# Treatment of Services Under Section 482; Allocation of Income and Deductions From Intangible Property; Stewardship Expense

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URL: https://www.frixlaw.com/law-library/documents/fr%3AE9-18326

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** August 4, 2009
- **Citation:** 74 FR 38830

## Text

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 31, and 602
[TD 9456]
RIN 1545-BI78, 1545-BI79, 1545-BI80
Treatment of Services Under Section 482; Allocation of Income and Deductions From Intangible Property; Stewardship Expense

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations and removal of temporary regulations.

SUMMARY:

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

DATES:

Effective Date:
These regulations are effective on July 31, 2009.

Applicability Dates:
These regulations apply to taxable years beginning after July 31, 2009.

FOR FURTHER INFORMATION CONTACT:

Carol B. Tan or Gregory A. Spring, (202) 435-5265 for matters relating to section 482, or Richard L. Chewning (202) 622-3850 for matters relating to stewardship expenses (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-2149. The collection of information in these final regulations is in § 1.482-9. This information is required to enable the IRS to verify that a taxpayer is reporting the correct amount of taxable income. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number.

Books and records relating to a collection of information must be retained as long as their contents might become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

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

Regulations under section 482 published in the
Federal Register
(33 FR 5849) on April 16, 1968, provided guidance with respect to a wide range of controlled transactions, including transfers of tangible and intangible property and the provision of services. Revised and updated transfer pricing regulations were published in the
Federal Register
(59 FR 34971, 60 FR 65553, 61 FR 21955, and 68 FR 51171) on July 8, 1994, December 20, 1995, May 13, 1996, and August 26, 2003. While comprehensive in other respects, these regulations did not modify substantively the rules dealing with controlled services transactions. On September 10, 2003, proposed regulations relating to the treatment of controlled services transactions and the allocation of income from intangible property, in particular with respect to contributions by a controlled party to the value of intangible property owned by another controlled party (the 2003 proposed regulations), were published in the
Federal Register
(68 FR 53448, REG-146893-02 and REG-115037-00).

On August 4, 2006, temporary regulations relating to the treatment of controlled services transactions, the allocation of income from intangible property, and stewardship expenses (the 2006 temporary regulations) were published in the
Federal Register
(71 FR 44466, TD 9278, REG-146893-02, REG-115037-00, and REG-138603-03). A notice of proposed rulemaking cross-referencing the temporary regulations was published in the
Federal Register
on the same day (71 FR 44247, REG-146893-02, REG-115037-00, and REG-138603-03). Written comments responding to the notice of proposed rulemaking were received, and a public hearing was held on October 27, 2006.

The 2006 temporary regulations are generally effective with respect to taxable years beginning after December 31, 2006, and Notice 2007-5, 2007-1 C.B. 269, published on January 16, 2007, partially modified the effective date of the 2006 temporary regulations as it pertained to the identification of controlled services transactions eligible to be priced at cost. Accordingly, the 2006 temporary regulations related to the new services cost method in § 1.482-9T(b) (described in Section A.1 in this preamble) apply to taxable years after December 31, 2007, with the exception of the business judgment rule described in § 1.482-9T(b)(2), which had the same effective date (taxable years after December 31, 2006) as the other provisions of the temporary regulations.

By issuing the 2006 temporary regulations in temporary and proposed form, the Treasury Department and the IRS provided taxpayers an opportunity to submit additional comments prior to the time these regulations became effective.
See
§ 601.601(d)(2)(ii)(
b
). After consideration of all the comments, the proposed regulations under section 482 are adopted as revised by this Treasury decision, and the corresponding temporary regulations are removed.

Explanation of Revisions and Summary of Comments

Introduction

The Treasury Department and the IRS received a number of comments on the 2006 temporary regulations from taxpayers, their representatives, as well as industry and professional groups. Commentators generally approved of the 2006 temporary regulations and found the changes from the 2003 proposed regulations to be useful. Specifically, commentators approved of the replacement of the simplified cost-based method with the services cost method (SCM) and the inclusion of the shared services arrangement provision in the SCM rules. Commentators also generally approved of changes made to the profit split method. However, commentators did express concerns with some aspects of the 2006 temporary regulations.

While these final regulations reflect some modifications in response to comments received on the 2006 temporary regulations, both the format and the substance of the final regulations are generally consistent with the 2006 temporary regulations. The changes adopted are intended to make certain clarifications and improvements without fundamentally altering the policies reflected in the 2006 temporary regulations.

Explanation of Provisions

A. Controlled Services

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

a. Applicability of the Services Cost Method

Most comments focused on the SCM. Several commentators requested confirmation that application of the SCM is a matter within the control of the taxpayer, provided that the underlying services otherwise qualify for the SCM. Some commentators stated that the 2006 temporary regulations could be interpreted as requiring a taxpayer to apply the SCM if all the conditions for that method were satisfied.

Notice 2007-5 confirmed that taxpayers control whether the SCM applies. The final regulations make this clear. Section 1.482-9(b)(1) provides that, if a taxpayer applies the SCM in accordance with the rules of § 1.482-9(b), which requires that a statement evidencing the taxpayer's intent to apply the SCM be contained in the taxpayer's books and records, then the SCM will be considered the best method for purposes of § 1.482-1(c).

b. Specified Covered Services

Several commentators contended that the proposed list of specified covered services in Announcement 2006-50, 2006-2 C.B. 321, is too narrow. One commentator listed tax planning and public relations activities as examples of activities not on the list that illustrated the narrowness of the list. Some commentators suggested that the list should refer to departments, cost centers, or accounting classifications, rather than to specific activities or groups of activities. One commentator suggested that all activities in particular departments should be identified as eligible for the SCM. Commentators also stated that a comprehensive analysis would be required and that it would be too burdensome to track employee time for activities that are specified covered services vs. non-specified covered services.
See
§ 601.601(d)(2)(ii)(
b
). The Treasury Department and the IRS also received suggestions to broaden the general administrative provision and add additional specific activities to the list of specified covered services, including warehousing and distribution, quality control and quality assurance relating to manufacturing and construction, and environmental remediation.

The SCM is intended to provide a practical and administrable means of identifying low-margin services that may be evaluated by reference to total services cost without a markup. The list of services eligible to be priced at cost in the specified covered services portion of the SCM was added specifically in response to requests from commentators that the former simplified cost-based method be eliminated and replaced with just such a list of eligible services. In response to public comments, the Treasury Department and the IRS published Rev. Proc. 2007-13, 2007-1 C.B. 295, which added several categories as well as activities within existing categories. In particular, public relations and tax planning services were added to the list, and the individual categories of specified covered services were expanded to include “other similar activities.”

After careful consideration, the Treasury Department and the IRS believe that Rev. Proc. 2007-13 strikes the appropriate balance between broadening the list to include services similar to the specific services described and expanding the categories of services. The Treasury Department and the IRS do not believe that other additional services suggested by commentators were appropriate, but will continue to consider other recommendations for additional services to be added to the list in the future.

One commentator expressed concern that a review of services to determine if they qualify as specified covered services may require a more extensive analysis than under previous regulations, including interviews of individual employees or of small groups of employees. Although the covered services list is not applied on a departmental basis, a reasonable aggregation of similar services may be appropriate for performing the specified covered services analysis in some cases. To determine if the services cost method should apply to a particular service (or group of services) performed by a group of employees, the aggregation principle of Treas. Reg. § 1.482-1(f)(2)(i)(A) should be followed as appropriate. In certain cases, aggregation may assure a more accurate result, especially if it recognizes synergies that an individual employee analysis might ignore. An aggregation of employee services may, thus, efficiently evaluate the work of employees engaged in a common function, as well as recognize the added value that their collaborative effort might produce. Conversely, analysis on an aggregate basis does not permit characterization of an individual service as a specified covered service if it, in fact, is not a specified covered service.

c. Low Margin Covered Services

Commentators provided comments on low margin covered services described in § 1.482-9T(b)(4)(ii) of the 2006 temporary regulations. One commentator believed that the 7 percent limit is too high for the SCM. In the commentator's view, the limit should be lower because the 7 percent figure will cover activities that are risky. Most of the commentators, however, believed that the 7 percent limit is an appropriate measure. The Treasury Department and the IRS continue to believe that the 7 percent limit is appropriate in light of its purpose. That is, it minimizes the compliance burden on taxpayers and the IRS for relatively low-margin services.

Several commentators requested more guidance on low margin covered services. One commentator suggested that the Treasury Department and the IRS develop an analysis to determine if certain services have a markup of 7 percent or less and publish the results. For example, the IRS could develop a set of comparables for various groups of low margin services, such as human resources, accounting and finance, information services, and training. Some commentators requested guidance on when and how often a transfer pricing study is needed to support a determination that services are low margin covered services. In this regard, some commentators requested that the regulations specify a period of years (such as three years) for which a transfer pricing study may be valid for purposes of determining if a service is a low margin covered service. In support of this request, one commentator stated that the regulations could provide, for example, that the reliance period could apply to taxpayers whose facts and circumstances have not changed materially from the time the service was most recently established as a covered service.

