 proposed regulations, an external contribution generally consisted of the rights in the reference transaction (RT) in any resource or capability reasonably anticipated to contribute to developing cost shared intangibles. The RT consisted of a transaction, to be designated in the CSA documentation, affording the perpetual and exclusive rights in the subject resource or capability. While the RT was relevant to valuing the compensation obligation under a PCT, the controlled participants were not required to actually enter into the RT. Although the RT assumed

perpetual and exclusive rights, proration was required to the extent that the subject resource or capability was reasonably anticipated to contribute both to the CSA Activity and other business activities. Evaluation of the preliminary or contemporaneous transaction compensation obligation for the subject rights could be in the aggregate with preliminary or contemporaneous transaction compensation obligation with respect to other external contributions, or in the aggregate with the compensation obligations with respect to other rights, where valuation on an aggregate basis would provide the most reliable measure of an arm's length result for the aggregated preliminary or contemporaneous transactions and other transactions.

Commentators objected to the RT as overbroad. Commentators further contended that external contributions included elements such as workforce, goodwill or going concern value, or business opportunity, which in the commentators' view either do not constitute intangibles, or are not being transferred, and so, in the commentators' view, are not compensable.

The temporary regulations replace the term “external contribution” with the term “platform contribution” and replace the term “preliminary or contemporaneous transaction” with the term “platform contribution transaction.” The temporary regulations, like the 2005 proposed regulations, do not limit platform contributions that must be compensated in PCTs to the transfer of intangibles defined in section 936(h)(3)(B). For example, to the extent a controlled participant (the PCT Payee) contributes the services of its research team for purposes of developing cost shared intangibles pursuant to the CSA, the other controlled participant (the PCT Payor) would owe compensation for the services of such team under Temp. Treas. Reg. § 1.482-9T, just as would be the case in a contract research arrangement. Where there is a combined contribution of research services, intangibles in process, or other resources, capabilities, or rights, the temporary regulations provide for an aggregate valuation where that would provide the most reliable measure of an arm's length result for the aggregated PCTs and other transactions. The treatment available under the cost sharing rules of the contribution of the services of a research team as controlled services is without any inference concerning the potential status of workforce in place as an intangible within the meaning of section 936(h)(3)(B).

On the other hand, the temporary regulations only require the PCT Payor to compensate the PCT Payee for platform contributions, or cross operating contributions, reasonably anticipated to contribute to the CSA Activity in the PCT Payor's division as defined in Temp. Treas. Reg. § 1.482-7T(j)(1)(i). A PCT Payor is not obligated to compensate the PCT Payee for any of the PCT Payee's resources, capabilities, or rights that are reasonably anticipated to benefit only the PCT Payee's operations. Similarly, under the temporary regulations, the PCT Payee is also not entitled to compensation from the PCT Payor on account of any of the PCT Payor's own resources, capabilities, or rights, including any goodwill or going concern value of the PCT Payor. For example, where operations of parties involve undertaking functions and risks of scope and duration comparable to those of the PCT Payor, an application of the income method based on the comparable profits method would retain for the PCT Payor the returns reasonably anticipated to its own contributions to operations in its division, including any goodwill or going concern value associated with those operations, based on the returns to the comparable parties used in the CPM analysis. Similarly, the PCT Payor retains the ability to pursue its own business opportunities in its division, including through operating cost contributions to maintain or develop resources, capabilities, or rights to promote its operations.

In response to comments that the concept of the RT was unnecessary and confusing, the temporary regulations do not use that concept. Instead, the temporary regulations adopt a presumption that a PCT Payee provides any resource, capability, or right to the intangible development activity (IDA) pursuant to the CSA on an exclusive basis. A taxpayer can rebut the presumption by showing to the satisfaction of the Commissioner that the subject resource, capability, or right is reasonably anticipated to contribute not just to the CSA, but to other business activities as well. For example, if the platform resource is a research tool, then the taxpayer could rebut the presumption of exclusivity by establishing to the satisfaction of the Commissioner that the tool is reasonably anticipated not only to be applied in the IDA, but also to be licensed to an uncontrolled taxpayer. The temporary regulations provide guidance on proration of PCT payments in cases where the taxpayer rebuts the presumption.

4. Intangible Development Activity and Costs—Temp. Treas. Reg. § 1.482-7T(d)

Some commentators suggested that taxpayers can limit the application of the cost sharing rules by defining the IDA with reference only to specifically listed platform contributions. Without any inference intended as to the economic substance of such an approach, the temporary regulations are clarified to exclude this possibility. The scope of the IDA includes all 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, since the IDA is a function of what are the reasonably anticipated cost shared intangibles and such a list might 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 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.

The Treasury Department and the IRS requested in Notice 2005-99, 2005-52 CB 1214 comments regarding the valuation of stock options and other stock-based compensation. The Treasury Department and the IRS received comments and continue to consider the technical changes and issues described in Notice 2005-99 and intend to address those in a subsequent regulations project. See Treas. Reg. § 601.601(d)(2)(ii)(

5. Changes in Participation—Temp. Treas. Reg. § 1.482-7T(f)

The increased flexibility to adopt a divisional basis other than a territorial or field of use basis entails the need for provisions to prevent abuse and facilitate compliance. Capability fluctuations, whether market-driven or strategic, that materially alter the controlled participants' RAB shares as compared with their respective divisional interests create the equivalent of a controlled transfer of interests and should therefore equally occasion arm's length compensation. Accordingly, the temporary regulations modify the change of participation provision to classify such a material capability variation, in addition to a controlled transfer of interest, as a change in

participation that requires arm's length consideration by the controlled participant whose RAB share increases, to the controlled participant whose RAB share decreases, as the result of the capability variation.

C. Income and Other Specified and Unspecified Methods

1. Best Method Analysis Considerations—Temp. Treas. Reg. § 1.482-7T(g)(2)

The 2005 proposed regulations articulated “general principles”—such as the realistic alternatives principle—applicable to any method to determine the arm's length charge in a PCT. Commentators expressed uncertainty about the role intended for these principles. For example, they wondered if these principles themselves dictated, or trumped, methods or applications of methods.

The temporary regulations clarify that these principles were intended to provide supplementary guidance on the application of the best method rule to determine which method, or application of a method, provides the most reliable measure of an arm's length result in the CSA context. In other words, the principles provide best method considerations to aid the competitive evaluation of methods or applications, and are not themselves methods or trumping rules.

Consistency with upfront terms and risk allocation—the investor model—Temp. Treas. Reg. § 1.482-7T(g)(2)(ii).

The investor model is a core principle of the 2005 proposed regulations. A PCT Payor, through cost sharing and payments made pursuant to the PCT (PCT Payments), is investing for the term of the CSA Activity and expects returns over time consistent with the riskiness of that investment.

The upfront evaluation pursuant to the investor model of expected returns to particular risks assumed in intangible development and exploitation under the facts and circumstances is key to ensuring consistency of the results of a CSA with the arm's length standard. Commentators have criticized the investor model for stripping away risky returns from the PCT Payor. The temporary regulations provide additional guidance to explain that when the PCT Payor assumes risks, it accordingly enjoys the returns (or suffers the detriments) that may result from such risks.

For example, in addition to its cost contributions to developing cost shared intangibles, a PCT Payor may also commit significant operating contributions, such as existing marketing or manufacturing process intangibles, to operations in its division as well as make significant operating cost contributions towards further developing such intangibles. To the extent parties to comparable transactions undertake similar risks of similar scope and duration, the PCT Payor will be appropriately awarded based on a method that relies in whole or part on the returns in such comparable transactions (including applications of the income method based on a CUT or the CPM). To the extent its operating contributions are nonroutine, that is, not reflected in available comparable transactions, then the PCT Payor may share in nonroutine divisional profit under the application of the residual profit split method (RPSM) provided in the temporary regulations.

Moreover, the temporary regulations provide guidance on discount rates and arm's length ranges, so as to further clarify the ability of the PCT Payor to achieve results commensurate with its assumption of risks.

Aggregation of transactions—Temp. Treas. Reg. § 1.482-7T (g)(2)(iv).

The temporary regulations make conforming changes to the guidance included in the 2005 proposed regulations on aggregate evaluation of multiple transactions. Thus, if the combined effect of transactions in connection with a CSA involving platform, operating, and other contributions of resources, capabilities, or rights are reasonably anticipated to be interrelated, then determination of the arm's length charge for PCTs and other transactions on an aggregate basis may provide the most reliable measure of an arm's length result.

Discount rates—Temp. Treas. Reg. § 1.482-7T(g)(2)(v).

The 2005 proposed regulations provided general guidance that, where a present value is needed for a purpose in a cost sharing analysis, a discount rate should be used that most reliably reflects the risk of the particular set of activities or transactions based on all the information potentially available at the time for which the present value calculation is to be performed. Further, depending on the particular facts and circumstances, the discount rate may differ among a company's various activities and transactions. As examples, the proposed regulations indicated that a weighted average cost of capital (WACC) of the taxpayer, or an uncontrolled taxpayer, could provide the most reliable basis for a discount rate if the CSA Activity involves the same risk as projects undertaken by the taxpayer, or uncontrolled taxpayer, as a whole. As another example, in certain appropriate conditions, a company's internal hurdle rate for projects of comparable risk might provide a reliable basis for a discount rate in a cost sharing analysis.

Commentators offered several criticisms of the discount rate guidance. Some comments concluded that the 2005 proposed regulations placed an inappropriate emphasis on a taxpayer's WACC as a basis for analysis. Other comments suggested a clarification be made that more than a single discount rate may be appropriate in a cost sharing analysis. Yet other comments addressed whether a discount rate in a cost sharing analysis should be before, or after, tax. Some commentators asserted that cash flows, rather than items entering into income, analytically are the more appropriate amounts to be discounted.

The temporary regulations revise and elaborate upon the best method analysis considerations in regard to discount rates. Guidance is provided recognizing that the appropriate discount rate may, depending on the facts and circumstances, vary between realistic alternatives and forms of payment. As regards discount rate variation between realistic alternatives, for example, licensing intangibles needed for its operations would ordinarily be less risky for a licensee, and so require a lower discount rate, than entering into a CSA which would involve the licensee assuming the additional risk of funding its cost contributions to the IDA. As regards discount rate variation between forms of payment, for example, ordinarily a royalty computed on a profits base would be more volatile, and so require a higher discount rate to discount projected payments to present value, than a royalty computed on a sales base.

The temporary regulations recognize that, in general, discount rates inferred from the operations of the capital markets are post-tax rates. An analysis applying post-tax discount rates would be expected to treat taxes like any other expense. However, the equivalent result may in certain circumstances be achieved by applying a post-tax discount rate to pre-tax net income multiplied by the difference of one minus the tax rate. If such an approach is adopted in applying the income method, to the extent that the controlled participants' respective tax rates are not materially affected by whether they enter into the cost sharing or licensing alternative (or if reliable adjustments may be made for varying tax rates), the mulitiplier (that is, one minus the tax rate) may be cancelled from both sides of the equation of the cost sharing and

licensing alternative present values. Accordingly, in such circumstance it is sufficient to apply post-tax discount rates to pre-tax items for the purpose of equating the cost sharing and licensing alternatives. See also the discussion of the income method in this preamble.

The specific reference to a WACC or to hurdle rates are eliminated as unnecessary, but without any inference as to a WACC or a hurdle rate being an appropriate discount rate, or an appropriate starting point in ascertaining a discount rate, depending on the particular facts.

Certain methods in the temporary regulations (such as the income method under Temp. Treas Reg. § 1.482-7T(g)(4)) are theoretically based on valuation techniques that use “cash flow” projections rather than income projections. While use of cash flow projections is permitted under these methods, for a number of practical and administrative reasons, detailed guidance on the specific applications of the methods are based on income, rather than cash flow, measures. The Treasury Department and the IRS considered whether to provide guidance on the use of cash flows, rather than income, as the appropriate amounts to be discounted in a cost sharing analysis. The Treasury Department and the IRS continue to consider, and solicit 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 and its CWI requirement.

Projections—Temp. Treas. Reg. § 1.482-7T(g)(2)(vi).

The temporary regulations note that the reliability of an estimate will often depend upon the reliability of the projections used in making the estimate. Projections should reflect the best estimates of the items projected (for example, reflecting a probability weighted average of possible outcomes).

Arm's length range—Temp. Treas. Reg. § 1.482-7T(g)(2)(ix).

The 2005 proposed regulations provided supplemental guidance on applying arm's length methods in the cost sharing context in accordance with the provisions of Treas. Reg. § 1.482-1 including, inter alia, the arm's length range of Treas. Reg. § 1.482-1(e). The proposed regulations did not, however, provide guidance on how to adapt an arm's length range for cost sharing.

The temporary regulations adapt the guidance in Treas. Reg. § 1.482-1(e) for use with some of the methods for computing PCT Payments that are specified in the temporary regulation. The provisions elaborate, where the entire range of results cannot be regarded as of sufficient comparability and reliability, how to derive a statistically enhanced range of arm's length charges for a PCT.

The guidance in Treas. Reg. § 1.482-1(e) regarding arm's length ranges is most easily understood in the context of a method (for example, comparable uncontrolled price, cost plus, resale price, comparable uncontrolled transaction, comparable profits), in which the result of each comparable transaction directly provides an estimate for the result of the controlled transaction. Some of the methods specified in the temporary regulations (for example, the income method) have a different structure, in which an arm's length result is estimated by performing mathematical calculations that depend on two or more input parameters (for example, a relevant discount rate, certain financial projections, a return for routine activities) that must be determined. The additional guidance in this section addresses the arm's length range in the context of such methods.