The Treasury Department and IRS did not adopt this proposal. Because there may be significant differences among services across different businesses, a standardized, IRS-developed comparables set would not be feasible and would conflict with the fact intensive nature of an appropriately robust transfer pricing analysis. For similar reasons, the Treasury Department and the IRS did not adopt the proposal to specify the frequency or timing of transfer pricing analyses to support taxpayer positions. To do so would be inconsistent with a proper comparability analysis, including consideration of the time at which

transactions were undertaken, as well as other relevant economic circumstances.

One other commentator requested that the midpoint should be used in measuring a comparable markup on total services costs for purposes of low margin covered services. While it may be true that, in some cases, the midpoint could be used depending on the statistical method used, the interquartile range ordinarily provides an acceptable measure of an arm's length range.
See
§ 1.482-1(e)(2)(iii)(B). Therefore, the Treasury Department and the IRS believe that the interquartile range of the comparable median markup is an appropriate measure.

d. Excluded Activities

One commentator requested that engineering be removed from the list of services that are ineligible for the SCM in § 1.482-9T(b)(3) of the 2006 temporary regulations. This comment was not adopted, since, in the view of the Treasury Department and the IRS, intragroup engineering services generally should be subject to a robust transfer pricing analysis.

e. Business Judgment Rule

Several commentators expressed concern over how the business judgment rule would be administered. Some commentators requested that statements in the preamble about the business judgment rule in the 2006 temporary regulations be incorporated in final regulations. Other commentators suggested that the business judgment rule should be applied by reference to one or more trades or business of the controlled group rather than of the renderer, recipient, or both. These commentators claimed that the business judgment rule may yield incorrect results in some cases, for example, where a headquarters services company or other legal entity is established solely to provide centralized support services. The activities performed by such an entity would potentially be ineligible for the SCM under the business judgment rule because they would constitute the entity's core capability.

The Treasury Department and the IRS agree that the business judgment rule should be determined on a controlled group basis and expressed this view in Notice 2007-5. The final regulations clarify that the business judgment rule is determined by reference to a trade or business of the controlled group.

Section 3.04 of Notice 2007-5 clarified that the business judgment rule “is satisfied by a reasonable exercise of the taxpayer's business judgment, not a reasonable exercise of the IRS's judgment in examining the taxpayer.” The Treasury Department and the IRS reiterate that the final regulations incorporate a high threshold for application of the business judgment rule to exclude services otherwise eligible for the SCM. Section 1.482-9(b)(5) provides that the rule is based on a taxpayer's reasonable conclusion in its business judgment that the rule is satisfied. It has come to the attention of the Treasury Department and the IRS that the clarification in the notice of the business judgment rule has been misconstrued as creating a non-rebuttable presumption that a taxpayer's determination under the business judgment rule is always correct. This construction of the clarification was not intended and is not supported by the plain language of the business judgment rule. The business judgment rule requires a reasonable conclusion by the taxpayer. Thus, the taxpayer's business judgment is only the starting point of the analysis, and the taxpayer must make a reasonable conclusion in that regard. Whether the taxpayer's conclusion is reasonable may be subject to examination by the IRS in the course of an audit.

One commentator suggested that the regulations adopt a “principal activity” test similar to the test described in the
Organisation for Economic Cooperation and Development Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines)
in place of the business judgment rule. The Treasury Department and the IRS decline to adopt this suggestion. Another commentator pointed out that the examples illustrating the business judgment rule more accurately describe a high value service or intangible property, rather than a covered service. The Treasury Department and the IRS agree that some of the examples in the temporary regulations could be read as describing transfers of intangible property rather than provisions of services involving the intangible property. Some examples have been edited to improve clarity, including to ensure that they cannot be read as describing transfers of intangible property.

Commentators also raised questions concerning how to evidence the necessary business judgment; for example, whether an executive's representation must be preferred to the tax director's. The business judgment rule is applied on a case-by-case basis and takes into account the taxpayer's facts and circumstances.

One other commentator requested that the business judgment rule take into account whether a particular activity, such as that of a corporate tax department, contributes to the operating profit (as defined in § 1.482-5(d)(3)) of one or more controlled parties. Notice 2007-5 provided several clarifications to the business judgment rule, including a clarification that the business judgment rule should take into account whether a particular activity contributes to the operating profit of one or more controlled parties. After further consideration, the Treasury Department and the IRS decided not to add an operating profit consideration to the business judgment rule because the operating profit concept is broader than the intended rule and because it would implicitly require taxpayers to do the type of economic analysis (and create the attendant administrative burden for taxpayers) that the business judgment rule is intended to eliminate.

The Treasury Department and the IRS continue to believe, however, that the conclusion in Notice 2007-5 is correct—that activities such as back office tax services should not fail the business judgment rule because they may affect net income by reducing domestic or foreign income taxes. Depending on the facts and circumstances, tax services may or may not satisfy the business judgment rule.

f. Reorganization of the SCM

Section 1.482-9T(b) of the 2006 temporary regulations contains several requirements, all of which have to be satisfied in order for the SCM to be applicable. In other words, the requirements under § 1.482-9T(b) are conjunctive; failure to satisfy one of the requirements renders a service ineligible for SCM treatment regardless of whether any of the other requirements is satisfied. The Treasury Department and the IRS are aware that the rules under § 1.482-9T(b) have been misinterpreted as disjunctive such that satisfaction of only one of the requirements renders a service eligible for the SCM. This view is unsupported by the plain language of § 1.482-9T(b). To improve clarity, the requirements for the SCM are reorganized in the final regulations. Section § 1.482-9(b)(2) lists the conditions necessary for a service to be eligible for the SCM and provides a cross-reference to the paragraph in § 1.482-9(b) that corresponds to each condition. In summary, to be eligible for the SCM, a service must be a covered service, the service cannot be an excluded activity, the service cannot be precluded from constituting a covered service by reason of the business judgment rule, and adequate books and records must be maintained with respect to the service. The

reorganization does not substantively change the SCM rules.

Modifications have also been made to the list of excluded activities to harmonize it with Rev. Proc. 2007-13. In particular, instead of referring to “excluded transactions,” the regulations now refer to “excluded activities.”

g. Shared Services Arrangements

In general, commentators supported the shared services arrangement (SSA) provision in the 2006 temporary regulations as a useful mechanism for allocation of costs from shared or centralized services. Commentators called into question, however, the restriction of SSAs to covered services priced under the SCM. In response, Notice 2007-5 provided that a SSA may be used for controlled services transactions outside of the SCM context. Specifically, Notice 2007-5 states: “This Notice confirms that taxpayers may also make allocations of arm's length charges for services ineligible for the SCM that yield a benefit to multiple members of a controlled group. In such a case, however, the flexible rules under the SCM for establishing the joint benefits and selecting the allocation key are inapplicable. Instead, the more robust analysis under the general transfer pricing rules applies for purposes of determining the appropriate arm's length charges, benefits, allocation keys,
etc.
” The Treasury Department and the IRS considered providing additional SSA rules to services priced under methods other than the SCM, but concluded that such rules would be unnecessary. In any event, as stated in Notice 2007-5, the flexible SSA rules for establishing the joint benefits and selecting the allocation key are inapplicable in the non-SCM context.

Other commentators requested that a SSA should be respected even if a party that reasonably anticipates a benefit makes a payment equivalent to its share under an SSA to the service provider pursuant to a different arrangement. For example, assume that a controlled service provider performs services to ten taxpayers that are members of its controlled group. Assume further that nine of the service recipients agree in a single written contract to allocate the arm's length charge based on a reasonable allocation basis, but the tenth service recipient pays for its share of the services pursuant to a separate agreement. These comments were not adopted because whether an agreement constitutes a SSA requires a case-by-case determination based on the facts and circumstances.

Some commentators observed that the SSA rules require the allocation of costs on the basis that “most reliably reflects” the participants' respective shares of reasonably anticipated benefits, but some of the examples use the phrase “precisely known.” This led the commentators to question whether the SSA rules create an unattainable standard or, at least, a higher standard than the reasonable standard for allocation of costs described in Treas. Reg. § 1.482-9T(k) and to suggest a change to the examples. The examples do not create a standard based on precisely known shares of reasonably anticipated benefits. Rather, the examples use hypothetical, precisely known reasonably anticipated benefits as a measuring stick to provide an easily understood comparative analysis of potential allocation keys for illustrative purposes. The suggested changes are not adopted.

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

The comparable uncontrolled services price (CUSP) method evaluates whether the consideration in a controlled services transaction is arm's length by comparison to the price charged in a comparable uncontrolled services transaction. This method is closely analogous to the comparable uncontrolled price (CUP) method in § 1.482-3(b).