The temporary regulations distinguish certain input parameters (variable input parameters) that, for purposes of determining an arm's length range, may be assigned more than one possible value. Such input parameters are limited to those whose value is most reliably determined by considering two or more observations of market data (for example, profit levels or stock betas of two or more companies) that have, or with adjustment can be brought to, a similar reliability and comparability, as described in Treas. Reg. § 1.482-1(e)(2)(ii). If there are two or more variable input parameters, the narrowing effect of the interquartile range is used twice: First, to narrow the variation of each input parameter, and again to narrow the resulting set of PCT Payment values. This double narrowing reflects that the use of two or more variable input parameters normally introduces additional unreliability into a method, even though that method may be the best method.

Generally, Treas. Reg. § 1.482-1(e)(3) governs the Commissioner's ability to make an adjustment to a PCT Payment due to the taxpayer's results being outside the arm's length range. Consistent with the principles expressed there, adjustment under the temporary regulations will normally be to the median, as defined in Treas. Reg. § 1.482-1(e)(3). Also, the Commissioner is not required to establish an arm's length range prior to making an allocation under section 482.

The Treasury Department and the IRS solicit comments on the design and mechanics of the supplemental guidance on determination of an arm's length range in paragraph (g)(2)(ix) of the temporary regulations, including the limitation of variable input parameters to market-based input parameters. Any alternative proposal should specify the design and mechanics in detail, and should discuss whether such an approach enhances the reliability of the analysis, is administrable, and is not so manipulable as to yield unrealistic ranges.

2. Comparable Uncontrolled Transaction Method—Temp. Treas. Reg. § 1.482-7T(g)(3)

The 2005 proposed regulations provided for possible use of the comparable uncontrolled transaction (CUT) method to determine the arm's length charge in a PCT where appropriate in accordance with the standards of the intangibles transfer and controlled services provisions of the regulations under section 482. Some commentators asserted that any arrangement that uncontrolled parties might call a cost sharing arrangement could serve as a CUT, even though such arrangement may involve materially different risk allocations and provisions than addressed in the cost sharing rules.

In response to these comments, the temporary regulations describe the relevant considerations for purposes of evaluating whether a putative CUT may, or may not, reflect the most reliable measure of an arm's length result. Although all of the factors entering into a best method analysis described in Treas. Reg. §§ 1.482-1(c) and (d) must be considered, comparability and reliability under the CUT method in the CSA context are particularly dependent on similarity of contractual terms, degree to which allocation of risks is proportional to reasonably anticipated benefits from exploiting the results of intangible development, similar period of commitment as to the sharing of intangible development risks, and similar scope, uncertainty, and profit potential of the subject intangible development, including a similar allocation of the risks of any existing resources, capabilities, or rights, as well as of the risks of developing other resources, capabilities, or rights that would be reasonably anticipated to contribute to exploitation within the parties' divisions, that is consistent with the actual allocation of risks between the controlled participants as provided in the CSA in accordance with the cost sharing rules.

3. Income Method—Temp. Treas. Reg. § 1.482-7T(g)(4)

The 2005 proposed regulations made the income method a specified method for purposes of evaluating the arm's length charge in a PCT. Under the general rule, the arm's length charge was an amount that equated a controlled participant's present value of entering into a CSA with the present value of the controlled participant 's best realistic alternative. Also provided were two applications of the income method. One, based on a CUT analysis, assumed that a PCT Payee's best realistic alternative would be to develop the cost shared intangibles on its own, bearing all the intangible development costs (IDCs) itself, and then license the cost shared intangibles. A second, based on a comparable profits method (CPM) analysis, assumed that the PCT Payor's best realistic alternative would be to acquire the rights to external contributions (renamed platform contributions under the temporary regulations) for payments with a present value equal to the PCT Payor's anticipated profit, after reward for its routine contributions to its operations, from the CSA Activity in its territory (the only division permitted under the 2005 proposed regulations). Both income method applications provided for a cost contribution adjustment in order to allocate to the PCT Payor the return to its additional risk, as compared to its realistic alternative, of bearing its reasonably anticipated benefits (RAB) share of the IDCs. As set forth in the 2005 proposed regulations, both the CUT and CPM based applications of the income method built in a conversion to a royalty form of payment, either on sales or on operating profit.

Commentators offered several criticisms with reference to the income method. As a general matter, some comments asserted that the income method stripped away risky returns from the PCT Payor. Other comments focused on technical aspects of the method and the applications. In particular, comments pointed to the potential risk differentials between cost sharing and the alternative arrangements. For example, cost sharing would generally be more risky than licensing for the PCT Payor as the result of its sharing with the PCT Payee the risks of the IDA. As a corollary, cost sharing would generally be less risky for the PCT Payee than licensing. The comments observed that these risk differentials would ordinarily be reflected in different discount rates being appropriate under the cost sharing and licensing alternatives. Other comments suggested the possible use of different discounts for different financial flows (sales, cost of sales, operating expenses, cost contributions, etc.).

The temporary regulations provide further guidance on the income method and its applications. In general, they provide that the best realistic alternative of the PCT Payor to entering into the CSA would be to license intangibles to be developed by an uncontrolled licensor that undertakes the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA. Similarly, the best realistic alternative of the PCT Payee to entering into the CSA would be to undertake the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA and license the resulting intangibles to an uncontrolled licensee.

The licensing alternative is derived on the basis of a functional and risk analysis of the cost sharing alternative, but with a shift of the risk of cost contributions to the licensor. Accordingly, the PCT Payor's licensing alternative consists of entering into a license with an uncontrolled party, for a term extending for what would be the duration of the CSA Activity, to license the make-or-sell rights in subsequently to be developed resources, capabilities, or rights of the licensor. Under such license, the licensor would undertake the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA. Apart from the difference in the allocation of the risks of the IDA, the licensing alternative should assume contractual provisions with regard to non-overlapping divisional intangible interests, and with regard to allocations of other risks, that are consistent with the actual CSA in accordance with the cost sharing rules. For example, the analysis under the licensing alternative should assume a similar allocation of the risks of any existing resources, capabilities, or rights, as well as of the risks of developing other resources, capabilities, or rights that would be reasonably anticipated to contribute to exploitation within the parties' divisions, that is consistent with the actual allocation of risks between the controlled participants as provided in the CSA in accordance with the temporary regulations.

The temporary regulations, like the 2005 proposed regulations, describe both CUT-based applications and CPM-based applications of the Income Method. However, they differ from the applications described in the 2005 proposed regulations by equating the cost sharing and licensing alternatives of the PCT Payor using discount rates appropriate to those alternatives. In circumstances where the market-correlated risks as between the cost sharing and licensing alternatives are not materially different, a reliable analysis may be possible by using the same discount rate with respect to both alternatives. Otherwise, as recognized in the best method considerations concerning discount rates, realistic alternatives having the same reasonably anticipated present value may nevertheless involve varying risk exposure and, thus, generally are more reliably evaluated using different discount rates. To the extent that the controlled participants' respective tax rates are not materially affected by whether they enter into the cost sharing or licensing alternative (or reliable adjustments may be made for varying tax rates), it is appropriate to apply post-tax discount rates to pre-tax items for purpose of equating the cost sharing and licensing alternatives. The discount rate for the cost sharing alternative will generally depend on the form of PCT Payments assumed (for example, lump sum, royalty on sales, royalty on divisional profit).

The income method may be applied to determine PCT Payments in any form of payment (for example, lump sum, royalty on sales, royalty on divisional profit). If an income method application is used to determine arm's length PCT Payments in a particular form, then the PCT Payments in that form may be converted to an alternative form in accordance with Temp. Treas. Reg. § 1.482-7(h) (Form of payment rules).

The temporary regulations clarify the opportunities, depending on the facts and circumstances, for the PCT Payor to assume risks and, accordingly, to enjoy the returns (or suffer the detriments) that may result from such risks. For example, in addition to its cost contributions to developing cost shared intangibles, a PCT Payor may also commit significant operating contributions, such as existing marketing or manufacturing process intangibles, to operations in its division as well as make significant operating cost contributions towards further developing such intangibles. To the extent parties to comparable transactions undertake risks of similar scope and duration, the PCT Payor will be appropriately rewarded based on a method that relies in whole or part on returns in such comparable transactions under an application of the income method whether based on a CUT or the

CPM. Where its operating contributions are nonroutine, that is, not reflected in available comparable transactions, the PCT Payor may share in nonroutine divisional profit under the application of the RPSM provided in the temporary regulations. Similarly, while the income method is limited to cases in which only one of the controlled participants provides nonroutine platform contributions as the PCT Payee, the RPSM in the temporary regulations addresses the situation where more than one controlled participant furnishes nonroutine platform contributions.

Yet other comments criticized the income method as positing an unrealistic “perpetual life.” The income method is premised on the assumption that, at arm's length, an investor will make a risky investment (for example, in a platform for developing additional technology) only if the investor reasonably anticipates that the present value of its reasonably anticipated operational results will be increased at least by a present value equal to the platform investment. It may be, depending on the facts and circumstances, that the technology is reasonably expected to achieve an incremental improvement in results for only a finite period (after which period, results are reasonably anticipated to return to the levels that would otherwise have been expected absent the investment). The period of enhanced results that justifies the platform investment in such circumstances effectively would correspond to a finite, not a perpetual, life.

4. Acquisition Price and Market Capitalization Methods—Temp. Treas. Reg. § 1.482-7T(g)(5) and (6)

The 2005 proposed regulations included guidance on the acquisition price and market capitalization methods for evaluating the arm's length charge in a PCT. Under the acquisition price method, the arm's length charge for a PCT is the adjusted acquisition price, that is, the acquisition price increased by the value of the target's liabilities on the date of acquisition, and decreased by the value on that date of target's tangible property and any other resources and capabilities not covered by the PCT. Under the market capitalization method, the arm's length charge for a PCT is the adjusted average market capitalization, that is, the average daily market capitalization over the 60 days ending with the date of the PCT, increased by the value of the PCT Payee's liabilities on such date, and decreased on account of tangible property and any other resources and capabilities of the PCT Payee not covered by the PCT.

Commentators questioned the reliability of these methods in light of volatility of stock prices and lack of correlation between stock price and underlying assets, for example, owing to control premiums or economies of integration.

The Treasury Department and the IRS recognize that these comments point to considerations that, depending on the facts and circumstances, will need to be taken into account in a best method analysis that compares the reliability of the results under application of these methods as against the results under application of other methods (which may themselves have aspects that reduce their reliability). The temporary regulations retain the best method considerations from the 2005 proposed regulations that observe that reliability is reduced under these methods if a substantial portion of the target's, or PCT Payor's, nonroutine contributions to business activities is not required to be covered by a PCT and, in the case of the market capitalization method, if the facts and circumstances demonstrate the likelihood of a material divergence between the PCT Payee's average market capitalization and the value of its underlying resources, capabilities, and rights for which reliable adjustments cannot be made. The temporary regulations also provide that proximity in time between the acquisition of the target and the PCT Payment is an important comparability factor under the acquisition price method.

5. Residual Profit Split Method—Temp. Treas. Reg. § 1.482-7T(g)(7)

The temporary regulations conform the modified RPSM from the proposed regulations to the changes made to the income method.

6. Unspecified Methods—Temp. Treas. Reg. § 1.482-7T(g)(8)

Under the temporary regulations in order to use an unspecified method, a taxpayer must maintain documentation to describe and explain the method selected to determine the arm's length payment due in a PCT.

D. Form of Payment

1. Post Formation Acquisitions

The 2005 proposed regulations generally provided taxpayers flexibility to provide for PCT Payments either in fixed amounts (whether in lump sums or installment payments with arm's length interest) or in contingent amounts. PCT Payments could not be paid in shares of stock of the PCT Payor. The form of payment selected for any PCT, including the basis and structure of the payments, had to be specified no later than the date of the PCT. In the case of a post formation acquisition (PFA)—that is, an external contribution (renamed platform contribution in the temporary regulations) that is acquired by a controlled participant in an uncontrolled transaction (either directly, or indirectly through the acquisition of an interest in an entity or tier of entities)—the consideration under the PCT for a PFA had to be paid in the same form as the consideration in the uncontrolled transaction in which the PFA was acquired. An example indicates that acquisitions for stock were considered to be for a fixed form of payment. One principal rationale for the special rules for PFAs was that PFAs stand in the place of IDCs and, therefore, reflect a risk allocation equivalent to that in the IDC context, which requires the sharing of outlays on a fixed form of payment basis. Another principal rationale was the difficulty the IRS has had in examining CSAs using a contingent form of payment for PFAs.

Commentators criticized the same form of payment requirement for PFAs, especially the treatment of stock acquisitions as having a fixed form of payment. The comments pointed out that a purchaser paying with its own stock is selling a part of its business, and thus pays consideration that is ultimately contingent on the success of its business. Other comments objected to the timing mismatch caused by the same form of payment rule, because fixed PCT Payments would be immediately includable, but the PFA assets would be amortizable only over time. Still other comments asserted that taxpayers may choose their form of payment for PFAs, as with other external contributions, so long as the price (taking into account the form of payment) is arm's length.

The temporary regulations do not retain the special rules for PFAs. Subsequent acquisitions remain an important source of platform contributions that occasion the requirement of PCT compensation. However, the temporary regulations no longer require a special form of payment for such compensation. Therefore, controlled participants may choose the form of payment for PCTs regardless of whether the PCTs occur at the outset of the CSA or later. Removal of the special rules for PFAs moots questions regarding whether stock consideration should be treated as contingent or fixed payment and whether (and how) the timing mismatch should be addressed. Nonetheless, the IRS will continue to

scrutinize the contractual documentation, pricing, and implementation of contingent forms of payment for PFAs.

2. Contingent Payments—Temp. Treas. Reg. § 1.482-7T(h)(2)(iv) and (v)

The temporary regulations incorporate rules to ensure that the contingent form for PCT Payments is applied properly by both taxpayers and the IRS. In accordance with Treas. Reg. § 1.482-1(d)(3)(iii)(B), a CSA contractual provision that provides for payments for a PCT (or group of PCTs) to be contingent on the exploitation of cost shared intangibles will be respected as consistent with economic substance only if the allocation between the controlled participants of the risks attendant on such form of payment is determinable before the outcomes of such allocation that would have materially affected the PCT pricing are known or reasonably knowable. The temporary regulations require a contingent payment provision to clearly and unambiguously specify the basis on which the contingent payment obligations are to be determined. In particular, the contingent payment provision must clearly and unambiguously specify the events that give rise to an obligation to make PCT Payments, the royalty base (such as sales or revenues), and the computation used to determine the PCT Payments. The royalty base specified must permit verification of its proper use by reference to books and records maintained by the controlled participants in the normal course of business (for example, books and records maintained for financial accounting or business management purposes).