One commentator objected to the statement in the second sentence of § 1.482-9T(c)(1) of the 2006 temporary regulations that, to be evaluated under the CUSP method, a controlled service ordinarily must be “identical to or have a high degree of similarity” to the uncontrolled comparable transactions. The commentator claimed that such language creates a higher standard for determining the best method than in the rest of the section 482 regulations. For example, both § 1.482-1(c)(1) and § 1.482-9T(c)(2)(i) refer to the “most reliable measure of an arm's length result” standard. The sentence in question was intended merely as a guide to when the CUSP method is applicable. It was not intended to change the standard under the best method rule. To avoid further confusion, the sentence is removed, but without effecting a substantive change.

The CUSP method in these final regulations is substantially similar to the corresponding method in the 2006 temporary regulations.

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

The cost of services plus method is generally analogous to the cost plus method for transfers of tangible property in existing § 1.482-3(d). The cost of services plus method evaluates whether the amount charged in a controlled services transaction is arm's length by reference to the gross services profit markup realized in comparable uncontrolled transactions. Section 1.482-9T(e)(3)(ii)(A) provides that, if the appropriate gross services profit markup is derived from comparable uncontrolled services transactions of other service providers, then, in evaluating comparability, the controlled taxpayer must consider the results under this method expressed as a markup on total services costs of the controlled taxpayer because functional differences may be reflected in differences in service costs other than those included in comparable transactional costs.

One commentator objected to the required consideration of the results of the cost of services plus method expressed as a markup on total services costs of the controlled taxpayer when external comparables are utilized. In the commentator's view, this rule requires a confirming analysis under a comparable profits method (CPM) and, therefore, places an undue burden on the taxpayer. The same commentator also expressed the concern that the rule would create an even greater burden by requiring two sets of external comparables for application of the two methods.

These comments are not adopted for several reasons. First, the restatement of the price does not require researching two sets of external comparables under two different methods. The sole purpose of the calculation is to determine whether it is necessary to perform additional evaluation of functional comparability under the cost of services plus method. That is, if the price indicates a markup on the renderer's total services cost that is either low or negative when restated, this may indicate differences in functions that have not been accounted for under the traditional comparability factors under the cost of services plus method. Thus, a low or negative markup merely suggests the need for additional inquiry, which may lead to a determination that the cost of services plus method is not the most reliable measure of an arm's length result under the best method rule.

The cost of services plus method is adopted in the final regulations without change.

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

The final regulations provide additional guidance concerning application of the comparable profit

split and the residual profit split methods to controlled services transactions in § 1.482-9(g) and § 1.482-6(c)(3)(i)(B). Generally, the comparable profit split and the residual profit split methods evaluate whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contributions to the combined operating profit or loss.

The Treasury Department and the IRS received several comments on the profit split method. One commentator requested that § 1.482-8T(b),
Example 12
of the 2006 temporary regulations explain why the profit split method is preferable to using the financial results of a set of publicly-traded companies engaged in selling merchandise and related promotion and marketing activities.
Example 12
is revised in the final regulations to address this comment.

Another commentator argued that the profit split method should not apply to a party that does not own valuable intangible property or does not use any such property in the related party transaction being evaluated. The commentator noted that other parts of the regulations, such as the CPM, CUSP method, and costs of services plus method reference valuable intangible property in the examples. The same commentator asserted that the profit split method should be limited to parties that bear substantial risk in their intercompany transactions. The Treasury Department and the IRS believe that limiting application of the profit split method to contributions of valuable intangible property or the bearing of risks would be inappropriate. The changes in the 2006 temporary regulations to routine and non-routine contributions is an appropriate standard and conformed to the changes to § 1.482-6T(c)(3)(i)(B)(
1
), which defines a nonroutine contribution as “a contribution that is not accounted for as a routine contribution.” In other words, a nonroutine contribution is one for which the return cannot be determined by reference to market benchmarks.

The 2006 temporary regulations provide that the residual profit split method ordinarily is used where multiple controlled taxpayers make significant nonroutine contributions. A commentator requested that this provision be removed because it suggests that the method always applies where there are no market benchmarks. The provision regarding the residual profit split method that the commentator requested be removed has been changed to conform to language in the cost sharing regulations. Accordingly, § 1.482-9(g)(1) provides that the residual profit split method may not be used where only one controlled taxpayer makes significant nonroutine contributions. The commentator also claimed that the residual profit split method contains an inconsistency because, although the method applies when there are no market benchmarks, the method includes a market benchmark analysis for comparability purposes. Compare §§ 1.482-9(g)(1) and 1.482-6(c)(3)(i)(B)(
2
). The Treasury Department and the IRS do not consider that there is an inconsistency. The method contemplates the use of market benchmarks, if available, to determine the profit split that will be applied to the return to nonroutine contributions already determined under the method. The same commentator requested that the sentence in § 1.482-6T(c)(2)(ii)(B) of the 2006 temporary regulations relating to the comparable profit split method that states that “the comparable profit split method may not be used if the combined operating profit (as a percentage of the combined assets) of the uncontrolled comparables varies significantly from that earned by the controlled taxpayers” should be deleted. These comments are not adopted, since the stated condition is fundamental to comparability under the method.

5. Contingent Payments—Treas. Reg. § 1.482-9(i)

The 2006 temporary regulations provide detailed guidance concerning contingent-payment contractual terms. The rules built on the principle that, in structuring controlled transactions, taxpayers are free to choose from among a wide range of risk allocations. The provision acknowledged that contingent-payment terms—terms requiring compensation to be paid only if specified results are obtained—may be particularly relevant in the context of controlled services transactions.

Commentators raised several concerns about the substance and scope of this provision. One commentator said that the regulations do not address whether a taxpayer may, in the absence of a written agreement, present facts to demonstrate that a contingent payment arrangement best reflects the economic substance of the underlying transactions. The Treasury Department and the IRS do not agree that an arrangement may be treated as a contingent payment arrangement under § 1.482-9(i)(2) if the arrangement does not satisfy the requirements of the contingent payment arrangement provision, including the written contract requirement. However, where the Commissioner exercises its authority pursuant to § 1.482-1(d)(3)(ii)(B) to impute contractual terms, the taxpayer may present additional facts to indicate if an alternative agreement best reflects the economic substance of the underlying transaction, consistent with the parties' course of conduct in a particular case.
See
§ 1.482-1(d)(3)(ii)(C),
Examples 4
and
6.

The same commentator also pointed out that the requirement to evaluate whether a specified contingency bears a direct relationship to the controlled services transaction based on all of the facts and circumstances should be combined with the specified contingency requirement. The Treasury Department and the IRS agree that the language in § 1.482-9(i)(2) should be clarified. Accordingly, the regulations remove the last sentence in § 1.482-9T(i)(2)(i)(C) of the 2006 temporary regulations relating to a specified contingency and combine it with the requirement under § 1.482-9T(i)(2)(i)(B). Thus, § 1.482-9(i)(2)(i)(B) now requires that the contract state that payment for a controlled services transaction is contingent (in whole or in part) upon the happening of a future benefit (within the meaning of § 1.482-9(l)(3)) for the recipient directly related to the activity or group of activities. For this purpose, whether the future benefit is directly related to the activity or group of activities is evaluated based on all the facts and circumstances.

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

In the 2006 temporary regulations, total services costs include all costs directly identified with provision of the controlled services, as well as all other costs reasonably allocable to such services under § 1.482-9(k). “Costs” must reflect all resources expended, used, or made available to render the service. Generally accepted accounting principles (GAAP) or Federal income tax accounting rules may provide an appropriate starting point, but neither would necessarily be conclusive in evaluating whether an item must be included in total services costs.

Another commentator requested that value added costs (that is, labor costs and depreciation) should be distinguished from total services costs. The commentator stated that a markup on value added costs may be more reliable than a markup on total costs in certain instances and that this could be a useful measure for any of the transfer pricing methods, including the cost of services plus method. The regulations already provide flexibility in the context of the cost of services plus method,

which is determined by reference to comparable transactional costs, the comparable profits method, and unspecified methods. Consequently, the comment is not adopted. The definition of total services costs in these regulations is, thus, similar to the provisions in the 2006 temporary regulations.

Section 1.482-9T(j) of the 2006 temporary regulations explicitly states that total services costs include stock-based compensation, and
Examples 3
through
6
of § 1.482-9T(f)(3) illustrate when stock-based compensation constitutes a material difference requiring adjustments for comparability and reliability purposes. Commentators requested further guidance regarding the valuation, comparability, and reliability considerations for stock-based compensation. Other commentators objected to the explicit statement that stock-based compensation can be a total services cost. These final regulations do not provide further guidance regarding stock-based compensation. The Treasury Department and the IRS continue to consider technical issues involving stock-based compensation in the services and other contexts and intend to address those issues in a subsequent guidance project.

7. Controlled Services Transactions and Shareholder Activities—Treas. Reg. § 1.482-9(l)

Section 1.482-9(l) sets forth a threshold test for determining whether an activity constitutes a controlled services transaction subject to the general framework of § 1.482-9. Section 1.482-9(l)(3) provides rules for determining whether an activity provides a benefit. Paragraphs (l)(3)(ii) through (v) provide guidelines that indicate the presence or absence of a benefit. Section 1.482-9T(l)(3)(iv) of the 2006 temporary regulations provides that an activity is a shareholder activity if the sole effect of that activity is either to protect the renderer's capital investment in the recipient or in other members of the controlled group, or to facilitate compliance by the renderer with reporting, legal, or regulatory requirements applicable specifically to the renderer, or both.

The Treasury Department and the IRS received comments on shareholder activities. Some commentators asserted that the “sole effect” language is too restrictive and that the language should be replaced by a “primary effect” standard. Other commentators argued that the language appropriately encompasses shareholder activities. Another commentator requested a change to the regulations such that a shareholder activity should be considered to have a sole effect only if the benefits provided to the other controlled group members are either (i) indirect or remote or (ii) duplicative.

The Treasury Department and the IRS believe that the “sole effect” language is appropriate. The “primary effect” language in the 2003 proposed regulations could inappropriately include activities that are not true shareholder activities and may even consist of substantial activities that are non-shareholder activities. An activity that is described in § 1.482-9(l)(3)(ii) through (iv) does not produce a benefit, but the mere fact that an activity is not described in § 1.482-9(l)(3)(ii) through (iv) does not mean that the activity necessarily provides a benefit. An activity not described in § 1.482-9(l)(3)(ii) through (iv) provides a benefit only if it satisfies the incremental value standard of § 1.482-9(l)(3)(i). Furthermore, for that purpose, it may be more reliable, depending on the facts and circumstances, to measure incremental value on a functional aggregate activity, rather than a component activity-by-activity basis.

8. Third Party Costs—Treas. Reg. § 1.482-9(l)(4)

Under § 1.482-9T(l)(4) of the 2006 temporary regulations, a controlled services transaction may be analyzed as a single transaction or as two separate transactions depending on which approach provides the most reliable measure of the arm's length result under the best method rule in existing § 1.482-1(c). Two examples are provided illustrating different alternatives when a controlled services transaction included expenses related to a third-party contract (third party costs) with a controlled taxpayer. In both examples, third party costs that could be reliably disaggregated could be charged at cost. Commentators requested that all third party costs be treated as “pass through” items that are not subject to a markup applicable to costs incurred by the renderer in its capacity as service provider.

The Treasury Department and the IRS continue to maintain the view that whether to consider “pass through” items as disaggregated from, or aggregated with, other functions and costs, depends on which analysis most reliably reflects an arm's length result. Therefore, the rules of § 1.482-9(l)(4) are adopted without change.

9. Coordination With Other Transfer Pricing Rules—Treas. Reg. § 1.482-9(m) and Guarantees

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

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

Section 1.482-9T(m)(3) of the 2006 temporary regulations states that services provided by a controlled participant under a qualified cost sharing arrangement are subject to existing § 1.482-7. As part of the temporary cost sharing regulations (TD 9441, 2009-7 I.R.B. 460, 74 FR 340) published on January 5, 2009, the Treasury Department and the IRS replaced the coordination rules with new § 1.482-9T(m)(3). Section 1.482-9(m)(3) is reserved pending finalization of the cost sharing regulations.

b. Global Dealing Operations

The Treasury Department and the IRS are working on new global dealing regulations. The intent of the Treasury Department and the IRS is that, when final global dealing regulations are issued, those regulations will govern the evaluation of the activities performed by a global dealing operation. Pending the issuance of new global dealing regulations, taxpayers may rely on the proposed global dealing regulations to govern financial transactions entered into in connection with a global dealing operation as defined in proposed § 1.482-8. Thus, the cross-reference under proposed § 1.482-9(m)(6) (71 FR 44247), which provides that a controlled services transaction does not include a financial transaction entered into in connection with a global dealing operation as defined in proposed § 1.482-8, remains in proposed form. Section 1.482-9(m)(6) in these final regulations is reserved pending issuance of global dealing regulations.

c. Guarantees, Including Financial Guarantees

Financial transactions, including guarantees, are explicitly excluded from eligibility for the SCM by § 1.482-9(b)(4)(viii). However, no inference is intended that financial transactions (including guarantees) would otherwise be considered the provision of services

for transfer pricing purposes. The Treasury Department and the IRS intend to issue future guidance regarding financial guarantees.

B. Income Attributable to Intangible Property—Treas. Reg. § 1.482-4(f)(3) and (4)

Paragraphs (3) and (4) of § 1.482-4(f) provide rules for determining the owner of intangible property for purposes of section 482 and also provide rules for determining the arm's length compensation in situations where a controlled party other than the owner makes contributions to the value of intangible property. Section 1.482-4(f)(3)(i)(A) provides that the legal owner of intangible property pursuant to the intellectual property law of the relevant jurisdiction, or the holder of rights constituting intangible property pursuant to contractual terms (such as the terms of a license) or other legal provision, will be considered the sole owner of intangible property for purposes of this section unless such ownership is inconsistent with the economic substance of the underlying transactions. Some commentators believe that the rules should specify that a holder of bare legal title to intangible property should not be presumed to be the owner when other parties have all of the other benefits and burdens of ownership. After considering the public comments, the Treasury Department and the IRS continue to believe that the legal ownership standard as set forth in § 1.482-4(f)(3)(i)(A) is the appropriate framework for determining ownership of intangible property under section 482.

The provisions of § 1.482-4(f)(3) and (4) are adopted without change.

C. Economic Substance

A number of commentators expressed similar and sometimes interrelated concerns regarding economic substance considerations, imputation of contractual terms, the realistic alternatives principle, and the rules for income attributable to intangible property. The common thread running through these comments is a concern that the IRS will inappropriately treat taxpayers as having engaged in transactions different from those in which they actually engaged.

Section 1.482-4(f)(3)(i)(A) provides that, if no owner of intangible property is identified under the intellectual property law of the relevant jurisdiction, or pursuant to contractual terms (including terms imputed pursuant to § 1.482-1(d)(3)(ii)(B)) or other legal provision, then the controlled taxpayer that has control of intangible property, based on all the facts and circumstances, will be considered the sole owner of intangible property for purposes of this section. One commentator believes that the control rule for determining ownership of non-legally protected intangibles allows the IRS to attribute ownership of intangible property in a manner that is inconsistent with economic substance. Accordingly, the comment suggests that such control determinations must be consistent with economic substance in all cases. In the context of the control rule in § 1.482-4(f)(3)(i)(A), this is already reflected in the language “including terms imputed pursuant to § 1.482-1(d)(3)(ii)(B).”

Section 1.482-9T(h) of the 2006 temporary regulations provides that, consistent with the specified methods, an unspecified method should take into account the general principle that uncontrolled taxpayers compare the terms of a particular transaction to the realistic alternatives to that transaction, including economically similar transactions structured as other than services transactions, and only enter into a transaction if none of the alternatives is preferable to it. The realistic alternatives concept was imported from § 1.482-1(f)(2)(ii) to be consistent with the general aim to coordinate the analyses under the various sections of the regulations under section 482. This provision allows flexibility to consider non-services alternatives to a services transaction, for example, a transfer or license of intangible property, if such an approach provides the most reliable measure of an arm's length result.

Commentators suggested that the realistic alternative principle be clarified so that only transactions actually engaged in by the controlled taxpayer can constitute realistic alternatives or that the principle be removed altogether on the grounds that it inappropriately treats taxpayers as engaging in transactions other than those they chose. The Treasury Department and the IRS do not agree with the assertion that consideration of realistic alternatives improperly disregards a taxpayer's chosen arrangement and that the realistic alternative principle is limited to internal comparables. It is a longstanding principle under § 1.482-1(f)(2)(ii)(A) and in the valuation field, generally, that, although the Commissioner will evaluate the results of a transaction as actually structured by the taxpayer unless it lacks economic substance, the Commissioner may consider alternatives available in determining the arm's length valuation of the controlled transaction. The realistic alternatives principle does not recast the transaction. Rather, it assumes that taxpayers are rational and will not choose to price an arrangement in a manner that makes them worse off economically than another available alternative. Thus, if the price associated with a realistic alternative appears preferable in comparison with the price associated with the chosen arrangement, the logical implication is that the actual arrangement has been priced incorrectly through a flawed application of the best method rule. This is further reflected in the example in § 1.482-9T(h), which illustrates when realistic alternatives may be considered to evaluate the arm's length consideration, and explicitly states that the best method rule of § 1.482-1(c) governs the analysis.