The temporary regulations also provide that where a method yields a fixed value for PCT Payments, a conversion may be made to a contingent form of payments. Guidance is also provided on discount rates for purposes of such conversion. Certain forms of payment may involve different risks than others. For example, ordinarily a royalty computed on a profits base would be more volatile, and so require a higher discount rate to discount projected payments to present value, than a royalty computed on a sales base.

E. Periodic Adjustments

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

The 2005 proposed regulations addressed the CWI principle of the second sentence of section 482 in the context of cost sharing. The Commissioner could make periodic adjustments for an open taxable year (the Adjustment Year) and all subsequent years of the CSA Activity in the event of a Periodic Trigger. Under the 2005 proposed regulations, a Periodic Trigger arose if the PCT Payor realized, over the period beginning with the earliest date on which an IDC occurred through the end of the Adjustment Year, an actually experienced return ratio of the present value of its total territorial operating profits divided by the present value of its investment consisting of the sum of its cost contributions plus PCT Payments, outside the periodic return ratio range of between .5 and 2. In arriving at these present values, the Commissioner would use an applicable discount rate, which in the case of certain publicly traded entities would be their weighted average cost of capital, unless the Commissioner determines, or the controlled participants establish, that another discount rate better reflects the degree of risk of the CSA Activity. Periodic adjustments would be determined under a modified RPSM. Exceptions were provided, such as for an effective CUT or for results due to extraordinary events beyond the controlled participants' control and that could not have been reasonably anticipated. In determining whether to make any periodic adjustments, the Commissioner would consider whether the outcome as adjusted more reliably reflects an arm's length result under all the relevant facts and circumstances.

Commentators offered several criticisms of the periodic adjustment rules. Some comments considered the periodic adjustment rules to be inconsistent with the arm's length standard and, through hindsight, to strip away returns to risk. Other comments claimed for taxpayers the same ability as the Commissioner to make periodic adjustments to implement the CWI principle where subsequent results diverge from original expectations. Comments also addressed the exceptions and means for taxpayers to demonstrate their results were arm's length so as to avoid periodic adjustments.

The Treasury Department and the IRS reaffirm that the CWI principle is consistent, and periodic adjustments are to be administered consistently, with the arm's length standard. Congress adopted the CWI principle in 1986 out of concern about related-party long-term transfers of high-profit potential intangibles for relatively insignificant lump sum or royalty consideration justified by reference to putatively comparable transactions between unrelated parties that differed significantly in terms of the division of functionality and risks when compared to the transfers at issue. See H.R. Rep. 99-426, at 424-25 (1985). See also Notice 88-123 (the White Paper), 1988-2 CB 458, 472-74, 477-80. Congress intended that taxpayers be able to “use certain bona fide cost-sharing arrangements as an appropriate method of allocating income attributable to intangibles among related parties, if and to the extent such agreements are consistent with the purposes of this provision that the income allocated among the parties reasonably reflect the actual economic activity undertaken by each.” H.R. Conf. Rep. No. 99-841, at II-638 (1986). See Treas. Reg. § 601.601(d)(2)(ii)(

Accordingly, the temporary regulations continue to provide for periodic adjustments along lines similar to those in the intangible transfer section of the regulations, as adapted for the cost sharing context. Compare Treas. Reg. § 1.482-4(f)(2)(Periodic adjustments). The temporary regulations, however, adopt a smaller periodic return ratio range than the 2005 proposed regulations. Setting a Periodic Trigger to occur if the actually experienced return ratio falls outside the periodic return ratio range of between .667 and 1.5 (or between 0.8 and 1.25, if the taxpayer has not substantially complied with the documentation requirements of Temp. Treas. Reg. § 1.482-7T(k)) is intended to isolate situations in which actual results suggest the potential of an absence of arm's length pricing as of the date of the PCT. The Treasury Department and the IRS consider that the periodic return ratio range under the temporary regulations more realistically targets the threshold at which periodic adjustment scrutiny is appropriate. In determining whether to make any periodic adjustments, the Commissioner considers whether the outcome as adjusted more reliably reflects an arm's length result under all the relevant facts and circumstances.

The temporary regulations also make conforming changes to the determination of periodic adjustments, in the event of a Periodic Trigger, in light of other changes in the temporary regulations, for example, in the RPSM and form of payment provisions.

2. Advance Pricing Agreement

In addition, the Treasury Department and the IRS intend to issue by revenue procedure separate published guidance that provides an exception to periodic adjustments, similar to exceptions

provided in Temp. Treas. Reg. § 1.482-7T(i)(6)(vi), in the context of an advance pricing agreement (APA) entered into pursuant to Rev. Proc. 2006-9, 2006-1 CB 278 (as it may be amended or superseded by subsequent administrative pronouncement). The guidance would provide that no periodic adjustments will be made in any year based on a Trigger PCT that is a covered transaction under the APA. See Treas. Reg. § 601.601(d)(2)(ii)(

An APA process generally is contemporaneous with a taxpayer's original transactions and involves transparency concerning a taxpayer's upfront efforts to conform to the arm's length standard. Thus, the APA process may overcome the asymmetry in information addressed by the periodic adjustment provisions, eliminating a primary basis for a CWI adjustment. See generally 70 FR 51128-51130 (preamble to 2005 proposed regulations).

The Treasury Department and the IRS considered the possibility of a further exception to periodic adjustments based on documentation that a taxpayer would maintain contemporaneously with a PCT. Compare Treas. Reg. § 1.6662-6(d)(2)(iii). Such an exception was not incorporated into the temporary regulations in light of the concern that documentation prepared only by the taxpayer would not benefit from a similar degree of contemporaneous transparency and explanation as involved in an APA. The Treasury Department and the IRS continue to consider this matter and solicit comments on whether and how a documentation exception could be adapted to the purposes of the CWI principle.

F. Terminology and Table of Definitions—Temp. Treas. Reg. § 1.482-7T(j)(1)

For ease of reference, a comprehensive table of terms is provided. The table sets forth, alphabetically, technical terms used in the regulations, any applicable abbreviations, definitions (if not elsewhere defined in the regulations), and cross references to relevant portions of the regulations where the terms are defined or used.

G. Administrative and Transition Rules—Temp. Treas. Reg. § 1.482-7T(m)

The 2005 proposed regulations included transition rules for existing qualified cost sharing arrangements so as not to disturb taxpayers' reliance on the prior regulations, while providing for appropriate prospective application of the new regulations. Grandfather treatment would have been terminated in certain events, including the occasion of a Periodic Trigger as the result of a subsequent PCT occurring after the regulations' effective date, a material change in the scope of the arrangement, such as a material expansion of the activities undertaken beyond the scope of the intangible development area, or a 50 percent or greater change in the ownership of interests in cost shared intangibles.