The unspecified method provisions in these final regulations are adopted without change.

Section 1.482-9(i)(3) provides that, consistent with the authority in § 1.482-1(d)(3)(ii)(B), the Commissioner may impute contingent-payment contractual terms in a controlled services transaction if the economic substance of the transaction is consistent with the existence of such terms. When the 2003 proposed regulations were issued, commentators expressed concerns with the rule for imputing contingent payment terms to the extent that it permits the IRS to recast arrangements if there is a disagreement about the pricing of a service. The temporary regulations responded to this concern by providing a new
Example 5
in § 1.482-1T(d)(3)(ii)(C) to illustrate that if a taxpayer's pricing is outside of the arm's length range, that fact alone would not support imputation of additional contractual terms based on economic substance grounds. Commentators responded, however, that the last sentence of
Example 5
perpetuated the same problem of allowing the IRS to recast arrangements if there were pricing disputes between a taxpayer and the IRS.

The Treasury Department and the IRS agree that the last sentence of
Example 5
in § 1.482-1T(d)(3)(ii)(C) did not clearly convey its intended meaning, which is that a transfer pricing method and the price derived from the application of that method do not inform the terms of the transaction or the risks borne by the entities. Rather, the selection and application of a transfer pricing method should be based on a comparability analysis of the transaction, which must consider the risks borne by each entity in the transaction. Thus, the last sentence in § 1.482-1T(d)(3)(ii)(C)
Example 5,

paragraph (iv), was intended to explain that the IRS is not required to accept the transfer pricing method and form of payment terms of a transaction as represented by a taxpayer if they are inconsistent with the conduct of the entities and the economic substance of the transaction. Because this sentence caused confusion, it has been removed. However, the Treasury Department and the IRS affirm that the IRS may impute contingent-payment terms where the economic substance of the transaction is consistent with the existence of such terms.

D. Stewardship Expenses—§ 1.861-8

The regulations under § 1.861-8(e)(4) conform to, and are consistent with, the language relating to controlled services transactions as set forth in § 1.482-9(l). The regulations under § 1.861-8(e)(4) are applicable for taxable years beginning after December 31, 2006.

E. Effective/Applicability Date—§ 1.482-9(n)

These regulations are applicable for taxable years beginning after July 31, 2009. Controlled taxpayers may elect to apply retroactively all of the provisions of these regulations to any taxable year beginning after September 10, 2003. Such election will be effective for the year of the election and all subsequent taxable years.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation. It is hereby certified that the collections of information in this regulation will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that the collections of information are related to elective provisions for determining taxable income that simplify and reduce compliance burdens in connection with controlled services transactions. When collection of information is required, it is expected to take taxpayers approximately 2 hours to comply, and the administrative and economic costs will be nominal in comparison with the resulting simplification and reduction of compliance burdens. Thus, the economic impact of the collections of information will not be significant. Similarly, while some small entities may be subject to the collections of information if they elect one of the provisions, the collections of information are not expected to affect a substantial number of small entities. Accordingly, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal authors of these regulations are Carol B. Tan and Gregory A. Spring, Office of Associate Chief Counsel (International) for matters relating to section 482, and Richard L. Chewning, Office of Associate Chief Counsel (International) for matters relating to stewardship expenses.

List of Subjects

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

26 CFR Part 31
Employment taxes, Income taxes, Penalties, Pensions, Railroad retirement, Reporting and recordkeeping requirements, Social Security and Unemployment compensation.

26 CFR Part 602
Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1, 31, 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 in part as follows:

Authority:

26 U.S.C. 7805 * * *.

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

Par. 2
. Section 1.482-0 is amended as follows:

1. The introductory text is revised.
2. The entries for § 1.482-1(a)(1), (d)(3)(ii)(C), (d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(iii), (i) and (j) are revised.
3. The entries for § 1.482-2(b), (e) and (f) are revised.
4. The entries for § 1.482-4(f)(3), (f)(4), (g), and (h) are revised.
5. The entry for § 1.482-4(f)(7) is removed.

6. The entries for § 1.482-6(c)(2)(ii)(B)(
1
), (c)(2)(ii)(D), (c)(3)(i)(A), (c)(3)(i)(B), (c)(3)(ii)(D), and (d) are revised

7. The entry for § 1.482-8(c) is added.
8. The entries for § 1.482-9 are revised.
The addition and revisions read as follows:

§ 1.482-0
Outline of regulations under section 482.
This section contains major captions for §§ 1.482-1 through 1.482-9.

§ 1.482-1
Allocation of income and deductions among taxpayers.
(a) * * *

(1) Purpose and scope.

(d) * * *

(3) * * *

(ii) * * *

(C) Examples.

(v) Property or services.

(f) * * *

(2) * * *

(ii) * * *

(A) In general.

(iii) * * *

(A) * * *

(B) Circumstances warranting consideration of multiple year data.

(g) * * *

(4) * * *

(iii) Examples.

(i) Definitions.

(j) Effective/applicability date.

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

(b) Rendering of services.

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

(f) Effective/applicability date.

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

(f) * * *

(3) Ownership of intangible property.

(i) Identification of owner.

(A) In general.

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

(ii) Examples.

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

(i) In general.

(ii) Examples.

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

(h) Effective/applicability date.

§ 1.482-6
Profit split method.

(c) * * *

(2) * * *

(ii) * * *

(B) * * *.

(
1
) In general.

(D) Other factors affecting reliability.

(3) * * *

(i) * * *

(A) Allocate income to routine contributions.

(B) Allocate residual profit.

(
1
) Nonroutine contributions generally.

(
2
) Nonroutine contributions of intangible property.

(ii) * * *

(D) Other factors affecting reliability.

(d) Effective/applicability date.

§ 1.482-8
Examples of the best method rule.

(c) Effective/applicability date.

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

(b) Services cost method.

(1) In general.

(2) Eligibility for the services cost method.

(3) Covered services.

(i) Specified covered services.

(ii) Low margin covered services.

(4) Excluded activities.

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

(6) Adequate books and records.

(7) Shared services arrangement.

(i) In general.

(ii) Requirements for shared services arrangement.

(A) Eligibility.

(B) Allocation.

(C) Documentation.

(iii) Definitions and special rules.

(A) Participant.

(B) Aggregation.

(C) Coordination with cost sharing arrangements.

(8) Examples.

(c) Comparable uncontrolled services price method.

(1) In general.

(2) Comparability and reliability considerations.

(i) In general.

(ii) Comparability.

(A) In general.

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

(iii) Data and assumptions.

(3) Arm's length range.

(4) Examples.

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

(i) In general.

(ii) Example.

(d) Gross services margin method.

(1) In general.

(2) Determination of arm's length price.

(i) In general.

(ii) Relevant uncontrolled transaction.

(iii) Applicable uncontrolled price.

(iv) Appropriate gross services profit.

(v) Arm's length range.

(3) Comparability and reliability considerations.

(i) In general.

(ii) Comparability.

(A) Functional comparability.

(B) Other comparability factors.

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

(D) Buy-sell distributor.

(iii) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(4) Examples.

(e) Cost of services plus method.

(1) In general.

(2) Determination of arm's length price.

(i) In general.

(ii) Appropriate gross services profit.

(iii) Comparable transactional costs.

(iv) Arm's length range.

(3) Comparability and reliability considerations.

(i) In general.

(ii) Comparability.

(A) Functional comparability.

(B) Other comparability factors.

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

(iii) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(4) Examples.

(f) Comparable profits method.

(1) In general.

(2) Determination of arm's length result.

(i) Tested party.

(ii) Profit level indicators.

(iii) Comparability and reliability considerations—Data and assumptions—Consistency

in accounting.

(3) Examples.

(g) Profit split method.

(1) In general.

(2) Examples.

(h) Unspecified methods.

(i) Contingent-payment contractual terms for services.

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

(2) Contingent-payment arrangement.

(i) General requirements.

(A) Written contract.

(B) Specified contingency.

(C) Basis for payment.

(ii) Economic substance and conduct.

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

(4) Evaluation of arm's length charge.

(5) Examples.

(j) Total services costs.

(k) Allocation of costs.

(1) In general.

(2) Appropriate method of allocation and apportionment.

(i) Reasonable method standard.

(ii) Use of general practices.

(3) Examples.

(l) Controlled services transaction.

(1) In general.

(2) Activity.

(3) Benefit.

(i) In general.

(ii) Indirect or remote benefit.

(iii) Duplicative activities.

(iv) Shareholder activities.

(v) Passive association.

(4) Disaggregation of transactions.

(5) Examples.

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

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

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

(3) [Reserved]. For further guidance,
see
§ 1.482-0T, the entry for § 1.482-9T(m)(3).

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

(5) Examples.

(n) Effective/applicability date.

(1) In general.

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

Par. 3
. Section 1.482-0T is amended as follows:

1. Revise the section heading and introductory text.
2. Revise the section headings for §§ 1.482-1T, 1.482-4T and 1.482.9T and the entries for §§ 1.482-1T, 1.482-2T, 1.482-4T and 1.482.9T.
3. Remove the entries for § 1.482-6T.
The revisions read as follows:

§ 1.482-0T
Outline of regulations under section 482 (temporary).
This section contains major captions for §§ 1.482-1T, 1.482-2T, 1.482-4T, 1.482-7T, 1.482-8T, and 1.482-9T.

§ 1.482-1T
Allocation of income and deductions among taxpayers (temporary).

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

(i) Methods.

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

(j) Effective/applicability date.

(k) Expiration date.

§ 1.482-2T
Determination of taxable income in specific situations (temporary).

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

(e) Cost sharing arrangement.

(f) Effective/applicability date.

(1) In general.

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

(3) Expiration date.

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

(a) through (f)(3)(i)(A) [Reserved]. For further guidance,
see
§ 1.482-0, the entries for § 1.482-4(a) through (f)(3)(i)(A).

(B) Cost sharing arrangements.

(f)(3)(ii) through (f)(6) [Reserved]. For further guidance,
see
§ 1.482-0, the entries for § 1.482-4(f)(3)(ii) through (f)(6).

(g) Coordination with rules governing cost sharing arrangements.

(h) Effective/applicability date.

(i) Expiration date.

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

(a) through (m)(2) [Reserved]. For further guidance,
see
§ 1.482-0, the entries for § 1.482-9(a) through (m)(2).

(3) Coordination with rules governing cost sharing arrangements.

(n) Effective/applicability dates.

(o) Expiration date.

Par. 4
. Section 1.482-1 is amended by revising paragraphs (a)(1), (d)(3)(ii)(C)
Examples 3,

4,

5,
and
6,
(d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii)
Example 1,
(i), and (j)(6) to read as follows:

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

(a)
In general
—(1)
Purpose and scope.
The purpose of section 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions. Section 482 places a controlled taxpayer on a tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer. This section sets forth general principles and guidelines to be followed under section 482. Section 1.482-2 provides rules for the determination of the true taxable income of controlled taxpayers in specific situations, including controlled transactions involving loans or advances or the use of tangible property. Sections 1.482-3 through 1.482-6 provide rules for the determination of the true taxable income of controlled taxpayers in cases involving the transfer of property. Section 1.482-7T sets forth the cost sharing provisions applicable to taxable years beginning on or after January 5, 2009. Section 1.482-8 provides examples illustrating the application of the best method rule. Finally, § 1.482-9 provides rules for the determination of the true taxable income of controlled taxpayers in cases involving the performance of services.

(d) * * *

(3) * * *

(ii) * * *

(C) * * *

Example 3.

Contractual terms imputed from economic substance.
(i) FP, a foreign producer of wristwatches, is the registered holder of the YY trademark in the United States and in other countries worldwide. In year 1, FP enters the United States market by selling YY wristwatches to its newly organized United States subsidiary, USSub, for distribution in the United States market. USSub pays FP a fixed price per wristwatch. USSub and FP undertake, without separate compensation, marketing activities to establish the YY trademark in the United States market. Unrelated foreign producers of trademarked wristwatches and their authorized United States distributors respectively undertake similar marketing activities in independent arrangements involving distribution of trademarked wristwatches in the United States market. In years 1 through 6, USSub markets and sells YY wristwatches in the United States. Further, in years 1 through 6, USSub undertakes incremental marketing activities in addition to the activities similar to those observed in the independent distribution transactions in the United States market. FP does not directly or indirectly compensate USSub for performing these incremental activities during years 1 through 6. Assume that, aside from these incremental activities, and after any adjustments are made to improve the reliability of the comparison, the price paid per wristwatch by the independent, authorized distributors of wristwatches would provide the most reliable measure of the arm's length price paid per YY wristwatch by USSub.

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

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

Example 4.

Contractual terms imputed from economic substance.
(i) FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries worldwide. In year 1, FP enters into a licensing agreement that affords its newly organized United States subsidiary, USSub, exclusive rights to certain manufacturing and marketing intangible property (including the AA trademark) for purposes of manufacturing and marketing athletic gear in the United States under the AA trademark. The contractual terms of this

agreement obligate USSub to pay FP a royalty based on sales, and also obligate both FP and USSub to undertake without separate compensation specified types and levels of marketing activities. Unrelated foreign businesses license independent United States businesses to manufacture and market athletic gear in the United States, using trademarks owned by the unrelated foreign businesses. The contractual terms of these uncontrolled transactions require the licensees to pay royalties based on sales of the merchandise, and obligate the licensors and licensees to undertake without separate compensation specified types and levels of marketing activities. In years 1 through 6, USSub manufactures and sells athletic gear under the AA trademark in the United States. Assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangible property, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm's length royalty owed by USSub to FP, apart from the additional facts in paragraph (ii) of this
Example 4.

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

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

Example 5.

Non-arm's length compensation.
(i) The facts are the same as in paragraph (i) of
Example 4.
As in
Example 4,
assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangible property, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm's length royalty owed by USSub to FP, apart from the additional facts described in paragraph (ii) of this
Example 5.

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

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

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

Example 6.

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

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

(iii) In determining whether an allocation is appropriate in year 4, the Commissioner may consider the economic substance of the arrangements between Company X and Company Y, and the parties' course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that an uncontrolled taxpayer operating at arm's length would make available the results of its research and development or perform services that resulted in transfer of valuable know how to another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of receiving a future benefit from those activities. In this case, Company X's undertaking the research and development activities and then providing technical data and know-how to Company Y in year 4 is inconsistent with the registration and subsequent exploitation of the patent by Company Y. Therefore, the Commissioner may impute one or more agreements between Company X and Company Y consistent with the economic substance of their course of conduct, which would afford Company X an appropriate portion of the premium return from the patent rights. For example, the Commissioner

may impute a separate services agreement that affords Company X contingent-payment compensation for its services in year 4 for the benefit of Company Y, consisting of making available to Company Y technical data, know-how, and other fruits of research and development conducted in previous years. These services benefited Company Y by giving rise to and contributing to the value of the patent rights that were ultimately registered by Company Y. In the alternative, the Commissioner may impute a transfer of patentable intangible property rights from Company X to Company Y immediately preceding the registration of patent rights by Company Y. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties' course of conduct in the particular case.

(v)
Property or services.
Evaluating the degree of comparability between controlled and uncontrolled transactions requires a comparison of the property or services transferred in the transactions. This comparison may include any intangible property that is embedded in tangible property or services being transferred (embedded intangibles). The comparability of the embedded intangibles will be analyzed using the factors listed in § 1.482-4(c)(2)(iii)(B)(
1
) (comparable intangible property). The relevance of product comparability in evaluating the relative reliability of the results will depend on the method applied. For guidance concerning the specific comparability considerations applicable to transfers of tangible and intangible property and performance of services,
see
§§ 1.482-3 through 1.482-6 and § 1.482-9;
see
also §§ 1.482-3(f), 1.482-4(f)(4), and 1.482-9(m), dealing with the coordination of the intangible and tangible property and performance of services rules.

(f) * * *

(2) * * *

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

(iii) * * *

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

(g) * * *

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

(iii) * * *

Example 1.

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

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

(j) * * *

(6)(i) The provisions of paragraphs (a)(1), (d)(3)(ii)(C)
Example 3
,
Example 4
,
Example 5
, and
Example 6
, (d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii), and (i) of this section are generally applicable for taxable years beginning after July 31, 2009.

(ii) A person may elect to apply the provisions of paragraphs (a)(1), (b)(2)(i), (d)(3)(ii)(C)
Example 3
,
Example 4
,
Example 5
, and
Example 6
, (d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii), and (i) of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9(n)(2).

Par. 5
. Section 1.482-1T is amended by revising paragraphs (a), (b)(1), the first sentence in paragraph (b)(2)(i), (b)(2)(ii), the second sentence in paragraph (b)(2)(iii), (c), (d), (e), (f), (g), (h), (i), and (j) to read as follows:

§ 1.482-1T
Allocation of income and deductions among taxpayers (temporary).

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

(b)(2) * * * (i) * * * Sections 1.482-2 through 1.482-6, 1.482-7T and 1.482-

9 provide specific methods to be used to evaluate whether transactions between or among members of the controlled group satisfy the arm's length standard, and if they do not, to determine the arm's length result. * * *

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

(iii) * * * Sections 1.482-4 and 1.482-9, as appropriate, provide the specific methods to be used to determine arm's length results of arrangements, including partnerships, for sharing the costs and risks of developing intangible property, other that a cost sharing arrangement covered by § 1.482-7T. * * *

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

(j)(6)(i) The provisions of paragraphs (b)(2)(i) and (b)(2)(iii) of this section are generally applicable on January 5, 2009.