Commentators objected to the grandfather termination events, in particular in the case of a subsequent Periodic Trigger or a 50 percent change of ownership, as defeating taxpayers' legitimate expectation under the prior regulations.

The temporary regulations do not terminate grandfather treatment upon a 50 percent change of ownership or on account of a subsequent Periodic Trigger or a material change in scope of the arrangement. The temporary regulations instead adopt a targeted provision that applies the temporary regulations' periodic adjustment rules to PCTs that occur on or after the date of a material change in the scope of the grandfathered CSA. A material change in scope would include a material expansion of the activities undertaken beyond the scope of the intangible development area, as described in former Treas. Reg. § 1.482-7(b)(4)(iv). For this purpose, a contraction of the scope of a CSA, absent a material expansion into one or more lines of research and development beyond the scope of the intangible development area, does not constitute a material change in scope of the CSA. Whether a material change in scope has occurred is determined on a cumulative basis. Therefore, a series of expansions, any one of which is not a material expansion by itself, may collectively constitute a material expansion.

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 been determined also that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special Analyses section of the preamble to the cross-reference notice of proposed rulemaking published in the Proposed Rules section in this issue of the

Federal Register

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

Drafting Information

The principal author of these proposed regulations is Kenneth P. Christman of the Office of Chief Counsel (International). However, other personnel from the Treasury Department and the IRS 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 1.482-7A also issued under 26 U.S.C. 482. * * *

Par. 2.

Section 1.367(a)-1 is added to read as follows:

§ 1.367(a)-1

Transfers to foreign corporations subject to section 367(a): In general.

(a) through (d)(2) [Reserved].

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

(d)(4) through (g) [Reserved].

Par 3.

Section 1.367(a)-1T is amended by revising the second sentence of 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) * * * A person's entering into a cost sharing arrangement under § 1.482-7T or acquiring rights to intangible property under such an arrangement shall not be considered a transfer of property described in section 367(a)(1). * * *

Par. 4.

Section 1.482-0 is amended by adding the entries for §§ 1.482-1(b)(2)(iii), 1.482-2(e) and (f), 1.482-4(g)

and (h) and revising the entries for § 1.482-7 to read as follows:

§ 1.482-0

Outline of regulations under section 482.

§ 1.482-1

Allocation of income and deductions among taxpayers.

(b) * * *

(2) * * *

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

§ 1.482-2

Determination of taxable income in specific situations.

(e) and (f) [Reserved]. For further guidance, see § 1.482-0T, the entries for § 1.482-2T(e) and (f).

§ 1.482-4

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

(g) and (h) [Reserved]. For further guidance, see § 1.482-0T, the entries for § 1.482-4T(g) and (h).

§ 1.482-7

Methods to determine taxable income in connection with a cost sharing arrangement.

[Reserved]. For further guidance, see § 1.482-0T, the entries for § 1.482-7T.

Par. 5.

Section 1.482-0T is amended as follows:

1. The entries for §§ 1.482-1T(b)(2)(iii), (c), (d)(1), (d)(2), (d)(3)(ii)(A), and (d)(3)(ii)(B) are revised.

2. A new entry for § 1.482-1T(b)(2)(iii) is added.

3. The entries for § 1.482-2T(e) are revised, and new entries for § 1.482-2T(f) are added.

4. The entries for § 1.482-4T(f)(7) are removed, and the entries for § 1.482-4T(g) and (h) are added.

5. The entries for § 1.482-7T are added.

6. The entries for § 1.482-9T(m)(3) and (n) are revised.

The additions and revisions read as follows:

§ 1.482-0T

Outline of regulations under section 482 (temporary).

§ 1.482-1T

Allocation of income and deductions among taxpayers (temporary).

(b) * * *

(2) * * *

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

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

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

§ 1.482-2T

Determination of taxable income in specific situations (temporary).

(e) Cost sharing arrangement.

(f) Effective/applicability Date.

(1) In general.

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

(3) Expiration date.

§ 1.482-4T

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

(g) Coordination with rules governing cost sharing arrangements.

(h) Effective/applicability date.

(1) In general.

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

(3) Expiration date.

§ 1.482-7T

Methods to determine taxable income in connection with a cost sharing arrangement (temporary).

(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.

(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.

(

) Transfers to which section 421 applies.

(

) Deductions of foreign controlled participants.

(

) Modification of stock option.

(

) Expiration or termination of CSA.

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

(

) In general.

(

) Publicly traded stock.

(

) Generally accepted accounting principles.

(

) Time and manner of making the election.

(4) IDC share.

(5) Examples.

(e) Reasonably anticipated benefit shares.

(1) Definition.

(i) In general.

(ii) Examples.

(2) Measure of benefits.

(i) In general.

(ii) Indirect bases for measuring anticipated benefits.

(A) Units used, produced, or sold.

(B) Sales.

(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 pusuant to a CSA.

(i) In general.

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

(A) In general.

(B) Examples.

(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 rates.

(

) Discount rate variation between realistic alternatives.

(

) Discount rate variation between forms of payment.

(

) Post-tax rate.

(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.

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

(

) No variable input parameters.

(

) One variable input parameters.

(

) 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.

(D) Only one controlled participate 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 alternatives.

(A) Evaluation based on CUT.

(B) Evaluation based on CPM.

(iv) Lump sum payment form.

(v) Best method analysis considerations.

(vi) Routine platform and operating contributions.

(vii) Examples.

(5) Acquisition Price Method.

(i) In general.

(ii) Determination of arm's length charge.

(iii) Adjusted acquisition price.

(iv) Best method analysis consideration.

(v) Examples.

(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 consideration.

(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.

(

) In general.

(

) Relative value determination.

(

) Determination of PCT Payments.

(

) Routine platform and operating contributions.

(iv) Best method analysis considerations.

(A) In general.

(B) Comparability.

(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.

(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 projects.

(B) Foreign-to-foreign adjustments.

(D) Examples.

(iii) Timing of CST allocations.

(3) PCT allocations.

(4) Allocations regarding changes in participation under 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.

(iv) ADR.

(A) In general.

(B) Publicly traded companies.

(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.

(

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

(

) Results not reasonably anticipated.

(

) Reduced AERR does not cause Periodic Trigger.

(

) Increased AERR does not cause Periodic Trigger.

(B) Circumstances in which Periodic Trigger deemed out to occur.

(

) 10-year period.

(

) 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.

(

) In general.

(

) Transitional modification of applicable provisions.

(3) Special rule for certain periodic adjustments.

(n) Expiration date.

§ 1.482-9T

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

(m) * * *

(3) Coordination with rules governing cost sharing arrangements. * * *

(n) Effective/applicability dates.

Par. 6.

Section 1.482-1 is amended by revising the last sentence of paragraph (c)(1) to read as follows:

§ 1.482-1

Allocation of income and deductions among taxpayers.

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

Par. 7.