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

(iii) The applicability of paragraphs (b)(2)(i) and (b)(2)(iii) of this section expires on or before December 30, 2011.

Par. 6
. Section 1.482-2 is amended by revising paragraph (b), (e), and adding paragraph (f) to read as follows:

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

(b)
Rendering of services
. For rules governing allocations under section 482 to reflect an arm's length charge for controlled transactions involving the rendering of services,
see
§ 1.482-9.

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

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

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

Par. 7
. Section 1.482-2T is amended as follows:

1. Revise paragraphs (a), (b), (c), (d), and (f)(2).
2. Remove the first sentence in both paragraphs (f)(1) and (f)(3).
The revisions read as follows:

§ 1.482-2T
Determination of taxable income in specific situations (temporary).

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

(f) * * *

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

Par. 8
. Section 1.482-4 is amended as follows:

1. Revise paragraphs (f)(3) and (f)(4).
2. Add paragraphs (g) and (h).
The revisions and addition read as follows:

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

(f) * * *

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

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

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

Example 1.

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

Example 2.

The facts are the same as in
Example 1
. As a result of its sales and marketing activities, USSub develops a list of several hundred creditworthy customers that regularly purchase AA trademarked products. Neither the terms of the contract between FP and USSub nor the relevant intellectual property law specify which party owns the customer list. Because USSub has knowledge of the contents of the list, and has practical control over its use and dissemination, USSub is considered the sole owner of the customer list for purposes of this paragraph (f)(3).

(4)
Contribution to the value of intangible property owned by another
—(i)
In general
. The arm's length consideration for a contribution by one controlled taxpayer that develops or enhances the value, or may be reasonably anticipated to develop or enhance the value, of intangible property owned by another controlled taxpayer will be determined in accordance with the applicable rules under section 482. If the consideration for such a contribution is embedded within the contractual terms for a controlled transaction that involves such intangible property, then ordinarily no separate allocation will be made with respect to such contribution. In such cases, pursuant to § 1.482-1(d)(3), the contribution must be accounted for in evaluating the comparability of the controlled transaction to uncontrolled comparables, and accordingly in determining the arm's length consideration in the controlled transaction.

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

Example 1.

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

Example 2.

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

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

appropriate with respect to these embedded contributions.

(iii) Whether an allocation is warranted with respect to the transfer price for the wristwatches is determined under §§ 1.482-1, 1.482-3, and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, including the nature of the intangible property embedded in the wristwatches and the nature of the marketing activities required under the agreement. This analysis would also take into account that the compensation for the activities performed by USSub and FP, as well as the consideration for USSub's use of the YY trademark, is embedded in the transfer price for the wristwatches, rather than provided for in separate agreements.
See
§§ 1.482-3(f) and 1.482-9(m)(4).

Example 3.

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

(ii) The consideration for FP's and USSub's respective marketing activities is embedded in the contractual terms of the license for the AA trademark. Accordingly, pursuant to paragraph (f)(4)(i) of this section, ordinarily no separate allocation would be appropriate with respect to the embedded contributions in year 1.
See
§ 1.482-9(m)(4).

(iii) Whether an allocation is warranted with respect to the royalty under the license agreement would be analyzed under § 1.482-1, and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of the license, the nature of the intangible property subject to the license, and the nature of the marketing activities required to be undertaken pursuant to the license. Pursuant to paragraph (f)(4)(i) of this section, the analysis would also take into account the fact that the compensation for the marketing services is embedded in the royalty paid for use of the AA trademark, rather than provided for in a separate services agreement. For illustrations of application of the best method rule,
see
§ 1.482-8
Examples 10
,
11
, and
12
.

Example 4.

(i)
Facts
. The year 1 facts are the same as in
Example 3
, with the following exceptions. In year 2, USSub undertakes certain incremental marketing activities in addition to those required by the contractual terms of the license for the AA trademark executed in year 1. The parties do not execute a separate agreement with respect to these incremental marketing activities performed by USSub. The license agreement executed in year 1 is of sufficient duration that it is reasonable to anticipate that USSub will obtain the benefit of its incremental activities, in the form of increased sales or revenues of trademarked products in the U.S. market.

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

Example 5.

(i)
Facts
. The year 1 facts are the same as in
Example 3
. In year 2, FP and USSub enter into a separate services agreement that obligates USSub to perform certain incremental marketing activities to promote AA trademark athletic gear in the United States, above and beyond the activities specified in the license agreement executed in year 1. In year 2, USSub begins to perform these incremental activities, pursuant to the separate services agreement with FP.

(ii) Whether an allocation is warranted with respect to USSub's incremental marketing activities covered by the separate services agreement would be evaluated under §§ 1.482-1 and 1.482-9, including a comparison of the compensation provided for the services with the results obtained under a method pursuant to § 1.482-9, selected and applied in accordance with the best method rule of § 1.482-1(c).

(iii) Whether an allocation is warranted with respect to the royalty under the license agreement is determined under § 1.482-1, and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of the license, the nature of the intangible property subject to the license, and the nature of the marketing activities required to be undertaken pursuant to the license. The comparability analysis would take into account that the compensation for the incremental activities by USSub is provided for in the separate services agreement, rather than embedded in the royalty paid for use of the AA trademark. For illustrations of application of the best method rule,
see
§ 1.482-8
Examples 10
,
11
, and
12
.

Example 6.

(i)
Facts
. The year 1 facts are the same as in
Example 3
. In year 2, FP and USSub enter into a separate services agreement that obligates FP to perform incremental marketing activities, not specified in the year 1 license, by advertising AA trademarked athletic gear in selected international sporting events, such as the Olympics and the soccer World Cup. FP's corporate advertising department develops and coordinates these special promotions. The separate services agreement obligates USSub to pay an amount to FP for the benefit to USSub that may reasonably be anticipated as the result of FP's incremental activities. The separate services agreement is not a qualified cost sharing arrangement under § 1.482-7T. FP begins to perform the incremental activities in year 2 pursuant to the separate services agreement.

(ii) Whether an allocation is warranted with respect to the incremental marketing activities performed by FP under the separate services agreement would be evaluated under § 1.482-9. Under the circumstances, it is reasonable to anticipate that FP's activities would increase the value of USSub's license as well as the value of FP's trademark. Accordingly, the incremental activities by FP may constitute in part a controlled services transaction for which USSub must compensate FP. The analysis of whether an allocation is warranted would include a comparison of the compensation provided for the services with the results obtained under a method pursuant to § 1.482-9, selected and applied in accordance with the best method rule of § 1.482-1(c).

(iii) Whether an allocation is appropriate with respect to the royalty under the license agreement would be evaluated under §§ 1.482-1 through 1.482-3, this section, and §§ 1.482-5 and 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of USSub's license, the nature of the intangible property subject to the license, and the marketing activities required to be undertaken by both FP and USSub pursuant to the license. This comparability analysis would take into account that the compensation for the incremental activities performed by FP was provided for in the separate services agreement, rather than embedded in the royalty paid for use of the AA trademark. For illustrations of application of the best method rule,
see
§ 1.482-8,
Example 10
,
Example 11
, and
Example 12
.

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

(h)
Effective/applicability date
—(1)
In general
. The provisions of paragraphs (f)(3)(i)(A), (f)(3)(ii), and (f)(4) of this section are generally applicable for taxable years beginning after July 31, 2009.

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

Par. 9
. Section 1.482-4T is amended as follows:

1. Revise paragraphs (a), (b), (c), (d), (e), (f)(1), (f)(2), (f)(3)(i)(A), (f)(3)(ii), (f)(4), (f)(5), (f)(6), and (h)(3).
2. Redesignate paragraph (h)(1) as paragraph (h), revise the heading and remove the first sentence in newly-designated paragraph (h).
3. Remove paragraph (h)(2).
4. Redesignate paragraph (h)(3) as paragraph (i).
The revisions read as follows:

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

(a) through (f)(3)(i)(A) [Reserved]. For further guidance,
see
§ 1.482-4(a) through (f)(3)(i)(A).

(B) * * *

(f)(3)(ii) through (f)(6) [Reserved]. For further guidance,
see
§ 1.482-4(f)(3)(ii) through (f)(6)

(g) * * *

(h)
Effective/applicability date
. * * *

Par. 10
. Section 1.482-6 is amended by revising paragraphs (c)(2)(ii)(B)(
1
), (c)(2)(ii)(D), (c)(3)(i)(A), (c)(3)(i)(B), (c)(3)(ii)(D), and adding paragraph (d) to read as follows:

§ 1.482-6
Profit split method.