Section 1.482-1T is amended by:

1. Revising paragraphs (b)(2)(i), (b)(2)(ii), (c), (d)(1), (d)(2), (d)(3)(i), (d)(3)(ii) and (j)(6)(iii).

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:

§ 1.482-1T

Allocation of income and deductions among taxpayers (temporary).

(b) * * *

(2)

Arm's length methods

—(i)

Methods

. Sections 1.482-2 through 1.482-6, 1.482-7T, and 1.482-9T provide specific methods to be used to evaluate whether transactions between or among members of the controlled group satisfy the arm's length standard, and if they do not, to determine the arm's length result. Section 1.482-1 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 1.482-7T provides the specific methods to be used to evaluate whether a cost sharing arrangement as defined in § 1.482-7T produces results consistent with an arm's length result.

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

Example 1

and

(iii)

Coordination of methods applicable to certain intangible development arrangements

. Section 1.482-7T 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 § 1.482-7T. Sections 1.482-4 and 1.482-9T, 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 § 1.482-7T. See also §§ 1.482-4T(g) (Coordination with rules governing cost sharing arrangements) and 1.482-9T(m)(3) (Coordination with rules governing cost sharing arrangements).

Examples 1

and

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

Example 1

and

(j) * * *

(6) * * *

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

(iii) Except as noted in the succeeding sentence, the applicability of § 1.482-1T expires on or before July 31, 2009. The applicability of paragraph (b)(2)(iii) of this section expires on or before December 30, 2011.

Par. 8.

Section 1.482-2T is amended as follows:

1. Paragraph (e) is redesignated as paragraph (f) and newly-designated paragraph (f) is revised.

2. New paragraph (e) is added.

The addition and revision reads as follows:

§ 1.482-2T

Determination of taxable income in specific situations (temporary).

(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 § 1.482-7T.

(f)

Effective/applicability date

—(1)

In general

. The provision of paragraph (b) of this section is generally applicable for tax 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 § 1.482-9T(n)(2).

(3)

Expiration date

. The applicability of paragraph (b) of this section expires on or before July 31, 2009. The applicability of paragraph (e) of this section expires on or before December 30, 2011.

Par. 9.

Section 1.482-4T is amended as follows

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

2. Paragraph (f)(7) is removed.

3. New paragraphs (g) and (h) are added.

The additions and revision reads as follows:

§ 1.482-4T

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

(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 § 1.482-7T.

(g)

Coordination with rules governing cost sharing arrangements

. Section 1.482-7T 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 § 1.482-7T. In the case of such an arrangement, consideration of the principles, methods, comparability, and reliability considerations set forth in § 1.482-7T 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 § 1.482-9T(n)(2).

(3)

Expiration date

. The applicability of this section expires on or before December 30, 2011.

Par. 10.

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.

(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 § 1.482-7T(d)(3)(i)) among the tested party and comparable parties.

Par. 11.

Section 1.482-7 is redesignated § 1.482-7A, and an undesignated centerheading preceding § 1.482-7A is added to read as follows:

Regulations applicable on or before January 5, 2009.

Par. 12.

Section 1.482-7T is added to read as follows:

§ 1.482-7T

Methods to determine taxable income in connection with a cost sharing arrangement (temporary).

(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), § 1.482-1T(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 § 1.482-4T(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 §§ 1.482-1 and 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 (for example, provision of a cross operating contribution, as defined in paragraph (j)(1)(i) of this section, or make-or-sell rights) require arm's length consideration from the latter controlled participant under the rules of §§ 1.482-1, 1.482-4 through 1.482-6, and 1.482-9T 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 1.482-1T(b)(2)(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:

(

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

(

) 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.

(

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

(

) 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—

(

) 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

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

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 different method for determining the arm's length amount of the PCT Payment for the P-Cap patent rights 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 IRS 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, use of the P-Cap patent rights in research is 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) of this section (Terms of platform contributions—Presumed to be exclusive). 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)(1)(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)(I) 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 intangible without further development, 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.

(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 license 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.

(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 § 1.482-9T(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 § 1.482-9T(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)(

) 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)(

) 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.

(

)

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).

(

)

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.

(

)

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.

(

)

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

—(

)

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.

(

)

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.

(

)

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—

(

) 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

(

) 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.

(

)

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)(

) 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. 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 projections used to estimate benefits, as described in paragraph (e)(2)(iii) of this section.

(ii)

Example.

The following example illustrates the principles of this paragraph (e)(1):

Example.

(i) USP and FS plan to conduct research to develop Product Lines A and B. USP and FS reasonably anticipate respective benefits from Product Line A of 100X and 200X and respective benefits from Product Line B, respectively, of 300X and 400X. USP and FS thus reasonably anticipate combined benefits from Product Lines A and B of 400X and 600X, respectively.

(ii) USP and FS could enter into a separate CSA to develop Product Line A with respective RAB shares of 33

1/3

percent and 66

2/3

percent (reflecting a ratio of 100X to 200X), and into a separate CSA to develop Product Line B with respective RAB shares of 42

6/7

percent and 57

1/7

percent (reflecting a ratio of 300X to 400X). Alternatively, USP and FS could enter into a single CSA to develop both Product Lines A and B with respective RAB shares of 40 percent and 60 percent (in the ratio of 400X to 600X). If the separate CSAs are chosen, then any costs for activities that contribute to developing both Product Line A and Product Line B will constitute IDCs of the respective CSAs as required by paragraphs (d)(1) and (d)(2) of this section.

(2)

Measure of benefits

—(i)

In general.

In order to estimate a controlled participant's RAB share, the amount of each controlled participant's reasonably anticipated benefits must be measured on a basis that is consistent for all such participants. See paragraph (e)(2)(ii)(E)

Example 9

of this section. If a controlled participant transfers a cost shared intangible to another controlled taxpayer, other than by way of a transfer described in paragraph (f) of this section, that controlled participant's benefits from the transferred intangible 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). Reasonably anticipated benefits are measured either on a direct basis, by reference to estimated benefits to be generated by the use of cost shared

intangibles (generally based on additional revenues plus cost savings less any additional costs incurred), or on an indirect basis, by reference to certain measurements that reasonably can be assumed to relate to benefits to be generated. Such indirect bases of measurement of anticipated benefits are described in paragraph (e)(2)(ii) of this section. A controlled participant's reasonably anticipated benefits must be measured on the basis, whether direct or indirect, that most reliably determines RAB shares. In determining which of two bases of measurement is most reliable, the factors set forth in § 1.482-1(c)(2)(ii) (Data and assumptions) must be taken into account. It normally will be expected that the basis that provided the most reliable estimate for a particular year will continue to provide the most reliable estimate in subsequent years, absent a material change in the factors that affect the reliability of the estimate. Regardless of whether a direct or indirect basis of measurement is used, adjustments may be required to account for material differences in the activities that controlled participants undertake to exploit their interests in cost shared intangibles. See

Examples 4

and

of paragraph (e)(2)(ii)(E) of this section.

(ii)

Indirect bases for measuring anticipated benefits.

Indirect bases for measuring anticipated benefits from participation in a CSA include the following:

(A)

Units used, produced, or sold.

Units of items used, produced, or sold by each controlled participant in the business activities in which cost shared intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will more reliably determine RAB shares to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to the cost shared intangibles per unit of the item or items used, produced, or sold. This circumstance is most likely to arise when the cost shared intangibles are exploited by the controlled participants in the use, production, or sale of substantially uniform items under similar economic conditions.

(B)

Sales.

Sales by each controlled participant in the business activities in which cost shared intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will more reliably determine RAB shares to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to cost shared intangibles per dollar of sales. This circumstance is most likely to arise if the costs of exploiting cost shared intangibles are not substantial relative to the revenues generated, or if the principal effect of using cost shared intangibles is to increase the controlled participants' revenues (for example, through a price premium on the products they sell) without affecting their costs substantially. Sales by each controlled participant are unlikely to provide a reliable basis for measuring RAB shares unless each controlled participant operates at the same market level (for example, manufacturing, distribution, etc.).

(C)

Operating profit.

Operating profit of each controlled participant from the activities in which cost shared intangibles are exploited, as determined before any expense (including amortization) on account of IDCs, may be used as an indirect basis for measuring anticipated benefits. This basis of measurement will more reliably determine RAB shares to the extent that such profit is largely attributable to the use of cost shared intangibles, or if the share of profits attributable to the use of cost shared intangibles is expected to be similar for each controlled participant. This circumstance is most likely to arise when cost shared intangibles are closely associated with the activity that generates the profit and the activity could not be carried on or would generate little profit without use of those intangibles.

(D)

Other bases for measuring anticipated benefits.

Other bases for measuring anticipated benefits may in some circumstances be appropriate, but only to the extent that there is expected to be a reasonably identifiable relationship between the basis of measurement used and additional income generated or costs saved by the use of cost shared intangibles. For example, a division of costs based on employee compensation would be considered unreliable unless there were a relationship between the amount of compensation and the expected additional income generated or costs saved by the controlled participants from using the cost shared intangibles.

(E)

Examples.

The following examples illustrate this paragraph (e)(2)(ii):

Example 1.

Controlled parties A and B enter into a CSA to develop product and process intangibles for already existing Product P. Without such intangibles, A and B would each reasonably anticipate revenue, in present value terms, of $100M from sales of Product P until it becomes obsolete. With the intangibles, A and B each reasonably anticipate selling the same number of units each year, but reasonably anticipate that the price will be higher. Because the particular product intangible is more highly regarded in A's market, A reasonably anticipates an increase of $20M in present value revenue from the product intangible, while B reasonably anticipates an increase of only $10M in present value from the product intangible. Further, A and B each reasonably anticipate spending an additional amount equal to $5M in present value in production costs to include the feature embodying the product intangible. Finally, A and B each reasonably anticipate saving an amount equal to $2M in present value in production costs by using the process intangible. A and B reasonably anticipate no other economic effects from exploiting the cost shared intangibles. A's reasonably anticipated benefits from exploiting the cost shared intangibles equal its reasonably anticipated increase in revenue ($20M) plus its reasonably anticipated cost savings ($2M) less its reasonably anticipated increased costs ($5M), which equals $17M. Similarly, B's reasonably anticipated benefits from exploiting the cost shared intangibles equal its reasonably anticipated increase in revenue ($10M) plus its reasonably anticipated cost savings ($2M) less its reasonably anticipated increased costs ($5M), which equals $7M. Thus A's reasonably anticipated benefits are $17M and B's reasonably anticipated benefits are $7M.

Example 2.

Foreign Parent (FP) and U.S. Subsidiary (USS) both produce a feedstock for the manufacture of various high-performance plastic products. Producing the feedstock requires large amounts of electricity, which accounts for a significant portion of its production cost. FP and USS enter into a CSA to develop a new process that will reduce the amount of electricity required to produce a unit of the feedstock. FP and USS currently both incur an electricity cost of $2 per unit of feedstock produced and rates for each are expected to remain similar in the future. The new process, if it is successful, will reduce the amount of electricity required by each company to produce a unit of the feedstock by 50%. Switching to the new process would not require FP or USS to incur significant investment or other costs. Therefore, the cost savings each company is expected to achieve after implementing the new process are $1 per unit of feedstock produced. Under the CSA, FP and USS divide the costs of developing the new process based on the units of the feedstock each is anticipated to produce in the future. In this case, units produced is the most reliable basis for measuring RAB shares and dividing the IDCs because each controlled participant is expected to have a similar $1 (50% of current charge of $2) decrease in costs per unit of the feedstock produced.

Example 3.

The facts are the same as in

Example 2,

except that currently USS pays $3 per unit of feedstock produced for electricity while FP pays $6 per unit of feedstock produced. In this case, units produced is not the most reliable basis for measuring RAB shares and dividing the IDCs because the participants do not expect to have a similar decrease in costs per unit of the feedstock produced. The Commissioner

determines that the most reliable measure of RAB shares may be based on units of the feedstock produced if FP's units are weighted relative to USS's units by a factor of 2. This reflects the fact that FP pays twice as much as USS for electricity and, therefore, FP's savings of $3 per unit of the feedstock (50% reduction of current charge of $6) would be twice USS's savings of $1.50 per unit of feedstock (50% reduction of current charge of $3) from any new process eventually developed.

Example 4.

The facts are the same as in

Example 3

, except that to supply the particular needs of the U.S. market USS manufactures the feedstock with somewhat different properties than FP's feedstock. This requires USS to employ a somewhat different production process than does FP. Because of this difference, USS would incur significant construction costs in order to adopt any new process that may be developed under the cost sharing agreement. In this case, units produced is not the most reliable basis for measuring RAB shares. In order to reliably determine RAB shares, the Commissioner measures the reasonably anticipated benefits of USS and FP on a direct basis. USS's reasonably anticipated benefits are its reasonably anticipated total savings in electricity costs, less its reasonably anticipated costs of adopting the new process. FS's reasonably anticipated benefits are its reasonably anticipated total savings in electricity costs.

Example 5.

U.S. Parent (USP) and Foreign Subsidiary (FS) enter into a CSA to develop new anesthetic drugs. USP obtains the right to market any resulting drugs in the United States and FS obtains the right to market any resulting drugs in the rest of the world. USP and FS determine RAB shares on the basis of their respective total anticipated operating profit from all drugs under development. USP anticipates that it will receive a much higher profit than FS per unit sold because the price of the drugs is not regulated in the United States, whereas the price of the drugs is regulated in many non-U.S. jurisdictions. In both controlled participants' territories, the anticipated operating profits are almost entirely attributable to the use of the cost shared intangibles. In this case, the controlled participants' basis for measuring RAB shares is the most reliable.

Example 6.

(i) Foreign Parent (FP) and U.S. Subsidiary (USS) manufacture and sell fertilizers. They enter into a CSA to develop a new pellet form of a common agricultural fertilizer that is currently available only in powder form. Under the CSA, USS obtains the rights to produce and sell the new form of fertilizer for the U.S. market while FP obtains the rights to produce and sell the new form o

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