(c) * * *

(2) * * *

(ii) * * *

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

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

(3) * * *

(i) * * *

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

(B)
Allocate residual profit
—(
1
)
Nonroutine contributions generally.
The allocation of income to the controlled taxpayer's routine contributions will not reflect profits attributable to each controlled taxpayer's contributions to the relevant business activity that are not routine (nonroutine contributions). A nonroutine contribution is a contribution that is not accounted for as a routine contribution. Thus, in cases where such nonroutine contributions are present there normally will be an unallocated residual profit after the allocation of income described in paragraph (c)(3)(i)(A) of this section. Under this second step, the residual profit generally should be divided among the controlled taxpayers based upon the relative value of their nonroutine contributions to the relevant business activity. The relative value of the nonroutine contributions of each taxpayer should be measured in a manner that most reliably reflects each nonroutine contribution made to the controlled transaction and each controlled taxpayer's role in the nonroutine contributions. If the nonroutine contribution by one of the controlled taxpayers is also used in other business activities (such as transactions with other controlled taxpayers), an appropriate allocation of the value of the nonroutine contribution must be made among all the business activities in which it is used.

(
2
)
Nonroutine contributions of intangible property.
In many cases, nonroutine contributions of a taxpayer to the relevant business activity may be contributions of intangible property. For purposes of paragraph (c)(3)(i)(B)(
1
) of this section, the relative value of nonroutine intangible property contributed by taxpayers may be measured by external market benchmarks that reflect the fair market value of such intangible property. Alternatively, the relative value of nonroutine intangible property contributions may be estimated by the capitalized cost of developing the intangible property and all related improvements and updates, less an appropriate amount of amortization based on the useful life of each intangible property. Finally, if the intangible property development expenditures of the parties are relatively constant over time and the useful life of the intangible property contributed by all parties is approximately the same, the amount of actual expenditures in recent years may be used to estimate the relative value of nonroutine intangible property contributions.

(ii) * * *

(D)
Other factors affecting reliability.
Like the methods described in §§ 1.482-3, 1.482-4, 1.482-5, and 1.482-9, the first step of the residual profit split relies exclusively on external market benchmarks. As indicated in § 1.482-1(c)(2)(i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, to the extent the allocation of profits in the second step is not based on external market benchmarks, the reliability of the analysis will be decreased in relation to an analysis

under a method that relies on market benchmarks. Finally, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the residual profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and assumptions are significantly more reliable with respect to one of the parties than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results.

(d)
Effective/applicability date
—(1)
In general.
The provisions of paragraphs (c)(2)(ii)(B)(
1
) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section are generally applicable for taxable years beginning after July 31, 2009.

(2)
Election to apply regulation to earlier taxable years.
A person may elect to apply the provisions of paragraphs (c)(2)(ii)(B)(
1
) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9(n)(2).

§ 1.482-6T
[Removed]

Par. 11
. Section 1.482-6T is removed.

Par. 12
. Section 1.482-8 is amended by revising paragraph (b)
Examples 10
,
11
,
12
,
13
,
14
,
15
,
16
,
17
and
18,
and adding paragraph (c) to read as follows:

§ 1.482-8
Examples of the best method rule.

(b) * * *

Example 10.

Cost of services plus method preferred to other methods.
(i) FP designs and manufactures consumer electronic devices that incorporate advanced technology. In year 1, FP introduces Product X, an entertainment device targeted primarily at the youth market. FP's wholly-owned, exclusive U.S. distributor, USSub, sells Product X in the U.S. market. USSub hires an independent marketing firm, Agency A, to promote Product X in the U.S. market. Agency A has successfully promoted other electronic products on behalf of other uncontrolled parties. USSub executes a one-year, renewable contract with Agency A that requires it to develop the market for Product X, within an annual budget set by USSub. In years 1 through 3, Agency A develops advertising, buys media, and sponsors events featuring Product X. Agency A receives a markup of 25% on all expenses of promoting Product X, with the exception of media buys, which are reimbursed at cost. During year 3, sales of Product X decrease sharply, as Product X is displaced by competitors' products. At the end of year 3, sales of Product X are discontinued.

(ii) Prior to the start of year 4, FP develops a new entertainment device, Product Y. Like Product X, Product Y is intended for sale to the youth market, but it is marketed under a new trademark distinct from that used for Product X. USSub decides to perform all U.S. market promotion for Product Y. USSub hires key Agency A staff members who handled the successful Product X campaign. To promote Product Y, USSub intends to use methods similar to those used successfully by Agency A to promote Product X (print advertising, media, event sponsorship,
etc.
). FP and USSub enter into a one-year, renewable agreement concerning promotion of Product Y in the U.S. market. Under the agreement, FP compensates USSub for promoting Product Y, based on a cost of services plus markup of A%. Third-party media buys by USSub in connection with Product Y are reimbursed at cost.

(iii) Assume that under the contractual arrangements between FP and USSub, the arm's length consideration for Product Y and the trademark or other intangible property may be determined reliably under one or more transfer pricing methods. At issue in this example is the separate evaluation of the arm's length compensation for the year 4 promotional activities performed by USSub pursuant to its contract with FP.

(iv) USSub's accounting records contain reliable data that separately state the costs incurred to promote Product Y. A functional analysis indicates that USSub's activities to promote Product Y in year 4 are similar to activities performed by Agency A during years 1 through 3 under the contract with FP. In other respects, no material differences exist in the market conditions or the promotional activities performed in year 4, as compared to those in years 1 through 3.

(v) It is possible to identify uncontrolled distributors or licensees of electronic products that perform, as one component of their business activities, promotional activities similar to those performed by USSub. However, it is unlikely that publicly available accounting data from these companies would allow computation of the comparable transactional costs or total services costs associated with the marketing or promotional activities that these entities perform, as one component of business activities. If that were possible, the comparable profits method for services might provide a reliable measure of an arm's length result. The functional analysis of the marketing activities performed by USSub in year 4 indicates that they are similar to the activities performed by Agency A in years 1 through 3 for Product X. Because reliable information is available concerning the markup on costs charged in a comparable uncontrolled transaction, the most reliable measure of an arm's length price is the cost of services plus method in § 1.482-9(e).

Example 11.

CPM for services preferred to other methods.
(i) FP manufactures furniture and accessories for residential use. FP sells its products to retailers in Europe under the trademark, “Moda.” FP holds all worldwide rights to the trademark, including in the United States. USSub is FP's wholly-owned subsidiary in the U.S. market and the exclusive U.S. distributor of FP's merchandise. Historically, USSub dealt only with specialized designers in the U.S. market and advertised in trade publications targeted to this market. Although items sold in the U.S. and Europe are physically identical, USSub's U.S. customers generally resell the merchandise as non-branded merchandise.

(ii) FP retains an independent firm to evaluate the feasibility of selling FP's trademarked merchandise in the general wholesale and retail market in the United States. The study concludes that this segment of the U.S. market, which is not exploited by USSub, may generate substantial profits. Based on this study, FP enters into a separate agreement with USSub, which provides that USSub will develop this market in the United States for the benefit of FP. USSub separately accounts for personnel expenses, overhead, and out-of-pocket costs attributable to the initial stage of the marketing campaign (Phase I). USSub receives as compensation its costs, plus a markup of X%, for activities in Phase I. At the end of Phase I, FP will evaluate the program. If success appears likely, USSub will begin full-scale distribution of trademarked merchandise in the new market segment, pursuant to agreements negotiated with FP at that time.

(iii) Assume that under the contractual arrangements in effect between FP and USSub, the arm's length consideration for the merchandise and the trademark or other intangible property may be determined reliably under one or more transfer pricing methods. At issue in this example is the separate evaluation of the arm's length compensation for the marketing activities conducted by USSub in years 1 and following.

(iv) A functional analysis reveals that USSub's activities consist primarily of modifying the promotional materials created by FP, negotiating media buys, and arranging promotional events. FP separately compensates USSub for all Phase I activities, and detailed accounting information is available regarding the costs of these activities. The Phase I activities of USSub are similar to those of uncontrolled companies that perform, as their primary business activity, a range of advertising and media relations activities on a contract basis for uncontrolled parties.

(v) No information is available concerning the comparable uncontrolled prices for services in transactions similar to those engaged in by FP and USSub. Nor is any information available concerning uncontrolled transactions that would allow application of the cost of services plus method. It is possible to identify uncontrolled distributors or licensees of home furnishings that perform, as one component of their business activities, promotional activities similar to those performed by USSub. However, it is unlikely that publicly available accounting data from these companies would allow computation of the comparable transactional costs or total services costs associated with the marketing or promotional activities that these entities performed, as one component of their business activities. On the other hand, it is possible to identify uncontrolled advertising and media relations companies, the principal

business activities of which are similar to the Phase I activities of USSub. Under these circumstances, the most reliable measure of an arm's length price is the comparable profits method of § 1.482-9(f). The uncontrolled advertising comparables' treatment of material items, such as classification of items as cost of goods sold or selling, general, and administrative expenses, may differ from that of USSub. Such inconsistencies in accounting treatment between the uncontro

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3AE9-18326. Public record. Not legal advice.